Don't Jump --- Yet!

The interconnectedness and velocity of modern markets make this crash unique, says Martin Vander Weyer. But all is not lost yet: this is a time for cool heads and open minds

On Monday afternoon I rang a Wall Street friend who used to work at Lehman Brothers. ‘What’s the mood?’ I asked him. ‘Do you think this is the turning point?’

‘Hold on a moment,’ he replied. ‘Let me just climb back in off the window ledge.’ There was a pause, then a nervous chuckle. For the half-second of that pause, I actually wondered whether he was serious. And that was just Monday: since then, things have got really frightening.

The former Federal Reserve chairman Alan Greenspan says the current financial crisis is ‘a once-in-a-half-century, probably once-in-a-century type of event’, but he’s wrong. There has never been a situation like this: the global interconnectedness of today’s markets, the speed of internet communication, the extent to which markets impact on ordinary folks’ pensions, savings and aspirations of home ownership, all make this utterly different to 1929 in New York or 1866 in London.

The pace and reach of the contagion is astonishing. The US insurance giant AIG, an icon of financial sophistication, went from rumour to rescue in 24 hours. By the time you read this, the spotlight in the US may have shifted to Washington Mutual — a Seattle-based savings and loan association that turns out to be America’s sixth largest bank, and may or may not be seriously strapped for cash.

On this side of the Atlantic, all eyes are on HBOS, the merger of Halifax and Bank of Scotland which is the biggest UK mortgage lender, and which has seen half of its market value wiped out by short-selling share speculators in the past few days. No serious commentator believes HBOS is about to be ruined by its domestic mortgage book — and yet rumour feeding upon rumour, malicious or innocent, could rapidly cripple its ability to fund itself. As we go to press, an emergency merger with the untainted Lloyds TSB looks to be on the cards. That would create a bank as strong as any in the western world today: and if it goes ahead at a fair price for long-term HBOS shareholders, let’s hope the short-sellers take a caning.

If anyone tells you they can see how all this is going to end, ignore them. Small things will cause huge swings of sentiment: in New York, it could be the nuance of a statement by the Treasury Secretary Hank Paulson, or (as in 1929) the sighting of a repairman on a roof mistaken for a suicide jumper; over here, it could be a particularly strangulated paragraph from Robert Peston, or a computer glitch that causes a queue in an HBOS branch. Historians will one day tell us which deal or speech or price-change marked the nadir, but we probably won’t spot it as it happens. No, the only way to weather this storm is simply to absorb the facts one day at a time — and remember that what goes down will eventually go up again. In that spirit, let me try to pick out some points of optimism from the last few days.

First, it was a positive sign that Lehman was allowed to go bust. Paulson let it happen because he could: failure of the fourth largest investment bank in New York was judged not to represent a ‘systemic’ threat, after Lehman’s major trading counterparties got together on Sunday and reshuffled their exposures in such a way as to minimise the damage. When Bear Stearns went under in March, by contrast, the potential hit to the rest of the market was big enough to prompt the Fed into underpinning an emergency takeover by JPMorgan Chase.

So Lehman fell without knocking over the dominoes. And that fall was, after all, richly deserved: up to its eyeballs in ‘toxic’ subprime debt, Lehman had ample time to sell itself or attract new capital after its shares started collapsing in March — but negotiations repeatedly broke down because Lehman’s chairman, the hard-driving former bond trader Dick Fuld, held out for too full a price. Fuld was paid $5 million in cash and $35 million in stock units last year; many of his colleagues also took their bonuses in stock which is now worthless. They do not need your sympathy, however, and nor do any but the most junior of the 4,500 London staff now departing from that gleaming Lehman tower in Canary Wharf: as Sir Martin Jacomb observes in his wise essay on page 28, moral hazard has at last been reasserted, and that too is a positive signal.

Always a fractious firm, Lehman was going to be a bundle of trouble for any buyer who responded to the last-minute call for rescue bids last weekend: Barclays and Bank of America held their noses and took a look, then — in the absence of guarantees from Paulson — backed away. That’s one more positive sign: Barclays has subsequently picked off $2 billion worth of bits of the Lehman carcass, but shareholders can breathe a sigh of relief that their high street bank has not tried, python-like, to swallow it whole.

As for Bank of America, it bought Merrill Lynch instead, and that part of the story has both positives and negatives. Merrill’s shares had fallen by 70 per cent since the beginning of the year, but BoA’s offer came at a premium to last Friday’s market close and valued Merrill at more than $40 billion — pricing Merrill as a going concern, not a basket case. And that’s important because, as one banker remarked to me, ‘Merrill is Main Street, not Wall Street’: its vast retail brokerage network is, like Fannie Mae, woven into the fabric of American life.

The negative is that Bank of America may well be the only US bank still strong enough to buy anything on the scale of Merrill (JPMorgan Chase having already bitten off Bear Stearns), but it will not now buy anything else: so the pool of potential rescuers just got a lot smaller. More broadly, the crisis is provoking a revival of the belief that giant financial conglomerates are intrinsically dangerous, especially those that combine retail deposit-taking with the rollercoaster risks of investment banking. As Gary Hector wrote in a book about Bank of America’s problems back in the 1980s: ‘Perhaps the time has come to resume the crusade against bigness itself.’

And AIG? Well, at least the financial community can take comfort from the muscularity with which ‘Hammerin’ Hank’ Paulson is dealing with one casualty after another. Back in July in these pages we accused him of dithering like Alistair Darling; he’s certainly not dithering now.

Meanwhile, as one by one the solemn temples of finance dissolve, other thoughts come to mind. The first is a memory of the Black Monday crash in 1987, when I was in charge of a share-dealing operation in Hong Kong and had to report the wreckage to my boss. I mumbled nervously about ‘the next support level’ for the plunging Hang Seng index. ‘In these conditions,’ his eyes narrowed, ‘there are no support levels.’ But the truth was he knew no more about what would happen next than I did; and before long, the market was creeping up again.

Finally, noticing the strange normality of everything except the financial news, I recall Auden’s Musée des Beaux Arts: ‘In Breughel’s Icarus, for instance: how everything turns away/ Quite leisurely from the disaster; the ploughman may/ Have heard the splash, the forsaken cry,/ But for him it was not an important failure...’ In the City and on Wall Street, we are watching the fall of an arrogant, self-deluded generation that flew too close to the sun. We have heard the splash. Right now it looks and feels like an important failure. But stay calm, close your ears to the voices of doom: only time will tell.