24 hours of turmoil and turbulence
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The last 24 hours have seen the world’s financial markets in a turmoil last seen in 1929. After more than a year of the credit crunch and financial woes the proverbial has hit the fan.
The investments bank Lehman Brothers’ bankruptcy has dealt the money markets a crippling blow, incapacitating them for a considerable time to come. Fears about other banks’ exposures to Lehman and renewed uncertainty as to where the crisis may strike next will freeze the wholesale markets up again. The crunch is back with a vengeance.
The collapse of Lehman Brothers into bankruptcy protection is the biggest corporate debt default in history and, in the complex interwoven world of modern banking, no one properly understands where the risks lie.
Unlike with Northern Rock last year nobody in the UK stands to lose their life savings. Lehman Brothers is an investment bank and so specialises in large and complex deals and investments.
Despite this, Lehman’s collapse will still be felt by us here in the UK. Most of our banks and pension funds have dealings with Lehman, or with firms like hedge funds that traded extensively with Lehman.
Unwinding Lehman’s complex deals could take weeks or months. During that time the global financial system will be in limbo. Most banks won’t know for sure how much they are exposed to Lehman, and will have difficulty freeing up the money in those deals.
This in turn is likely to intensify the credit crunch, with potentially dire consequences for businesses and consumers.
What little confidence the markets had restored in recent months has been knocked down again. According to experts, Lehman has $150bn of debt outstanding. In comparison, US telecoms group WorldCom, which was the largest debt default until now, had $23bn to $30bn when it went bankrupt in 2002.
The holders of that debt, therefore, are facing huge potential losses with untold ramifications of their own.
Furthermore, Lehman’s collapse will flood the market with assets for which there are very few buyers anyway. The banks are already having to writedown their positions on a quarterly basis, often because the valuation of these assets is declining.
Central banks know it will be touch and go for many other financial institutions. Hence the $70bn liquidity pool provided by ten of the biggest investment banks for any one of them that needs to tap it.
This also explains the extra £5bn of liquidity the Bank of England is providing the UK money markets.
At the very least, the collapse of Lehman is potentially as costly as the $200bn initial estimate of the US sub-prime mortgage fall out. As the complex web of deals and lending is worked out, financial institutions here in the UK could be even more heavily effected. Because of that there’s every reason to be worried.
