After the Big Bang, The Big Bust

This is just a brief comment. I've had difficulty finding hot spots the last few days.

A Few blogs back I warned of the possibility of a severe financial crisis in the Banking sector. That concern was flagged not just by the on going Credit Crunch, but from the fact that Oil Prices had fallen sharply. Oil Prices have fallen even further now to below $100 a barrel. The reason given for this is fears of a global slowdown reducing demand for oil. There is no doubt some truth oin that, but it is a partial truth.

Back when I posted my initial warning there had been rulours that the cause of the sharp sell-off in oil prices was that a number of Banks and other Financial insitutions were facing a severe liquidity shortage, and were having to sell-off profitable positions in oil and other asset classes, aprticularly commodity futures in order to raise cash. Last week on CNBC a similar poijnt was made by a Financial Analyst from Axa Framlington, Chris Tinker, who said that a number of Hedge Funds and other institutions had been caught in a short squeeze. Over the last year Banks, and Building and Construction company shares have been declining hit by the Credit Crunch and Housing slump, whilst shares in Oil Companies, and other commodity producers such as Miners have been rising sharply as strong world economic growth meant that supply could not keep up with demand. So finance companies have gone long the latter, whilst shorting the former i.e. they have sold shares in them they do not have in the belief that they can buy the shares needed to complete the deal at a later, lower price.

However, in recent weeks shares in Banks and builders have risen as fears over the Credit Crunch receded, whilst oil prices and commodity prices came off their highs as concern over an world economic slow down grew, and as economic actvity in China was deliberately slowed during the Olympics. This meant these companies were caught in a short squeeze i.e. their gamble that prices would fall tuned bad, and they had to scramble to buy shares in Banks and Builders before prices rose further, and this pushed those prices even higher. In order to raise the Capital to cover their short positions they had to resort to forced sales of profitable assets, Oil Futures, and other Commodity Futures which most analysts believe will recover again soon as world economic growth resumes, and as China kicks its production back up after the Olympics.

It was no surprise then that last week the US Government had to intervene to nationalise the two huge mortgage houses Freddie Mac, and Fannie May. Nor was it a surprise that other US Financial institutions soon came into the firing line of the market which looked for the next company to go bust. Lehman Brothers had been touted for some time, and whilst it could possibly have done a deal with A Korean Bank it refused to acept the terms, and then went bust the following day. Barclays also had looked at picking up the Company, and now looks likely to pick up some bits at rock bottom prices as part of the liquidation of the Company. At around the same time after pressure from the US Government and the Fed, the other large US Investment Bank Merril Lynch sold itself to Bank of America. BUt, the contagion is spreading. Analysts now believe that Investment Banks like Merrill cannot survive separate from a large Bank. Other companies such as Morgan Stanley are likely to be next. In the meantime UBS in Switzerland looks to have similar problems, but the bigger risk is AIG the huge US insurer, with a Balance Sheet of over £1 trillion. Its shares have fallen by more than 90%, and although it is receiving financial support from New York State and other sources in a $75 billion package, Bond Traders have signalled that they beleive it is bust by effectively pricing its debt as junk. In similar vein Standard and Poor's has graded the Credit of Washington Mutual another large US finance house as junk too.

The irony is that there is a vast reservoir of cash sitting on the sidelines. Some companies with strong Balance Sheets that have not been so burned by the Credit Crunch - like bank of America are picking up cheap assets. Even today a $3billion taveover of Ciba by BASF took place. As yet, there still seems only marginal carry over of the fianncial crisis to the real economy,and with China cutting interest rates as its inflation rate has fallen in line with the rising RMB the economic downturn still looks to be fairly muted and short lived. However, if the financial crisis does get out of hand that could change. Today even companies such as GE in the US are in the firing line, because in recent years they and companies like General Motors have also diversified into finance. The US Government today made it clear that it saw no reason to save Lehman Brothers. It is watching nervously what happens with AIG, hoping that a Warren Buffett or some other private sector solution will come along. But, in times like these it is sometimes better to do what Barclays is likely to do with Lehman's, wait for liquidation, then buy up what is profitable at a knock down price. The problem with that for the capitalist state is that it could bring trhe whole edifice tumbling down. Not so much in terms of simply the economic crisis that could be much more severe than it would otherwise have been, but the ideological consequence of what it will say to ordianry workers and the middle class about the desirability of free market capitalism. UNder those circumstances they may find that a slight corruption of the free market in terms of a return to the more overt State intervention of the past as opposed to the more subtle state intervention through Monetary policy of the last 30 years is a price worth paying.