Leading article: The global credit crisis has entered a new dimension

There are lessons to learn from the failure of Lehman Brothers

Share
Related Topics

When the Chancellor of the Exchequer said last month that the UK faced its worst economic crisis for 60 years, he was widely criticised for being too pessimistic. After the events of the past 36 hours, it could be argued that he was not being pessimistic enough.

Add the bankruptcy of 158-year-old Lehman Brothers and the fire-sale of Merrill Lynch to the demise of Bear Stearns in March, then three of the top five names in American investment banking have now bitten the dust. One of the world's largest insurance companies, AIG, is also reported to be in trouble. The global credit crisis has taken on a whole new dimension.

Given that the immediate causes of this crisis are now well known – irresponsible lending by financial institutions, and the creation of ever-more complex credit instruments that concealed the true extent of banks' exposure – there are only three questions that are worth asking at this juncture. Is this the worst it is going to get? What can be done in the short term to mitigate the effects? And what measures can be taken to prevent any recurrence?

The news eight days ago that the US administration had given up hope of solving the mortgage crisis by free market means and taken the country's largest mortgage lenders into full public ownership ended weeks of mounting uncertainty. It seemed also to offer reassurance to borrowers that, when such large lenders were in danger, the government would have no choice but to step in. That Lehmans has been forced to seek Chapter 11 protection in the United States and to call in the administrators over here induced a new and immediate chill. The simultaneous sale of Merrill Lynch – regarded as the next most vulnerable bank – was clearly timed to pre-empt any possible domino effect. Even so, stock markets around the world fell by between 3 and 5 percentage points yesterday.

How far other banks and companies might still be contaminated by bad debt, not just in the US but in Britain and other European countries, is still unknown. But it would be foolish for shareholders and employees not to be prepared for more bad news. Those queues outside branches of Northern Rock might seem ancient history now, but it is now evident how much closer they were to the beginning of this crisis than to its end. And until the surviving banks regain confidence in each other's creditworthiness, the stagnation in lending will continue.

The message from the failure of Lehman Brothers is that the principle of moral hazard is back, or – and it hardly matters which – that there are limits to the depth of even the US Treasury's purse. There is now no reason for any bank to delay disclosing its liabilities in the hope of a bail-out. But there is no guarantee either that the pain will end here. It is lack of confidence and credibility, quite as much as any lack of money, that keeps this crisis going.

This makes mitigating the effects in the short-term that much harder. The British mortgage market has thawed a little for home-buyers with adequate liquidity and, with prices falling, first-time buyers would probably be well advised to stay out of the market for the moment. But it is businesses that face the most acute difficulties from the reluctance of banks to lend: the small companies that would, under normal circumstances, be regarded as credit-worthy risk being deprived of their life-blood along with the improvident.

Nor is it only the staff of failed banks who will suffer: the knock-on effects have still to make themselves felt in almost every sector of the economy. Higher, perhaps much higher, unemployment looks inevitable. So far, the Bank of England has – rightly – stopped short of following the Federal Reserve and reducing interest rates. But there may come a time when the pain starts to outweigh the gain.

As for trying to minimise the prospects of anything remotely similar happening again, it is clear that the regulatory regimes that failed to detect the dangers from such complex and opaque credit arrangements need a complete and urgent overhaul. Transparency and simple lines of accountability in banking must be priorities. But the temptation to fight the last war in too much fine detail should be resisted.

It may be hard to recall in present circumstances, but the flexibility that accompanied the globalisation of the past 20 years fostered more that was good than bad. It facilitated growth that brought higher living standards almost everywhere, improving the lives of ordinary people from India and China to the backwoods of America. However strict any new regulatory regime, there should be no flight to protectionism. Today's sclerosis will not be cured by regulation that simply exchanges new blockages for old.

React Now

Latest stories from i100
iJobs Job Widget
iJobs General

Recruitment Genius: Graduate Programme - Online Location Services Business

Negotiable: Recruitment Genius: What do you want to do with your career? Do yo...

Recruitment Genius: Senior QC Scientist

Negotiable: Recruitment Genius: This company is a leading expert in immunoassa...

Recruitment Genius: Development Scientist

Negotiable: Recruitment Genius: A Development Scientist is required to join a ...

Recruitment Genius: Accountant

£25000 - £100000 per annum: Recruitment Genius: This is an opportunity to join...

Day In a Page

Read Next
File: David Cameron offers a toast during a State Dinner in his honour March 14, 2012  

I saw the immigration lies a mile off - and now nobody can deny it

Nigel Farage
The Uber app allows passengers to hail a taxi with a smartphone  

Who wouldn’t like a sharing economy? Well, me, for one

Mary Dejevsky
Cameron, Miliband and Clegg join forces for Homeless Veterans campaign

Cameron, Miliband and Clegg join forces for Homeless Veterans campaign

It's in all our interests to look after servicemen and women who fall on hard times, say party leaders
Millionaire Sol Campbell wades into wealthy backlash against Labour's mansion tax

Sol Campbell cries foul at Labour's mansion tax

The former England defender joins Myleene Klass, Griff Rhys Jones and Melvyn Bragg in criticising proposals
Nicolas Sarkozy returns: The ex-President is preparing to fight for the leadership of France's main opposition party – but will he win big enough?

Sarkozy returns

The ex-President is preparing to fight for the leadership of France's main opposition party – but will he win big enough?
Is the criticism of Ed Miliband a coded form of anti-Semitism?

Is the criticism of Miliband anti-Semitic?

Attacks on the Labour leader have coalesced around a sense that he is different, weird, a man apart. But is the criticism more sinister?
Ouija boards are the must-have gift this Christmas, fuelled by a schlock horror film

Ouija boards are the must-have festive gift

Simon Usborne explores the appeal - and mysteries - of a century-old parlour game
There's a Good Girl exhibition: How female creatives are changing the way women are portrayed in advertising

In pictures: There's a Good Girl exhibition

The new exhibition reveals how female creatives are changing the way women are portrayed in advertising
UK firm Biscuiteers is giving cookies a makeover - from advent calendars to doll's houses

UK firm Biscuiteers is giving cookies a makeover

It worked with cupcakes, doughnuts and macarons so no wonder someone decided to revamp the humble biscuit
Can SkySaga capture the Minecraft magic?

Can SkySaga capture the Minecraft magic?

It's no surprise that the building game born in Sweden in 2009 and now played by millions, has imitators keen to construct their own mega money-spinner
The King's School is way ahead of the pack when it comes to using the latest classroom technology

Staying connected: The King's School

The school in Cambridgeshire is ahead of the pack when it comes to using the latest classroom technology. Richard Garner discovers how teachers and pupils stay connected
Christmas 2014: 23 best women's perfumes

Festively fragrant: the best women's perfumes

Give a loved one a luxe fragrance this year or treat yourself to a sensual pick-me-up
Arsenal vs Borussia Dortmund: Alex Oxlade-Chamberlain celebrates century with trademark display of speed and intuition

Arsenal vs Borussia Dortmund

The Ox celebrates century with trademark display of speed and intuition
Billy Joe Saunders vs Chris Eubank Jnr: When two worlds collide

When two worlds collide

Traveller Billy Joe Saunders did not have a pampered public-school upbringing - unlike Saturday’s opponent Chris Eubank Jnr
Homeless Veterans Christmas Appeal: Drifting and forgotten - turning lives around for ex-soldiers

Homeless Veterans Christmas Appeal: Turning lives around for ex-soldiers

Our partner charities help veterans on the brink – and get them back on their feet
Putin’s far-right ambition: Think-tank reveals how Russian President is wooing – and funding – populist parties across Europe to gain influence in the EU

Putin’s far-right ambition

Think-tank reveals how Russian President is wooing – and funding – populist parties across Europe to gain influence in the EU
Tove Jansson's Moominland: What was the inspiration for Finland's most famous family?

Escape to Moominland

What was the inspiration for Finland's most famous family?