The fallout is already producing some clear winners and losers.

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Events have moved so fast in the financial markets in the last two weeks that it has become difficult to make reliable assessments of what might happen two days hence, let alone on any more normal investment horizon. The sequence of events that has taken out Fannie Mae and Freddie Mac, Lehman Brothers, AIG and HBOS/Lloyds TSB (plus whatever other events may have unfolded in the days between this column being written and it appearing in print) is unprecedented in terms of the speed and drama with which they have unfolded.
 
It is surely no accident that gold should record its largest one day percentage rise of all time last week. A financial system that relies on confidence has been shaken to its core and the barbarous relic has not lost its role as the kneejerk safe haven in times of financial crisis. This column was however wrong to predict that the banking system was set for a period of “boring consolidation”. The consolidation is certainly happening, but nobody could describe the process as remotely “boring”.
 
Nor can anyone doubt that the consequences of the vortex that has gripped the financial world will be far-reaching and enduring. Politicians and regulators will be rewriting the rules of the financial game for years to come, with - inevitably - many unintended and undesirable consequences.  Public sector solutions to private sector woes are almost invariably sub-optimal, and the more politicised the process becomes, the worse the damage that can ensure. These adverse consequences will be part of the price that the financial system has to pay for the excesses of the last few years.
 
The fallout is already producing some clear winners and losers, even if the way that rewards and penalties are being distributed is grossly disproportionate.  Rarely has Ben Franklin’s comment that “fortune favours the prepared mind” been so amply vindicated. After years of being left behind, and even derided for their lack of ambition, for example, a handful of prudently and cautiously managed banks are finally collecting outsize dividends in the form of opportunities to buy massive amounts of market share from crumbling rivals at what look like bargain basement prices.
 
For those with long memories and a sense of history, the drama is also throwing up some extraordinary denouements. It is one thing to come to terms with the idea of Merrill Lynch having made itself so vulnerable that it should be humiliatingly knocked down to a rival over the course of a weekend, startling though that idea still is. Investment banking has always lived by its own bizarre rules and as a result nothing ever completely surprises.
 
But who with any sense of financial history would have thought that an institution such as HBOS, which was set up to combine the stolidity of the UK’s largest mortgage lender with the dour penny-pinching rectitude of the Bank of Scotland, should one day find itself hounded into the arms of one of its major competitors by fears that it might go bust? Even in an age of hyperbole, that is truly an extraordinary outcome.
 
What everything that has happened in the last two weeks speaks to of course is the corrosive loss of confidence inside the banking and financial system. With the exception of Northern Rock, which lost the confidence of its depositors after the opportunity of a rescue was bunglingly lost last year, the cancer that has been eating away at the financial system for most of the last year has not been a failure of nerve by consumers, the traditional source of banking troubles.
 
It has been the banks themselves and their counterparties which have lost faith in the value of their balance sheets. They have looked into the potential abyss of unmeasurable losses from loans and credit instruments they themselves have helped to invent and sell and been found wanting in nerve. The fact that the board of HBOS was prepared to sell out the whole bank for a price that is below that of the deeply discounted rights issue it launched only a few short weeks ago is just one of many testimonies to this huge failure of confidence.
 
The other remarkable feature of the current crisis is that it has been both a long time coming and so widely predicted. Jeremy Grantham memorably described the process a few weeks ago as like “watching a slow motion train crash”. Ian Rushbrook at Personal Assets first pointed out the dangers in the reckless expansion of the US mortgage market at least three years ago. My own conversion to the market implosion thesis was sealed 10 months ago when I learned first hand that senior central bankers were themselves scared stiff of what might happen and did not really know how to respond.
 
The one bright element in all this is the dramatic intensity of recent events has more of the hallmarks of a bear market climax than any earlier phase in the credit crunch. Emerging markets and commodities have both now joined in sharp market declines, two necessary conditions for a renewed bull market. Financials collectively seem to have found a temporary floor in July. Investor sentiment has moved from anxious towards fearful.
 
Because of the scale of the global crisis, and its unfathomable complexity, it is impossible to be sure that the climax has yet arrived. There may well be worse to come, as George Soros and others say. The best that can be said is that the building blocks for an eventual recovery are at least starting to move into place. When bankers regain their own nerve, the sun will one day shine again.




Jonathan Davis
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