THE DEEPENING CRISIS: The signs are that this period of exceptional volatility will continue for some time
AFTER A weekend of frenzied brinkmanship on Wall Street culminated in the abrupt demise of 158-year-old investment bank Lehman Brothers and the sale of rival firm Merrill Lynch, stock markets responded with severity yesterday to extract punishing losses from the value of bank shares around the world.
With a wrenching shake-up of unparalleled scale under way in the very foundations of the international financial system, all the signs are that this period of exceptional volatility will continue for some considerable time as the banking crisis deepens. The crisis "is probably a once-in-a-century event" that will lead to the failure of more firms, said Alan Greenspan, former head of the US Federal Reserve. "There's no question that this is in the process of outstripping anything I've seen, and it is still not resolved."
More than a year since the seismic outbreak of disruption in international credit markets, the affair took a decisive new turn on Sunday when US treasury secretary Hank Paulson baulked at the provision of any government guarantee to Lehman to facilitate a rescue sale to Barclays Bank.
Paulson had already let it be known that he would not follow the federal rescue of wholesale mortgage giants Fannie Mae and Freddie Mac last week and assistance for the bailout of Bear Stearns with any public underwriting of Lehman's liabilities.
He held firm on the ne plus ultra for government intervention over a weekend in which Wall Street's most eminent bankers shuttled in and out of a hectic series of meetings at the New York Federal Reserve, where he held court. Three hours after Barclays pulled away from Lehman, Bank of America walked out of its own talks with the bank.
Lehman then put plans in motion for a bankruptcy petition, starting an ignominious winding up of a storied institution which survived railway bankruptcies in the 1800s, the ravages of the Great Depression and two World Wars. Brought to heel by the subprime mortgage debacle it helped create, Lehman's bankruptcy is the world's largest. With some $613 billion in debt, Lehman has $80 billion in "bad assets".
There was more to the drama. Having opted against a deal with Lehman, Bank of America moved with great speed into the final stages of takeover talks with Merrill Lynch, a Wall Street luminary whose own business might have been been at risk as a result of Lehman's collapse.
The transaction, hammered out in a 48-hour negotiation, values Merrill at $50 billion.
Meanwhile, it emerged that insurance giant AIG was working on a plan to raise capital as a result of huge losses it incurred from guaranteeing bad mortgage investments. AIG may need to raise as much as $20 billion in capital and sell $20 billion of assets to ease its financial crunch.
No surprise, then, that stock markets around the world had a hard time of it yesterday. Financial stocks took a drubbing in Dublin, where the Iseq index dropped more than 3 per cent, losing €1.2 billion of their value.
The decline was in keeping with a downturn already well entrenched, as such stocks have lost €42.29 billion since the market peaked in February 2007.
If those losses underline the vulnerability of Irish institutions to external shocks in markets in which their profits and bad debt levels are under pressure due to the property downturn, there is no sense that recent events will expedite a return to stability.
"I'd agree with Alan Greenspan's interpretation today that what we're going through is unprecedented and a one-in-100-year event. There's probably still more correction to go before the market reaches that tipping point that means the market is back to equilibrium," said Mark Duffy, chief of Bank of Scotland (Ireland).
"I didn't think anybody could reliably guess when that tipping point is. It could be today or over the next few months; it's just too difficult to predict."
Similarly, Merrion Capital chief John Conroy said it would be "dangerous" to assume that the lowest point of the international crisis had now been reached.
"The fact that the authorities have demonstrated that they will allow a major bank to collapse will have to be digested by investors worldwide and naturally investors will seek out weaknesses in other big names," he said.
"Given the interconnections in the global banking system, what's happening in the US cannot be divorced from the European banking system, in which case the lending environment is going to remain very constrained for an significant period and that is going to impact on economic performance in the world's major economies. Stock markets will generally recover ahead of the economies, and indeed valuations in some markets are now looking attractive, but it's still too soon to call any sustainable upturn."
Conroy acknowledged that Irish banks had "considerable domestic issues to worry about, primarily on the property side". But he pointed out, nevertheless, that leading Irish banks "haven't had exposures to the some of the major international issues like subprime losses".
Inasmuch as a constant feature of the current crisis has been the tendency of the market to move its attention from company to company once their vulnerabilities spill into the open, there is every possibility of further volatility in the short term.
Paulson's decision to allow Lehman's collapse is important in that respect, as it is likely to hasten scrutiny of weaker banks, in the US system at least.
"Various banks, within a sector that is basically well capitalised overall, will be in difficulty," said Italian central bank governor Mario Draghi this weekend, before Lehman's insolvency.
European banks seemed to be far better protected from the crisis than US or emerging market counterparts, he said. "The conclusion is that there will be a series of consolidations in the world banking system. We've seen some already but we are a long way from seeing the end of this."
Sobering thoughts indeed.
