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Turbulent Times

Markets and politics

Winston Churchill wrote that in 1929 under his New York bedroom, where he was staying on a speaking tour, “a gentleman cast himself down fifteen storeys and was dashed to pieces, causing a wild commotion and the arrival of the fire brigade.”  The cause was attributed to events of the previous day, Tuesday 29th October, when shares on the Wall Street stock market fell sharply for the second day in a row.  Churchill himself lost over £10,000 in 1920s prices.  That evening he was guest of honour at a dinner with many business guests – in a burst of dark humour a guest proposed a toast to “friends and former millionaires”.  On the Wednesday Churchill visited the dealing floor of the New York Stock Exchange.  He found the scene surprisingly calm but the dealers were “like a slow motion picture of a disturbed ant heap, offering to each other enormous blocks of securities at a third of their old prices…”

Almost eighty years later, the recent falls in stock markets across the world provided occasion for us to dust off such stories of crashes and financial disasters, though we are some way from a 1929 repeat.  It is unlikely any of our political leaders today will be having such a direct experience of stock market panic.  Thoughts turn more to 1998, when the hedge fund Long Term Capital Management (LTCM) became a financial black hole when Russia defaulted on its debt.  The US Federal Reserve had to organise a bail out and cut interest rates.  “Is history repeating or is it different this time?” is the question asked across dealing floors in the City and abroad.

Markets have been reacting to problems in the US sub-prime (higher risk) mortgage market.  Some institutions were too eager to lend and many loans had high interest clauses in the small print so that borrowers have been defaulting on their mortgages.  President Bush’s belated expression of empathy for those who have lost homes is unlikely to have endeared him much to victims who have lost almost everything.

The mortgages had been repackaged into bonds and sold to financial institutions.  On top of these, many derivatives have been created, magnifying the impact of the underlying securities.

As confidence in the sub prime sector dropped, hedge funds and others found they had difficulty pricing the securities in their portfolios.  On 9th August, the French bank BNP Paribas announced it had suspended three of its funds as a result.  This sense that market prices could be some way below last published prices acted as an injection of fear, which has spread to markets around the world.  Banks became cautions about lending to each other, prompting central banks to supply cheaper finance to money markets.

On one day the FTSE 100 fell over 3.7% as markets sought to adjust to new realities.  This completed a fall of over 10% from a high.  The private equity funds questioned by the Treasury Select Committee a few weeks ago had helped buoy shares because of speculation about new bids for companies.  Now it is harder for them to borrow cheaply, making some bids less likely.

The global economy however remains healthy, according to the IMF.  In the UK, the latest Bank of England Inflation Report indicated that interest rates would probably have to rise to 6% to reduce inflation to the target level over two years, but the outlook for inflation (down) and growth (strong) in the next few months was positive. 

At times like these, there is little government can do immediately.  Stock markets will always gyrate as prices factor in the latest information, as well as fear and greed at times.  Barring a financial crisis, central banks are unlikely to cut rates unless they can see a direct economic impact.  Government policy has to continue to focus on economic stability and an investment orientated environment for the long term.

This article previously appeared in Tribune magazine.
Stephen Beer, Friday 13 August 2007
Tribune 13 August 2007, 13/08/2007

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