Today marks a big day for the global credit crisis. It’s exactly one year old.
Or to be more precise, 24 July 2007 was when the world’s stock markets finally cottoned on to what was being brewed up in the murky world of US sub-prime mortgage derivatives. From within 1.5% of its high, the FTSE 100 dropped 6% in three days. By the end of the month, everyone working in the financial markets knew far more than they’d ever wanted to about the alphabet soup of CDOs, CLOs and SIVs.
Many of the supposed ‘experts’ said it would all be sorted out within a few weeks. But not only was that not even close, it was just about as wrong as you can get. Because what we’ve seen so far is only the starter. In fact here in Britain, the real credit crunch is just about to begin…
We may think things are tough now, but they’re about to get tougher.
So far, ‘all’ we’ve seen is a so-called liquidity squeeze in the money markets, as well as lots of banks incurring plenty of heavy credit losses. OK, property prices have tanked, but as we’ve been saying at MoneyWeek for longer that we can remember, the UK housing market meltdown is hardly a huge surprise, because prices rose so far into fantasyland they had to crash at some stage. The liquidity squeeze simply provided the pin to burst the bubble. And while there have been loads of media tales about consumers cutting back and their borrowing limits being reduced, here in Britain our credit card borrowings are still up by 7.5% over the last year, according to yesterday’s figures from the British Bankers Association.
But now things are set to turn ugly.
It’s often said that credit is the lifeblood of capitalism. The amount of credit sloshing around in the system depends on two things. Firstly, the level of bank capital - broadly, that’s the total of money raised through share sales, etc., added to profits made – and secondly, the ‘credit multiplier’: somewhere between £8 and £10 of credit is created, i.e. lent out, for every £1 of banks' risk-free capital.
Early estimates of credit crunch losses were a complete joke
Here’s where all those credit losses come in. We now know that the early estimates of the overall damage were a complete joke. The first guess from US Federal Reserve chairman Ben Bernanke was a ‘mere’ $50bn. Now we’re already up to over $400bn and counting. And we haven’t seen the half of it yet.
Globally, “banks and brokers will destroy somewhere between $1,000bn to $1,400bn of their own risk-free capital owing to losses on all forms of credit in this crunch”, says David Roche of Independent Strategy. This means that in theory, the planet’s credit should contract by something like 8-10 times the amount lost. In reality, it’s not quite that bad, because capital will be boosted by future profits and fund-raising exercises like rights issues, but even then, “you are left with a reduction of 5%-7% in global credit”.
That may not sound too horrendous. But Mr Roche reckons that for every $1 of GDP growth, we need $4-$5 of new credit, “so even a standstill in total credit outstanding is a credit crunch”.
Why we are facing a savage slowdown in bank lending
Here in the UK, banks certainly aren’t likely to be able to keep up their recent rates of lending, having been hit by £27bn of losses already with a further £8bn-ish of property-related write-downs on the way.
“We think that about £65bn in extra capital is needed in order to compensate for the credit crunch and to keep lending at recent levels”, says Vicki Redwood of Capital Economics, “and banks are already showing signs of contracting. Just for their balance sheets just to stagnate, UK banks may have to raise £35bn.”
Even that’s unlikely to happen. The UK banks may so far have managed to raise about £20bn of capital, but the tap is being turned off - there are now signs of ‘shareholder fatigue’. If no more cash is pulled in, the banks could have to shrink their balance sheets by as much as 7% or £180bn, equivalent to some 13% of annual GDP.
In short, all the pieces of the jigsaw are being put in place for a savage slowdown in bank lending. Indeed it looks like it’s already started. Eurozone bank credit expanded by 10% per annum in the year to April, but loan growth is now plunging. In the US, total bank credit has turned negative in “the sharpest fall in over 40 years”, says Ambrose Evans Pritchard in the Telegraph.
And here in Britain, one of the key measures of money, ‘adjusted M4’, which covers loans to UK businesses, has actually shrunk by 3.5% over the three months to May, according to Bank of England stats. What’s more, over the last four months, mortgage approvals have almost halved, said yesterday’s BBA figures.
There’s always a bit of a time lag before this lot hits the high street. But now we’re finally starting to see the impact on the official retail sales figures. The 3.9% plunge in June more than reversed May’s rather suspect-looking 3.6% rise. Annual sales growth has now dived from 7.9% to 2.2%. As Redwood says, “the consequences of this squeeze on capital for the real economy could be devastating”.
In other words, the real credit crunch is about to begin. That means a brutally sharp recession, with much lower company profits and many more job losses. And your bank manager could be about to start getting extremely nasty.
Or to be more precise, 24 July 2007 was when the world’s stock markets finally cottoned on to what was being brewed up in the murky world of US sub-prime mortgage derivatives. From within 1.5% of its high, the FTSE 100 dropped 6% in three days. By the end of the month, everyone working in the financial markets knew far more than they’d ever wanted to about the alphabet soup of CDOs, CLOs and SIVs.
Many of the supposed ‘experts’ said it would all be sorted out within a few weeks. But not only was that not even close, it was just about as wrong as you can get. Because what we’ve seen so far is only the starter. In fact here in Britain, the real credit crunch is just about to begin…
We may think things are tough now, but they’re about to get tougher.
So far, ‘all’ we’ve seen is a so-called liquidity squeeze in the money markets, as well as lots of banks incurring plenty of heavy credit losses. OK, property prices have tanked, but as we’ve been saying at MoneyWeek for longer that we can remember, the UK housing market meltdown is hardly a huge surprise, because prices rose so far into fantasyland they had to crash at some stage. The liquidity squeeze simply provided the pin to burst the bubble. And while there have been loads of media tales about consumers cutting back and their borrowing limits being reduced, here in Britain our credit card borrowings are still up by 7.5% over the last year, according to yesterday’s figures from the British Bankers Association.
But now things are set to turn ugly.
It’s often said that credit is the lifeblood of capitalism. The amount of credit sloshing around in the system depends on two things. Firstly, the level of bank capital - broadly, that’s the total of money raised through share sales, etc., added to profits made – and secondly, the ‘credit multiplier’: somewhere between £8 and £10 of credit is created, i.e. lent out, for every £1 of banks' risk-free capital.
Early estimates of credit crunch losses were a complete joke
Here’s where all those credit losses come in. We now know that the early estimates of the overall damage were a complete joke. The first guess from US Federal Reserve chairman Ben Bernanke was a ‘mere’ $50bn. Now we’re already up to over $400bn and counting. And we haven’t seen the half of it yet.
Globally, “banks and brokers will destroy somewhere between $1,000bn to $1,400bn of their own risk-free capital owing to losses on all forms of credit in this crunch”, says David Roche of Independent Strategy. This means that in theory, the planet’s credit should contract by something like 8-10 times the amount lost. In reality, it’s not quite that bad, because capital will be boosted by future profits and fund-raising exercises like rights issues, but even then, “you are left with a reduction of 5%-7% in global credit”.
That may not sound too horrendous. But Mr Roche reckons that for every $1 of GDP growth, we need $4-$5 of new credit, “so even a standstill in total credit outstanding is a credit crunch”.
Why we are facing a savage slowdown in bank lending
Here in the UK, banks certainly aren’t likely to be able to keep up their recent rates of lending, having been hit by £27bn of losses already with a further £8bn-ish of property-related write-downs on the way.
“We think that about £65bn in extra capital is needed in order to compensate for the credit crunch and to keep lending at recent levels”, says Vicki Redwood of Capital Economics, “and banks are already showing signs of contracting. Just for their balance sheets just to stagnate, UK banks may have to raise £35bn.”
Even that’s unlikely to happen. The UK banks may so far have managed to raise about £20bn of capital, but the tap is being turned off - there are now signs of ‘shareholder fatigue’. If no more cash is pulled in, the banks could have to shrink their balance sheets by as much as 7% or £180bn, equivalent to some 13% of annual GDP.
In short, all the pieces of the jigsaw are being put in place for a savage slowdown in bank lending. Indeed it looks like it’s already started. Eurozone bank credit expanded by 10% per annum in the year to April, but loan growth is now plunging. In the US, total bank credit has turned negative in “the sharpest fall in over 40 years”, says Ambrose Evans Pritchard in the Telegraph.
And here in Britain, one of the key measures of money, ‘adjusted M4’, which covers loans to UK businesses, has actually shrunk by 3.5% over the three months to May, according to Bank of England stats. What’s more, over the last four months, mortgage approvals have almost halved, said yesterday’s BBA figures.
There’s always a bit of a time lag before this lot hits the high street. But now we’re finally starting to see the impact on the official retail sales figures. The 3.9% plunge in June more than reversed May’s rather suspect-looking 3.6% rise. Annual sales growth has now dived from 7.9% to 2.2%. As Redwood says, “the consequences of this squeeze on capital for the real economy could be devastating”.
In other words, the real credit crunch is about to begin. That means a brutally sharp recession, with much lower company profits and many more job losses. And your bank manager could be about to start getting extremely nasty.
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