Experts divided over whether good times are back

Source : Straits Times - 3 May 2008

Is the global financial crisis really over? Many in the financial industry seem to think so.
On Thursday, Britain’s central bank suggested that the credit crisis was easing, saying the market has been overly pessimistic in valuing certain assets which now even look like bargains.

But a number of economists continue to caution that much of the optimism is misplaced. The full extent of the crisis, they say, has yet to wend through the wider economy, and may be the trigger for a long-overdue unwinding of economic imbalances that have built up in recent years.

Echoing earlier optimistic comments by heads of investment banks, the Bank of England (BOE) said that ‘while there remain downside risks, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months’.

Mr John Gieve, a BOE deputy governor, said in the bank’s twice-yearly Financial Stability Report that ‘the pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals’.

The report added, ‘As uncertainty falls and market liquidity improves, it should become clearer that some assets appear cheap relative to credit fundamentals.’

The comments are the latest in a discussion among policymakers, bankers, economists and investors about whether the current financial and economic turmoil is nearing the end.

On Wednesday, United States Treasury Secretary Henry Paulson Jr said that credit market conditions were improving. ‘We are closer to the end of this problem than we are to the beginning,’ he told Bloomberg Television.

The International Monetary Fund has estimated that the ultimate cost will reach nearly US$1 trillion (S$1.36 trillion) in write-downs and credit losses in the current crisis. But this estimate, based on imperfect information and models, may turn out to have been unduly pessimistic, the BOE said.

Still, some economists, like Mr Julian Jessop, the chief international economist at Capital Economics in London, said that even if conditions in the financial markets improved quickly, the wider economic fallout from the credit crisis would persist for many months or even years to come.

‘Indeed, the financial crisis might be seen as simply the trigger for the long-overdue unwinding of the economic imbalances that have built up in recent years,’ he said.

Uncertainties about the extent of the economic downturn and house price declines, Mr Jessop added, will add to the risk aversion in the financial sector.

The BOE shared some of that caution in its report on Thursday, saying tight credit conditions could lead to a pickup in defaults among vulnerable borrowers, parts of the commercial property sector and some non-financial companies with a lot of debt.

The BOE cut its benchmark interest rate last month for a third time since December, to 5 per cent, while the US Federal Reserve on Wednesday lowered its benchmark rate to 2 per cent, its seventh cut since September.

The BOE, following a similar initiative by the Fed, also announced a plan to swop £50 billion (S$133.59 billion) of British government bonds for up to three years in exchange for the illiquid mortgage securities that banks were holding on their balance sheets.

But some analysts pointed out that the banks’ need for such a facility illustrated that there were still not enough buyers for these assets in the market and that their value might have to drop further.

Banks worldwide have already written off more than US$300 billion in soured investments since the crisis began last summer with the collapse of the US sub-prime mortgage market.

The BOE is conscious that the market is partly ruled by sentiment, and the bank made clear in its report that too much pessimism about valuations and persisting concerns ‘could become self-fulfilling’.

Mr James Knightley, an economist at ING Financial Markets in London, said that ‘there may be signs that the credit crunch is easing up but there are still uncertainties about write-downs, and the macro numbers will get worse before they get better’.

‘There is still so much uncertainty that it is difficult to value the costs of the credit crisis, and there are so many shifts and turns in sentiment that it’s impossible to predict any timeframe,’ he said.

PROBLEMS WILL PERSIST
‘The financial crisis might be seen as simply the trigger for the long-overdue unwinding of the economic imbalances that have built up in recent years.’ - MR JULIAN JESSOP, chief international economist at Capital Economics in London, who believes the wider economic fallout from the credit crisis will persist for many months or even years

STILL TOO EARLY TO TELL
‘There is still so much uncertainty that it is difficult to value the costs of the credit crisis, and there are so many shifts and turns in sentiment that it’s impossible to predict any timeframe.’ - MR JAMES KNIGHTLEY, an economist at ING Financial Markets in London