The credit crisis eases a little; now for the recession

The combined EU, UK and US injections of $2tr of public money into debt-ridden banks over the last week has eased the credit crunch marginally. But after an initial sharp bounce from the co-ordinated governments’ action the global stock markets have resumed their downward plunge. After falling by 20% last week the Dow Jones index in the USA shot up 11% on Monday 13 October only to lose all that again in the following days.

A stream of bad news from both sides of the Atlantic on unemployment, car sales, high street spending, as well as poor third quarter results from the top US banks and plans to cut investment from the big mining companies, has made the markets firmly price in a recession.

News headlines have gone from “staring into the abyss” to “back from the brink” to “deep recession” in a week. The volatility of the equity markets, like headlines, will continue, fluctuating week by week as bad news on profits, output and unemployment vie for space with any whispers that the housing market in the US may have bottomed out. Stories of more government cash injections will circulate and plans will even be leaked to boost government spending on public projects to compensate for the fall in private sector investment. But the recession will not be denied.

Money markets unfreeze – a bit
The immediate objective of the pseudo-nationalisation of the banks (i.e. public money but not public control) was to unfreeze the credit markets which threatens to drag the non-financial sector down. If solvent companies cannot get money for investment and wages to turn over their short-term debt then they will collapse and millions will suffer.

The early signs are that the recapitalisation of the banks has eased the money markets a little. The price for insuring bank debt in the credit-default-swaps market has halved over the past few days. So the likelihood of further widespread bank failure has diminished.

But banks are still not keen on lending to each other. On 14 October the European interbank lending rate for three-month euro loans, known as Euribor, fell 0.07% to 5.17% from 5.24% the day before. The difference between what banks and the US Treasury pay to borrow money for three months also eased to 4.55%.

But it is a measure of just how reluctant the banks remain to lend to each other that this so-called TED spread averaged 0.41% in the 17 years up to July 2007 when the credit crunch exploded.

By comparison, on 20 October 1987, when stocks collapsed globally on what became known as Black Monday, the spread was at 3%. It peaked at 1.6% after the hedge fund Long-Term Capital Management LP imploded in 1998.

In the UK the Libor rate (rate of interbank lending) in the first half of 2007 – before the credit crunch – was 0.09% above the Bank of England rate for overnight borrowing. Then came the crunch and for the first year until last month the Libor rate climbed sharply but fluctuated between 0.2% and 1%.

In the aftermath of the decision to let Lehman Brothers collapse in the US the Libor rate soared to an all-time high of 2.19% on 10 October. Now, with all the new money and guarantees, it has edged down to 2.02%.

So credit remains incredibly tight and available only on onerous terms. The US and EU governments are meant to use their new found leverage to press the banks to use the new capital they have been given to start lending freely again. But the banks seem intent on hoarding cash for the bad times ahead.

This only underlines the point made many times here that only full nationalisation of the banking system, with the state in control of the money markets, can completely restart the process of lending money to non-financial firms.

More problems ahead

Even if interbank lending rates continue to fall in the short to medium term there are plenty of more credit problems that could hit the banks in the weeks and months ahead. The size of the capital injection from the G7 governments is meant to be of such a size that the banks are enabled to withstand any more blows hurled at them in the future.

Yet last week, the International Monetary Fund estimated that banks around the world would need $675bn in fresh capital over the next several years to recover: less than has been promised. The IMF also said on 7 October that financial losses would total $1.4 trillion, an almost 50% increase from a prediction in April.

And as recession bites other forms of consumer debt (car loan, credit cards) may prove unsustainable for households, leading to further irrecoverable losses that have to be shifted onto the banks’ balance sheets.

In addition, the $64tr credit default swap market is a time bomb ticking away underneath the banks. When Lehman Brothers debts were auctioned off last Friday they only fetched 11 cents to the dollar, leaving those – mainly hedge funds – holding CDSs (a form of insurance against going bust) having to find $90 cents in the dollar to pay the buyer of the CDS.

As it unfolded, the total exposure by hedge funds and banks to Lehman Brothers turned out to be $6bn globally – not enough to sink any major institution. But there will be more such revelations in the future as more firms go bust, and the estimated 3,100 hedge funds that managed a combined $1.9tr as of 30 June will be but under the hammer again; many will not survive. Already about 10% of hedge funds have been wound up, something that involves mass selling of their shares – which in turn depresses share prices.

Recession
The second, systemic, phase of the financial crisis is giving way to the third –  recession in the “real economy”. The September figures on UK unemployment show a sharp increase in both claimant count (to nearly one million) and in those looking for a job (1.78 million). This is the highest monthly increase since 1991, the time of the last UK recession. This number will increase sharply in the next half year as the cull of jobs in finance and construction in the last few months is added to by redundancies in retail, business services and manufacturing.

As we say in the latest issue of Permanent Revolution:

“The UK economy is currently suffering from a triple whammy. First, like the USA the UK’s liberalised financial and mortgage markets have encouraged a major housing asset bubble by loose lending, compounded by the government and private sector’s failure to increase the housing stock in line with demand.

As a result household indebtedness has grown more than anywhere else in the G7 and is now unwinding painfully. House sales in August were the lowest for 30 years. The fall out in the construction sector and associated retail sector has been heavy.

Second, the explosion in prices for energy and foodstuffs in the last year (mainly prompted by exceptionally high levels of economic growth in Asia in the last five years) has hit households and businesses hard, eroding profits and wages and hence dampening retail spending and business investment, the motors of economic growth.

Third, the credit crunch, now more than one year old, has hit the UK financial sector hard, exposed more than anywhere else apart from the USA to the losses from sub-prime fiasco. Given the large relative weight of the financial sector in the UK economy, the rapid downturn in its fortunes was bound to take its toll on profits and employment.”

What to do
It is possible that in the UK the government – intent on political survival – may announce new public spending projects to shore up demand. They have pledged help for “small businesses” of £100m and more money for training the enlarged ranks of the unemployed in the future.

Clearly the trade unions need to go on a war footing. Instead of praising Gordon Brown for his “world leadership” in saving the banks, the union leaders need to demand of the Labour government that they nationalise without compensation all firms announcing large-scale redundancies or closures. These jobs can be protected by government guaranteed orders for their produce, and by adopting a massive programme of public works to convert whole sectors and workforces to the production of green technologies.

It is a scandal that a country like Germany employs 250,000 people in such industries while there are only a few thousand in the UK. If the new government minister for climate change, Ed Miliband, is serious about adopting the 80% cut in carbon emission target for 2050 then this needs to be backed up by billions of pounds invested in this sector now.

But we cannot wait for the trade union leaders, whose only function these days seems to be to protect Brown’s back from the Tories, to take the initiative. In each workplace under threat rank and file workers – both in unions and not – need to get together to discuss what action can be taken to prevent sackings. Divide and rule is the order of the day for management as they call 10% or 20% or more of the workers into the office to tell them they will “have to let them go”.

Anyone threatened with the sack must be the signal for all to occupy and strike; to demand the books of the company are opened up to workforce and union reps to get a measure of the problem and draw up a plan of action. Workers employed in other firms up and down the supply chain must establish cross-firm links, swap intelligence and prepare resistance, mobilising the local communities in political campaigns to force the government and local councils to nationalise or municipalise.

The recession is a reality. The only question now is how to resist and prevent it being “cured” at the expense of working class families across the country.

Thu 16, October 2008 @ 12:17