Warren Buffett is right – the Federal Reserve has done a wonderful job in handling the credit crisis and was right to step in on Bear Stearns.
In fact, when the history books are written about this crisis, all of the world’s central banks are going to come out of it looking very good indeed. The Fed, the Bank of England, the Reserve Bank of Australia and the European Central Bank have so far prevented a calamity.
On Friday they were still at it: The Fed, along with the European Central Bank, the Bank of England and the Swiss National Bank, said they would increase the amount of cash they were providing to banks and were now, for the first time, prepared to accept as collateral bonds backed by car loans and credit cards.
Most downturns are caused by central banks raising rates to control inflation.
But central banks had nothing to do with starting this one. It began when the world’s private sector bankers all got up one morning in August, looked in the mirror, and saw the horrible mess they had created, as if for the first time, and stopped lending to each other.
The central banks stepped in and provided the cash liquidity needed to keep the wheels of commerce turning, and they’re still doing it. The Fed also cut interest rates earlier and far more aggressively than in previous cycles.
As a result we now have a paradox.
The credit markets are still clogged up and most experts are talking about at least 12 months of pain from sub-prime mortgage resets and the refusal of lenders to extend maturities beyond a few months. Yet the equities bear market looks to be over.
In essence we have seen the removal of the maturity mismatch that banks normally hold on their balance sheets – borrowing short and lending long, using capital to balance the risk. Now they will only lend short, matching their funding maturities, and even then that funding is largely coming from central banks.
Companies, by their nature, have to invest long. Normally they can borrow long as well, but they are being forced to turn to equity for long maturity capital, as seen recently with Wesfarmers.
Despite this, on superficial measures the US economy does not appear to be in recession and the sharemarket is resuming its appetite for risk.
US March quarter GDP growth was 0.6%, and the US S&P500 has rallied 11% from its lows (the All Ordinaries is up 11.5%). Wall Street is at a four-month high.
If the sharemarket remains stable and doesn’t retest the January lows, it was the world’s shortest ever bear market – four months and 25% – coming off, we are still being told, the world’s worst ever credit crunch; as bad as the Great Depression.
The situation may not last, but we can thank central bankers for this. The Fed probably caused the credit bubble in the first place with too much liquidity after 9/11, but all central banks have been standing between Armageddon and us for six months.
Whether the US bear market is over depends on the depth of the US recession and the earnings retrenchment there.
The consensus of Wall Street analysts is that June quarter S&P500 earnings will decline 4.1% on top of a 14% decline in the March quarter, but that the third quarter will see a 16.3% recovery. For calendar year 2008, earnings are expected to rise 11.2%.
With the recession still unfolding, this is a courageous consensus and the risks are all to the downside of it.
As for Australia, we’ve got China and the long commodities march.
This story first appeared in Business Spectator