Bank of England Fears Financial Meltdown

The BBC is reporting Banks warned over lending fears.

The Bank of England has warned that banks' fears of a financial meltdown may become a self-fulfilling prophecy. Banks previously over-willing to lend are now too reluctant, even with credit-worthy borrowers, it suggests.

My Comment: The psychology of deflation sets in. Banks are unwilling or unable to lend.

This increased fear of risk has itself undermined confidence in financial institutions and made them reluctant to lend to each other, the Bank adds.

My Comment: This is what happens when banks have a bloated balance sheet and deteriorating assets.

Its financial stability report suggests the credit exposure not declared by UK banks may be near to £100bn. The quarterly report says that there is a "significant increase" in the risk that a major bank collapse or reluctance to lend will disrupt the financial system.

In its quarterly Financial Stability Report, the Bank of England warns that there are potentially large exposures that have still not been declared by financial institutions.

My Comment: That suggests that banks may have insufficient capital to lend whether someone is a good credit risk or not.

However, the Bank points out that the freezing up of markets has meant that these estimated losses may be inflated because of the difficulty of pricing the complex securities which are now very difficult to value.

It says that "credit losses from the turmoil are unlikely ever to rise to levels implied by current market prices unless there is a significant deterioration in fundamentals."

And it estimates that total sub-prime losses could be reduced from $400bn to $200bn once market conditions return to normal.

My Comment: Market conditions may not return to "normal" for decades, if "normal" means anything like we have seen for the past 5 years. Otherwise, normal is likely to be years. Whatever "normal" means, talk of reduced loan losses is fantasy.

The Bank of England judges that there is a risk that "the currently elevated risk premia in some markets will persist".

"This could lead to a self-fulfilling adverse cycle in which persistent market illiquidity and falling asset prices further undermine confidence in banks and results in a sharper tightening of credit conditions."

My Comment: The risk is the BOE and the Fed manages to encourage more foolish lending. The more banks lend now, the bigger the defaults will be later. In a world awash in overcapacity, I fail to see the need for massive amounts of lending.

Lending drying up

The Bank's quarterly survey of credit conditions shows that lenders are tightening up credit sharply not just on home loans, but also on household lending and commercial loans to companies.

And the sources of future loans in wholesale money markets have also contracted sharply.

The market for "asset-backed securities" such as sub-prime and other mortgages has collapsed - with the value of such assets issued going from $700bn a quarter in the middle of 2007 to just $100bn in the first quarter of 2008.

My Comment: Tightening credit is the smart thing to do. Banks that tighten the most will lose the least.

The Bank of England argues that to rebuild financial confidence, it will continue to allow UK banks to swap illiquid assets with safe UK government securities.

My Comment: Swaps accomplish nothing. What is swapped today has to be swapped back later. Except in some make believe pretend world, virtually nothing is accomplished by swapping.

Get Ready To Cry For Argentina Again

Bloomberg is reporting Argentine Bonds Plunge on Mounting Default Concerns.

Argentine bonds show growing speculation that the country will default for the second time this decade as inflation and anti-government protests swell.

The nation's $10.8 billion of floating-rate dollar bonds due in 2012 yielded 7.20 percentage points more than Treasuries of similar maturity at 5:43 p.m. in New York. That implies an almost 20 percent chance of Argentina halting payments in the next two years, according to Credit Suisse Group. No other emerging-market government securities have as high a probability of default.

"Argentina has serious problems," said Igor Arsenin, an emerging-markets strategist at Credit Suisse in New York. "There's a lack of investor confidence. They are concerned lenders won't be willing to extend credit if this continues."

Wheels Fly Off Eurozone Economy

The Telegraph is reporting wheels fly off eurozone economy.

Spain's business federation warned that Spanish unemployment will rise by 500,000 by the summer unless the government takes "valiant measures" to offset the housing and construction crash. "For every dwelling not built, two workers will lose their jobs," said the group's president, Gerardo Diaz Ferran.

My Comment: That qualifies for the clown statement of the day. Is Spain supposed to do keep building houses no one needs just to keep people employed? Then again, perhaps there is a place for talent like that on Bush's team of economic advisers.

The country's credit group ASNEF said the volume of personal loans had dropped 30pc in the first quarter, the worst performance since the country's financial crisis in the early 1990s.

David Owen, an economist at Dresdner Kleinwort, said Europe would soon be engulfed by the twin effects of a "collapse in export volumes" and a slow motion credit squeeze. "The wheels are coming off the eurozone economy," he said.

BNP Paribas warned clients yesterday that the "decoupling story" was no longer credible. "We see Europe in the early stage of a credit crunch, and if we are right credit supply will shut down," it said. Key governors of the European Central Bank began to back away from their hawkish stance of recent weeks, clearly disturbed by the market perception that they are mulling a rate rise to choke off price rises.

France is succumbing to the slowdown. Insee business climate index fell harder than expected in April to 106, from 108 in March.

Eric Chaney, Europe strategist at Morgan Stanley, said the April survey by French corporate treasurers was "alarming", pointing to distress in the financial system. "Let's call a spade a spade, some sort of credit crunch is unfolding in the funding of French companies," he said.

Avalanche Of Redundancies In the UK

The Telegraph is reporting UK job cuts feared in economic slowdown.

Britain could be heading for an "avalanche of redundancies" in the coming months as economic reality finally catches up with the jobs market, a leading expert has warned.

John Philpott, of the Chartered Institute of Personnel and Development, said that the labour market was now close to its peak, and that the rise in unemployment could be more sudden and sharp than in previous economic downturns.

At 5.2pc, the unemployment rate is currently the lowest in many years. The warning comes amid growing fears that, having enjoyed some of its best months on record, the jobs market is set for an imminent deterioration.

He said: "I don't believe the labour market can defy gravity. It would be a miracle if there weren't some softening. We probably have peaked and unemployment will go up a little bit. "The conditions are building for an avalanche - the question is whether there will be a trigger point. I suspect the housing market will hold the key. If you get a bigger shock than people are anticipating that will have a knock-on effect, which could cause jobs to tumble."

The global economy is clearly slowing. Increased bank lending makes little economic sense in this environment, and even less when one considers the precarious capital positions at most banks.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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