Jeremy Warner's Outlook: US is slipping, but the crisis is still containable

Joe Lewis goes bottom-fishing; Insurance merger brings role reversa; Anita Roddick
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Analysis of the deeper intricacies of the present credit crunch has over the past week given way to a wider, over-arching question. Is the US economy about to slip into recession? Few observers have yet been prepared to call it, preferring, like Jean-Claude Trichet yesterday, to hedge their bets.

Summarising a meeting of G10 central bankers in Switzerland, the president of the European Central Bank said that though the outlook for the world economy had plainly become more uncertain, it was still too early to declare the long run of solid growth over. Everything hinged, he said, on what happened in the US.

One economist who has been less timid in his remarks is Martin Feldstein, head of the National Bureau of Economic Research (NBER). In Europe, a recession is defined as two consecutive quarters of declining output. In the US, the definition is a more fluid affair, but, by convention, it is always the NBER which eventually decides whether there has been one. Professor Feldstein should therefore know what he is talking about. His message is an unwelcome one. Eight of the past 10 recessions, he points out, have been preceded by the sort of collapse in housebuilding that we have seen in the United States in recent months.

Last week's relatively weak employment data seemed to remove one of the last remaining lifelines which the optimists had to cling to – namely that the US labour market remained strong. In fact, employment in the US economy now seems to be declining. The credit crunch, which is already leading to mass layoffs in the financial services industry, plainly doesn't help matters.

Yet to my mind, there is still a reasonable chance of the US avoiding recession altogether. Things are now sliding so fast in the US that if the Federal Reserve sat there and did nothing, recession would indeed become inevitable. In fact, Ben Bernanke, the chairman, is highly likely to cut interest rates at next week's meeting of the Open Markets Committee, and then continue cutting them until certain he has maintained some semblance of ongoing growth. In that sense, the credit crunch has acted as an important wake-up call. It has brought forward the time when the Fed could reasonably start cutting rates. Of course, it may already be too late for such action. Yet the other reason for thinking that even if there is a recession it ought to be short and shallow is the continued and apparently unstoppable growth of emerging markets.

Few previous US slowdowns have had the benefit of such a powerful counterweight. In past cycles, the US has succeeded in pushing the whole world into recession. The present cycle will therefore prove an important test of the growing economic might of China, India and the rest of the developing world.

In any case, recessions are no longer what they used to be, when there would be factory closures, mass unemployment, plummeting house prices and sky-high interest rates. If investors thought there was that kind of a recession coming down the line at us, the stock market would be hugely lower than it is. Its relatively muted reaction to the credit crunch so far is instructive. Investors are not yet betting on economic calamity.

This relatively sanguine prognosis still looks right to me. Slower growth is certain, and perhaps lower house prices and more subdued consumption too. Yet after the overheating of the past year, the world economy needed a bucket of water thrown over it. With luck, that's all that the present cocktail of traumas amounts to.

Joe Lewis goes bottom-fishing

Joe Lewis is as canny a market operative as they come, so, if he's bought 7 per cent of Bear Stearns, he's essentially calling the bottom not just of this stock, but of the banking sector more generally. Bear Stearns was one of the first US investment banks to be hit by the meltdown in US sub-prime mortgages, and badly so too. Its share price has suffered accordingly. If there is a bounce coming, then this one ought to bounce the highest.

But the call depends crucially on the present crisis being just a temporary aberration. My guess is that it is quite a lot more than that. The bank that emerges from the cauldron without any damage whatsoever to balance sheet and profits will be a rare example of the species indeed. Even so, the present state of blind panic in credit markets is almost certainly an over-reaction to what is still a comparatively minor problem of defaults in the US mortgage market. This has caused investors to question the pricing of credit risk more generally, prompting a painful repricing.

Yet as Bob Diamond, head of Barclays Capital, pointed out in a speech to a conference yesterday organised by Lehman Brothers, the problem is essentially one of confidence. The mass breakdown this collapse in confidence has caused is a fixable problem. As far as BarCap is concerned, Mr Diamond reports no significant losses and good progress in sorting out the mess. What's more, he sees continued growth for credit as an asset class.

In present circumstances, this latter claim may seem almost laughable, yet once the present scare is over he may quite soon be proved correct. Certainly, the present crisis already provides myriad opportunities for picking up essentially sound assets on the cheap. Joe Lewis and Bear Stearns are just the visible tip of the iceberg. Things may well get worse before they get better, but eventually there will be a massive bounce. As ever, it will be the investment bankers, now pariah figures, who benefit most.

Insurance merger brings role reversal

Nobody in the City is exactly bowled over by plans for a nil- premium merger between Clive Cowdery's Resolution and Friends Provident, but in the absence of anything better, does it really make any sense to stop it? That's what Hugh Osmond's Pearl, with 16.5 per cent of Resolution, was threatening to do, and would quite likely have succeeded but for the reversal of roles agreed yesterday by the merging parties.

Instead of the 75 per cent level of support needed to push the merger through – difficult to achieve with Mr Osmond sitting there with 16.5 per cent – Resolution now needs only 50 per cent. Other shareholders are therefore given the opportunity to accept a proposal a commercial competitor, as a minority shareholder, was trying to block.

Does Mr Osmond have any kind of a case? At just £100m, the synergies of the merger seem almost too small to be worth the bother, even if the eventual benefits are likely to prove quite a bit bigger. Resolution has just managed to find another £100m of synergies from a previous takeover. The same thing is expected to occur with Friends. All the same, it all looks a bit uninspired and the suspicion is that size is being pursued for the sake of it. If there was a worthwhile alternative, the City would stampede to accept it. So far, nobody has stepped forward other than Mr Osmond.

The ball is now firmly in his court. Pearl is a privately owned company so cannot offer paper. To stop the deal, Mr Osmond must offer cash at a decent premium to the see through price of the merger with Resolution. What's more, except in circumstances where the premium is irresistible, there can be no shilly- shallying around with tentative offers dependent on an adequate due diligence. Pearl is a commercial competitor, which makes it quite unlike an ordinary private equity bidder.

Mr Osmond claims Resolution is under-selling itself by agreeing to merge with Friends. He must now put his money where his mouth is.

Anita Roddick

There was huge sadness in the business world last night on learning about the death of Anita Roddick. This was a woman who practically invented the idea of ethical retailing in Britain. She pursued her vision with uncompromising passion, drive and energy, not primarily for the purpose of making money – which though she enjoyed its trappings she thought of as essentially vulgar – but because business was to her a force for good and dynamic change. The business world will be a drearier place without her.

j.warner@independent.co.uk

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