In the aftermath of one of the hardest weeks in decades on the U.S. financial market, analysts agree that the impact will continue to reverberate throughout world markets.
After bank Lehman Brothers met an abrupt end on Sept. 15, the world financial markets shuddered. Markets tied closest to the U.S. tumbled dramatically, but the impact was felt throughout all financial systems. On Sept. 16, the dramatic bail out of U.S. insurance giant American International Group (AIG) invoked a brief moment of relief only to raise more concern and rapid fire questioning from markets worldwide.
U.S. financial daily The Wall Street Journal has likened the crisis to a disease spreading through the U.S. financial system. Professor of International Business at the Fletcher School of International Affairs at Tufts University Laurent L. Jacque made a similar comparison. “There is this contagion circling the world at a very high speed,” he told CBW. “It’s creating a cloud over financial institutions and an air of panic.”
The Prague Stock Exchange (PSE) registered the sharpest drop of all bourses in Central Europe on Sept. 16, and the headline PX index plummeted by 2.51 percent to 1,205.8 points early in the day. All shares traded on PSE posted losses.
However, the impact on the Czech market and the market in the CEE region has been relatively minimal. “The CEE region still has comfortable growth forecasts [of over 5 percent] … compared with Austria at 2.1 percent and the eurozone at 1.5 percent,” explained Hana Cygonková, spokeswoman for the Central and Eastern Europe (CEE) region of Erste Group.
Firms in the CEE region have not been very involved in the U.S. prime and subprime markets, and thus there is no direct impact or at least the impact of the recent developments is very minimal, Fritz Mostböck, the head of Erste Group Research, told CBW.
Positive recoveries were reported on all markets late last week on news of aid from central banks. This does not mean that anyone can breathe a collective sigh of relief. “The next level of concern for the Czech Republic and for other countries as well is how Wall Street will affect Main Street in the U.S.,” Laurent said. Moreover, most analysts agree that there is still a massive concern over the potential failure of other institutions around the world.
U.S. regulators were taking further steps at the end of last week, banning short selling of financial companies. Government plans for an aid package for banks were also announced, but details were not finalized by press time.
‘Panic Play’ and a $247 billion gift
“This has been the worst financial crisis since the Great Depression. There is no question about it,” Mark Gertler, a New York University economist who worked with current Federal Reserve chairman Ben Bernanke, told The Wall Street Journal. “But at the same time we have the policy mechanisms in place fighting it, which is something we didn’t have during the Great Depression.”
With the collapse of Lehman Brothers and the last minute sale of Merrill Lynch & Co. to Bank of America fresh in the collective mind of the banking sector, the massive bail out of AIG further proved that the problems are far from over. Mostböck explained that the continued rumors originating in the U.S. about the uncertain fates of other institutions has ultimately driven the markets. “Ninety to 100 percent is panic right now,” he said, describing the “psychological momentum” driving the markets down in the face of further uncertainty last week.
“Panic is justified if you are a stock owner,” Herb London, president of the Washington, D.C.-based think tank and public policy research organization Hudson Institute, told CBW. “There is a psychological effect that influences everyone because we have heightened anxiety—particularly those living on fixed income who are now concerned that their assets might disappear. Some of that fear is exaggerated but understandable considering the present conditions.”
On Sept.18 $247 billion was pumped into the financial system by central banks worldwide, bringing a rapid boost in confidence within the markets. The PSE opened trading Sept. 19 with steep growth, the PX Index up by 7.25 percent at 1,263.4 points soon after trading began.
“Central banks are trying to signal that it is a crisis, but it’s not the world collapsing,” Laurent said. “They are trying to allay the fears by doing this.”
Miroslav Singer, vice governor of Czech National Bank (ÄNB), told CBW that he viewed it as a step necessary to support attempts to stabilize the markets. The ÄNB would not consider releasing funds into the market “unless the crisis spreads to our financial market, of which at present we have no signal,” Singer said. He stated he doubts that any central bank in the “new” EU member states is being pushed to consider the step, either. “In the new member states the financial markets work smoothly as to my knowledge,” he said.
Expensive to be a savior
Insurer AIG saw its share prices fall over 95 percent from $70.13 to just $1.25 on Sept.16 and reported over $13.2 billion in losses in the first six months of the year. The implications of this were clear, and rumors spread quickly that the group would be filing for bankruptcy. Late in the evening on Sept. 16, the Federal Reserve announced it would lend up to $85 billion to the ailing institution in exchange for a nearly 80 percent stake in the company. U.S. President George Bush, defending the AIG bail out, said a failure of the firm “could have caused a severe disruption in our financial market and threaten other sectors of the economy.”
Most analysts agree that the lifeline to AIG was necessary to prevent what may have been a catastrophe for the U.S. economy; however, in this case survival is costly. With the approximate national debt at $9.7 trillion, it begs the question of how much the Fed can afford to rescue these collapsing institutions. “They do have the means,” Laurent said.
Considering it is ultimately the taxpayers who pay for the bail outs, “[the government] has very deep pockets.” However, Laurent noted that there is a disturbing discrepancy between how much the government can afford to insure bank deposits and how much more massive bank failures may cost. “The U.S. has a federal program to protect and guarantee bank deposits up to $100,000, which is insured by the FDIC [Federal Deposit Insurance Corporation]. There is around $60 billion on its balance sheet,” he said.
Perhaps even more puzzling, Laurent questioned the fate of major banks that originate in countries that would not be able to afford the money for a bail out. “Almost every major financial institution, Citibank, AIG, Deutsche Bank … all have home countries with deep pockets … the government can come to the rescue,” he explained. But a bank such as the Swiss UBS is in an awkward position. Switzerland would not have the mean to pay for the failure of such a massive institution, and the country is not a European Union member. “Should UBS come under further stress, who would come to the rescue?” Laurent asked.
“Not only is it an extraordinary amount of assets the Fed is putting into companies, but where do you draw the line? At what point do you say the government shouldn’t be the owner of these private assets? If the taxpayers own these companies, can they exercise options in the market without the interference of Washington bureaucrats?” Hudson Institute’s London asked. “The financial markets are obviously undergoing a battering in the face of this financial drawdown. However, anytime you increase the size of public assets, you draw down on private assets. Consequently, in the long term this is unsustainable.”
‘Winnowing process’
The inevitability of the recent crisis has been a common theme in analysis. Many experts agree that although this was not in any way positive, it was ultimately necessary.
“This is a difficult period, and I think credit will be tight and difficult to obtain. It also seems to me that the bail out of several companies will lead to a hyperinflationary period over the next year or two. You will see people evaluating their own assets. There will be a period of worry and anxiety, but in the end, most of the assets are secure,” London explained, adding that “for many of those who had stock in the failing companies, it will be a tragedy of enormous proportions.”
J. Jay Choi, professor of finance and international business at Temple University in the U.S., told CBW that there is a continuing, systematic risk. “Even though some of these [institutions] can be and have been ‘rescued’ by stronger financial institutions or by U.S. government, this amounts to treatment of symptoms rather than causes,” he said.
Ultimately things may get worse before they get better for the U.S. “From the standpoint of foreign governments, a shift in the investment of their reserve assets away from the U.S. dollar and toward euro and other currencies may also reduce currency-related losses somewhat. The huge increase in U.S. debt that will result from these government involvements, in addition to the already-high debt due to the Iraq War, is bound to lead to a weaker dollar,” Choi said.
We have not seen the full impact on the U.S. economy yet, according to Laurent. What we’ve witnessed so far has been primarily in the financial markets, on Wall Street not Main Street, he said. “[The U.S.] has had so much growth in the past five years, like it or not, it’s time for a slowdown,” he said.
“The financial markets in the U.S. needed this kind of winnowing process. There will be survivors, and there will be failures. The markets will recover because there is a demand for banking activity. It’s easy to exaggerate the winnowing process, but in the end we’ll look back and say this was a healthy development for the financial markets,” London said.
“Each crisis is also creating chances,” Mostböck said. These chances and opportunities may not be clear just yet, he said, adding that his advice to investors now is to wait and see in all markets.
