Spring will be followed by winter. That’s the best way of summing up the state of the global financial markets. Winter – a deep, ferocious, storm-laden winter – last ended on March 17, when the Federal Reserve, aided and abetted by the Department of the Treasury, gave JPMorgan $30 billion with which to buy Bear Stearns, and gave Bear Stearns an offer it couldn’t refuse – either to be bought for next to nothing, or to be allowed to crash and burn. In so doing, the Fed and Treasury saved the global financial system from systemic collapse, which would probably have triggered a global depression.
Not surprisingly, the cathartic effect of being saved from total disaster triggered a huge wave of relief which, fueled by vast amounts of money that the Fed and other central banks pumped into the financial system, quickly turned euphoric. Markets recovered and with them spirits lifted. At first, in the second half of March, the atmosphere was still hesitant and suspicious. But as April came and flowers bloomed, no new disasters occurred and a new bon mot began to make the rounds of London, New York and other financial centers: ‘the worst is behind us’. In its most practical form, this meant that although banks and other financial entities would still have to make large write-offs of the garbage loans and bonds that they had assiduously accumulated in their balance sheets during the boom years, this was now a manageable task and so people could now start ‘looking beyond the immediate crisis and its aftermath’. As usual on Wall Street, ‘looking beyond’ meant that somewhere, over the rainbow, was a new Shangrila in which bankers once again made hefty profits and took home absurd and often obscene ‘remuneration packages’.
The prospect of financial Armageddon, so imminent in the first quarter of 2008, receded rapidly into memory – or, better, was deleted from memory entirely. The bulls stampeded, share prices rose, the situation in the money, bond and other credit markets improved. The heads of famous financial institutions, where the walls had been shaking on March 15, now made speeches explaining what had gone wrong and why things were now getting better. Hardly anyone asked what credibility these greedy, nest-lining incompetents could muster, after having failed to foresee – or, in some cases, having deliberately silenced all would-be warners of – the disaster building in the housing market and in the assets the banks held both on- and off their balance sheets.
Meanwhile, in the real economy, the situation was deteriorating – rapidly in the US, more slowly elsewhere, but everywhere in the same, negative, direction. The most remarkable change, perhaps, was that the Fed stopped talking up the economy. In both public and private speeches and briefings, Fed officials from Bernanke downwards painted a grim picture and made no more efforts to gloss over the seriousness of the situation Indeed, they stressed how the problems were actually growing. Central banks around the world were forced to admit that their benign assessment of the impact of commodity price inflation had been mistaken. This led, in a few short weeks between roughly early May to early June, to a near-180 degree reversal in expectations regarding inflation, interest rates and the focus of monetary policy around the world. As if regretting their lapse into monetary laxity during the financial crisis, central bankers are now competing over who can make the toughest statements.
Yet the financial crisis has not gone away. It merely abated under the impact of the flood of liquidity released by the central banks – primarily the Fed – between September and April. But that is all liquidity under the bridge now. Future prospects have swung from monetary loosening to monetary tightening, although businesses and consumers are reeling under the pressure of soaring prices for oil, steel, corn and all the rest. It has become clear that the improvement in share markets stemmed mostly from the rise in oil and resource companies. Banks and most other financials never recovered – indeed they are at much lower levels than they were in March.
So let’s sum up, short and sharp. The worst is not behind us. The worst is ahead. More inflation, worse recession and an ongoing financial crisis. The global economy is heading into winter and the markets are going from spring to fall. Summer’s gone on a long vacation.