The Crash Of 2008 Has Arrived

Up And Down Wall Street Daily
The Credit-Induced Crash Of 2008 Has Arrived

By Randall W. Forsyth | 22 January 2008

WELCOME TO THE CRASH OF 2008.

After the biggest falls in global markets since the aftermath of Sept. 11, 2001, the U.S. equity markets appear headed for a rerun of October 1987, or at least October 1998. And, as in those episodes, the markets are anticipating the Federal Reserve will take similar, decisive action to counter the free-fall in equity asset values. Indeed, a coordinated interest-rate cut by the Fed, the European Central Bank, the Bank of England, and other major central banks including even the Bank of Japan should not be dismissed as a counter to the crash in equity values around the world. Make no mistake, interest-rate cuts would not cure the bursting of the credit bubble in all corners of the globe. Think of them as parachutes; they won't prevent the fall, but they may help slow the declines and dampen the worst of the impacts. Indeed, credit injections by central banks would merely bandage over the asset losses suffered by lenders and investors. Without such action, credit losses can result in a downward spiral as plunging asset prices beget further tightening of credit conditions as market participants rein in risks. Many bourses have already entered bear market territory with losses of 20% or more from their highs of last October or November.

As of Monday evening in the U.S. (Tuesday morning in Asia), stocks in Asia are down another 5%-7% after Monday's plunges in the region of 4%-5.5% and upwards of 7% in Europe and 5%-6% in Latin America. The closure of U.S. markets for the Martin Luther King holiday may have exaggerated the overseas losses, but clearly can't be blamed for the entire extent of the decline. Futures on the S&P 500 fell 4.5% in electronic trading while the cash markets were closed.

Neither can the U.S. fiscal stimulus plan proposed by President Bush be fingered for the declines. The putative $140 billion "stimulus" package pales next to the $2.4 trillion decline in the value of DJ Wilshire 5000 index, the broadest measure of the U.S. stock market, since its peak in October, a 15% decline as of the end of last week, prior to the Monday meltdown abroad. To expect such a scheme to counter the credit crunch is unrealistic, at best.

As in 1987 and 1998, equity markets are plunging because of the squeeze on credit. In 1987, credit was being squeezed as a result of the dollar's decline and the pressure on the Federal Reserve to raise interest rates to defend the U.S. currency under the exchange-rate regime prevailing at the time. The 1998 Asian crisis followed the unraveling of exchange-rate pegs, which had encouraged reckless borrowing in the region.

Ironically, exchange rates are not a factor in the current collapse. While the yen is rising sharply, this is an effect rather than cause of the equity plunge; the unwinding of carry trades— involving the borrowing of yen to fund other investments— results in the purchase of yen to repay those loans.

In the current market plunge, the credit contraction is emanating from the U.S. but the losses are reverberating around the globe. Tuesday, trading in the Bank of China (a commercial bank, not the central bank, which is the People's Bank of China) was suspended on reports it would be the latest to take writedowns totaling $8 billion on its U.S. subprime mortgage holdings. Year-to-date, Bank of China is off 18%, which isn't an aberration for the sector.

The latest manifestation is apparent in the meltdown in monoline credit insurers, culminating in the downgrade of Ambac by Fitch Investors, stripping it of its former triple-A rating. This is but the latest wobble in the credit house of cards. Credit inflated asset values, from U.S. residential real estate to stock prices being pumped up by leveraged private-equity buyout artists or hedge fund players. Now the process is being played in reverse. And it is far from over.

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Normxxx    
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