As the crunch breaks bones on Wall Street and in the Square Mile, Observer writers take the fevered temperature of the masters of the universe and the minions who know only the state can save them now
* Heather Stewart in New York
* The Observer,
* Sunday March 23 2008
'Honestly? The past nine months have been sheer hell.' That was one Wall Street veteran's verdict this weekend, as weary traders fled Manhattan for the Easter break. 'You heading for the hills?' asked one, as his colleagues left the trading floor. 'Nope, for the bar,' came the reply.
It was hard to blame them, after what one called a 'seismic' week. In just five days, they had witnessed a government-brokered buyout of Bear Stearns, America's fifth-largest investment bank; a three-quarters of a percentage point cut in interest rates from the Federal Reserve; and a rash of warning signs that the American economy had already slipped into recession.
Even as traders trudged home a week earlier, on Friday 14 March, after absorbing the shocking news that the Fed had made an emergency loan of $30bn to Bear Stearns through rival bank JP Morgan, there was speculation that this was just a temporary fix. But few guessed the speed with which events would move.
Not for the Americans the slow, lingering collapse into nationalisation of Northern Rock. Before the Asian markets opened for trading last Sunday evening, Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke had rammed through an extraordinary cut-price fire sale.
Rather than take the risk that Bear Stearns's collapse could bring the entire financial system down with it, the government brokered a deal.
A year ago, Bear's shares were trading at $130 each; JP Morgan snapped it up for $2 a share. One blogger even quipped that the price tag was so low that the talk-show host Oprah Winfrey could make a counter-bid with her personal fortune. Investors were staggered. 'None of us slept much on Sunday night,' said one.
So keen was the Fed to see the deal go through that it offered to stand behind the $30bn of hard-to-sell mortgage-backed securities on Bear's balance sheet and agreed to a series of tough conditions imposed by JP Morgan boss Jamie Dimon. Shareholders will have to approve the deal in a vote; but Dimon secured a clause in the agreement saying it can be voted on repeatedly until it is sealed. JP Morgan also has the right to buy almost 20 per cent of Bear's shares at the bargain rate of $2, even if the deal is not approved.
Shell-shocked Bear staff - many of whom are likely to lose their jobs, as well as seeing their shareholdings in their employer virtually written off - are livid. There was even a rumour circulating inside the bank that Alan Schwartz, its chief executive, who had failed to reassure the markets of Bear's solvency, went to the gym on Monday night to work off some of the stress, only to be punched by a furious investor.
'Turnover is high enough in this industry that you know people who've left to work there,' said a senior employee at a rival firm. 'They're gone. They're just gone.'
As they returned to their desks on Monday morning, traders also had to absorb the fact that the Fed had cut the discount rate, at which it lends to banks, by three-quarters of a point, and extended a new emergency loan facility to investment banks, which cannot usually access Fed cash - the latest in a rapid-fire series of attempts to make extra funding available to the markets.
This package was meant to act as what Paul Sheard, chief global economist at Lehman Brothers, calls a 'circuit-breaker', to end a pernicious spiral of gossip, anxiety and downright panic.
At first, it did not appear to be working. Richard Iley, US economist at BNP Paribas, says the Fed's measures smacked of - understandable - desperation. 'Because we're in unprecedented territory, they're making it up as they go along: there's no rule book.'
This feeling perhaps contributed to the grim mood on Monday. Lehman Brothers found itself the subject of a bout of damaging gossip as traders shocked by the weekend's developments cast about for 'the next Bear', and watched its share price plunge by 30 per cent.
But after it delivered better than expected results on Tuesday, Lehman bounced back: helped, some insiders said, by a series of stern phone calls from the Fed to various market players about the consequences of irresponsible rumour-mongering.
The Fed added another dose of confidence-boosting medicine on Tuesday lunchtime, with a three-quarter-point cut in its key target rate. It has now slashed borrowing costs by three percentage points - from 5.25 per cent to 2.25 per cent - since the crisis began.
Share prices rocketed, as investors cheered the Fed's resolve, and recovered some of their faith in banks and other financial institutions. The Dow Jones closed up a stunning 420 points.
By Wednesday, though, the jitters were back. The New York Stock Exchange's grand neo-classical façade was swathed in a giant banner, celebrating the record-breaking $18bn market debut of credit card firm Visa, as if to say, 'credit crunch, what credit crunch?' But as the rain lashed down, traders lost their nerve, and the markets fell yet again.
Finally, as the sun broke through the clouds on Thursday afternoon and Wall Street's finest began to anticipate a quiet long weekend, the pendulum swung back and investors went on a buying spree, sending the Dow Jones back up by more than 250 points.
On Lehman's giant trading floors, at its headquarters on Seventh Avenue, an atmosphere of calm chatter had replaced the vertigo of Monday, when its very solvency was being questioned by panic-stricken investors.
Across the road, in Starbucks - another American icon in trouble - chino-clad bankers swung in, glued glumly to their Blackberries, grabbed unfeasibly large vats of coffee to keep them going until the end of the week, and bustled out. 'I'm going to be bouncing off the walls!' yelled one exhausted young man.
In normal times, each of this week's daily market moves would be extraordinary; strung together, they added up to a nerve-shredding week, the like of which few can remember. Dark mutterings about 'the next domino' have not gone away, with credit derivatives - complex bets on how likely a borrower is to default - high on the list.
It emerged on Thursday that Merrill Lynch is suing monoline insurer XL Capital Assurance over six such 'credit default swaps', worth more than $3bn. The weakness of these monoline insurers, which offer guarantees covering many of the investment banks' huge bets, has already caused alarm.
TJ Marta, fixed income strategist at RBC Capital Markets in New York, says financial whizz kids have looked on with horror at the chaos they have unleashed. 'We have created an alternative universe, which means that any stresses in the mortgage market are going to create 100 or 1,000 times the losses in the financial system. Bernanke is trying to manage a controlled implosion. He is recklessly, bravely, heroically - choose your adjective - trying to take this down.'
Lehman's Sheard says he sees the current crisis as nothing less than 'a challenge to the architecture of the modern capital markets system'.
Meanwhile, far away from Wall Street and the Fed, house prices are continuing to fall - and that will send shockwave after shockwave through the byzantine financial architecture built to bet on an ever-rising property market.
Jan Hatzius, Goldman Sachs's chief US economist, who has taken a bird's-eye view of the crisis from his eyrie on the 45th floor, overlooking the Manhattan skyline, says that every financial crisis boils down to a mistaken belief. In the late 1990s, enthusiastic investors thought hi-tech companies were somehow different from old-fashioned firms, so the standard models for valuing them could be chucked away. They were wrong. And this time, everyone, from struggling households to the best-paid maths PhDs in New York, believed that US house prices could never fall.
'This is not a sub-prime crisis, it's a housing and mortgage crisis,' Hatzius says. 'It seems very likely that we are in recession at this point; and over time things are likely to deteriorate further: in particular, the big worry is that it's going to bring more problems for the banks and financial institutions - which then feed back into the real economy.'
According to Ken Goldstein, at the Conference Board, which monitors public opinion, 75 per cent of Americans already believe their economy is in recession - and the Fed's comforting rate cuts are not reaching them. 'For the ordinary Joe from Cincinnati, he hears about the Fed cutting interest rates by 75 points, and he is sitting there saying, "My mortgage, my car loan, my credit card, is not changing."'
In bustling Manhattan, where shoppers were heading out to snap up some Easter bargains on Friday, it was difficult to spot much sign of hard times - but people do say their costs are rising.
'Everything is going up,' says Ahmed, who works six days a week to support his family. 'We are middle class, and feel a lot of problems: the gas price, everything.' There is a thriving debate about the shape of the coming downturn. Ian Morris, of HSBC, is expecting a 'w'. 'The big picture is that this is a banking-based economic downturn, and they tend to be long-lasting: it's quite different to what happened after the tech bust in 2001.'
Later this year, US households and businesses will receive a huge, one-off financial boost from a $150bn package of tax rebates agreed by Congress - they will literally get a cheque in the post.
That, Morris argues, should help to kick-start spending, helping the economy for a short while at least. By early 2009, however, he believes Bush's successor in the White House will have to reach for the tax-cut weapon once again, as the effects of the first boost wear off and the economy slumps.
Sheard, too, is braced for a long haul. 'It's a slow-moving shock: it's not a knock-out punch, it's a series of body blows.'
Experts increasingly believe there will have to be direct, taxpayer-funded intervention in the housing market, to stop prices falling. Amid the pandemonium last week, the regulator that controls the taxpayer-backed mortgage funds (nicknamed Freddie Mac and Fannie Mae) loosened the rules, allowing them to buy larger loans, in the hope that fresh funds will be released to borrowers.
Nariman Behravesh, of Massachusetts-based consultancy Global Insight, says: 'What's needed is for the government to come to some sort of rescue. I believe that Congress and the administration will come under pressure to do something - and it is an election year. There's much better than a 50-50 chance that we get some action in the next few months.'
The financial panic may be over for the time being, at the steep cost of the sacrifice of a venerable Wall Street investment bank, sold for a song. But that is only likely to throw the focus back on the health of the economy - and that looks grim. As one Wall Street watcher sighed at the end of the week: 'It's a cliche, I know - but we're not out of the woods yet.'
Tales of the turmoil
· Joe Lewis, the East End-born billionaire investor, lost his magic touch, ploughing heavily into Bear Stearns - even hours before it collapsed. The Barbados-based trader's losses in Bear could top $1bn. Lewis, close mates with Tiger Woods, rarely acts alone in his daring raids. Did his regular compadres, the Irish horse-racing tycoons John Magnier and JP McManus, along with Dermot Desmond, also pile in?
· Bear Stearns's buyer was JP Morgan. What is the venerable bank's exposure to credit default swaps? Potentially up to $3.5 trillion - almost a third of the United States economy - according to one informed estimate. What is the current value of these assets? Despite requests, JP Morgan fails to answer.
· There are suggestions that Irish government officials are holding talks with its banking sector over the possibility of merging certain institutions to mitigate huge exposure to the commercial property market, where values have dropped in some areas by a third.
· Deal-mad Robert Tchenguiz is taking a well deserved breather this Easter weekend in the south of France. Many bystanders reckon his labyrinthine business empire, encompassing shares, property and leisure businesses, is leveraged to the hilt and he is facing steep margin calls. Suggestions that he was hurting after last week's decision to pull the sale of Somerfield, the supermarket group in which he owns a large stake, are given short shrift. Don't you need liquidity, Robert? 'If I relied on the sale of Somerfield, I would not be a good business manager,' he responds.
· Major wheat exporters Russia, Argentina and Kazakhstan have imposed export tariffs to maintain supplies at home. Russia has also slapped higher tariffs on fertiliser. More food for thought for those who believe conditions today are eerily reminiscent of the Thirties.
· Guy Hands, the Meat Loaf fan who owns EMI, may increasingly invest overseas because of new UK tax regulations on capital gains. If only capital gains were an issue at EMI, which the Terra Firma chief bought for £2.3bn. The odds on Hands making this deal work are one in 10, according to many, as the label struggles under the weight of 'insanely' high debt. The debt is owned by Citigroup. There have not been many volunteers to take it off its ... er ... hands.
· Is this a new form of California Soul? Lawmakers in the Golden State are to vote on barring its powerful pension funds from investing with private equity firms owned by sovereign wealth funds linked to countries with poor human rights records. Will legislators in other jurisdictions follow?
· Is it true that a bank property chief laid off staff while at the real estate industry's annual schmoozefest at Cannes?
· There were no signs of a credit crunch last Thursday at the private view of the latest exhibition of the work of Billy Childish, Tracey Emin's ex. Pictures worth several thousands flew off the Aquarium gallery's wall in Clerkenwell. Earlier in the week, the Affordable Art Fair had more than 22,500 people spending £5m in 40 hours at Battersea Park. But in New York, Sotheby's failed to sell the four most expensive items, valued at $10m, at an auction of Chinese antiquities.
Nick Mathiason
It was hard to blame them, after what one called a 'seismic' week. In just five days, they had witnessed a government-brokered buyout of Bear Stearns, America's fifth-largest investment bank; a three-quarters of a percentage point cut in interest rates from the Federal Reserve; and a rash of warning signs that the American economy had already slipped into recession.
Even as traders trudged home a week earlier, on Friday 14 March, after absorbing the shocking news that the Fed had made an emergency loan of $30bn to Bear Stearns through rival bank JP Morgan, there was speculation that this was just a temporary fix. But few guessed the speed with which events would move.
Not for the Americans the slow, lingering collapse into nationalisation of Northern Rock. Before the Asian markets opened for trading last Sunday evening, Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke had rammed through an extraordinary cut-price fire sale.
Rather than take the risk that Bear Stearns's collapse could bring the entire financial system down with it, the government brokered a deal.
A year ago, Bear's shares were trading at $130 each; JP Morgan snapped it up for $2 a share. One blogger even quipped that the price tag was so low that the talk-show host Oprah Winfrey could make a counter-bid with her personal fortune. Investors were staggered. 'None of us slept much on Sunday night,' said one.
So keen was the Fed to see the deal go through that it offered to stand behind the $30bn of hard-to-sell mortgage-backed securities on Bear's balance sheet and agreed to a series of tough conditions imposed by JP Morgan boss Jamie Dimon. Shareholders will have to approve the deal in a vote; but Dimon secured a clause in the agreement saying it can be voted on repeatedly until it is sealed. JP Morgan also has the right to buy almost 20 per cent of Bear's shares at the bargain rate of $2, even if the deal is not approved.
Shell-shocked Bear staff - many of whom are likely to lose their jobs, as well as seeing their shareholdings in their employer virtually written off - are livid. There was even a rumour circulating inside the bank that Alan Schwartz, its chief executive, who had failed to reassure the markets of Bear's solvency, went to the gym on Monday night to work off some of the stress, only to be punched by a furious investor.
'Turnover is high enough in this industry that you know people who've left to work there,' said a senior employee at a rival firm. 'They're gone. They're just gone.'
As they returned to their desks on Monday morning, traders also had to absorb the fact that the Fed had cut the discount rate, at which it lends to banks, by three-quarters of a point, and extended a new emergency loan facility to investment banks, which cannot usually access Fed cash - the latest in a rapid-fire series of attempts to make extra funding available to the markets.
This package was meant to act as what Paul Sheard, chief global economist at Lehman Brothers, calls a 'circuit-breaker', to end a pernicious spiral of gossip, anxiety and downright panic.
At first, it did not appear to be working. Richard Iley, US economist at BNP Paribas, says the Fed's measures smacked of - understandable - desperation. 'Because we're in unprecedented territory, they're making it up as they go along: there's no rule book.'
This feeling perhaps contributed to the grim mood on Monday. Lehman Brothers found itself the subject of a bout of damaging gossip as traders shocked by the weekend's developments cast about for 'the next Bear', and watched its share price plunge by 30 per cent.
But after it delivered better than expected results on Tuesday, Lehman bounced back: helped, some insiders said, by a series of stern phone calls from the Fed to various market players about the consequences of irresponsible rumour-mongering.
The Fed added another dose of confidence-boosting medicine on Tuesday lunchtime, with a three-quarter-point cut in its key target rate. It has now slashed borrowing costs by three percentage points - from 5.25 per cent to 2.25 per cent - since the crisis began.
Share prices rocketed, as investors cheered the Fed's resolve, and recovered some of their faith in banks and other financial institutions. The Dow Jones closed up a stunning 420 points.
By Wednesday, though, the jitters were back. The New York Stock Exchange's grand neo-classical façade was swathed in a giant banner, celebrating the record-breaking $18bn market debut of credit card firm Visa, as if to say, 'credit crunch, what credit crunch?' But as the rain lashed down, traders lost their nerve, and the markets fell yet again.
Finally, as the sun broke through the clouds on Thursday afternoon and Wall Street's finest began to anticipate a quiet long weekend, the pendulum swung back and investors went on a buying spree, sending the Dow Jones back up by more than 250 points.
On Lehman's giant trading floors, at its headquarters on Seventh Avenue, an atmosphere of calm chatter had replaced the vertigo of Monday, when its very solvency was being questioned by panic-stricken investors.
Across the road, in Starbucks - another American icon in trouble - chino-clad bankers swung in, glued glumly to their Blackberries, grabbed unfeasibly large vats of coffee to keep them going until the end of the week, and bustled out. 'I'm going to be bouncing off the walls!' yelled one exhausted young man.
In normal times, each of this week's daily market moves would be extraordinary; strung together, they added up to a nerve-shredding week, the like of which few can remember. Dark mutterings about 'the next domino' have not gone away, with credit derivatives - complex bets on how likely a borrower is to default - high on the list.
It emerged on Thursday that Merrill Lynch is suing monoline insurer XL Capital Assurance over six such 'credit default swaps', worth more than $3bn. The weakness of these monoline insurers, which offer guarantees covering many of the investment banks' huge bets, has already caused alarm.
TJ Marta, fixed income strategist at RBC Capital Markets in New York, says financial whizz kids have looked on with horror at the chaos they have unleashed. 'We have created an alternative universe, which means that any stresses in the mortgage market are going to create 100 or 1,000 times the losses in the financial system. Bernanke is trying to manage a controlled implosion. He is recklessly, bravely, heroically - choose your adjective - trying to take this down.'
Lehman's Sheard says he sees the current crisis as nothing less than 'a challenge to the architecture of the modern capital markets system'.
Meanwhile, far away from Wall Street and the Fed, house prices are continuing to fall - and that will send shockwave after shockwave through the byzantine financial architecture built to bet on an ever-rising property market.
Jan Hatzius, Goldman Sachs's chief US economist, who has taken a bird's-eye view of the crisis from his eyrie on the 45th floor, overlooking the Manhattan skyline, says that every financial crisis boils down to a mistaken belief. In the late 1990s, enthusiastic investors thought hi-tech companies were somehow different from old-fashioned firms, so the standard models for valuing them could be chucked away. They were wrong. And this time, everyone, from struggling households to the best-paid maths PhDs in New York, believed that US house prices could never fall.
'This is not a sub-prime crisis, it's a housing and mortgage crisis,' Hatzius says. 'It seems very likely that we are in recession at this point; and over time things are likely to deteriorate further: in particular, the big worry is that it's going to bring more problems for the banks and financial institutions - which then feed back into the real economy.'
According to Ken Goldstein, at the Conference Board, which monitors public opinion, 75 per cent of Americans already believe their economy is in recession - and the Fed's comforting rate cuts are not reaching them. 'For the ordinary Joe from Cincinnati, he hears about the Fed cutting interest rates by 75 points, and he is sitting there saying, "My mortgage, my car loan, my credit card, is not changing."'
In bustling Manhattan, where shoppers were heading out to snap up some Easter bargains on Friday, it was difficult to spot much sign of hard times - but people do say their costs are rising.
'Everything is going up,' says Ahmed, who works six days a week to support his family. 'We are middle class, and feel a lot of problems: the gas price, everything.' There is a thriving debate about the shape of the coming downturn. Ian Morris, of HSBC, is expecting a 'w'. 'The big picture is that this is a banking-based economic downturn, and they tend to be long-lasting: it's quite different to what happened after the tech bust in 2001.'
Later this year, US households and businesses will receive a huge, one-off financial boost from a $150bn package of tax rebates agreed by Congress - they will literally get a cheque in the post.
That, Morris argues, should help to kick-start spending, helping the economy for a short while at least. By early 2009, however, he believes Bush's successor in the White House will have to reach for the tax-cut weapon once again, as the effects of the first boost wear off and the economy slumps.
Sheard, too, is braced for a long haul. 'It's a slow-moving shock: it's not a knock-out punch, it's a series of body blows.'
Experts increasingly believe there will have to be direct, taxpayer-funded intervention in the housing market, to stop prices falling. Amid the pandemonium last week, the regulator that controls the taxpayer-backed mortgage funds (nicknamed Freddie Mac and Fannie Mae) loosened the rules, allowing them to buy larger loans, in the hope that fresh funds will be released to borrowers.
Nariman Behravesh, of Massachusetts-based consultancy Global Insight, says: 'What's needed is for the government to come to some sort of rescue. I believe that Congress and the administration will come under pressure to do something - and it is an election year. There's much better than a 50-50 chance that we get some action in the next few months.'
The financial panic may be over for the time being, at the steep cost of the sacrifice of a venerable Wall Street investment bank, sold for a song. But that is only likely to throw the focus back on the health of the economy - and that looks grim. As one Wall Street watcher sighed at the end of the week: 'It's a cliche, I know - but we're not out of the woods yet.'
Tales of the turmoil
· Joe Lewis, the East End-born billionaire investor, lost his magic touch, ploughing heavily into Bear Stearns - even hours before it collapsed. The Barbados-based trader's losses in Bear could top $1bn. Lewis, close mates with Tiger Woods, rarely acts alone in his daring raids. Did his regular compadres, the Irish horse-racing tycoons John Magnier and JP McManus, along with Dermot Desmond, also pile in?
· Bear Stearns's buyer was JP Morgan. What is the venerable bank's exposure to credit default swaps? Potentially up to $3.5 trillion - almost a third of the United States economy - according to one informed estimate. What is the current value of these assets? Despite requests, JP Morgan fails to answer.
· There are suggestions that Irish government officials are holding talks with its banking sector over the possibility of merging certain institutions to mitigate huge exposure to the commercial property market, where values have dropped in some areas by a third.
· Deal-mad Robert Tchenguiz is taking a well deserved breather this Easter weekend in the south of France. Many bystanders reckon his labyrinthine business empire, encompassing shares, property and leisure businesses, is leveraged to the hilt and he is facing steep margin calls. Suggestions that he was hurting after last week's decision to pull the sale of Somerfield, the supermarket group in which he owns a large stake, are given short shrift. Don't you need liquidity, Robert? 'If I relied on the sale of Somerfield, I would not be a good business manager,' he responds.
· Major wheat exporters Russia, Argentina and Kazakhstan have imposed export tariffs to maintain supplies at home. Russia has also slapped higher tariffs on fertiliser. More food for thought for those who believe conditions today are eerily reminiscent of the Thirties.
· Guy Hands, the Meat Loaf fan who owns EMI, may increasingly invest overseas because of new UK tax regulations on capital gains. If only capital gains were an issue at EMI, which the Terra Firma chief bought for £2.3bn. The odds on Hands making this deal work are one in 10, according to many, as the label struggles under the weight of 'insanely' high debt. The debt is owned by Citigroup. There have not been many volunteers to take it off its ... er ... hands.
· Is this a new form of California Soul? Lawmakers in the Golden State are to vote on barring its powerful pension funds from investing with private equity firms owned by sovereign wealth funds linked to countries with poor human rights records. Will legislators in other jurisdictions follow?
· Is it true that a bank property chief laid off staff while at the real estate industry's annual schmoozefest at Cannes?
· There were no signs of a credit crunch last Thursday at the private view of the latest exhibition of the work of Billy Childish, Tracey Emin's ex. Pictures worth several thousands flew off the Aquarium gallery's wall in Clerkenwell. Earlier in the week, the Affordable Art Fair had more than 22,500 people spending £5m in 40 hours at Battersea Park. But in New York, Sotheby's failed to sell the four most expensive items, valued at $10m, at an auction of Chinese antiquities.
Nick Mathiason
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