And the country is deeper in debt. Unfortunately, the global financial crisis is likely to continue growing.
Since the first domino—IKB, a German bank—tipped over at the end of July 2007, the global financial crisis (the illegitimate child of the subprime debacle) has produced a string of financial shocks. So far, bank losses have totaled almost $500 billion, banks have failed or been forced to merge, and bank stocks have lost much of their value.
What caused all these problems? The Bank for International Settlements, a Swiss bank owned by the Federal Reserve and other countries, provided a candid answer in its annual report: “Loans of increasingly poor quality made and then sold to the gullible and greedy.”
The result is a crisis that ebbs and flows, but refuses to end. Alan Greenspan put it this way in an article he recently wrote for the Financial Times: “This crisis is different: a once or twice a century event deeply rooted in fears of insolvency of major financial institutions.”
Charles Dallara, managing director of the International Institute of Finance and a former Treasury official, thinks the crisis is beginning to dissipate. However, he says that “it’s going to take time. It will involve pain for financial institutions and for the broader economy. But there is no alternative.”
Watch a video interview with Charles Dallara, managing director of the International Institute of Finance, on how close we really are to the end of the financial crisis.
The underlying problem is that house prices are still falling, and defaults are spreading from subprime to more conventional mortgages. That means the banks will lose more in the months ahead, and more banks will fail.
One consequence is that bankers are increasingly worried about lending to each other, never mind the rest of us. That’s how the financial crisis spreads throughout the economy: without new credit, there is no growth. A weakening economy inevitably brings more defaults on credit card bills, auto loans and leases, among other consumer debts.
Roger Kubarych, chief U.S. economist for UniCredit Markets, believes that until foreclosures end, the crisis can only worsen. He points out that defaults don’t have to translate into foreclosures. “They didn’t for Argentina or for Chrysler,” he says. “Instead, we found ways to stretch out the debt. We could do the same for homeowners.”
He suggests unifying the waiting time between the day a homeowner stops paying and when the bank can foreclose. Today, it varies from 60 days in Texas to 440 days in New York.
That kind of initiative won’t happen before the election and probably not before a new president and Congress. At that point, policymakers will probably also be looking at changes in how banks are regulated, as well as further measures to help the housing sector.
If the banks are to avoid a regulatory backlash like the one that followed the Enron accounting scandal, the largest financial institutions will have to scale back their businesses and dramatically improve how they manage risk. Dallara admits such changes are necessary, but worries that regulators might go too far or too fast.
Meanwhile, the crisis is mostly being managed by the Federal Reserve, which has reduced interest rates nine times since last summer. Most spectacularly, the Fed provided more than $30 billion to Morgan Chase to take over Bear Stearns. The Fed is also lending billions every week to commercial and investment banks that need credit to operate.
In addition, the federal government has already taken over more than a dozen banks or credit unions so far this year. This list includes IndyMac, the second largest bank failure in U.S. history that closed when depositors withdrew millions of dollars on (self-fulfilling) rumors that the bank was insolvent.
Watch an interview with David Resler, chief U.S. economist of Nomura Securities, on the causes and solutions to the housing problems.A run on a bank is one thing, but a run on an institution owned by the U.S. government is another. This summer, Congress passed emergency legislation giving the Treasury a blank check to keep the two quasi-public mortgage banks—with the curious names of Fannie Mae and Freddie Mac—in business. Since Fannie and Freddie have guaranteed roughly $6 trillion in mortgages, the check would be very big if it ever gets written.
Most analysts don’t think it will come to that. But Dallara recognizes that “once trust is fractured, it is very difficult to repair.”
Which leads David Resler, chief U.S. economist of Nomura Securities, to conclude that “the worst may be over, but this crisis is not over.”
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