ALAN GREENSPAN, former chairman of the US Federal Reserve, America's central bank, yesterday described the financial crisis there as likely to be the most "wrenching" since the end of the second World War. On a day that saw global share prices slump and the dollar fall as oil and gold prices rose, no one was more qualified than he to make that judgment. For what happened on global stock markets provided a graphic illustration of his thesis. Trading screens turned red as bank stocks plummeted in value as nervous investors showed their declining confidence in financial institutions. The latest sharp fall followed the takeover of Bear Stearns, a major US investment bank, by JP Morgan Chase.
A week ago Bear Stearns, the fifth largest bank of its kind in America, was reassuring investors that it had no financial problems. Days later, with its cash reserves almost depleted, the investment bank was preparing to file for bankruptcy protection having lost the confidence of its clients and its creditors. JP Morgan's swift move to buy out Bear Stearns, paying $236 million for a bank that was worth $3.5 billion last Friday, clearly spooked the market. But this hurriedly arranged sale may well have pre-empted a much bleaker scenario. For had Bear Stearns filed for bankruptcy, the fallout could have proved less predictable and much more serious.
A truly global financial crisis may well have been narrowly averted by yesterday's prompt action. Nevertheless, the negative fallout from the Bear Stearns collapse was keenly felt on world markets. Nervous investors have become increasingly risk averse as yesterday's sharp fall in equity prices demonstrated.
This financial crisis, which stems from rising defaults in the US subprime mortgage market and which has led to a credit crunch, may be American in origin. But it is now global in nature and extent. In the short term, market nervousness and financial uncertainty are set to continue. Results are imminent from several other US investment banks and the scale of their write downs on subprime and on leveraged loans will affect investor sentiment. In the long term, as Mr Greenspan pointed out in a Financial Timesarticle yesterday, the crisis will end when home prices stabilise, a point that "is still an indeterminate number of months in the future".
That said, as yesterday's market action showed, there are few safe havens in times of financial turmoil and market uncertainty. The 4.6 per cent fall in the value of Irish shares reflects, in part, a domestic stock market dominated by financial companies and therefore vulnerable to changes in investor sentiment in banking stocks elsewhere. Irish banks, however are well capitalised. They remain very profitable and they have limited exposure to the subprime mortgage markets. But investors remain worried about the banks' financial exposure to the property sector. Until, as Mr Greenspan suggests, equilibrium in the US housing market is restored, which should help ease the global credit crisis, financial markets will continue to face difficult times as that painful adjustment is completed.