Until America gets better, we're all ill

26 September 2008
There's an age-old adage in the financial world, that when America sneezes, the world catches a cold. But given events over the past year and past fortnight it seems that America is sneezing loudly, and we've caught the flu.

We've seen our house prices plummet in value, sales grind to a standstill, mortgage funding dry up, the demise and nationalisation of Northern Rock, the extension of the financial compensation scheme, rising unemployment, while mortgage lenders have posted paltry profits. The Bank of England has pumped billions into the money market, we've seen volatile stockmarkets, the banning of short-selling and the household names of Alliance & Leicester and HBOS taken over by Santander and Lloyds. Yes, our financial services industry is really suffering.

But if we think we've it bad, spare a thought for our cousins across the pond. The home of the credit crunch has witnessed events that make our run on Northern Rock look like a drop in the ocean.

Back in March the Federal Reserve had to guarantee $29 billion to support the bail-out of investment bank Bear Stearns, a further $200 billion to sort out financial problems at the government-sponsored mortgage lenders Fannie Mae and Freddie Mac, let the 158 year-old investment bank Lehman Brothers go to the wall, while lending $85 billion to shore up the insurance giant (and sponsor of Manchester United) AIG's books.

Not only that, they are facing inflation of 5.4%, there was a 55% rise in home repossessions last month and last week unemployment figures rose to a seven-year high.

However, given the recent rejection by Congress of the planned $700 billion worth of 'distressed assets' from Wall Street, it seems good ol' George W's warning that the whole world would enter a 'long and painful recession' is unfolding in front of our eyes. The distressed assets he alludes to are mortgages that are now going bad – recent estimates state that one in 10 US mortgage holders are now 90 days or more in arrears, and one in four families with a sub-prime mortgage are seriously so.

After speaking to a US stockmarket analyst last week, the problem that those who voted no believe that by issuing more government debt it would seriously increase the budget deficit (taking it to $1.2 trillion!), which would not only be terribly inflationary, it would make the US more dependent on foreign banks (who would buy Treasury securities) and essentially ask the taxpayer to foot the bill of bankers' foolish lending practices.

It seems that if we want a clean bill of health, America needs curing first. So let's hope Congress approves the second reading of the bill on Monday. But is bailing out irresponsible banks a remedy?

I won't ever pretend to be an economist, but the fact remains that if we are to cure the US it all boils down to the frozen money markets. Banks do need to borrow and to lend to each other – something they have not really been able to do for well over a year now. We need confidence to return to the market, which would spread to our mortgages and stop house prices plummeting, our loans and our credit cards. But when this happens is anybody's guess.

Whatever happens in America one thing is clear, banks have had their fingers burnt badly by irresponsible lending and will be reluctant to do so in future. But then again, history always repeats itself - 1929 anyone?

Liam Tarry is the Staff Writer at Moneywise