SUMMARY. In the midst of Armageddon-style headlines through August and September, most of us are left wondering what all the fuss is about (that is unless you work for a hedge fund or investment bank, hold/held an account with Northern Rock, or suffer from a poor credit history).
It is a tale of two economies in the UK. Company profits remain healthy, and debt levels are low. Employment is steady, retail sales are surprisingly robust, though unexciting. In contrast, the news headlines through August and September (peaking with saturation coverage of Northern Rock queues, a run on a bank unprecedented since Dickens’ lifetime) hinted at Armageddon.
Interest rates being too low for too long, and a lack of effective regulation in key areas, encouraged the animal spirits of lenders and indolence of borrowers (and sometimes visa versa), yet we continue to believe that the consequences are containable.
In the US, falling house prices, a trend of quite a few months, and increasing numbers of mortgage defaults from sub-prime borrowers, will obviously have some impact on US consumer spending, but this is manageable with the Fed intent on reducing rates as required.
Packages of those sub-prime mortgages were sold on to institutional investors who were heavy on enthusiasm and light on experience. These packages, sold in huge volumes globally, are now of doubtful value, and, as it is unclear who is bearing the massive losses, banks are now wary of lending to each other (such interbank lending being a vital part of what makes the global and national banking system tick).
This is where the Northern Rock debacle came in, as it relied more than any other bank on such wholesale lending, but their problem is not isolated. Other small banks around the globe such as Netbank in the US, another in Germany, and several in New Zealand, have gone to the wall. Yet even though there will be unemployment arising from the problems of these financial institutions, these are limited problems in the context of the wider economy. Similarly with higher interest rates for lower quality mortgages, where the impact will be narrow. Another example of collateral damage is the art market, where there is talk of a “crash”, but this again is of little concern in the broader economy.
Do expect global growth to slow, but not catastrophically, with the Federal Reserve clearly in a mood to cut rates sharply should it be required. The cultural tendency for cynicism coupled with predilection to panic is an unpleasant mix, but think of it as creating investment-buying opportunities.
It isn’t the best of times. Nor is it the worst of times.