Letting Lehman Collapse Was Right Move

It’s been an extraordinary weekend on Wall Street and the latest events in the financial crisis will probably affect us all.
Lehman Brothers’ move to Chapter 11 -- roughly equivalent to administration in the UK -- is extraordinary in itself. Lehman is (or was) the fourth largest investment bank in the world after all. But on top of that, you have an emergency takeover of Merrill Lynch and insurance giant AIG in deep trouble, too.
Today’s news makes it even clearer that the days of cheap credit and surging property prices are over. Stability will eventually return but I may not see ‘irrational exuberance’ again in my lifetime.

Today’s markets

Shares in London have fallen across the board this morning and we’ll probably see a similar picture this afternoon on Wall Street. As I write, the FTSE 100 is down 185 points at 5,232 while mortgage bank HBOS (LSE: HBOS) has slumped 52p to 229p.
Other financial fallers include Royal Bank of Scotland (LSE: RBS), down 21p at 212p, and Barclays (LSE: BARC), which has dropped 36p to 314p.
I can understand why investors are selling out. Lehman had big positions in derivatives markets and we don’t know which banks are exposed to those positions. Lehman’s positions will now have to be unwound in very difficult markets and other assets may be sold at ‘fire sale’ prices, too.
There’s a risk of a domino effect across the financial sector as asset values fall further.

Beyond shares

Sadly I fear Lehman’s collapse will even affect those of us without a share portfolio. For starters, the economy will be hit as bankers lose jobs and confidence suffers.
And the mortgage market could be hit as well. In recent weeks we had seen tentative signs of a revival with rate cuts on some mortgages. I reckon we’ll see that trend go into reverse as lenders once again find it harder to raise finance.
On the plus side, central banks such as the Bank of England may start to cut interest rates more quickly than had been expected. Central bankers will know that further bank failures could lead to deflation -- where retail prices fall. The obvious way to avert deflation is to cut interest rates.

What now?

The most important advice I can give is: ‘Don’t Panic!’ We’ll get through this crisis in the end. If you can focus on the long term, now is probably a good time to drip money into the stock market. The good old index-tracker fund will do nicely.
However, I would stress that any stock-market investments should really be for the long term. I mean ten years or longer. Drip feeding your cash in every month is a good approach, as it means you can 'average down' at lower prices if the market falls further.
The one area I’d avoid is bank shares. Sure, they look cheap at first glance -- if you believe analyst forecasts, HBOS is trading on a price/earnings ratio of just 4 for this year.
Trouble is, it’s very hard to ascertain the true health of the loan book and there’s a real risk of further fund raisings in this sector. Possibly even a Lehman-style collapse. I’m steering clear of the lot for now.

Hank got it right

But in spite of all the gloom, I am pleased about one thing. US Treasury Secretary, Hank Paulson, made the right call. We’ve seen government bail-outs of Fannie, Freddie, Bear Stearns, and Northern Rock, but it’s been different for Lehman. Paulson has let Lehman go to the wall.
That was the right decision because bankers had to learn that the government wouldn’t always rescue them when they took on too much risk. If bankers never learned that lesson we’d see another bubble all too soon.
The biggest risk for all of us now is deflation. Let’s hope that central bankers and governments can inject enough cash into the system to stop that happening.

* - Article from Motley Fool

Recession in UK 'is months away'

The BCC says there is still time for the UK to avoid a recession

Recession looms in the UK in the next six to nine months as firms face "a difficult and risky climate", the British Chambers of Commerce warns. UK growth will be slightly negative or zero in the next two or three quarters, but a major recession is unlikely, the BCC says in its latest forecast.

But prospects will be worse if interest rates are not cut soon, it adds. The BCC predicts UK unemployment will rise by between 250,000 and 300,000 in the next 18 months to two years.
That could take the jobless total to more than two million for the first time since Labour came to power in 1997.

'Bigger danger'

"Over the next two or three quarters, we expect UK GDP growth to be slightly negative or zero, satisfying the conditions of technical recession," the BCC says.

"But the bigger danger of a major UK recession can and must be prevented," it adds.
"Our central scenario envisages that UK Bank Rate would be cut to 4.75% in [the fourth quarter of] 2008, followed by an additional cut to 4.5% in [the first quarter of] 2009.
"But if [the Bank of England's Monetary Policy Committee] decides not to cut rates in the next three to six months, growth prospects would be worse."
BCC director general David Frost told the BBC that the "full impact of going into a major recession as we did in the early 1990s could be avoided now".
Mr Frost said the UK needed "to get back to a a path of steady growth" as nobody wanted to experience the "major dislocation and major problems emerging from a deep recession".

Confidence falling

Whatever happens to interest rates, the BCC says, "a marked slowdown in UK activity is highly likely over the next 18 months".

This would be mainly caused by "a very sharp deceleration in consumer spending growth, in reaction to falling house prices and the acute squeeze on household disposable incomes".
At the same time, a new survey of 200 firms by Lloyds TSB bank indicates that nearly two out of three companies are more pessimistic about the state of the economy than they were three months ago.

One in five of them predicted that the level of activity in their business would decline during the next 12 months.

And the Institute of Chartered Accountants in England and Wales (ICAEW) has added to the gathering economic gloom with a survey showing another sharp fall in business confidence.
Its Business Confidence Monitor (BCM) index, covering the period from 24 April to 24 July, produced a reading of -25.7, compared with -19.7 in the previous three months.

WHAT IS A RECESSION?

There are a number of definitions of a recession.
The most commonly used one is when there are two quarters in a row of economic contraction, or negative growth.
But it is quite possible to have two quarters of negative growth and another couple of quarters of decent growth - so the economy actually grows year on year, despite going through a technical recession.