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Northern exposure

The market got off to a quiet but encouraging start this year but the first rumblings of trouble in US housing market were already audible.

It was at the end of 2006 that the first of the US sub-prime lenders applied for protection under Chapter 11. The boom in US house prices had ended more than a year previously and warnings that problems would emerge had been delivered several months earlier. In January, HSBC announced increased provision for non-performing US mortgages, but the first half of the year sped by with little additional concern.

Much attention was focused on China and India as these two aspiring economic giants powered their way up the GDP league tables. Even so, China was to enjoy only a late surge in stockmarket success, with interest swinging its way as the true extent of problems in the indebted developed nations attracted growing attention. Prices were driven higher swiftly and decisively, with concern over a bubble developing manifesting itself late in the year.

But profit-taking in Chinese shares did not turn into a rout, nor did it dent the new status accorded to emerging markets. The emerging markets shrugged aside the mounting woes of the Western financial system to overtake developed markets on valuation criteria. With fears of a US recession growing, decoupling became the buzzword.

If evidence of the growing power of these populous and newly enfranchised nations were needed, you need look no further than the consequences of the credit crunch. The ripples from the collapse in the US sub-prime market exposed more victims but it was when Northern Rock got into trouble that the true nature of the crisis gripped attention.

Opportunistic investors leapt aboard the stricken bank’s share register in the belief that such a hitherto successful mortgage lender could not possibly go to the wall. They may be correct, although that is not to say the shares have any value. Northern Rock was exposed as breaching one of the basic laws of banking. It lent long and borrowed short.

It was the failure of banks to renew their lending facilities to Northern Rock that forced Rock into the arms of the Bank of England and so problems in the US housing market exposed shortcomings at home.

The division of responsibility between setting interest rate policy and acting as lender of last resort with that of regulating the banking sector demands closer co-operation than that demonstrated by the Bank of England and the FSA – nor did the Chancellor and the Treasury win plaudits. Months after the problems fell into the public domain, no resolution has been achieved.

The other consequence of imprudent lending and the massive growth in the trading of complex financial instruments designed to shift the responsibility of lending decisions to others has been a collapse in trust of banking institutions and not just from the public.

The most vigorous exponents of caution in where to deposit surplus cash have been the banks themselves. The credit crunch that has stalled lending in the West is a direct result of banks not trusting each other to avoid making imprudent decisions.

This is the note on which the year draws to a close. To head off an economic slowdown brought about by tougher borrowing conditions, central banks are collectively loosening monetary policy. Yet it was with easy credit that this whole sorry business began. We are far from being out of the woods yet.

Brian Tora ( is principal of the Tora Partnership


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