Anatomy of a credit crunch
August 6, 2007
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site www.greatconservatives.com
The German bank IKB has been the recipient of an $11 billion bailout. $64 billion of leveraged buyout financings have been withdrawn in the last month. Standard and Poors have talked of down-rating Bear Stearns, two of whose funds have collapsed. We are clearly in the beginning phase of a classic credit crunch, and it’s therefore worth looking at how these have played out in the past, and where and how holes in the fabric of the world’s financial system are most likely to appear.
Credit crunches are relatively rare, rarer than stock market downturns. There was no credit crunch in 2000-02, though the stock market downturn was substantial. In 1989-92 there was a mild credit crunch in junk bonds and New England real estate, but relatively little spillover to other areas of the credit market. In 1982, there was a credit crunch in emerging market debt, which was eventually solved by a mass debt forgiveness and bailout of the New York banks which were most heavily exposed. Even during that period, there was no great credit crunch in the domestic U.S. market.
The last true credit crunch was thus that of 1973-74, which was particularly severe in Britain but spread throughout the international debt markets. That’s before the working lifetime of most market participants today. Sam Molinaro, chief financial officer of Bear Stearns said Friday that conditions in the fixed income market were “as bad as I have seen in 22 years” – since he is 49 he was presumably referring to his period of participation in the market rather than some hitherto obscure crisis in 1985, from memory a placid and bullish year. One can pause for a moment to mourn the length of institutional memory of 1950s London, where Morgan Grenfell’s chairman Lord Bicester served until his death in office at 89, thus being able to give his junior colleagues a first hand account not only of the 1929 crash but of its predecessors in 1890 and 1907.
It’s worth looking at how the credit crunch of 1973-4 developed.
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