Post by Steve Gardner on Jan 26, 2008 19:04:15 GMT
Source: The Telegraph
By Gordon Rayner
Gordon Rayner asks if this week's stock market crashes spell the beginning of the end for US and European domination of the world economy, as China and India prepare to swoop
Even before the news broke on Thursday of Jérôme Kerviel's £3.7 billion losses as a "rogue trader", this week had already gone down in the financial world as the most turbulent in decades. Not since the dark days of the early 1970s had panic and fear gripped the markets with such monumental effect - a £77 billion slump in the value of the stock market on Monday, an unprecedented 0.75 per cent interest rate cut by the US Federal Reserve on Tuesday, followed by the blessed relief of a rally in prices on Wednesday.
Intriguingly, senior City figures are now raising the question of whether the chaotic trading of Monday and Tuesday was directly linked to Kerviel's actions. The crisis was fuelled, in part, by the sale of billions of pounds worth of futures on the European market, driving prices down and making traders deeply suspicious that "something was up".
What none of them knew at the time, because the identity of sellers is never revealed, was that around 10 per cent of all trading on the futures market was originating from the French bank Société Générale, which was desperately closing down fraudulent accounts allegedly set up by Kerviel.
Not only did Kerviel's losses contribute to the mayhem in the markets, it seems, but there is even talk of whether the fire sale of the accounts he set up may have "panicked" the Federal Reserve into making its huge interest rate cut.
"There is a question mark over whether the Fed was duped or pushed into making the emergency rate cut because of what was happening in Europe," says Danny Gabay, director of Fathom Financial Consulting. "The Fed has issued a statement saying it didn't know about the SocGen losses when it made the decision, which does call into question whether it would still have made the cut if it had been told about SocGen."
Sir Howard Davies, the former head of the UK's financial regulator, the Financial Services Authority, and now director of the London School of Economics suggests: "Maybe that increased the scale of the fall and influenced the Fed's reaction. I think it's slightly surprising they didn't know."
In terms of Monday's slump in the markets, there is plenty of evidence that prices were heading for a tumble before SocGen started dumping the Kerviel accounts, as the Asian and Australian markets had already fallen.
However, many traders are convinced that SocGen's closure of the Kerviel accounts exacerbated Monday's falling prices, when the FTSE100 index of Britain's biggest companies fell by 5.5 per cent in a single day, the biggest fall since the September 11 terrorist attacks.
"It's like going to an estate agent, giving them 10 houses and saying that you want them sold by the end of the day," says Howard Wheeldon, a senior strategist at spread-betting firm BGC Partners. "It's going to drive down local house prices."
Mr Kerviel, who has now contacted his lawyers, is likely to spend this weekend being interviewed by police. His immediate concern will be whether, like Nick Leeson before him, he will face a lengthy stretch in jail if he is charged with and convicted of fraud.
For the rest of us, however, the long-term implications of this week's events will be measured in jobs, property prices and unemployment as we wait to discover whether the UK is on the brink of a full-blown recession.
George Soros, the investor who famously "broke" the Bank of England by betting, and winning, against the pound remaining in Europe's Exchange Rate Mechanism, said this week that it would be "very difficult to avoid" recessions in the US and the UK as the world's financial muscle shifts inexorably from the West to emerging economies, in particular China and India.
But why, after several months of economic gloom, did events take such a sudden and spectacular turn this week?
The turmoil began on Friday night, with two separate, and, at the time, unrelated events in New York and Paris.
At 7.25pm GMT, financial newswires in New York reported that Fitch Ratings, a company which measures stocks and shares according to their reliability as an investment, was downgrading the specialist insurer Ambac and removing its crucial AAA rating.
Although no one outside the world of high finance would have heard of Ambac, the removal of its top-grade investment status had a knock-on effect which triggered panic in the markets.
Ambac had become the latest victim of the dreaded sub-prime mortgage crisis that began infecting the world's financial institutions last summer, which led to the crumbling of Northern Rock, the British bank currently being propped up by £50 billion from the taxpayer in loans and guarantees.
Sub-prime mortgages - loans made to householders who could not afford to pay them back - were sold on by mortgage lenders in the form of bonds, and in turn the bonds were insured by companies like Ambac.
Such bond insurance is known in the City as "monoline" insurance (a piece of jargon which is likely to become as familiar in the coming months as "sub-prime") and was traditionally seen as one of the safest forms of investment. But when Ambac lost its coveted AAA status, jitters began to set in among traders, who feared that the sub-prime crisis was about to claim a whole new tranche of high-profile victims. As Jamie Dimon, chairman and chief executive of JP Morgan Chase, puts it: "If one of these entities doesn't make it, the secondary effect could be pretty terrible."
Shares in leading US insurers and other financial stocks began to tumble during the course of Friday afternoon, and when the Australian, Asian and European markets opened on Monday they followed suit.
Coincidentally, at roughly the same time the announcement of the Ambac downgrading broke in New York, Jean-Pierre Mustier, the chief executive of Société Générale's commercial and investment banking division, was taking a call on his mobile on his way home in Paris. "Something fishy" had been discovered in the bank's accounts, he was told.
He returned to his headquarters in the La Défense business district of Paris, and began going through the books with senior executives. Working late into the night - and carrying on the following morning - the horrified bankers uncovered more and more holes in their trading accounts, adding up to more than £1.2 billion by Saturday afternoon. The trades were traced to one junior employee: Jérôme Kerviel.
The 31-year-old trader was summoned to the office, where he was grilled by Mustier for six hours. Undeterred by the monumental scale of his losses gambling with the bank's money on movements in the European stock markets, Kerviel tried to convince his boss that he had come up with a brilliant strategy for making the bank huge profits.
At a crisis meeting on Sunday, SocGen's chief executive Daniel Bouton decreed that, rather than announcing the loss straight away, the bank would quietly unwind Kerviel's loss-making accounts over the course of three days, supposedly to avoid panic in the markets.
It began selling Kerviel's futures on Monday morning, but quickly got caught in a vicious circle which tripled its losses.
The markets, already primed for meltdown by Friday afternoon's downturn in New York, went into freefall as soon as they opened, and SocGen's sale of the Kerviel futures only made matters worse. A £1.2 billion loss ended up being a £3.7 billion loss thanks to the plunging prices.
By the close of trading on Monday, a colossal £77 billion had been wiped off the FTSE100 - and, therefore, the value of the UK's top companies.
"It was gut-wrenching watching the share prices fall and fall," says Gabay. "For years, we had been bemoaning the lack of volatility in the markets, because a flat curve means trading opportunities are few and far between. But you have to be careful what you wish for."
The only markets which did not take a tumble on Monday were in America, where the banks were closed for Martin Luther King Day. But at 11pm that night, UK time, the governors of the Federal Reserve, America's central bank, held a video conference which resulted in the momentous decision to cut interest rates by 0.75 per cent, the biggest cut in a quarter of a century.
Ben Bernanke, the Fed's chairman, famously admitted six years ago that the Fed was responsible for the Great Depression of the 1930s - on which he is one of the world's leading authorities - because it had set interest rates too high. He was darned if the predictions of another depression were going to prove right during his watch.
Unaware of the Fed's decision, the Asian markets continued to tumble overnight on Monday, with every single share on traders' screens in Tokyo turning red for "sell". One man, despairing at the tumbling value of his investments, climbed on to the roof of a Beijing department store and threatened to jump.
By 2am on Tuesday the Hong Kong markets had opened, and once again there was carnage, with £160 billion wiped off shares during the day's trading. A similar story unfolded in Bombay, Shanghai and the Middle East and, by 8am, when the London markets opened, still unaware of the impending Fed rate cut, traders were bracing themselves for another day of pandemonium.
It was only when rumours began to sweep through the trading floors that the Fed was about to announce an interest rate cut that share prices began to rally, and the City held its breath as it waited for an official announcement from Wall Street, which finally came at 1.20pm. At first, the reaction was one of relief, but suspicion and doubt quickly began to take over. The cut was unexpectedly high - did the Fed know something it wasn't letting on? Was the situation in America worse than had been thought?
By the close of trading on Tuesday, the mood in the City was broadly optimistic, and the FTSE rallied to close up by 161.9 points.
But many analysts believe the more important decision came on Wednesday, when US banks confirmed that they had begun talks over a bail-out plan for the monoline insurers, involving a possible £7 billion injection of funds to shore them up and win back their AAA status.
The markets perked up further as a result, and by Wednesday night the relief in the City was palpable. The weekend could not come soon enough for the exhausted traders. Yet the week's biggest surprise was still to come.
When trading opened on Thursday, Société Générale dropped its bombshell: almost its entire annual profit had been wiped out by the losses incurred by Kerviel.
SocGen had a reputation as one of Europe's best-run banks, yet a single rogue trader had managed to rack up multi-billion dollar losses undetected. The fiasco simply added to the impression that the executives running the world's biggest financial institutions are highly fallible.
After all, if giant institutions such as Citibank and Bear Stearns in the US could lose billions of pounds to the sub-prime mortgage crisis, and France's second-biggest bank could allow a rogue trader to wreak such havoc, could anyone be trusted with the stewardship of funds worth billions?
Although the markets have recovered many of their losses from the early part of the week, the crisis of confidence, particularly in the monoline insurance sector, is likely to drag on for months. And, even if the Western economies do manage to recover their losses, they must get used to the fact that they will soon lose their dominant position in the world economy.
As political and business leaders gathered in Davos, Switzerland, this week for the World Economic Forum, it was the representatives of the emerging economies, particularly China and India, who had a spring in their step. While the West awaits a possible recession, the emerging economies can look forward to a boom that will see them overtake the US in terms of economic power.
As George Soros told those gathered in Davos: "I think we are seeing the end of the dollar as the international currency and we need a new sheriff."
Mervyn Davies, chairman of Standard Chartered, a bank based in Britain which focuses on the Far East, claims: "There is a seismic change going on. There are emerging powers which are much richer and more powerful than people have realised."
Among the wise old heads in Davos, however, there are plenty who believe there is cause for optimism.
Bob Diamond, president of Barclays, says America's forceful moves to shore up its economy - including a proposed presidential stimulus package worth $150 billion - will keep a recession at bay. "If you and I sat together six months from today," he says, "we would be talking about a US economy in better shape than six months earlier, not one shifting further into trouble, because they've acted so boldly."
But, while there is widespread praise in Davos for the decisive actions of the US Federal Reserve, there is disdain for the European Central Bank, which did virtually nothing to quell the panic in the markets this week.
"If the largest economy in the world is behaving in a way which is producing this kind of decision by its monetary authorities, you can't ignore it," claims Angel Gurría, the secretary-general of the Organisation for Economic Co-operation and Development. "Believing that Europe has become bulletproof or armour-plated would certainly not be recommendable."
Stephen Roach, president of Morgan Stanley in Asia, puts it more bluntly: "Europe is not going to get some special dispensation from a global slowdown."
After the City's much-needed rest this weekend, all eyes will turn on Monday to the European Central Bank, to see whether it follows the Fed in taking action to shore up the European markets.
As Gabay observes: "A lot of medicine has been applied to the markets in terms of the Fed rate cut, the monoline bailout plan and other measures, but the markets are still very, very uncertain about each other. We can expect investors' nerves to be tested again next week."
By Gordon Rayner
Gordon Rayner asks if this week's stock market crashes spell the beginning of the end for US and European domination of the world economy, as China and India prepare to swoop
Even before the news broke on Thursday of Jérôme Kerviel's £3.7 billion losses as a "rogue trader", this week had already gone down in the financial world as the most turbulent in decades. Not since the dark days of the early 1970s had panic and fear gripped the markets with such monumental effect - a £77 billion slump in the value of the stock market on Monday, an unprecedented 0.75 per cent interest rate cut by the US Federal Reserve on Tuesday, followed by the blessed relief of a rally in prices on Wednesday.
- How will the market crash affect you?
- Double blow 'may have made rogue trader reckless'
- Jerome Kerviel's CV: The ambitious judo teacher
Fluttering stomachs: an investor watches a share price indicator
in horror as stocks plunge in Shanghai on Wednesday
in horror as stocks plunge in Shanghai on Wednesday
Intriguingly, senior City figures are now raising the question of whether the chaotic trading of Monday and Tuesday was directly linked to Kerviel's actions. The crisis was fuelled, in part, by the sale of billions of pounds worth of futures on the European market, driving prices down and making traders deeply suspicious that "something was up".
What none of them knew at the time, because the identity of sellers is never revealed, was that around 10 per cent of all trading on the futures market was originating from the French bank Société Générale, which was desperately closing down fraudulent accounts allegedly set up by Kerviel.
Not only did Kerviel's losses contribute to the mayhem in the markets, it seems, but there is even talk of whether the fire sale of the accounts he set up may have "panicked" the Federal Reserve into making its huge interest rate cut.
"There is a question mark over whether the Fed was duped or pushed into making the emergency rate cut because of what was happening in Europe," says Danny Gabay, director of Fathom Financial Consulting. "The Fed has issued a statement saying it didn't know about the SocGen losses when it made the decision, which does call into question whether it would still have made the cut if it had been told about SocGen."
Sir Howard Davies, the former head of the UK's financial regulator, the Financial Services Authority, and now director of the London School of Economics suggests: "Maybe that increased the scale of the fall and influenced the Fed's reaction. I think it's slightly surprising they didn't know."
In terms of Monday's slump in the markets, there is plenty of evidence that prices were heading for a tumble before SocGen started dumping the Kerviel accounts, as the Asian and Australian markets had already fallen.
However, many traders are convinced that SocGen's closure of the Kerviel accounts exacerbated Monday's falling prices, when the FTSE100 index of Britain's biggest companies fell by 5.5 per cent in a single day, the biggest fall since the September 11 terrorist attacks.
"It's like going to an estate agent, giving them 10 houses and saying that you want them sold by the end of the day," says Howard Wheeldon, a senior strategist at spread-betting firm BGC Partners. "It's going to drive down local house prices."
Mr Kerviel, who has now contacted his lawyers, is likely to spend this weekend being interviewed by police. His immediate concern will be whether, like Nick Leeson before him, he will face a lengthy stretch in jail if he is charged with and convicted of fraud.
For the rest of us, however, the long-term implications of this week's events will be measured in jobs, property prices and unemployment as we wait to discover whether the UK is on the brink of a full-blown recession.
George Soros, the investor who famously "broke" the Bank of England by betting, and winning, against the pound remaining in Europe's Exchange Rate Mechanism, said this week that it would be "very difficult to avoid" recessions in the US and the UK as the world's financial muscle shifts inexorably from the West to emerging economies, in particular China and India.
But why, after several months of economic gloom, did events take such a sudden and spectacular turn this week?
The turmoil began on Friday night, with two separate, and, at the time, unrelated events in New York and Paris.
At 7.25pm GMT, financial newswires in New York reported that Fitch Ratings, a company which measures stocks and shares according to their reliability as an investment, was downgrading the specialist insurer Ambac and removing its crucial AAA rating.
Although no one outside the world of high finance would have heard of Ambac, the removal of its top-grade investment status had a knock-on effect which triggered panic in the markets.
Ambac had become the latest victim of the dreaded sub-prime mortgage crisis that began infecting the world's financial institutions last summer, which led to the crumbling of Northern Rock, the British bank currently being propped up by £50 billion from the taxpayer in loans and guarantees.
Sub-prime mortgages - loans made to householders who could not afford to pay them back - were sold on by mortgage lenders in the form of bonds, and in turn the bonds were insured by companies like Ambac.
Such bond insurance is known in the City as "monoline" insurance (a piece of jargon which is likely to become as familiar in the coming months as "sub-prime") and was traditionally seen as one of the safest forms of investment. But when Ambac lost its coveted AAA status, jitters began to set in among traders, who feared that the sub-prime crisis was about to claim a whole new tranche of high-profile victims. As Jamie Dimon, chairman and chief executive of JP Morgan Chase, puts it: "If one of these entities doesn't make it, the secondary effect could be pretty terrible."
Shares in leading US insurers and other financial stocks began to tumble during the course of Friday afternoon, and when the Australian, Asian and European markets opened on Monday they followed suit.
Coincidentally, at roughly the same time the announcement of the Ambac downgrading broke in New York, Jean-Pierre Mustier, the chief executive of Société Générale's commercial and investment banking division, was taking a call on his mobile on his way home in Paris. "Something fishy" had been discovered in the bank's accounts, he was told.
He returned to his headquarters in the La Défense business district of Paris, and began going through the books with senior executives. Working late into the night - and carrying on the following morning - the horrified bankers uncovered more and more holes in their trading accounts, adding up to more than £1.2 billion by Saturday afternoon. The trades were traced to one junior employee: Jérôme Kerviel.
The 31-year-old trader was summoned to the office, where he was grilled by Mustier for six hours. Undeterred by the monumental scale of his losses gambling with the bank's money on movements in the European stock markets, Kerviel tried to convince his boss that he had come up with a brilliant strategy for making the bank huge profits.
At a crisis meeting on Sunday, SocGen's chief executive Daniel Bouton decreed that, rather than announcing the loss straight away, the bank would quietly unwind Kerviel's loss-making accounts over the course of three days, supposedly to avoid panic in the markets.
It began selling Kerviel's futures on Monday morning, but quickly got caught in a vicious circle which tripled its losses.
The markets, already primed for meltdown by Friday afternoon's downturn in New York, went into freefall as soon as they opened, and SocGen's sale of the Kerviel futures only made matters worse. A £1.2 billion loss ended up being a £3.7 billion loss thanks to the plunging prices.
By the close of trading on Monday, a colossal £77 billion had been wiped off the FTSE100 - and, therefore, the value of the UK's top companies.
"It was gut-wrenching watching the share prices fall and fall," says Gabay. "For years, we had been bemoaning the lack of volatility in the markets, because a flat curve means trading opportunities are few and far between. But you have to be careful what you wish for."
The only markets which did not take a tumble on Monday were in America, where the banks were closed for Martin Luther King Day. But at 11pm that night, UK time, the governors of the Federal Reserve, America's central bank, held a video conference which resulted in the momentous decision to cut interest rates by 0.75 per cent, the biggest cut in a quarter of a century.
Ben Bernanke, the Fed's chairman, famously admitted six years ago that the Fed was responsible for the Great Depression of the 1930s - on which he is one of the world's leading authorities - because it had set interest rates too high. He was darned if the predictions of another depression were going to prove right during his watch.
Unaware of the Fed's decision, the Asian markets continued to tumble overnight on Monday, with every single share on traders' screens in Tokyo turning red for "sell". One man, despairing at the tumbling value of his investments, climbed on to the roof of a Beijing department store and threatened to jump.
By 2am on Tuesday the Hong Kong markets had opened, and once again there was carnage, with £160 billion wiped off shares during the day's trading. A similar story unfolded in Bombay, Shanghai and the Middle East and, by 8am, when the London markets opened, still unaware of the impending Fed rate cut, traders were bracing themselves for another day of pandemonium.
It was only when rumours began to sweep through the trading floors that the Fed was about to announce an interest rate cut that share prices began to rally, and the City held its breath as it waited for an official announcement from Wall Street, which finally came at 1.20pm. At first, the reaction was one of relief, but suspicion and doubt quickly began to take over. The cut was unexpectedly high - did the Fed know something it wasn't letting on? Was the situation in America worse than had been thought?
By the close of trading on Tuesday, the mood in the City was broadly optimistic, and the FTSE rallied to close up by 161.9 points.
But many analysts believe the more important decision came on Wednesday, when US banks confirmed that they had begun talks over a bail-out plan for the monoline insurers, involving a possible £7 billion injection of funds to shore them up and win back their AAA status.
The markets perked up further as a result, and by Wednesday night the relief in the City was palpable. The weekend could not come soon enough for the exhausted traders. Yet the week's biggest surprise was still to come.
When trading opened on Thursday, Société Générale dropped its bombshell: almost its entire annual profit had been wiped out by the losses incurred by Kerviel.
SocGen had a reputation as one of Europe's best-run banks, yet a single rogue trader had managed to rack up multi-billion dollar losses undetected. The fiasco simply added to the impression that the executives running the world's biggest financial institutions are highly fallible.
After all, if giant institutions such as Citibank and Bear Stearns in the US could lose billions of pounds to the sub-prime mortgage crisis, and France's second-biggest bank could allow a rogue trader to wreak such havoc, could anyone be trusted with the stewardship of funds worth billions?
Although the markets have recovered many of their losses from the early part of the week, the crisis of confidence, particularly in the monoline insurance sector, is likely to drag on for months. And, even if the Western economies do manage to recover their losses, they must get used to the fact that they will soon lose their dominant position in the world economy.
As political and business leaders gathered in Davos, Switzerland, this week for the World Economic Forum, it was the representatives of the emerging economies, particularly China and India, who had a spring in their step. While the West awaits a possible recession, the emerging economies can look forward to a boom that will see them overtake the US in terms of economic power.
As George Soros told those gathered in Davos: "I think we are seeing the end of the dollar as the international currency and we need a new sheriff."
Mervyn Davies, chairman of Standard Chartered, a bank based in Britain which focuses on the Far East, claims: "There is a seismic change going on. There are emerging powers which are much richer and more powerful than people have realised."
Among the wise old heads in Davos, however, there are plenty who believe there is cause for optimism.
Bob Diamond, president of Barclays, says America's forceful moves to shore up its economy - including a proposed presidential stimulus package worth $150 billion - will keep a recession at bay. "If you and I sat together six months from today," he says, "we would be talking about a US economy in better shape than six months earlier, not one shifting further into trouble, because they've acted so boldly."
But, while there is widespread praise in Davos for the decisive actions of the US Federal Reserve, there is disdain for the European Central Bank, which did virtually nothing to quell the panic in the markets this week.
"If the largest economy in the world is behaving in a way which is producing this kind of decision by its monetary authorities, you can't ignore it," claims Angel Gurría, the secretary-general of the Organisation for Economic Co-operation and Development. "Believing that Europe has become bulletproof or armour-plated would certainly not be recommendable."
Stephen Roach, president of Morgan Stanley in Asia, puts it more bluntly: "Europe is not going to get some special dispensation from a global slowdown."
After the City's much-needed rest this weekend, all eyes will turn on Monday to the European Central Bank, to see whether it follows the Fed in taking action to shore up the European markets.
As Gabay observes: "A lot of medicine has been applied to the markets in terms of the Fed rate cut, the monoline bailout plan and other measures, but the markets are still very, very uncertain about each other. We can expect investors' nerves to be tested again next week."
