Global Crisis in the World of High Finance

Thanks to David J. Weston and his missives to his ‘movers and shakers’ list:

TheStar.com – Columnist – Global crisis in world of high finance

March 13, 2008

Thomas Walkom

The most important story of the week has nothing to do with New York Governor Eliot Spitzer’s alleged trysts with prostitutes. Nor does it have to do with Hillary Clinton, Barack Obama and which Canadian government official said what to whom about either.

The most important story of the week – of the year perhaps – is that the international financial system that lubricates and feeds the world economy is in big, big trouble.

So big, in fact, that five of the world’s central banks, including Canada’s, were forced on Tuesday to take near-unprecedented steps to head off the damage. In effect, the world’s top central bankers (which ultimately means the citizens of Switzerland, the European Union, the United States and Canada) have agreed to at least partially bail out some of the biggest financial institutions in the world by briefly taking $245 billion (U.S.) in dodgy loans off their books.

That came just four days after an earlier $200 billion bailout from the U.S. Federal Reserve, that country’s central bank. If the move works, commercial lending rates will fall, the stock markets will rise and the central bankers will be heroes. But there is no indication this massive co-ordinated bailout will work. It certainly didn’t in December when the five central banks tried a more modest version of the same thing.

Because what is going on in the world of high finance is a global crisis in confidence, something that hasn’t happened on a large scale since the 1930s and something that even our sophisticated central banks, such as the Bank of Canada, are no longer well-positioned to solve.

“Crisis in confidence” isn’t just one of those mumbo-jumbo phrases. In banking and finance, confidence is crucial for the very simple reason that all involved are kiting – that is to say, lending money they don’t actually have.

It’s a practice that’s perfectly legal. And it usually works – unless all those owed money (and that includes people with modest savings accounts) want all of it back at the same time. Think of those photos from the Depression of farmers lining up around the block to remove their savings from failing banks.

Paul Krugman, an American economist who also writes in The New York Times, calls the current international credit crunch a less visible version of a classic run on the bank, which is probably a good way to look at it. Thanks to the plethora of peculiar and incomprehensible loans that have been allowed to develop and which are now in trouble (of which so-called sub-prime mortgages are only one example), big lenders have become exceedingly wary of extending credit to one another.

So far, that unease has expressed itself largely through commercial or mortgage interest rates that are stubbornly refusing to come down as quickly as the central banks wish. But the real fear is that big institutions holding some of the dodgiest assets may face bankruptcy, causing them to suddenly call in all the loans they have out.

Which, as the effects ricochet through the system, would lead to massive layoffs in even the soundest of firms.

Incidentally, these kinds of confidence problems, while certainly connected to the current slowdown in the U.S. economy, have implications far beyond those of a normal recession. On top of everything else, they are harder to fix.

Canadians have experienced wrenching economic downturns in recent times. But we haven’t seen a full-blown international financial crisis for almost 70 years. They are not fun.

Thomas Walkom’s column appears Thursday and Saturday.

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2 responses to “Global Crisis in the World of High Finance

  1. thanks for the post. i hope to listen some more.
    Best regards from Sebbi

  2. Well, Sebbi,

    It appears as if you work in German on http://finanzen.blogsome.com/

    Vielleicht dann mal auf deutsch an sabine @ 3dmetrics.co.uk?

    Best wishes,
    Sabine

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