My Two Cents

More Thoughts on Today

Chris Farrell Sep 15, 2008

George Magnus, senior economic adviser at UBS Investment Bank in London has been one of the more accurate observers of the ongoing credit crunch.

A couple of highlights from his latest thinking:

…In terms of events, it’s not possible to know exactly what happens next, but as you all know there are other major institutions in the financial instability frame, not to mention the maybe 100 or more smaller or non-diversified banks that in all probability could get into bad loan difficulties or fail. The problem at the moment of course, is the speed at which the de-leveraging is unravelling, and the not-knowing how and when a systemic solution will be found. I don’t think there’s any question about ‘if’ this will happen, but when and under what circumstances.

The strong theme underlying the Minsky Moment from the beginning was that if you have a systemic problem in the financial system in which market mechanisms fail, then you have to have to have a systemic solution. As we know well, central banks can do and have done a great deal to keep the financial system liquid and funded, through special lending schemes and normal emergency borrowing facilities. But the nature of this de-leveraging, in which declining asset values, debt reduction, and asset sales, reinforce one another, calls for additional interventionist action by government in 5 major ways:

First, state-sponsored re-capitalisation

Second, the creation by the state of an asset management company or companies to enable problem banks and non-performing or illiquid assets to be sold or run down in a relatively orderly way

Third, state-orchestrated pressure for significant consolidation and ownership change within the banking sector

Fourth, changes in accounting regulations to permit some types of losses to be taken over time, rather than under chaotic conditions, and

Fifth, legislation to provide borrowers and lenders, whether in the financial or housing sectors, with a framework within which to work out loans and payments. The recently passed FHA Housing Stabilisation and Homeowners Retention Act was of course the first major example.

You can see how seriously he takes the credit crunch. Here’s how he summarizes his current thinking:

First, a reasonable, orderly work-out of financial deleveraging, if it were ever a possibility, now no longer seems possible

Second, the speed and spread of the unravelling in the financial sector is of major concern

Thirdly, the greater intervention of the State in the US financial system has not ended, and is likely to increase as the viability of some institutions and assets – and the orderly disposal of others – is taken on to the government’s balance sheet

And fourth, the economic consequences cannot be fairly estimated really until financial stability has been restored. At this point, it would seem as though the recession in the US, and in some other countries, may continue into the first half of 2009; and that a new cause for concern is the impact of the policy response to the financial crisis on US debt instruments and the US dollar.

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