Rarely can a long weekend have been so welcome to so many people as this Easter weekend surely is to everyone involved in the financial markets. The last week has been exceptionally nerve-racking even from the point of view of bystanders, let alone that of participants — from the extraordinary events of last Thursday, through the save-Bear-Stearns weekend and the drama of Monday and Tuesday, with markets careening down and then recovering dramatically, and on to the developments of Wednesday and Thursday, when commodity prices finally took a plunge and the dollar staged a recovery. At the beginning of this week, the entire global financial system seemed to be teetering on the verge of collapse, only to be pulled back and perhaps even to be regaining a semblance of stability by week’s end. A couple of days without trading, courtesy of Good Friday and Easter Monday are just what most people could do with.
Perhaps the most pressing need, for analysts at least, is to catch their breath and be able to take stock of what has actually changed. The pyrotechnics of the markets, with massive rises and falls following each other almost daily, has served to obscure whether anything — and if so what — has been achieved in terms of addressing the substance of the financial crisis, rather than its symptoms. Whilst the main focus has been on damage containment in the markets, with the enforced sale of Bear Stearns to JPMorganChase standing out in this regard, there have been important moves in the real economy as well. The decision by the US regulators to allow the state-owned mortgage companies, ‘Fannie Mae’ and ‘Freddie Mac’ to sharply increase their purchases of mortgage backed securities is an important factor in eventually stabilising the mortgage market, which is where the trouble started and ultimately stems from.
But the critical question is whether this and other steps are not still in the ‘too little and too late’ category. Critics will say that they are and that small-scale palliatives are grossly insufficient when millions of households are facing foreclosure and losing their homes. One counter-argument now being heard more often is that nothing can now be done to prevent a major disaster, but that the extent and length of that disaster can still be influenced by government action, or inaction. The dam, in other words, has broken and the flood is on the way – but that doesn’t invalidate efforts to build up flood walls downstream. If anything, it makes such efforts more necessary.
The single biggest change in the financial and business environment is the degree to which government – in the widest sense, as distinct from the private sector — is now the focus of attention. As the situation has gone from bad to worse, the relative roles of the private and public sectors have inverted. The Bear Stearns affair was the epitome of this process, with Wall Street dropping any pretence of seeking a private sector solution to the potential systemic crash that the demise of the number five investment banking house represented. New York is suddenly humbled and the bureaucrats from Washington have emerged as the source of salvation for the former ‘Masters of the Universe’.
In fact, the relative status of the Wall Street mighty is even worse than that. Until recently, bond traders, managers of hedge funds and investment banker ‘rainmakers’ were the people who generated the huge profits of the big firms, and were themselves rewarded with massive bonuses. Now these lions live in mortal fear of the previously despised rabbits – the paper-pushing back-office clerks who determine whether to issue ‘margin calls’ which can and do bring the biggest firms and funds to their knees. Margin calls go out when the funds have overstepped the limit of their borrowing authorisation, which is happening with increasing regularity as bond prices fall and the value of the collateral underlying the traders’ and funds’ positions shrinks. The embarrassing truth, that the hedge funds’ bravado was based on vast borrowing and that the lenders are finally moving to close the taps, is one of the central factors in the recent market turmoil. Down the road, the government people are preparing rules and regulations to try and ensure that the taps stay shut, so that the lost glory of the hedge funds may never return.