It’s not over yet: The credit crunch continues to wreak havoc

25 October 2007
The credit crisis continues to affect the global economy and is threatening UK banks with aftershocks as financial institutions become fragile, credit becomes scarce, and increased vulnerability can be seen in UK and US share prices.

The Bank of England published its half yearly Financial Stability Report today, assessing the recent credit crisis and tackling the issues of cause and effect. It also points to measures that could prevent a similar thing happening in the future, such as improved management of liquidity, more clarity in the valuation of SIVs, and better contingency plans.

While some financial markets are noticing marginal recovery, the Bank warns of tighter credit conditions to come, particularly for high-risk borrowers, and says that the advanced economies – all of which have been effected – remain vulnerable to further adjustment.

John Gieve, Deputy Governor for Financial Stability, said of the crisis that “the speed and ferocity with which that adjustment disrupted core markets and institutions internationally had not been anticipated by firms or authorities.”

UK banks face costs of almost £150 billion if the situation calls for them to set aside capital to protect themselves against damage from reeling structured investment vehicles (SIVs), leveraged loans and mortgage-backed securities.

The American interest rate looks likely to take another half point cut in the wake of more falls in house sales to an annual 5.04 million – the lowest levels since 1999. This not only fuels fears that the worst is yet to come, but also puts additional strain on the American economy as it strives to keep the wolf from the door and avoid a recession.

Merrill Lynch – the world’s biggest brokerage – announced yesterday that it is writing off $7.9 billion of sub prime mortgage investments. It still has $15 billion of investments backed by US mortgage debt – loans made to people with bad credit histories that have fallen foul of rising interest rates and repossession.

The firm has seen “a larger write-down of these assets than initially anticipated,” said Stan O'Neal, chairman and chief executive officer of Merrill Lynch. “We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact” after being overexposed to the sub prime market, he said. The loss caused the Dow Jones to crash 200 points.

RV Capital has become the latest casualty of the credit crunch as it ran into severe liquidity issues in August and yesterday announced that it is going into administration, facing losses of more than £10 million. Ratings agency Moody’s Investor Services also reported yesterday that it has seen a fall of 13 per cent third quarter net income.

The private equity industry is feeling the strains of the credit stretch, as commercial property is particularly prone to hits from the rising cost of debt. However, it is believed that the industry has yet to feel the full effects of the crunch, as the already depleted volume of deals is expected to fall further as banks remain reluctant to lend.

© Fair Investment Company