Alea

As advertised here more than a month ago, and Anatole Kaletsky explains:

Did you happen to notice the collapse of global capitalism and the end of the world financial system as we know it? If not, don’t worry. Like me, you must have been on holiday in August. While dozing on the beach or driving round a medieval hill-town, you might have heard some snippets on the radio about banks collapsing, hedge funds going bankrupt and millions of Americans losing their homes in mortgage foreclosures. But you probably didn’t fully understand these broadcasts because they were in Serbo-Croat.

Alternatively, you may have picked up a page from a discarded business newspaper or magazine at the airport. There you would have seen a terrifying financial crisis described in shock-horror headlines atop a story consisting entirely of baffling jargon and alphabet soup: “Barclays was forced to raise £1.6 billion in emergency financing yesterday from the Bank of England because of temporary liquidity interruptions in three-month Libor due to discontinuous rating agency resets for German balance-sheet conduits of SIV-lite sub-prime US mortgage-backed ABS default-swap securitisations.”

Assuming that you didn’t immediately take in the full significance of such announcements, you probably went back to dozing in your deckchair, having made a mental note to check on the value of your share portfolio and other assets as soon as you got back home.

If you finally faced up to this painful exercise yesterday morning, you probably had a pleasant surprise. At Tuesday’s closing prices, you would have seen that the FTSE 100 index, representing the 100 biggest shares on the London stock market, was at 6,377, almost identical to its closing level of 6,360 of July 31. All other leading stock markets, apart from Tokyo, have performed at least as well.

Does this mean that all the lurid stories about a global financial crisis were just a silly season exercise in trying to sell extra papers, and all the thundering speeches from politicians and regulators denouncing government bailouts of reckless borrowers and lenders were simply a waste of breath? The answer, as all too often in the world of economics and finance, is yes and no.

For many bankers, professional investors and finance directors, this really was a crisis of historic proportions, and still is. While ordinary investors and bank depositors are unlikely to lose – or make – any money as a result of what happened this summer, the world of high finance will never be quite the same.
The summer crisis started with the failure of some overburdened American homeowners to pay their mortgages, but then spread rapidly to German banks, French insurance companies and Japanese pension funds. The precise mechanism of this breakdown is unimportant and a full explanation would drag us again into financial alphabet soup. All that matters is that two of the basic assumptions that have supported the prosperity of global finance in the past decade have been shaken, if not entirely blown apart.

The first of these fallacies is that mathematical models of past financial behaviour can predict the future with sufficient accuracy to support hundreds of billions of dollars of profitable financial trading and to turn assets, such as mortgages to families with low incomes and poor credit histories, which were previously considered very risky, into “triple A” investment propositions, at least some of which are as safe as American or British government bonds.

The second questionable assumption is that globalised financial markets can almost completely replace the old-fashioned local banks and building societies that used to dominate every nation’s financial system, providing a risk-free and immediately accessible home for the deposits of that country’s savers and investors and then lending the money thus raised to local businesses and mortgage borrowers.
What happened this summer in a nutshell, was first that some supposedly ultra-safe “triple A” securities turned out to be much less safe than others. And just as investors in “triple A” mortgage loans were starting to realise this in the early summer, those who decided to take their money out were hit by a second shocking revelation: that money that could supposedly be withdrawn at a moment’s notice from the most developed and regulated of international financial markets, for example the London interbank market for wholesale commercial loans, was actually much less immediately available than money placed on deposit in any respectable bank.

From a longer-term perspective, however, this crisis will probably turn out to be another storm in a teacup. Lenders will doubtless become more cautious for a while after the traumas they have just suffered, but the economic effects of these tougher lending standards – on employment, wages, profits and even house prices – will be largely compensated by the Bank of England and the Fed setting interest rates at a lower level than seemed likely a few months ago.
More fundamentally, last month’s crisis is no more likely than its predecessors of the past decade to interrupt the relentless progress of globalised finance. The economic logic of financial globalisation will remain as compelling as ever: investors and savers from around the world will continue to seek out financial opportunities wherever they may arise. Bankers and fund managers will continue to identify these opportunities, structure new types of financial instruments and then distribute them across national boundaries – always learning something from their previous mistakes, though never quite enough to satisfy bearish sceptics.

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Posted by jck at 11:32 am EST on September 6th, 2007 |