by Martin Webber
Business Editor, BBC World Service
It’s a horrible mess, withincompetence at major companies, incompetence at the regulators.
That’s the ugly picture to emerge from recent events in the United States and Britain.
The result is not only a sharp downturn in the global economy, but a murky entanglement of governments, bailing out failing private companies that many had confidently thought had been consigned to history.
So how did it all happen
In particular, how did the banks that should be in the relatively safe “utility-type” business of savings and loans for ordinary people, come to need taxpayers‘ billions to stay afloat
Well, it seems the companies just gambled that the recent global boom would continue indefinitely and, according to the leading UK economist Roger Bootle, the regulators didn’t care.
“We’d imagined that it was perfectly all right for banks to be a mixture of a utility and a casino and for the casino bit to be dominant without really bothering about it - and that’s an extraordinary position we’ve got ourselves into,” he said.
Wall Street Shaken
It all really began in March with the collapse of the New York investment bank, Bear Stearns - a pillar of Wall Street. It was bought for a pittance by rival JP Morgan Chase.
Outside the Bear Stearns building in midtown Manhattan the mood was grim and chilly as the winter weather. One worker said: “Bear was a terrific place and I think we’re all kind of feeling dazed and confused.”
One man trying not to sound dazed and confused was the US Treasury Secretary Henry Paulson.
“Our financial institutions - our banks and investment banks - are very strong and I’m convinced that they are going to come out of this situation very strong,” he said at the time.
How wrong can you be - easy to say now after nine months of chaos, but one famous financier was saying it clearly at the time.
In May, the Hungarian-born investor George Soros told World Business News:
“This very powerful global financial system is actually built on some false ideas and therefore it is in danger of breaking down.”
“Now you have a bust and you have credit and wealth destruction. I’m trying to keep out of trouble and I personally run a basically negative portfolio, betting on the markets going down.”
What a clever move that was.
Since George Soros uttered those words the main Dow Jones industrial average on the New York stock market has tumbled - at one point it was down by 40%.
Domino effect
The month when everything really fell apart was September.
On Monday 8th, the US government announced it was stepping in to bail out the US mortgage providers Fannie Mae and Freddie Mac.
Many Asian investors had believed debt from these entities to be as safe as US government debt - it just did not seem an option for America to let them fail.
"This is a once-in-a-half century, probably once-in-a-century, type of event"
Alan Greenspan, former Federal Reserve Chairman
The rescue happened, but still it didn’t stop the rot. Just two days later, the markets had another victim in their sights - the Wall Street firm, Lehman Brothers.
Lehman shares fell 40% in one trading session after a potential investor from Korea pulled out of talks.
On that day, Peter Morici of the University of Maryland, said:
“Lehman Brothers is in a lot of trouble. They have bad real estate investments both in the form of mortgage backed securities and properties they have invested in, particularly in Britain.”
“Its balance sheet is too messy for anyone to become involved with. Only a fool would acquire this company right now.”
When asked how close a collapse was, Mr Morici said: “Just a breath away. It is very close to collapse.”
Indeed it was - four days later Lehman Brothers was allowed to go bankrupt.
There was government bail-out and finally it seemed that a Wall Street name had been forced to pay the ultimate price for its mistakes.
For many on Main Street this was justice for Wall Street, but it was a shocking blow to Alan Greenspan, the man who had run US interest rate policy for 20 years.
“This is a once-in-a-half century, probably once-in-a-century, type of event. There’s no question that this is in the process of outstripping anything I’ve seen and it still is not resolved and it still has a way to go,” he said.
Only two days later America’s biggest insurance company, AIG, was given emergency taxpayer cash. The company was deemed to be too big to fail.
Government rescue
Next, the US government came up with a massive $700bn plan to buy up failing securities from banks based on home loans - a so-called “cash for trash” scheme.
The idea was to support banks without ending up owning them.
President George W Bush insisted lawmakers had to pass the package but many economists hated the plan, saying it was throwing good money at a failed financial market.
"Government owning a stake in any private US company is objectionable to most Americans"
US Treasury Secretary Henry Paulson
The House of Representatives shocked everyone by rejecting it and and on one Monday afternoon fear gripped Wall Street and share prices tumbled at a frightening pace.
By the end of the week however, politicians had settled their differences and the government cash was approved.
But shares continues to tumble, unimpressed by a co-ordinated worldwide cut in interest rates.
The British government was forced to pump more taxpayers’ money into UK banks and the US Treasury Secretary Henry Paulson, then swung his rescue vehicle into reverse.
Instead of “cash for trash”, the US government said it would copy Britain and take direct stakes in America’s banks to keep them afloat.
It left Mr Paulson feeling very uncomfortable.
“Government owning a stake in any private US company is objectionable to most Americans - me included. Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable.”
Many have tried to paint the past year’s events as something unforeseen - a type of financial natural disaster.
But the reality is different.
Over recent decades, financial markets have turned away increasingly from the old-fashioned dull idea of handing cash over to entrepreneurs to innovate and thus grow economies.
Instead, financiers have become obsessed with chasing market trends which, in the short term, can often be a lucrative game.
But when markets turn, disaster can strike for the unlucky hedge funds and for the mainstream banks that have lent vast sums to the speculators.
House prices in both Britain and the US had seen many years of annual gains of 20% but with total national incomes to pay for the homes only rising at 5% per cent a year, it didn’t take a genius to work out that it was all a very fragile bubble.
See how UK house prices and the economy have evolved
Warnings ignored
One expert much derided for his gloomy predictions during recent years was the London based economist, Roger Bootle.
We asked him if in retrospect, he could have done any more to alert the world to the trouble ahead.
“I’ve been writing a newspaper column every week. I’ve written several books and I’ve been pretty explicit.
“But the problem is if you are a fundamentals-based forecaster and you see a distortion happening, you sort of take a pride in seeing it early and speaking out early. You can though be too early and frankly, my problem was I was too early,” he said.
In other words because the property collapse predicted by Mr Bootle and Mr Soros didn’t happen instantly, governments dismissed their fears.
And it seems regulators failed to ensure that banks were set up so they could withstand the quite predictable drop of 20-30% in house prices.
Optimism
But to finally take a more upbeat view - Roger Bootle thinks it could have been a whole lot worse if the bubble had carried on even longer.
“We needed the bubble to be deflated,” he said.
“I suppose that in the best of all possible worlds - this is a sort of policymakers‘ dream - if you can imagine this as a sort of balloon, what we would have somehow liked to have achieved is to somehow pricked the balloon, kept one’s hands over the hole and allowed the balloon to deflateever so slowly - without making a horrible noise.”
“We’d have had a very gentle deflation of this bubble without adverse consequences,” he said.
“But frankly, I don’t know any example in history of that occurring.”
And another silver lining for many of the world’s poorest people is that food and energy prices have fallen sharply from their peaks.
Oil prices neared $150 a barrel but are now back down to just $40.
And for those worried about greenhouse gases, the sudden winding down of China’s manufacturing machine could mean an actual reduction in global annual energy use - something no climate deal has yet achieved.
Overall, though, it’s been a traumatic year for everyone looking at and affected by financial markets or the global economic currents, perhaps the most dramatic year since the 1970s oil shock.
And who’s to say there’s not more drama to come.
