FTAdviser.com

Advertising

“Events, dear boy, events”. That was what Harold Macmillan most feared in his premiership and it is what investors (and columnists) have to worry about at the moment.

As I write, the American political establishment is making itself foolish as it gambles with recession (or depression) because neither congressmen, nor the two presidential candidates, want to be saddled with the blame for passing an unpopular bail-out package. The American political timetable sees Congress set to disappear and not adjourn again until January. Within a month, a lame duck president and Treasury secretary will be in charge of finances, while the new administration takes two months to settle in.

Meanwhile, the money markets have frozen because no one wants to lend to banks for any longer than overnight. Where money is available at a week or three months, it is ridiculously expensive; so expensive indeed as to make the business of banking uneconomic. That has required the central banks to step in to lend money to the banks at the one-week and three-month levels (tiding them over the critical New Year period).

In the meantime, Washington Mutual, once the largest savings bank in the US, was seized by regulators and its assets sold to JPMorgan, the latest in a long series of bail-outs, nationalisations and failures that includes two of the five biggest investment banks, and the two biggest mortgage companies.

One has to assume that, by the time you read this, the Americans have got their act together. Banks may be greedy and foolish but they oil the wheels of the economy. If they fail, the system grinds to a halt. Letting them go bust to punish their chief executives is cutting your nose off to spite your face.

It depends

Will this plan save us from recession? It depends what one means by us. Britain, America and much of Europe are probably doomed to some kind of downturn, thanks to the events already put in train by higher commodity prices, lower house prices and now the inevitable reductions in lending that will follow the distress of the banking sector. China and India seem unlikely to go into recession.

What the plan might do is save us from a very severe recession. In the very short term, it does not matter whether the plan will work; it matters whether the markets think it will. If they do, then they may be willing to resume lending to the banking sector. And the immediate crisis will then be eased. The key figure to watch over the next few weeks is not the FTSE100 or the Dow Jones Industrial Average but three month Libor and the spreads between Libor and swap rates, a good guide to risk aversion towards banks. We need to see those numbers come down quickly.

If they do not, then one of three things will happen. First, higher borrowing costs will be passed on to companies and consumers as they already have been in the mortgage market. Second, consumers and companies will be unable to borrow as much as they would like, which will cause bankruptcies, higher unemployment and lower demand. Third, more banks will go bust, which could cause a retail run on the banking system, akin to the institutional one that has already occurred.

None of those things are very palatable which means we have to assume that, if the Paulson plan doesn’t work, the authorities will keep trying other plans until they do. Coordinated interest rate cuts across the globe is another possibility – there is plenty of scope for them to fall in the UK. So one small tip for clients might be to lock in fixed savings rates at the moment – subject to the £35,000 deposit insurance limit, of course.

Philip Coggan is Buttonwood columnist for The Economist