A brief outline of what's happening in the turbulent world of the American Banking system, followed by a short analysis. Why this American crisis will have significant effects outside the States, and why you should care if you live in the UK or elsewhere.
The American banking system is in turmoil after two of America’s largest investment banks fall victim to the growing credit crunch, bringing the total so far to three such cases this year.
After a turbulent weekend of pessimistic activity, Lehman Brothers -America’s fourth largest investment bank- began the week by filing for chapter eleven bankruptcy protection to the American central bank (The Federal Reserve). ‘chapter eleven’ specifies a certain type of bankruptcy plan, where a failed business is allowed the time to work something out with those it owes money, in order to pay what it can afford over an extended period of time (The whole process being scrutinised by government officials to ensure fair play).
Secondly and almost as alarmingly, Merrill Lynch –another of America’s struggling investment banks- announced that it has accepted a deal to be bought by the Bank of America at a fairly cheap price, considering the bank’s size. This takeover has created the largest financial service bank in the world.
If you add those two recent problems to the now distant Bear Stearns incident, you will quite quickly begin to paint a picture of economic crisis, involving three of America’s top five investment banks, painted in the blood of many a Washington politician I would expect.
If you live in the States this is all old news to you and I am simply rubbing salt in that wallet sized wound you have there in your pocket, but if like me you come from Europe, Asia or anywhere else for that matter, you may well be thinking to yourself, ‘but how does this effect us all the way over here? I’ve never heard of these banks before, so why should I care?’
These investment banks are less well heard of than your average ‘high street bank’ (The likes of Barclays or Santander), but they effect us all precisely because they are investment banks.
An investment bank works a lot like a building society, but on a totally different scale. Big businesses will feed millions of dollars in to these great financial behemoths, who will then use this money to invest in stock markets -amongst other things- around the world. When this is done well the interest gained from investment can be very rewarding indeed, many times above inflation (far greater than your building society at any rate).
Although these giant finance institutions are American, because they have billions of dollars invested in shares around the world, when the banks go bust billions of dollars are ripped out of the stock markets around the world (reflected by significant falls in share values, particularly ones held by the failed bank).
On the day that Lehman Brothers went in to bankruptcy the Dow Jones -The Wall Street Stock Market- fell by over three hundred points (a drop of 2.7%) whilst the UK’s FTSE100 share index –the index of Great Britain’s largest one hundred companies- fell by more than two hundred points (a drop of 3.9%). The UK bank HBOS (The result of a merger between Halifax and the Bank of Scotland) was particularly badly effected, losing 17% of its share value in a single day. All in all, a bad day at the office.
As well as the economic hammer blows, in the UK five thousand Lehman Brothers employees found themselves abruptly unemployed. This the British part of a twenty five thousand worldwide staff, now seeking new work. As if that wasn’t enough, these previously employed investors, secretaries and the like are not likely to receive any part of the wages that they have already worked for this month. The administrators for the British part of the company -an accountancy firm called Pricewaterhousecoopers (Or PWC for short)- revealed that there was absolutely no money left within the business at all.
So why did Lehman Brothers go bankrupt? After all, it’s not every day that a company this big collapses. As with every financial institution we hear about being in trouble these days, it seems to be because of risky investment and bad economic performance. Big risks used to mean big money but these days, with such a poor economic outlook all big risks mean are big problems. Unfortunately, old habits die hard and some investment institutions continue to eye up the large potential returns that line their pockets.
When these investments fail and continue to fail then you lose money. When we’re talking about billions of dollars of failed investment, we start talking bankruptcy.
Quite often it is preferred to keep business’ afloat rather than let them go bankrupt (Think of Northern Rock or Bear Stearns), but the American treasury decided that this time public money would not be best spent propping up this fallen bank. Additionally, rescue plans by the Bank of America and Barclays Bank failed to conclude in any meaningful way, leaving Lehman Brothers very few options.
What’s next then? It’s hard to say really, but I think that one quote that has been thrown around sums it up to me really, “Expect more of the same”
This view is certainly well supported with a wealth of evidence. For one, the insurance company AIG (once the world’s largest insurer) has been taking steps to raise cash and has applied to the Federal Reserve for forty billion dollars of emergency funding to keep it afloat. Acts of a clearly struggling company.
Secondly are the pessimistic actions of the central banks of Europe and the United Kingdom, injecting thirty billion Euros and five billion pounds respectively to oil the straining cogs of the financial machine.
Finally there is news that the previously mentioned Bear Stearns, who were kept afloat thanks to intervention from the American government earlier this year, are to be bought for mere peanuts by the financial giant JP Morgan in March.
I would love to say to you now, ‘Alas, but it’s not all that bad’. However, the fact remains that the economic future seems very bleak, and the banking future bleaker still. If you live in the UK like myself, or someplace outside the USA, all I can give you is but one crumb of comfort. At least we won’t be hit anywhere near as badly as America will. The economic slump that we might feel will be nothing compared to the looming recession that America will likely suffer. Doom and gloom all round really, for the moment at least.
