From Bear to worse: the outlook is gloomy
America’s economic plight will hurt the rest of the world too, says Philip Delves Broughton
How bad is this going to get? After the swift garroting of Bear Stearns over the weekend - sold to JP Morgan Chase, which is paying $2 for shares once valued at $100 - bankers around the world woke up today wondering who will be next.
Will it be Lehman Brothers, the bank whose balance sheet most resembles that of the late Bear? Or Merrill Lynch, which has been struggling for breath for months? How safe is anyone these days? Could even the mighty Goldman Sachs be starting to sweat?
A crisis which began with sleazy mortgage brokers arranging loans for unqualified borrowers across America has now reached the very pinnacle of Wall Street.
The entire plumbing of America's financial system is seizing up and no matter what the Federal Reserve tries, whether it cuts interest rates or opens yet another $100bn credit line to cash-starved banks, nothing seems to be working.
The gold bugs, an unloved tribe on the edge of the financial system who long predicted a rush to gold as it became clear that America's finances were broken, are now everyone's darling. Gold has crossed the $1,000 threshold for the first time ever and investors around the world are rushing to buy it as a haven from the plummeting dollar.
One of the most prominent of these gold bugs, Jim Sinclair, wrote on Friday that Americans should not just be buying gold but getting hold of all their assets held by financial institutions. Liquidate those pension funds, cash out the savings, he urged. Banks and fund managers weren't to be trusted. You don't want to be the one at the end of the line when the bank run happens.
Sinclair makes gloomy reading, but his predictions over the past year have been chillingly accurate.
It seems almost impossible the US could be heading for a meltdown of such proportions. A few months ago, only the academic fringe dared suggest that the losses stemming from this financial crisis might add up to $1tr, or seven per cent of America's GDP. Now that number is seen as a low estimate. How long before we start talking Zimbabwe or the Weimar Republic and wheelbarrows of money? The collapse of a crane on a construction site in Manhattan on Saturday afternoon felt creepily symbolic of the current mood in the city.
Despite the fact the crisis has been building over months, it remains unclear what is going on. We know many financial institutions lent money in ways they never should have, whether to ill-educated home buyers or private equity funds borrowing to buy companies. We know these shoddy loans were used as collateral for yet more loans, creating derivative structures only a 20-something maths prodigy could love.
Since all of this became clear, insecurity has bred inaction. Only the very gutsiest - or those ready to pay all cash - are playing the market these days. The rest are terrified and their fear is gumming up a system which relies on tidal flows of money to function. Those financiers not either fighting for their lives (most of them) or scouring the blighted markets for acquisitions (the happy few) are simply gnawing their fingernails and imagining the worst.
At best, there will be another 10 per cent fall in house prices, further retreat by American consumers, broad job losses, inflation, stoked by rising commodity prices and falling US interest rates, and three to five years of misery. The very worst scenario involves a takeover of America's great businesses by sovereign wealth funds, the abject collapse of the dollar and the loss of global economic leadership for a generation.
While there may be some enjoying America's economic plight, it can only end up hurting the whole world. The retreat of the American consumer is good for no one, but especially those countries which trade heavily with the United States or hold large, and fast devaluing, dollar reserves. Europe, China and the Middle East would be foolish to gloat. ·
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