Just when everyone was starting to get complacent again, the market has come back and slapped investors in the face.Yesterday’s triple-digit plunge in major stock markets was a not-so-gentle reminder that this isn’t a one-week summer storm in a teacup, as some commentators have already been suggesting.
The truth is, this crisis has barely even begun to get going…
Most of the major papers were running stories yesterday along the lines of - “Is the crisis over so soon? Bravo, the Federal Reserve. Well done central banks of the world. Isn’t modern finance wonderful?”
This burst of utterly irrational exuberance was probably the most obvious indicator that markets were going to take a dive later in the day.
It’s just utter nonsense to be wiping the sweat from brows and saying “Phew! Thank goodness that’s over!” For a start, we’re in probably one of the deadest weeks of the year as far as markets are concerned. Plenty of the big guns and decision makers are still on holiday, so anything that happens just now is pretty much a holding pattern ahead of September, when everyone gets back to work and starts to think about the mess they’re in.
So what was worrying markets yesterday? Well, the same things that are going to keep worrying markets for the foreseeable future. The US housing market, and the troubles in the commercial paper market.
First, we had US house price data. The S&P/Case-Shiller US National Home Price Index was down 3.2% in the second quarter on last year, its sharpest fall since the index began in 1987. The Consumer Confidence Index also took a nose-dive in August, falling from 111.9 in July to 105.
Meanwhile, the troubles in the commercial paper market (which we’ll be delving into in great detail in this week’s issue of MoneyWeek) continued to cause ructions. Barclays denied a report in the FT that suggested it had exposure of several hundred million dollars to debt vehicles created by it for troubled German bank Sachsen, but the market still marked down its shares by 22p to 589p. Other financials were weaker too.
But never mind, eh? Central banks can come to our rescue – in fact, why haven’t they already? This is the attitude typified in a comment from Gerald Baker, The Times’s US correspondent, who wrote yesterday: “One question that will dog the Fed in the next few months will be the accusation that it wasn’t timely enough in responding to the financial markets.” If the panic is over so soon, he ponders, could the Fed have ended it even more quickly by intervening sooner?
It’s an incredible statement, and shows just how much the “Greenspan put” has become part of the Wall Street thinking process. The Fed has turned into Pavlov’s dog as far as the markets are concerned. Just as Pavlov trained a dog to salivate when he rang a bell, the markets now think they’ve trained the Fed to cut rates as soon as they hit a losing streak.
It may well be true. Given Alan Greenspan’s penchant for cutting rates quickly and sharply at the faintest hint of a bit of pain for the financial markets, it’s no surprise that Wall Street thinks it has the Fed on a tight leash.
But even if the Fed cuts rates now, the good old days of Ninja loans aren’t coming back. The threat of class action lawsuits and the reality of mass redundancies at mortgage lenders and falling house prices has seen to that. The US housing market isn’t going to be bailed out, and that means the US consumer is in for a painful come down.
All that lowering interest rates does in this scenario is prolong the pain, by allowing ailing companies that should be denied the oxygen of cheap credit, to limp on. It’s something that Japan discovered in the Nineties and from which it is still suffering the ill-effects.
Here in the UK, plenty of people are still arguing that we don’t have a subprime problem. But they shouldn’t get over-optimistic. In this week’s issue of MoneyWeek, we take a look at why the UK’s subprime problem could be much worse than most estimates reckon. If you’re not already a subscriber, you can sign up for a three-week free trial by clicking here: Sign up for a three-week free trial of MoneyWeek. (http://www.moneyweek.com/file/194/subscribe-from-not-logged-in.html).
source-Money Morning