Credit
Crunch Could Bring Recession
By Nick Beams
07 September, 2007
WSWS.org
While
global share markets appear to have stabilised—at least for time
being—it’s a different story as far credit markets are concerned.
Here there are fears that a growing crisis could spark a major downturn
in the world economy.
In an article on Wednesday,
the Financial Times pointed to problems in the interbank markets, where
banks and major financial institutions lend to each other. Here interest
rates are on the rise “suggesting a frantic scramble for liquidity
among financial groups.”
This was “deeply unnerving”
for policymakers and investors because it was taking place despite the
massive injections of liquidity into financial markets by the US Federal
Reserve and the European Central Bank—moves that were aimed at
trying to calm money markets and ease the credit crunch.
The report cited one market
analyst who stated that the interbank lending business had “broken
down almost completely”, not only in the euro and dollar markets
but across the world.
Concerns about the state
of credit markets and the implications of the absence of liquidity were
the subject of a statement from the European Central Bank on Wednesday.
It warned that financial volatility was returning after a brief period
of stability.
The ECB alert came as the
Organization for Economic Cooperation and Development (OECD), which
embraces the world’s major economies, issued a report warning
that economic growth, especially in the United States, could be adversely
affected by the financial market turmoil.
While the crisis had struck
under conditions when world economic momentum was still strong, future
prospects were more uncertain. “Downside risks have become more
ominous, in a context where overall financial market conditions are
likely to remain durably tighter,” the report stated.
Economic growth in the United
States was likely to fall “distinctly below potential” during
the second half of this year following a strong rebound in the second
quarter. The report cautioned that its predictions “may err on
the upside, since it has not been possible to fully evaluate the negative
impact of credit market turbulences on economic activity.”
The report’s author,
OECD chief economist Jean-Philippe Cotis, said a US recession could
not be ruled out.
Figures issued on Wednesday
showed the extent of the decline in the US housing market. Demand for
housing fell to a six-year low as lending conditions tightened. While
the expectation had been for a 2 percent drop in home sales, the decline
was actually 12.2 percent, according to the National Association of
Realtors.
Merrill Lynch chief economist
David Rosenberg said: “There is absolutely no question the housing
sector is going from bad to worse. Even with the deterioration in home
prices, we can see demand continuing to fall.”
And the decline is set to
continue in the coming months. Figures issued by the Mortgage Bankers
Association for the second quarter of the year—that is, before
the latest tightening of credit—show that a record number of homes
entered the foreclosure process.
In the case of subprime adjustable-rate
mortgages, 18 states reported that at least 19 percent of these loans
were “delinquent.” In Mississippi and West Virginia, the
figure was more than 26 percent. Second quarter foreclosures were 44
percent higher than the corresponding period in 2006.
In another report released
on Wednesday, the United Nations Conference on Trade and Development
said world growth would slow to 3.4 percent this year from 4 percent
last year. It warned of the possibility that an “outright contraction”
in American house prices could lead to cutbacks in consumer demand,
impacting on exports from developing countries.
An indication of the growing
sense of crisis in the credit markets was provided by a report and a
letter that appeared in the Financial Times this week. On Wednesday,
the paper reported remarks by Hans Jörg Rudloff, chairman of Barclays
Capital, who said financial markets had suffered a “heart attack”
and now faced a critical period of convalescence. The next four to six
weeks would be crucial as investors tried to establish price levels
for asset-backed debts.
“This is the big question:
are we capable to establishing a new price level for these assets? If
we stay stuck, the patient is going to die,” he told a meeting
of Russian business executives in Moscow.
The following day the Financial
Times published a letter from Paul Mortimer-Lee, the global head of
market economics at BNP Paribas, a leading private bank. Expanding on
the “heart attack” analogy, he said the situation was serious
but the central banks had so far confined their activity to dispensing
aspirin when a defibrillator was needed. More serious treatment was
being withheld on the grounds of “moral hazard”—the
claim that major intervention provided an underpinning to bad investment.
This was equivalent to denying treatment to the heart attack victim
on the grounds that he should have improved his diet and exercised more.
According to Mortimer-Lee,
the liquidity injections organised by central banks had failed and a
credit crunch was coming.
“When the patient is
in seizure and the extremities are starting to turn blue it is not the
time to worry about the patient’s longer-term dietary plans or
about undesirable side-effects of the current treatment. Yet I fear
this is what central banks will do. The next set of steps had better
be convincing and decisive, otherwise a much wider financial implosion
and economic recession will become very likely.”
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