Dow plunges below 8,000 to five-year low

New turmoil in global bond markets on commercial mortgage fears

Stephen Foley,Sean O'Grady
Thursday 20 November 2008 02:00 GMT

Renewed turmoil on the world's debt markets signalled the credit crisis is far from over, and sent share prices plunging on both sides of the Atlantic.

With relentlessly grim economic news and emerging signs of deflation as a backdrop, traders were also yesterday watching the plunging value of securities backed by mortgages on commercial property.

Citigroup, the US financial giant, lost more than a fifth of its value on concerns about its exposure to so-called commercial mortgage-backed securities (CMBS) and other debt instruments. Financial stocks led the way down on stock markets in New York and in London.

In the UK, the minutes of the last meeting of the Bank of England's Monetary Policy Committee (MPC) showed members were so worried about the economy they considered an even bigger reduction in interest rates than the dramatic 1.5 percentage-point cut they delivered. And in the US, figures revealed the cost of living fell by the most on record and builders started work on fewer homes last month since at least the 1960s, as the recession bit more deeply into the world's largest economy.

The FTSE 100 ended down 4.8 per cent at 4,005.68, while the Dow Jones Industrial Average lost 5.1 per cent of its value at 7,997.3, as it closed below 8,000 for the first time since 2003.

Traders have begun to fear that the trillions of dollars pumped into the financial system by governments and central banks around the world may not be enough to end the credit crisis.

The deputy governor of the Bank of England responsible for financial stability, Sir John Gieve, indicated policymakers are far from confident, too.

Sir John said: "Financial markets across the world are still badly impaired; spreads have not yet returned to their summer levels; and, while banks look more secure, many hedge funds for example are under increased pressure. In the wider economy, we are only in the early stages of a recession in the advanced economies and of the slowdown in emerging markets. So we must be ready to take further action if required, whether monetary, fiscal, or directly in the financial sector."

CMBS prices slumped for the second consecutive day, amid concerns that the owners of some of the world's biggest office developments might default on their mortgages. In a parallel to the sub-prime mortgage crisis in the residential property market, commercial mortgages have been packed together and sold as CMBS to banks and hedge funds across the world.

The cost of insuring CMBS and corporate bonds rose sharply in yesterday's nervous atmosphere, and investors fled for safe US government bonds, pushing their interest rates sharply lower.

Citigroup has more than $16bn (£10.7bn) of exposure to CMBS, and after four consecutive quarters of losses is seen as ill-equipped to deal with more writedowns. It has been trying to raise money by selling assets and business divisions, and has taken $25bn in US government bailout money, but its shares continued their collapse yesterday.

Other US financial stocks hit included Goldman Sachs, the mighty investment bank, which ended at its lowest since floating in 1999. In the UK, HSBC was down 8 per cent on concerns over its financial strength going into a global economic downturn.

The plunging price of oil and other commodities on the world's markets has begun feeding through to petrol and food prices, and where only a few months ago policymakers were concerned about inflation they are now faced with a more dangerous spectre: deflation. The US consumer price index fell 1 per cent in October, its sharpest decline since records began in 1947, and even core inflation, stripping out food and energy, unexpectedly fell. Meanwhile, builders began construction on fewer new homes in the US in October, for the fourth month in a row. Housing starts were 38 per cent below the rate of a year ago, as demand and prices continue to be depressed.

In the UK, publication of the minutes of the last MPC meeting fuelled fears of a deep recession and strengthened the belief that the Bank is determined to cut interest rates aggressively. At its last meeting on 6 November, the committee considered slashing interest rates by more than 2 percentage points before settling for a 1.5 percentage-point cut. The MPC voted unanimously for the cut to 3 per cent, the lowest cost of borrowing in more than half a century. Its members did not want to surprise the markets too much, and seemed keen to keep something in reserve for future cuts.

City economists agreed more cuts would depend on the scale of the tax cuts and spending increases in the pre-Budget report. Howard Archer, of Global Insight, said: "If the Government's planned stimulus is at the top end of the £15bn-£30bn range being bandied about, then the Bank is unlikely to cut interest rates by more than 50 basis points from 3 per cent to 2.5 per cent in December. However, a smaller fiscal stimulus could see the bank cut interest rates by up to 100 basis points next month. Interest rates seem ever more likely to fall as low as 1 per cent in 2009."

News from the economy continues to worsen. The CBI's latest industrial trends survey revealed confidence about output is at its slowest level since 1980.

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