March 17, 2008 | posted by Michael Baxter in credit crunch |

When the Northern Rock crisis first hit the headlines, and the UK suffered its first run on a bank since Queen Victoria was on the throne, US  Treasury Secretary Henry Paulson was in Britain.    “We look like a third-world country,” said some press reports. Mr Paulson himself looked bewildered,  as he stood beside Alistair Darling at a press conference and our chancellor tried to reassure us.  “What must he have thought?” they asked.”

Well, now, some 7 months on, it’s the turn of the US, and maybe all those critics of the way the government handled Northern Rock will wake up to the reality.  This is a mess, no doubt – but it’s a complicated mess, and much of the criticism levelled at the way the Northern Rock saga was handled, went way wide of the mark.

There are differences. Northern Rock was a High Street lender – its customers members of the public.  Bear Stearns is an investment bank,  and as such the US bank could not benefit directly from Fed money, instead Fed loans it received had to be via a conduit.

In the case of Northern Rock, the authorities tried to manage a takeover by Lloyds TSB behind the scenes, so that when the extent of Northern Rock’s exposure was revealed, the deal would have been done – and panic avoided.

They did of course fail, and the final outcome was one that no one seemed to want, just about everyone seemed worse off.

In the US, speed, but in the open, was the order of the day, and within two days of the announcement of  Bear Stearns’ bail out, then the saga had gone to the next stage, and  a buyout by JP Morgan Chase was announced.

The fifth-biggest investment bank in the US is costing its new owner $236 million, and yet a week ago, the bank was valued at $140bn.        So just like the shareholders in Northern Rock before them, the former owners of Bear Stearn have taken a massive hit.

But the Fed is taking a hit too, it is funding $30bn of Bear Stearns’ less-liquid assets – that may make its exposure to the bank seems less serious than the UK’s government exposure, but it seems the UK government is far more likely to get its money back.

The truth be told though, both the Fed and the Bank of England were on hidings to nothing.    They were sure to be dammed if they did, and damned if they didn’t.

But maybe if they had done nothing, the consequences would have been even more serious.      If the history of economic crisis has one lesson, it is this,  banking crises are about as serious as you can get.

Sweden, for example,  suffered a major banking crisis in 1991 – and the cost to the economy – 6 per cent of GDP; further back in 1987 it was Norway that was struck, and the cost – 8 per cent of GDP. But in 19977, it was Spain which felt the horror of a full-scale banking crisis – and the cost, 16 per cent of GDP. Examples of other major banking crises include France (1994), Germany (1977), Japan (1992), the US (1984), but top of the order comes the UK (1974, 1991 and 1995).

Both the Fed and the Bank of England have to ensure neither economy suffers similar jolts – and the price paid so far by avoiding such crisis is cheap.

But the question has to be, what next?

Bear Stearns was one of the first banks to suffer from subprime fallout, with two of its funds failing over a year ago – indeed it was their failure that first threw the possibility of subprime crisis into the full glare of the public spotlight.

It is tempting to say that the crisis then has come full circle – it started with Bear Stearns, and will end with the bank.  

The reality though, is that it seems far more likely the global credit crisis is only just beginning to get going. 

It seems the US is in recession, but most are saying it will be a shallow recession – but those predictions seem optimistic.    The US economic growth story of recent years has been built on credit – this credit in turn fed the global economy.   

The best-case scenario is that once the subprime debt has worked its way through the system, the economy will be back on course.

A more likely outcome, however, is that we are seeing the consequences of far deeper problems unravelling.

The US has relied upon foreign money to fund its credit boom.  US consumers spent too much, some foreigners – especially Chinese, Japanese and consumers from the oil exporting countries, saved too much.      This pushed the dollar up, and stopped the US balance of trade deficit suffocating the economy.

But the falling dollar, the rising price of gold and oil – both sit at new records at the time of writing – could be telling a far bigger story. 

Foreigners are no longer willing to fund a US spending binge. In the long term, this may well prove to be a good thing for the US, but it is naive to assume there won’t be an agonizing period of change first. 

As for the UK – it suffers from exactly the same underlying problems besetting the US – but alas, it has less of the strengths seen in the economy across the pond.