After the sudden end to a credit boom coincided with last year’s surge in commodity prices, the outlook for the world’s richest countries has not been worse in generations. Oil may again be cheaper but banks are in trauma. G20 leaders gathering in Washington know that big risks remain. Use the hyperlinks below to explore this FT guide to the causes and effects of the daunting, near-global recession that is taking hold.
Economists have torn up their forecasts from as recently as early autumn after the combination of a vicious credit crisis and a – subsequently reversed – commodity price boom destroyed business and consumer confidence.
Households in rich countries, either too scared to spend for fear of losing their jobs or unable to secure credit, have sent early winter shivers down retailers’ spines; car sales have fallen through the floor. Companies, for their part, will also not risk much new investment in such a poor climate.
A recession in almost all advanced countries is now guaranteed, the first time since the second world war that the world’s rich economies have sunk simultaneously. Yesterday the Organisation for Economic Co-operation and Development, their own club, became the latest body to forecast a contraction in the world’s largest economies next year.
Among the rich countries, Britain appears most vulnerable, with the twin problems of having the most highly indebted consumers and a large financial and business services sector. The universal nature of the commodities boom and credit crisis will also lay the rest of Europe low, but the country that is likely to suffer the longest is the US, where the subprime mortgage bust led to the subsequent mess.
The dynamic emerging markets of Brazil, India and China are still growing, but at slower rates. Nerves are jangling at the notion that, far from pulling the rich world out of a recession, they too will be sucked in.
The summer break came to an abrupt end in early September when Fannie Mae and Freddie Mac, the two giant US mortgage lenders, became engulfed in severe liquidity problems and were in effect nationalised.
Woes on Wall Street were soon to follow as leading investments banks collapsed, were bought out or turned themselves into retail banks.
The demise of Lehman Brothers on Monday September 15 fuelled a by now global financial crisis that came to a head around the first week of October. In the space of a few days, the world’s financial system came to the point of collapse.
Barely a day passed without a large institution requiring a bail-out or a country battling to retain the confidence of its creditors. Iceland, the poster child of banking-led growth, saw its leading banks fail and its economy near breaking point.
The response was the first co-ordinated interest rate cut since 2001, undertaken by the world’s leading central banks on October 8. This capped a spate of attempts by governments to address the crisis.
In the US, the administration of President George W. Bush struggled to win approval from Congress for a $700bn bail-out package to buy up toxic assets and recapitalise the country’s banks, finally achieving a deal.
In the UK, banks were saved only by the government’s promise of taxpayer support and guarantees on wholesale funding; bail-outs for many of the rest of Europe’s banks were close behind. Ireland guaranteed all its banks’ liabilities to stop a mass run.
The turmoil spread beyond the rich world to engulf emerging markets, sending currencies of a number of countries tumbling and slashing the cost of emerging market debt.
In turn, this has given the International Monetary Fund a new lease of life: it is now devising large lending programmes for the first time in almost six years.
The speed and scale of the spreading malaise prompted world leaders to tear up their previous agendas. An early meeting in Paris by the main European Union powers ended inconclusively and fed fears that the authorities would not be able to counter the crisis. Later gatherings – the meeting of finance ministers and central bankers from the Group of Seven rich nations in mid-October and a second EU summit – proved more successful. Wordy communiqués were ditched in favour of pithy calls to action that were followed up by national initiatives such as bank recapitalisations.
Now the focus is on co-ordinating action to limit the slowdown in global growth and implementing measures to prevent a credit bubble – and bust – happening again.
The Financial Stability Forum, an arm of the G7, is co-ordinating international discussions over the necessary regulatory reforms. The International Monetary Fund is providing emergency finance to those vulnerable emerging markets deemed to be victims of a situation beyond their control.
The Group of 20 advanced and emerging market economies will support fiscal stimulus to limit the downturn and will consider institutional reform. No one expects quick answers – or economic recovery within the near future.
Credit default swaps are, in essence, insurance contracts against the risk that companies and other creditors will fail to pay back loans. In theory they should make the financial system safer because they allow investors to offset the risk of holding corporate bonds and other fixed-income securities.
CDS issuance exploded during the mid-decade credit boom, with insurance provided not just for corporate or government bonds but also the complex mortgage-backed securities that underpinned a surge in house prices.
Now the fear is that with so many institutions stretched for money, CDS issuers may not be able to fulfil their contractual obligations to pay up in the event of default. With a huge volume of outstanding contracts, there is still potential for the credit crisis to take a further turn for the worse.
Get alerts on Global Economy when a new story is published