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Financial Markets and a Far East Banking Lesson

The US Federal Reserve and European Central Bank have been taking on questionable mortgage debt as collateral against loans for many months now. If the large private financial institutions have helped cause many of the credit crunch problems through excessive risk taking should they be bailed out? If they were largely the sole beneficiary of the risks should they be bailed out by the tax payer? In a black and white world…no. But in a world with a lot of shades of grey then if they are not helped throughout the crisis then that will only exasperate the problems.

However one wonders how closely the questionable mortgage debt will be checked for value or will the western banks end up in the same boat as the Japanese financial institutions from the early ‘90s? If you recall they ended up with huge unrealised losses on 20-30 year loans being slowly amortised away. This scenario sounds fine until dealers remember that Japanese institutions could not borrow at market rates for many years as banks refused to increase credit lines. Where European and American’s had access to funds at sub-Libor rates the likes of Mitsubishi, Diawa and Nomura had to suffer Libor plus 1.5% or more.

This move shows up in sharp relief the inactivity of the Bank of England last autumn when they refused to accept good quality Northern Rock mortgage collateral. The lemming like following of the Federal Reserve shows how ineffective the UK central bank has become when coming up with original solutions to problems. With one of the rotting planks of financial stability being propped up one wonders if this will really make much difference or will another worm infested scenario rear its head. The last injection of liquidity did nothing to ease the credit crunch. Financial institutions merely used the Government’s generosity to reinforce their own weak lending book. They still refused to unlock the freeze on lines to other borrowers. This was highlighted in the collapse of Peloton and Carlyle. It remains to be seen whether the next pool of easy money will be any different.

As Simon Denom of Capital Spreads recently commented “The problem for the central banks is that they (and if we are honest, every single person in the capitalist society) cannot afford a single one of the major lenders to go under. All the lenders are so intertwined with long term lending deals that if one goes then many may follow”. Once Northern Rock got into difficulties the government was forced to act because otherwise all of Northern Rock’s mortgages would have had to be repaid or sold off en-bloc to another lender. At that time nobody had the spare £100bn+ available even at fire sale prices. In an extreme scenario this could have led to tens of thousands of houses being put on the auction block as mortgages were called in.

As the Japanese discovered, having virtually 0% interest rates does not mean that your economy will grow if your financial institutions are so crippled that they are unable to lend aggressively. Japan has been in a disinflationary environment for some 18 years which is the fear stalking the corridors of power in the States. The Bank of Japan debt levels make the US deficit appear very small potatoes indeed. Their experience of what happens when the central banks start to have to prop up the banks in this fashion will create the fear that the US Federal Reserve’s initial $200bn is just the start of something very nasty indeed.

As all those who are regularly spread betting on the Nikkei 225 will know, whilst the FTSE 100 has only just entered a bear market, the Nikkei 225 has been in one for over a year. In fact the Nikkei has still not repeated its 1989 peak. There are lessons to be learnt.

Spread betting carries a high level of risk to your funds. You can lose more than you initially invest. It may not suit all investors. Only speculate with funds that you can afford to lose. Ensure you understand the risks and seek independent financial advice if and when necessary.

Article Source: http://blisspublisher.com

The author is a well known financial journalist and contributor to some of the UK’s leading financial newspapers as well as regularly commenting on the spread betting companies and foreign exchange operators.

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