Nothing to fear from Y2K but ourselves
News Analysis: Mass hysteria in the run-up to the millennium could wreak more damage in the financial markets than the bug itself
Thursday 09 September 1999
At one stage this date was thought to pose as big a threat to the world economy as Y2K itself. As it turns out, few are expecting more than the odd hitch, in the developed world at least.
None the less, if the threat posed by the millennium bug is as real as the computer industry has claimed, we can expect serious problems to start emerging from now on. If nothing else the 9.9.99 date serves as a sharp reminder that the danger is still out there.
Two Y2K disaster movies are scheduled for release in the next couple of months, suggesting that, real or not, the perceived nature of the problem is expected to have a profound psychological effect. Having satisfied themselves that the necessary remedial action has been taken, financial authorities in the West have started to concentrate on heading off mass hysteria, a possibility which, paradoxically, may end up doing more harm than the bug itself.
On Tuesday, John Koskinen, chairman of the US president's council on Year 2000 Conversion, and Arthur Levitt, chairman of the US Securities & Exchanges Commission, congratulated Wall Street on its effort to ensure that come 1 January 2000, it will be business as usual.
In the UK, Michael Foot, head of banking supervision at the Financial Services Authority, has been similarly effusive in his tribute to British financial firms' efforts to get the Y2K house in order.
The public, however, remains unconvinced. Unilever, one of the world's biggest suppliers of foodstuffs, cosmetics and detergents, has already detected signs of panic buying by retailers trying to ensure that they do not run out of stocks in the next few months.
Treasury forecasters are anticipating that a surge in demand in the fourth quarter will have a noticeable effect on UK GDP. The effect is likely to be equally dramatic the other side of the New Year, as we rein in our spending to pay off our credit card bills and eat our way through our stock- piled cans of baked beans.
Vikas Nath, year 2000 global project coordinator for Credit Suisse First Boston, the investment bank, says this panic buying is a global phenomenon, by no means restricted to the consumer industries. "Of the banks we have surveyed, most are anticipating hard cash withdrawal in the run up to the millennium. At the same time more industrials are planning to stock up inventory," he says.
The trouble is that the surge in millennium-related activity in the real economy is coinciding with a growing wariness by those who provide capital. This unfortunate conjecture could be far more destabilising than even a sizeable computer failure in a single financial institution.
Stephen Lewis, chief economist at Monument Derivatives, says: "The financial markets are extremely apprehensive of Y2K disruption." As such it becomes a self-fulfiling prophecy. "Their fear," he says, "is that the financial markets will be highly illiquid ahead of the year-end, precluding all fund-raising possibilities until the extent of any Y2K problems becomes clear. Since the view that the markets will be illiquid is widespread, it follows that they will be illiquid."
Monetary authorities around the world are seeking to anticipate a repeat of last autumn when the introduction of the euro resulted in a sharp fall in market activity towards the year-end. Last week Hong Kong's Monetary Authority joined the US Federal Reserve and our own Bank of England in pledging to provide liquidity to the markets in order to keep the wheels turning in the run up to 1 January.
With this in mind, some believe yesterday's rise in interest rates from the Bank of England will be the last we see from any leading central bank in the run up to Christmas. Mr Nath says: "They [central banks] would look pretty silly raising rates in October just when they are about to increase liquidity to cope with Y2K."
This activism could bring other problems. The liquidity injected ahead of the New Year would presumably have to be mopped up later through a tightening of policy, and this might take place just as economies are weakening after the pre-millennium spending binge.
Of more immediate concern is the fact that the central banks foresaw this liquidity crunch being a temporary problem that would not affect the markets until the end of the year. But some of the effects are already visible. Investors have already made it clear that they will not be taking any new equity issues much beyond October. Demand for bonds, particularly high-yield corporate debt, is already drying up. In the US, estimates of the new corporate bond issuance in the pipeline for September range from $25bn to $100bn.
This spike in demand is having a knock-on effect on both yields (the price investors demand for taking the bonds) and on swaps spreads (the margin at which companies can trade their debt from floating rate to fixed rate). These have surged to crisis levels. For some categories of issuer the market is already closed to new finance. Emerging market spreads are 1100 to 1200 basis points (11 to 12 per cent) above US Treasuries. In normal times the spread is close to 300 to 400 basis points.
The nation that is most computer dependent and most worried about the Y2K, America, is also the biggest global investor. Although Europeans are more sanguine, the Americans have already decided that most of the world outside the OECD is no go, despite evidence that some emerging market economies are better prepared than outsiders think.
The reluctance of big commercial lenders to take the risk means many are pulling out offragile economies just when they need the finance most. Several big sovereign borrowers are due to refinance their public sector debt over the next few months. The impact on their domestic economies of having to refinance the debt at prohibitive rates of interest could be disastrous. Mr Nath says: "There are tectonic plates moving in opposite directions. They will brush against each other. The question is where and how big will be the earthquakes. At the very worst these countries will be so starved of capital it may derail economic recovery. Worst risk premiums will rise, making it more expensive for these countries to borrow."
However, most anecdotal evidence suggests market fears are overblown. Tim Johnson of Ovum, the technology consultancy, reckons the doomsday scenario is way off beam. "We would have seen much more of it if there was going to be meltdown," he argues.
There have been some embarrassing computer failures this year, he says, though mostly as a result of teething problems with new systems being brought in early to replace older ones that failed the millennium tests. In one case, the Bank of Scotland's international payment system went down. More spectacular was the failure of the satellite guidance system on which most of Tokyo's taxi drivers rely. Like most experts, Mr Johnson believes the real issue now is the psychological one. "The whole thing has gone beyond a computer problem and entered the realm of urban myth. Y2K now is a social phenomenon," he says.
The risk of a panic run on one or more financial institutions is one that regulators are more concerned about than they will publicly admit. One UK bank has contingency plans to ensure that none of its cash dispensers run out of money over the millennium weekend in order to avoid the risk that any failure to give out cash is put down to a Y2K computer glitch.
"There is going to be a bank somewhere, possibly more than one, that has made a hash of it and will get egg on its face," says Mr Johnson at Ovum.
The authorities are probably right to say that the prospect of a major failure is slim. But in the current mood, even one fairly insignificant failure might be enough to set off a stampede.
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