Against the Tide: It’s not even half-time for the credit crisis
More assets are yet to be hit in the credit crisis and, as leverage continues to fall out of play, liquidity will keep on drying up. Equity prices are bound to fall still further too.
The credit crisis is not over. The move by the Federal Reserve to flood the US credit market with liquidity through its new-fangled term auction facility and term securities lending facility is innovative in its attempt to get credit markets moving again. However, it will fail. The depth of the defaults and the breadth of the crunch are too big for the Fed to absorb.
Indeed, in terms of the hit to the capital of the financial institutions that have invested in the great global asset-backed securities boom, we are not even halfway through the crunch.
The US housing slump and the continuing falls in house prices in Europe have already led to heavy losses in the sub-prime mortgage market. But there are more shoes to fall in the consumer and corporate debt markets as well as in credit insurance instruments. And as the global economy slows, defaults and losses will mount.
Global liquidity is already contracting because securitized debt markets (both asset-backed debt and synthetic debt using derivatives) are shrinking rapidly. Eventually, bank credit will also contract and, with it, so will the global economy.
During the period of economic contraction, financial asset prices previously boosted by cheap leverage will fall.