Western Banking Crisis: Credit crisis here to stay say top bankers

Tuesday, 12 February 2008

The world economy faces a 'turbulent time', the Chancellor, Alistair Darling, warned this weekend after meeting finance ministers from the world's main industrialised nations in Tokyo to discuss ways of tackling the credit crunch.

Darling and his G7 counterparts were presented with a grim assessment of the damage wrought by reckless lending in the American housing market, which has snowballed into a global financial crisis over the past six months.

'It is likely that we face a prolonged adjustment, which could be difficult,' finance ministers were warned in a report by the Financial Stability Forum, made up of central bankers and financial regulators from around the world.

The politicians struck an anxious note after discussions on tightening financial regulation and improving early-warning systems to prevent future crises. 'The current financial turmoil is serious, and persisting,' said Hank Paulson, the US Treasury Secretary. Darling admitted: 'It is undoubtedly the case following the problems that arose in the US housing market last summer that the world is facing a turbulent time.'

The hard-hitting Financial Stability Forum report blamed feckless investors and irresponsible banks for exacerbating the credit crunch, which has pushed America to the brink of recession. Ben Bernanke, chairman of the US Federal Reserve, has already slashed interest rates by 2.25 per cent in the last five months - the fastest cuts for more than 25 years - in a desperate attempt to contain the crisis.

Presenting the first findings from their study of the credit crunch, the central bankers revealed a catalogue of failures that allowed risky 'sub-prime' lending to Americans with shaky credit records to career out of control, through what they called 'the complex network of interdependencies in the financial system'.

One culprit was the lavish performance-pay regime on Wall Street and in the City, which, they say, 'encouraged disproportionate risk-taking with insufficient regard to longer-term risks'. The secretive 'off balance sheet' accounting used by many banks to hide their borrowing was also criticised.

But the investors who bought securities backed by the shaky American mortgages did not escape blame either: the report identified 'poor investor practices, including excessive, too often mechanical, reliance on credit rating agencies'.

Darling urged his fellow finance ministers to tackle the role of the ratings agencies - such as Moody's and Standard and Poor's - which gave their imprimatur to the complex financial instruments at the heart of the credit crunch, many of which subsequently turned out to be almost worthless.

Since last August the crisis has claimed a crop of high-profile scalps, including the bosses of giant US banks Citigroup and Merrill Lynch, both of which made such huge losses on sub-prime lending that they have been forced to seek cash injections totalling $21bn (£10bn) from foreign backers.

And as banks battle to shore up their finances after losing billions of pounds, there are fears that the supply of credit to ordinary consumers and businesses is drying up, sending the world economy into a downturn - and potentially causing even more losses for the banks.

Darling has insisted that the UK has 'good reasons to be confident' about its ability to withstand a slowdown in the global economy; but the government rescue of Northern Rock illustrates that the banking sector, at least, is not immune.

The Bank of England has already cut interest rates twice to cushion the impact of the credit squeeze, but the British Chambers of Commerce (BCC) warned today that the economy was set to slow down rapidly in 2008.

'Our problems are not that different from those of the US: we have very large personal debt, a housing market which has been overblown and is now weakening, and a huge trade deficit,' said David Kern, the BCC's economic adviser. The Institute of Directors will add to the pessimistic mood tomorrow, when it reveals that business investment plans have 'fallen off a cliff' in the past three months.


Source : The Observer