Tuesday, September 16, 2008

'The worst crisis in the last century'

The quote is from Alan Greenspan. And there is no dearth of other doomsayers. But how bad is the economic situation following the collapse of Lehman and the sale of Merrill? Just a couple of quick points.

First, failures in investment banking and also banking are inevitable (although it is mainly the smaller banks that will be allowed to fail). In key products such as sub prime mortgages and securitisation, demand has shrunk and we will never see anything like the old volumes again.
That means that capacity must also shrink. This happens through bankruptcy or consolidation.

Two, I take heart from the US authorities' decision to let Lehman fail. (It's said that the US treasury secretary was adamant on this issue but I imagine the Fed chairman backed him). The decision reflects confidence in the managers of the US financial system as to the ability of the economy to withstand the fallout.

Let's face it: the US economy is in better shape today than most people had expected at the beginning of the year. (Greenspan was amongst those saying the probability of a recession was higher than 50%; now he's quoted as saying the chances are under 50%). A big chunk of banking losses has already been made good through fresh infusions. Major participants have had enough time to unwind risky positions.

Putting these two points together, the financial markets should stabilise in the near future and the survivors will emerge strengthened by the fall of rivals. So, it's not quite the end of the world.....

2 comments:

Rachit said...

Sir,
I think you probably misread/misquoted Sir Alan Greenspan's latest comment. He mentioned that chances of escaping recession in the US are less than 50% and not chances of facing recession in his last interview. Here's the URL :
http://afp.google.com/article/ALeqM5i6u55aefaUf_RXJC4-5kcva-gyWQ

Thanks,

Adorable Bad Guy said...

Perhaps Lehman was a small fish to be made example of. When it comes to AIG, the Fed developed cold feet and injected $85 billion into the company. Perhaps AIG is too big to fail.

I was wondering, how come in this hour of turmoil, Dollar is rising against most currencies? Is it because the investors that put USD in world markets are now scrambling to liquidate their assets and converting these to dollars to cover their positions in us?

Otherwise, I would have suspected that the US dollar should be punished(devalued) for covering the losses for AIG, Freddie Mac and Fannie Mae.

Maybe that too will happen once this short term dollar demand subsides.