January 25, 2008 | posted by Michael Baxter in US economy, credit crunch |

Despite it all, despite the holes that have been appearing in bank balance sheets, somehow it appears they have pulled it off. Well, at least they are trying. A few days ago, markets across the world were panicking, because fears were growing that the insurers who have been offering insurance against some of this nasty debt floating around the system, were themselves in trouble.

Really, there was no surprise in this revelation. Financial crises are a lot like dominos. Back in 1997 and 1998 we saw the dominos fall, first with the East Asia crisis, then the Russian credit crisis, and then the collapse of LTCM – each problem created the next. At the time, it seemed as if the world would fall into recession – but no, somehow the IMF, the Fed and then a Fed-inspired collective action by the banks to bail out Long Term Capital Management managed to save the day, and the economic growth continued.

That’s why many of the more-optimistic types feel that this time around, the crisis won’t be too bad.

Well this time, memories of the banks’ bail-out of LTCM were brought back when it emerged that the New York State insurance regulator is trying to get leading US banks to cough up around $15bn to stop the debt insurers hitting more serious problems.

It’s a case of the insured trying to help the insurers, so that the insurers can still afford to pay the insured bills. Try that next time your car has a prang. Invest some money into your insurance company before you ask them to pay up. Mind you, with the total level of cover being offered coming in at around $2.5 trillion of bonds, that $15bn won’t go very far if too many claims start coming in.

But then, the banks may be getting a little help from a billionaire. The first inkling that these insurers might have problems came when one of their number, Ambac, which insures around $555 billion worth of debt, had postponed plans to raise around $1bn worth of credit. Fitch Ratings promptly cut its rating – although only by one notch, and with that news, dismay hit Wall Street. Well, now the talk is that billionaire Wilbur Ross is looking to buy the insurer.

Then an even-bigger fish than Wilbur Ross got caught up in rumours. Now it has emerged that Warren Buffett himself is investing into the world’s biggest reinsurance company, Swiss Re.

So, that’s billionaires leaping in to the rescue, banks getting it together – no wonder the markets were so chuffed. In fact, yesterday, the FTSE 100 enjoyed its best day in five years.

But, alas, one must remain cynical. This crisis is worse than the LTCM debacle. Banks have enough problems shoring up their balance sheets as it is, without having to bail-out the insurers. Why, if things get much worse, some of the senior bankers might have to take a pay cut.

Efforts last autumn by the banks to pump liquidity into the markets turned out to be rather disappointing. And as Capital Economics said, “Such a rescue scheme would essentially involve the reshuffling of a diminishing pool of capital from one vulnerable part of the US financial system to another. The US banks are, of course, major holders of the bonds insured by the monolines. It would be more reassuring if the money came from elsewhere – such as a foreign Sovereign Wealth Fund, or some other institution which has been largely unaffected by the fall-out from the sub-prime crisis.”

But then, yesterday also saw news on the US housing market And it was bad, but if you squint your eyes, and look at it from a certain angle, you could say it was good.

The median price of existing homes in the US fell by 6 per cent last year, says the National Association of Realtors. That’s the first annual fall ever recorded. The median price of an existing home in the US is now $208,400. Furthermore, there was another sharp drop in the number of US existing home sales, which is now down to a 9-year low of 4.89m annualised.

But now squint. Turn the data on its side, shuffle it about a bit, and there, lurking in the corner, is the good news, because December also saw a reduction in the number of homes for sale. In fact, the fall in supply was greater than the fall in demand. Mind you, inventory levels are still way too high, so don’t get too excited.

A couple of years ago, one UK housing analyst said there was more chance of Elvis still being alive than there was of house prices crashing.

Well, right now, there is more chance of Frank Sinatra cropping up in Davos singing “I did it my way” than there is of seeing an imminent halt to the slide in US house prices.

PS
By the way, the small matter of £3.7bn disappearing from the French bank Société Générale is a good example of how one financial crisis can lead to another crisis. But at least in the case of this debacle, the bank’s loss is someone else’s gain. The money hasn’t gone from the system, it was gambled, meaning others picked up the gains. We will look at this in more depth next week.