As bankers pack off for the August break to their summer playgrounds, their Caribbean beach-side or Tuscan villas, or to their yachts, many will reflect uneasily on a tumultuous 12 months in global financial markets. This time a year ago, few could have guessed what a tornado was about to engulf them. News of the political and economic crisis in Russia filtered across the sunblock-scented airwaves in August. Within weeks, a huge speculative bubble in emerging-market debt that had built up in the first half of 1998 suddenly burst. Investors, traders and banks scrambled for margin and liquidity, spreads on all but the safest government bonds blew out as financial markets deleveraged, stocks tumbled and the dollar had its biggest ever one-day fall against the yen. The Federal Reserve found itself brokering the bail-out of an obscure hedge fund, which, had it collapsed, might have plunged the markets into catastrophe.
Investment banks were thrown into turmoil. Staff at Lehman Brothers had to listen to a daytime TV financial news reporter pronounce that their firm had gone bankrupt.
Twelve months on, the world certainly looks and feels like a safer place. The Federal Reserve has been, as ever, a deft operator, cutting interest rates just enough to reassure markets last year, and raising them modestly this, to head off excessive exuberance. The US economy is now entering uncharted territory in terms of sustained growth. And economists, who worried that the world was flying on the single engine of US growth, now see brighter prospects in Europe, and in the world’s second-largest economy, Japan, which grew 1.9% in the first quarter. True, this may be the result of a huge one-off boost in government spending. But there are signs that Japanese companies are squandering less on overinvestment, while consumer confidence has improved, despite rising unemployment, offering hope to Asian exporters.
Emerging countries themselves, with a few exceptions, like Argentina, Colombia and Pakistan, broadly seem to be in good shape, though worryingly, the rebound in Asia has been such that some countries, like Korea, are backsliding on promised structural reform, because they no longer see it as a prerequisite for recovery. Debate over a new global financial architecture, so urgent last autumn, has meandered into the academic backwaters.
Meanwhile, most financial firms have limited or abandoned emerging-market trading, tightened margin limits for dealing with hedge funds and, in many cases, reduced proprietary risk-taking. So bankers should be able to relax and enjoy the sun.
Of course, the wise ones won’t relax for a minute. Crises have come so thick and fast in recent years – the ERM currency crisis in 1992-93, the dire effects of US rate rises in 1994, the tequila crisis of 1995, the Asian contagion spreading from Thailand in the summer of 1997 and then Russia and the LTCM crisis in 1998 – that some bankers now worry that it is their own risk-management models – their market-to-market procedures and value at risk analysis – that exacerbate each plunge. No wonder bankers constantly agonize over what crisis will hit next.
The obvious suspects are a break-up of the European single currency or a collapse in the US stock market, though many a contrarian analyst and chief investment officer has shortened his career by making that particular call in recent years.
Here’s another question for banks in Europe to ponder. This year the two great developments in European financial markets have been enormous mergers and acquisitions and the rise of the corporate-bond market, the subject of this month’s cover story. The two are linked. Banks have been making huge bridge loans to companies to finance M&A deals, in the expectation of refinancing these swiftly in the capital markets. It’s worked for Olivetti, Mannesman and Repsol. At the end of July, Goldman Sachs, Morgan Stanley, Banque Nationale de Paris and Crédit Agricole each underwrote €4.5 billion of an €18 billion loan for Elf to back its counter-bid for TotalFina. Those are huge commitments, especially for non-banks, that they justify on the high pricing. But pricing never compensates for credit loss. And banks may be taking capital markets access for granted. Capital markets can close suddenly, as they did last autumn, even for good-quality corporates. Barclays was stuck with a bridge commitment to Kappa Packaging last autumn, which it refinanced only this July.
And what might cause the markets to close? How about contingency planning for Y2K? Companies are already thinking about rushing deals through before the fourth quarter, threatening an overcrowded bond market, then an empty one. Even more worryingly, some big commercial paper issuers are considering curtailing their issuance over the year-end and drawing on their back-up revolving credit facilities with the banks. If they all do that, the banks won’t have enough money to fulfil all their commitments. The central bank rescue parties will be scrambling again.
Happy holidays.
