Today, the plunge of financial markets spread with furious ferocity to Europe, where the London FTSE had its sharpest one-day fall ever, the French CAC 40 fell by a whopping 9%, the same as Madrid, while Frankfurt slumped 8%, and markets had to be temporarily closed in Russia. As the major Euro-American economies teeter on the brink of a prolonged recession, the dangers for many economies in the global South especially Africa rise as primary commodity prices plummet and foreign investment dries up. For many leftwing commentators the crisis confirms their long held distaste for and warnings about the dangers of untrammeled neo-liberalism. But how is the crisis seen in the pages of some of Euroamerica's leading financial newspapers? The following offers a fascinating glimpse from The Wall Street Journal to The Financial Times to The Economist to Fortune to BusinessWeek. P T Zeleza, Editor, The Zeleza Post
From The Wall Street Journal [1]October 6, 2008
America and the New Financial World By Zachary Karabell
Politicians can make the adjustment more or less painful.
Soon enough, America's financial crisis will wind down -- maybe in a month, maybe in a year. Yet regardless of when, this crisis marks the beginning of a new era for the U.S. For more than six decades, from the end of World War II in 1945 until now, the U.S. was the hub of global capital and capitalism. In the years to come, it will remain a vital center, but not the center.
In 1945, after an exhausting three decades of exertion against Germany, the United Kingdom emerged militarily victorious only to see itself economically exhausted. A year later, it was bankrupt, unable to find capital and on the verge of collapse. It had nowhere to turn but the U.S., which then dictated terms that amounted to a withdrawal of Great Britain from the world stage. The U.S. is not yet in the position of Great Britain, and our creditors in China are not yet as we were then. But absent a more humble and realistic attitude toward capital in Washington, that is the path we're headed down.
What is happening to finance today is similar to what happened to manufacturing beginning in the 1970s. Until then, U.S. manufacturing accounted for as much as half of all global output. By the 1970s, Germany and Japan began to exert themselves as manufacturing titans. So did Taiwan, Singapore, Korea and others that had benefited from American aid. The globalization of manufacturing continued, and was accelerated by the information technology revolution of the 1990s. While the U.S. today continues to produce a decent share of global manufactured goods, it is one among many and employs only 13 million people (10% of the workforce) in a sector that in the middle of the 20th century accounted for a third of all jobs. The same thing is now happening with finance.
In the past five years, there has been a transfer of wealth from the U.S. and Europe to Asia, the Middle East and Russia of trillions of dollars for oil and raw materials as well as inexpensive manufactured goods. Whether or not that transfer has been positive or negative for the U.S. economy writ large -- and there is considerable debate on that subject -- the outflow of wealth is a fact.
You can argue that the transfer of dollars to goods-producing countries, China above all, has provided American consumers with products that might otherwise be unaffordable but has had a negative effect on the U.S. labor force. The transfer of wealth to oil-producing states and countries rich in base metals has been an economic drain, especially as the price has spiked and the cost has risen.
That wealth transfer occurred just as the U.S. financial system began to expand its exposure to the housing market. The movement of capital away from the U.S. was one reason hungry banks turned to more absurd forms of leverage. That disguised the erosion of real capital.
Even as that was happening, however, American financial institutions still wore the mantle of global leadership. As China, the Gulf region, India, Brazil and other parts of the world have increased in affluence, they relied on the expertise, acumen and advice of Wall Street. Go to any region of the world and you will find central banks and investment banks staffed by people educated at U.S. business schools and graced with resumes that include time at the formerly premier institutions of Wall Street. Few major deals were brokered without involvement from a U.S. bank or access to Wall Street financing. That is now at an end.
It is at an end for two reasons. One is structural. There are now vibrant economies that don't depend on the U.S., are not heavily levered, and have a burgeoning, confident and ambitious middle class. But it is also at an end because those newly affluent regions of the world do not find the U.S. a welcoming home for capital.
There is no small irony in the fact that state-driven capitalism, which is the norm in the Persian Gulf and China, finds the U.S. too restrictive. Sovereign wealth funds, with enough cash on hand to bail out Wall Street and the U.S. housing market many times over, invested billions a year ago but are now saying no.
Uncertain growth for the United States is one reason. But the nature of the American regulatory regime is also to blame. Sarbanes-Oxley and the Patriot Act -- whose anti-money-laundering provisions had the unintended consequence of repelling legitimate investors -- combined with a tax code that places a heavy burden on corporations doing business in the U.S. has meant that, as the wealth transfer has happened, there is less and less inclination for global institutions to place that capital in the U.S.
This is a fact regardless of whether you believe that a high corporate tax rate is morally and fiscally correct. In truth, because of the differentials between high U.S. corporate taxes and the rates in Europe (lower) and Asia (in places nonexistent), even U.S.-listed companies that operate globally keep their profits outside the U.S., and thereby avoid those high taxes altogether.
In addition, the regulatory requirements of listing a company in the U.S. have led many companies to look to other markets and other exchanges for financing, hence the boom of financial centers such as Hong Kong, Dubai and even London.
This should not be a partisan argument. It is perfectly fair to argue that wealthy corporations should pay a greater share of the tax base than struggling middle-class Americans. Fair, but not realistic. The U.S. government can no longer dictate to global capital. Once, when the U.S. was the engine of global growth, when the world needed Wall Street for funding, capital could be taxed and controlled by the fiat of the U.S. government. No longer. The U.S. may have the will; it does not have the power.
The current debate in Washington gives no indication that this reality is understood. Both sides of the aisle are susceptible to a false sense of American economic sovereignty. Companies and countries flush with cash increasingly view U.S. laws, regulations and attitudes as undue burdens. As consumer activity accelerates outside the U.S. and Europe, and as financial centers spring up elsewhere, there is increasingly less inclination and less need for the world to go either to Wall Street or to Main Street.
For now, even with the breakdown of Wall Street, the U.S. remains vital to the global economy. It is the largest market, with a dynamic consumer culture, innovative companies, and is deeply enmeshed in the international system. But it is not the alpha and the omega; it is not the center; and the crisis hitting Wall Street is leading the rest of the world to form bonds that bypass the U.S.
Not all of this need be an absolute negative. In a truly interconnected world, more affluence and activity globally can be a universal benefit. U.S. companies operating outside the United States and Europe have already been reaping the rewards. But failure to accept the new reality will lead to the worst of all worlds.
As the U.S. government plunges into the markets, we must understand that this is the end of an era, and that attempts to unilaterally force capital to stay here will only lead to its continued flight. We are now one market among many, a huge and affluent one to be sure, but a wise nation recognizes both its strengths and its limitations. A more secure domestic capital base depends on the U.S. being seen as a desirable place for investment, and not as King Lear raging against the storm, alone, deluded and abandoned.
Mr. Karabell is president of River Twice Research. His latest book, "Chimerica: How the United States and China Became One," will be published next year by Simon & Schuster.
From The Financial Times [2]October 6, 2008
Conservatism Overshoots Its Limit By Gideon Rachman
The market for ideas - like the market for shares - always overshoots. Ideas become fashionable and get pushed to their logical conclusion and beyond, as their backers succumb to "irrational exuberance". Then comes the crash.
What we are experiencing now is the bust that has followed the 30-year bull run in conservative ideas that began with the Thatcher-Reagan revolution of 1979-80.
You can get a sense of how quickly the intellectual atmosphere has changed by picking up a copy of Alan Greenspan's The Age of Turbulence, which was published last year. Mr Greenspan, head of the Federal Reserve from 1987 until 2006, heaped praise on the magic of financial markets and decried the foolishness of those who called for more regulation: "Why do we wish to inhibit the pollinating bees of Wall Street?" he asked rhetorically. Why indeed?
Mr Greenspan was considered such a guru that last year Senator John McCain suggested putting him in charge of a committee on tax reform, adding: "If he's alive or dead it doesn't matter. If he's dead, just prop him up and put some dark glasses on him." But Mr Greenspan's reputation is now on the slide and Mr McCain has reinvented himself as a champion of regulation - and is denouncing the "corruption and unbridled greed that has caused a crisis on Wall Street".
This kind of ideological whiplash is what happens when an intellectual bull market crashes. The current financial crisis can be traced to three of the central ideas of the Reagan- Thatcher era: the promotion of home ownership, financial deregulation and a fervent faith in the market. Each of these ideas did sterling service for 30 years, increasing prosperity and freedom. But pushed too far - and combined - they have created a disaster.
The subprime mortgages that are at the heart of the current financial crisis expanded the dream of home ownership to people who could not afford the financial burdens they were taking on. In April 2005 Mr Greenspan praised subprime mortgages for helping to widen home ownership and hailed them as "representative of the market responses that have driven the financial services industry throughout the history of our country".
Investment bankers, the shock- troops of the Reagan-Thatcher revolution, were allowed to bet their banks on this new market, because regulators and politicians believed so firmly in the magical and self- regulating qualities of the market.
The same process of intellectual overshoot happened with other signature ideas of the Reagan- Thatcher era: privatisation, scepticism about environmentalism and democracy promotion.
When Thatcherites first mooted privatisation it was derided as an impractical dream. But early triumphs with airlines and telecommunications in Britain created a vogue that spread round the world. That emboldened the privatisers to take on new and harder challenges, such as the UK's railways. But failure there led to a backlash.
Similarly, when the conservative era started, foreign military engagements were out of fashion in the west. But Britain's Falklands war and the American invasion of Grenada began to change this. During the 1990s, a series of successful military interventions - the first Gulf war, Bosnia, Kosovo, Sierra Leone - made Anglo-American political leaders much more relaxed about the use of military force. Too relaxed. The horrors that have followed the invasions of Iraq and Afghanistan will mean that the intellectual pendulum will now swing in the opposite direction.
The idea of democracy promotion has gone through a similar boom-and-bust cycle. The collapse of the Soviet empire in 1989 was regarded as the ultimate vindication of the rightwing universalism that argued that all people did indeed desire democratic, free-market systems. Advocates of the globalisation of democracy became much more assertive. A policy of providing moral support to anti-Soviet dissidents in Europe in the 1980s had, by 2003, transmogrified into a policy of exporting democracy by force of arms to the Middle East.
Once again, a successful idea has been pushed to its logical conclusion - and beyond. And once again an intellectual backlash has begun. David Cameron, the leader of Britain's Conservatives, captured the new conventional wisdom when he said recently: "We should accept that we cannot impose democracy at the barrel of a gun. We cannot drop democracy from 10,000 feet."
Both Ronald Reagan and Margaret Thatcher favoured growth over greenery. Mrs Thatcher hailed "the great car-owning democracy" and Reagan mused that trees were a major source of pollution. But in Britain - and, to a lesser extent, the US - climate change has turned conservatives green with anxiety. Mr Cameron, a reliable intellectual weather-vane, ostentatiously cycles to work and has adopted a tree as the symbol of the new Tory party. Mr McCain takes climate change very seriously.
The ideological roots of the conservative era lay in a reaction to the excesses of the Keynesian consensus. Now that the intellectual cycle has swung so decisively against the rightwing ideas of the Reagan-Thatcher era, it is bound to overshoot in the other direction. The joys of government regulation will quickly pall. In a few years' time, nostalgia will set in for the go-go years on Wall Street and for the bracing moral certainties of neoconservatism.
Audacious intellectual investors should now be sniffing around. Quite soon ideas such as deregulation and democracy promotion will be a buy.
From The Economist [3]October 2nd 2008
World On The Edge
Whatever happens in Congress, the crisis is now global; that means governments must work together
AMERICA'S Congress is not used to being second-guessed. But as lawmakers wrestled in the Capitol, world stockmarkets have been giving real-time odds on the Bush administration's $700 billion bail-out becoming law. After the plan's thrashing by the House of Representatives on September 29th, spurred on by voters' loathing of "casino capitalism", investors panicked. Yet as The Economist went to press, they were optimistic that, after winning the Senate's approval on October 1st, the plan would pass.
Even if it does, that should not be a cause for optimism. Look beyond the stockmarkets, especially at the seized-up money markets, and there is little to see except bank failures, emergency rescues and high anxiety in the credit markets. These forces are drawing the financial system closer to disaster and the rich world to the edge of a nasty recession (see article [4]). The bail-out package should mitigate the problems, but it will not avert them.
The crisis is spreading in two directions-across the Atlantic to Europe, and out of the financial markets into the real economy. Governments have been dealing with it disaster by disaster. They have struggled to gain control not just because of the speed of contagion but also because policymakers, and the public they serve, have failed fully to grasp the breadth and depth of the crisis.
What's the Icelandic for "domino"?
Step forward, Peer Steinbrück, Germany's finance minister, who rashly declared on September 25th that America was "the source...and the focus of the crisis", before heralding the end of its role as the financial superpower. Within days, the focus shifted and Mr Steinbrück and his officials were obliged to arrange a €35 billion ($51 billion) loan from German banks and the German government to save Hypo Real Estate, the country's second-biggest property lender.
The hapless Mr Steinbrück is not alone. European banks were collapsing at a dizzying pace even as Christian Noyer, governor of the Bank of France, declared that "there is no drama in front of us." Hypo Real Estate was just one of five banks in seven European countries bailed out in three days. Belgium, Luxembourg and the Netherlands carved up Fortis, a big bancassurer; Britain nationalised Bradford & Bingley; Belgium, France and Luxembourg saved Dexia; and Iceland rescued Glitnir. Separately, Ireland took €400 billion of contingent liabilities onto the national balance sheet, when it stood behind the deposits and debts of its six large banks and building societies. You have to wonder what Mr Noyer regards as dramatic.
By some measures, many European banks look more vulnerable than their American counterparts do-and that is saying quite something, given the past week's forced sale of Washington Mutual, America's biggest thrift, and Wachovia, its fourth-biggest commercial bank. In America, outside Wall Street, the banks have lent 96 cents for each $1 of deposits. Continental European banks have lent roughly €1.40 for each €1 of deposits. They have to borrow the rest from money-market investors, who are not especially confident just now. Some Europeans, including the British, Irish and Spanish banks, have housing busts of their own. And they must contend with the toxic American securities they bought by the billion, as well as their own slowing economies.
Western Europe is not the limit of this: the panic has also struck banks in Hong Kong, Russia and now India. And it is not just the geographical breadth of this crisis that is alarming, but also its economic depth. Because it is rooted in the money markets (see article [5]and article [6]), it will feed through to businesses and households in every economy it hits.
Take a deep breath
Most of the time nobody notices the credit flowing through the lungs of the economy, any more than people notice the air they breathe. But everyone knows when credit stops circulating freely through markets to banks, businesses and consumers. For almost a year the markets had worried about banks' liquidity and solvency. After the bankruptcy of Lehman Brothers last month, amid confusion about whom the state would save and on what terms, they panicked. The markets for three-, six- and 12-month paper are shut, so banks must borrow even more money overnight than usual.
Banks used to borrow from each other at about 0.08 percentage points above official rates; on September 30th they paid more than four percentage points more. In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11%, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.
Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks' assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.
This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt. Managers delay new products, leave factories unbuilt, pull the plug on loss-making divisions, and cut costs and jobs. Carmakers and other manufacturers will no longer extend credit (see article [7]) and loans will become elusive and expensive. Consumers will suffer. Unemployment will rise. Even if the credit markets work well, the rich economies will slow as the asset-price bubble pops. If credit is choked off, that slowdown could turn into a deep recession.
Financial markets need governments to set rules for them; and when markets fail, governments are often best placed to get them going again. That's pragmatism, not socialism. Helping bankers is not an end in itself. If the government could save the credit markets without bailing out the bankers, it should do so. But it cannot. Main Street needs Wall Street; and both need Washington. Politicians-and President George Bush is the most culpable among them (see article [8]) -have failed to explain this.
Governments need not just to communicate, but also to co-ordinate. Past banking crises show that late, piecemeal rescues cost more and work less well. Ad hoc mergers work for a while, but demands for help tend to recur. Inconsistency sows uncertainty. Cross-border banking can make one country's policies awkward for the neighbours: the Irish government's guarantee of all deposits threatens to suck in money from poorly protected British banks. France's suggestion on October 1st that Europe's governments should work together was a good one; Germany's rejection of it was wrong.
Central banks have co-ordinated their liquidity operations. Now that oil prices have plunged and worries about inflation are receding, interest-rate cuts are possible. They would be more powerful if co-ordinated. But it is not only central banks that need to combine. Whatever America's Congress does, governments should work together on principles to stabilise and recapitalise banks-not just to stem panic but also to save money. Even if, as the Europeans claim, the crisis was made in America, it now belongs to everyone.
From Fortune [9]October 6, 2008
Europe: The new Wall Street? By Colin Barr
Many big European institutions are just as heavily leveraged as Lehman Brothers was before its demise.
Leverage, the menace that helped bring down some of the biggest names on Wall Street, is now threatening the health of big banks across the Atlantic.
The credit crunch that led to the failure or forced sale of seven big U.S. financial firms last month is now wreaking its havoc on Europe. Four major financial institutions have been rescued in just the past week, and financial shares are in free fall as investors fret that more banks will need help.
The problems in Europe are worth watching because additional bank failures threaten to further undermine investor confidence at a time when the global economy is slowing, stocks are plummeting, and short-term credit markets are locked up. Economists fear that with the global financial system under severe stress, the economy is especially vulnerable to a shock that could deepen what's shaping up as a serious recession.
"The events of the past month have clearly increased the risk that the adjustment to the Anglo-Saxon household balance sheet is sharp and painful rather than prolonged and manageable," writes Merrill Lynch economist Alex Patelis. "In a scenario of a violent U.S. consumption downturn, no economy globally would be spared, and a global recession ... would be unavoidable."
The problems in Europe show that the ills that brought down the likes of Lehman Brothers - heavy borrowing to support lending on now depreciating real estate assets - are now being felt in the rest of the world. Even the institutions that avoided the worst excesses of the subprime mortgage mess - such as Barclays (BCS [10]), which recently took over some Lehman operations in the U.S., and Deutsche Bank (DB [11]) - have asset-to-equity ratios well in excess of the ones carried by commercial banks in the U.S.
That means firms from ING (ING [12]) of the Netherlands to UBS (UBS [13]) in Switzerland have that much less of an equity cushion to absorb any losses on loans that go sour as the recession takes root. The fear that shareholders in those banks may be wiped out or seriously diluted in the next wave of rescues sent shares of big banks plunging Monday, with ING dropping 14%, UBS sliding 9%, and Deutsche Bank dropping 6%.
"Some of the major European banks have leverage ratios (often over 30, in some cases close to 50) that must, under current market conditions, be considered a disaster in waiting," Daniel Gros and Stefano Micossi of the Centre for European Policy Studies wrote last month.
Wall Street parallels
Indeed, the big European banks' leverage ratios - reflecting the amount of debt they carry for each dollar of equity held by their shareowners - rival those of the big U.S. investment banks.
The U.S. investment banks ran aground because they borrowed heavily in short-term debt markets to buy assets that the market lost appetite for as real estate prices stopped rising. When the collapse of the subprime mortgage market in the U.S. caused bond investors to stop offering those cheap, short-term loans, the investment banks were forced to sell assets to bring in new capital and to seek more stable funding via the deposits attracted by commercial banks.
When 2008 started, there were five independent Wall Street firms: Goldman Sachs (GS [14], Fortune 500 [15]), Morgan Stanley (MS [16], Fortune 500 [17]), Merrill Lynch (MER [18], Fortune 500 [19]), Lehman Brothers, and Bear Stearns. Now, with the failure of Bear and Lehman, Merrill's agreement to sell itself to Bank of America (BAC [20], Fortune 500 [21]), and the decision by Goldman and Morgan to become commercial banks, there are none.
The European banks have big deposit bases, so the funding pressures they face won't be as acute as the ones that swept down Wall Street last month. Still, it's worth noting that the wave of selling that has slammed stock and bond markets since the demise of Lehman has spurred governments in the U.S. and Europe to take unusual measures to stem the flow of capital.
Authorities, fearing bank runs like the ones that brought down California's IndyMac and Seattle's Washington Mutual, have raised deposit insurance limits. Germany and Ireland have guaranteed the safety of bank deposits, and the bailout signed last week by President Bush boosts the FDIC limit to $250,000 from $100,000.
But it's not yet clear whether the deposit limits will do much to keep depositors from fleeing banks - or whether the result will be to strengthen weaker banks at the expense of the stronger ones.
The heavy use of leverage isn't the only link between Europe and Wall Street. Many European banks used deals with American firms such as insurer AIG - itself the recipient of an $85 billion emergency loan from the Fed last month - to reduce their regulatory capital requirements, Gros and Micossi note.
AIG said in its second-quarter report with regulators that $307 billion worth of its $441 billion credit default swap portfolio [22]was written for the purpose of providing regulatory capital relief to European banks. By agreeing to guarantee loans on the banks' books, AIG allowed the banks to carry less capital against the loans - freeing the banks to lend that money elsewhere. AIG was a leading player in this business, but by no means was it the only one.
"The primary benefit of the credit default swap is its power as a new source of risk distribution," according to a note on the J.P. Morgan Treasury Services website. "It frees up regulatory capital, which facilitates additional business."
Now that the banks can see the value of their assets tumbling and capital is getting harder to raise, it's clear that the additional business was facilitated at substantial cost.
From BusinessWeek [23]October 2, 2008
The Credit Crunch Spreads to Business By Peter Coy
If companies around the globe are unable to borrow, they'll begin to cut jobs, cease investment, and default on their debt in larger numbers
The credit crunch hit 2640 Merchant Drive in Baltimore in September when Drew Greenblatt asked his bank for a $175,000 increase in the line of credit for his thriving company, Marlin Steel Wire Products. The bank said it wouldn't give him the money unless he put an equal sum into a certificate of deposit. In other words, the bank wasn't willing to let one more dime out of its sight. "It's laughable," says Greenblatt, not quite laughing. "We're a profitable company. When banks can't service guys like me, how are they doing it for the other guys?"
The 14-month-old credit crunch has entered a frightening new stage-one in which even healthy sectors are vulnerable and contagion is spreading to Europe and Asia. An explicit guarantee from the U.S. government has succeeded in keeping money flowing to prime home buyers through the Sept. 7 takeover of mortgage giants Fannie Mae (FNM [24]) and Freddie Mac (FRE [25]), which were able to sell $12.8 billion in debt in September. But that's not helping other parts of the U.S. economy, where manufacturers, car buyers, and local governments are struggling. One sign of the squeeze: Total nonfinancial investment-grade corporate debt issuance was only $10.5 billion in September, down from $41 billion a year earlier, according to Thomson Reuters (TRI [26]).
Innocent Victims
The longer credit remains unavailable, the greater the damage to the economy. That's why the Senate raced on the evening of Oct. 1 to vote for a bailout that would let the government buy $700 billion worth of unwanted mortgage-backed securities and other assets. The House's rejection of an earlier version of the legislation on Sept. 29 triggered a "lucky sevens" 777.7-point decline in the Dow Jones industrial average.
What makes a credit crunch scary is that it claims the innocent as well as the guilty. European authorities were forced to close five major financial institutions in a span of three days, and signs of stress broke out in Hong Kong, India, and South Korea. On Oct. 1 in the U.S., the Institute of Supply Management announced a plunge in its key manufacturing index for August to its lowest level since the month after September 11. That same day even vaunted General Electric (GE [27]) got caught in the crunch. With lenders demanding unprecedented risk premiums for short-term financing, GE said it would sell $12 billion in common shares to the public and $3 billion in preferred to investor Warren Buffett [28]on favorable terms.
Unless things stabilize soon, it could get a lot worse. Laurence Fink [29], CEO of investment manager BlackRock (BLK [30]), points to the buyers' strike in the commercial paper market, which banks and large corporations rely on for short-term funding needs. Says Fink: "Cost of capital for corporations is increasing dramatically, and if we don't stabilize that market, it will be a catastrophe." The same goes for cities and states. Lasana Mack, the treasurer of the District of Columbia, says higher rates are costing the district hundreds of thousands of dollars, and he has no clear idea how he'll sell debt issues slated for November and December. In the last week of September, just three significant municipal bond issues came to market, vs. the usual 100 or so. "Nothing," says Mack, "is really functioning normally."
Downward Spiral
Until now the business sector has kept the economy aloft even as consumers have cut back. But if the credit crunch shuts down borrowing, businesses will begin to ax jobs, cease investment, and default on their debts in larger numbers. If rising defaults cause banks to tighten credit even more, there will be a downward spiral. William Verhelle, founder and CEO of First American Equipment Finance, says his lease-financing business has been insulated from the credit crunch until recently, partly because his bank funding partners have remained solid. But he fears his sector won't be spared. "I feel much more nervous now than I have at any point in this process," he says.
Businesses rely on a healthy banking system, but at the moment it's on life support from the Fed. Banks are stashing their money in U.S. Treasury bills instead of extending credit to one another or to stretched customers. "It's like strangling the corporation," says Anthony Clemente, CEO of Canaras Capital Management, which buys pieces of syndicated loans and bundles them into collateralized debt obligations. "If you do it for only a few seconds and you let go, they are dizzy, but they recover. If you do it for a minute or any prolonged period of time, they are going to pass out and die." Banks that do manage to borrow in the interbank market can rarely secure loans for longer than overnight. Says one central banker: "If all you can do is borrow every night, then every day the firm faces a life-or-death situation."
The clearest sign of bank cash hoarding occurred on Sept. 30 when the overnight London Interbank Offered Rate-the interest rate on interbank loans in dollars-soared to 6.88%, far above the 2% federal funds rate it normally tracks. LIBOR is a benchmark rate for everything from home mortgages to corporate bonds. Says Lena Komileva, Group G7 economist at money broker Tullett Prebon: "These markets were dysfunctional for the past year, but in recent weeks they have become virtually nonexistent." The Sept. 30 spike in LIBOR occurred just one day after the Federal Reserve announced an unprecedented injection of an additional $630 billion into the global financial system, which ordinarily would have driven dollar-borrowing rates to near zero.
The latest vicious circle: Banks are being squeezed for cash because nonfinancial companies, worried they'll be cut off from other sources, are suddenly drawing on their lines of credit. Gannett (GCI [31]), Goodyear Tire & Rubber (GT [32]), General Motors (GM [33]), and ServiceMaster [34]are among the companies that withdrew billions of dollars from banks in late September and early October. Even Duke Energy (DUK [35]), a huge, financially stable utility, chose to draw down $1 billion from $3.2 billion in credit lines. The looming question is whether banks will be able to meet all of their commitments to provide credit. If companies grab their cash preemptively, "the prevailing mayhem could lead to a funding blitzkrieg...upon bank lenders," wrote research service CreditSights [36].
Skeptics point to the increase in lending to Duke Energy and others as evidence that there is no credit crisis. Alan Reynolds of the libertarian Cato Institute calls talk of a credit freeze "hysterical chatter," noting that all types of lending have risen over the past year. But much of the increased lending is involuntary. Banks are being forced to take assets back onto their balance sheets and keep loans they once would have shed. "That's actually the crux of the problem," says Lou Crandall, chief economist of Wrightson ICAP, a Jersey City (N.J.) research firm.
Building a Firewall
Under these conditions, the government bailout plan seems like weak medicine. The Senate bill takes a further step toward protecting the banking system by raising the limit on FDIC-insured deposits to $250,000 from $100,000. But that may not go far enough. Some economists say the U.S. should build a firewall against panic by at least temporarily emulating Ireland, which on Sept. 30 said it would insure all debts of its six biggest financial institutions. James Galbraith, an economist at the University of Texas Lyndon B. Johnson School of Public Affairs, is among those who favor that approach.
That's not the only possible solution to the crisis. But it's clear something has to be done-soon-to keep a dysfunctional banking system from wrecking the global economy.