“A financial crisis unmatched since the Great Depression”
“UBS to axe 6,000 jobs”
“How to keep a roof over your head”
“Swiss banking giant writes off another £9.6 billion”
The above are all headlines from newspapers and magazines in the past week. We are currently drowning in articles on the credit crunch, so we have decided to add to the overload by looking at this latest scare story; what it means for you, your business, and how to avoid financial Armageddon.
What is a credit crunch?
In America, banks were selling mortgages to people with poor credit history, who later could not repay these ‘sub prime’ mortgages. House prices fell, interest rates rose and missed repayments led to mass repossessions.
Buying loans from other banks is cheaper than borrowing from the Federal Reserve and these ‘sub prime’ mortgages were sold and resold, often to overseas banks. Once it was evident a lot of these loans were going unpaid, banks decided they could no longer trust each other.
The snowball effect, started by the housing slump in the US, led to financial institutions experiencing a lack of money. The dearth of liquidity, which means they are no longer able to lend to each other, has forced banks to compensate by increasing fees and rates on credit cards, loans and mortgages.
Bankers seem to make economic cycles worse, they lend umbrellas when it is sunny and ask for them back once it starts to rain. This time they have treated the markets like a drunken roulette player at a casino, and everyone else will have to pay as the global economy freezes.
In the US, a recession is defined by the National Bureau of Economic Research, as a “significant decline in economic activity spread across the economy, lasting more than a few months”. Measured by factors like GDP, income, employment and retail, it is obvious that the US has slid into recession. Wars also tend to have a recessional effect.
The UK is in danger of following and David Blanchflower, from the Bank of England’s monetary policy committee, thinks the credit crunch could push the economy in a downward spiral. He said: “In my view a correction of around one third in house prices does not seem implausible in the UK over two or three years.”
Economic factors are closely linked and constant talk of a recession can become a self-fulfilling prophesy. House prices are falling, mortgage lending is at a 15-year low and food and oil prices are rising, which is likely to lead to increased inflation. UK retailers are suffering because, as Lloyds TSB reported, people are increasingly worried about losing their jobs.
Europe, generally, it is argued, is keeping the credit crunch at arms’ length by avoiding the mistakes made by America. Its banks are in better shape and unemployment, at an average of around 7%, is at its lowest in 20 years, with the euro performing well.
However, there is no room for complacency. The European Central Bank (like the Federal Reserve), has flooded the financial system with liquidity, inflation is up to 3.5% and troubles in the US and the UK are starting to bite. The weak dollar is driving an American export boom and the strong euro is beginning to hinder Europe’s exports.
Housing is also a worry, with prices falling in Spain and Ireland, two countries reliant on construction. Some markets have adapted better than others to the constraints of the euro. Germany and the Netherlands have cut labour costs and their economies may be better placed than those of France, Spain and Italy.
The Bank of England has decided to support British banks and global credit conditions might stabilise within the next 12 months. Things, however, will be different from before.
The US economy will rely less on housing and consumption, but more on manufacturing and exports. The European economic cycle, around 18 months behind the US, will experience more of a slowdown, particularly in housing. In essence, things in Europe will have to get worse before they get better.
The forgotten victims
We may all have to make sacrifices in the face of the credit crunch, but two groups of individuals will have to pay disproportionately.
One of the unforeseen consequences has been a clampdown on city workers’ expense accounts. Deutsche Bank has banned employees from expensive business lunches, first class travel and even trips to strip clubs and brothels.
An internal memo from chief executive, Josef Ackerman (annual salary €15 million), said employees could not spend more than €80 on lunch per person, unless prior permission is obtained. Employees must travel second class on trains, unless journeys last more than two hours and no expenses will be paid for adult entertainment of any kind.
A worker at the bank said: “In the good old days you could pass off a trip to a knocking shop as a restaurant if the name wasn’t too obvious.”
An unfortunate side effect is that most of us will be forced more often into contact with these masters of the universe.
The other scapegoats are estate agents. In the UK, around 150 offices are closing each week and this trend is set to spread across Europe, with the job market swamped by spotty, suit-wearing negotiators. This will lead to problems for human resources as normal employees fight for voluntary redundancy.
Recruitment and HR
The downturn in the economy will mean a squeeze on budgets, unemployment will rise and wage growth will stop as companies try to cut costs wherever possible.
This is an opportunity for HR to assess priorities, plan the workforce and construct long-term perspectives on organisational health.
The Chartered Institute of Personnel and Development has predicted job creation will fall and that the recruitment sector will be busy managing an influx of skilled professionals, new to their market.
Steve Huxham, chairman of the Recruitment Society, says: “The business world will need to be cautious or it could talk itself into a recession.” He says there will not be a recruitment freeze because companies will still have turnover and global expansion plans.
He says it is a good time to invest in building networks and that it is important not to lose employees to rivals, who may want to employ people requiring little or no training once the ‘blip’ is over.
Rod Bailey, ExecutiveSurf’s ceo, agrees, but adds that recruiters typically underestimate recessions and forget the real effects are usually felt six months after retailers feel the squeeze. He says: “It’s easy to say we shouldn’t talk ourselves into recession, but that’s because we’re not feeling it yet.”
“Another point to consider, is coming out the other side of the recession. That’s when most firms will go under. There will be a couple of years of hard times, then all systems go again. But a lot of companies will no longer have the cashflow or credit lines to grow. They will go bust and that goes for banks as well.”
Jeffrey Sachs is a US economist and special advisor to the United Nations. Time magazine consistently ranks him among the world’s most influential people.
In answer to those who believe we are seeing the greatest financial crisis since the Great Depression, he says: “That was caused by a series of historical cataclysms, many related to the First World War, followed by massive policy failures of central banks, compounded by the lack of international co-operation and a breakdown of trade.”
He says there is no need to repeat such an event. “The current situation is caused by financial mismanagement following deregulation, natural resource scarcity and environmental threats. There will be no disaster unless these challenges are profoundly mismanaged.”
When asked whether central banks should bail out institutions who were victims of their own greed, he said: “We need to avoid financial panics that become self-fulfilling crises, while not bailing out poor management and recklessness.”
Central banks should ensure liquidity, but not ensure against insolvency. He says: “The central banks are close to the margin between being guardians against panic and becoming agents of moral hazard and inflation.”
The finer points of economics can cause headaches in most of us, but we instinctively feel that the banks are to blame. They recklessly reward themselves when times are good, but take no blame when they are bad. They expect to be bailed out, leaving the rest of us to pick up the tab.
Warren Buffett is the world’s wealthiest man and he understands the intricacies of banking better than most. For years, the ‘Sage of Omaha’ has warned that financial innovations, such as derivatives, credit swaps and repackaged debts were a disaster waiting to happen.
He has a straightforward perspective on investment. In April, 31,000 devotees went to see him at his annual meeting, where he said: “If you’re going to buy a farm, you wouldn’t get a different price set every day. You’d look at the yield, the cost of the assets and the price of fertiliser. You’d decide what it was worth on the basis of what its earnings will be.”
“If we want to buy something, we’ll just buy it. If we want to exit, we’ll sell it. We won’t get involved in these fancy techniques.”
For those of us not into buying farms, perhaps the best solution to the problems posed by the credit crunch, would be to buy cheaper champagne and avoid reading too many articles on the subject, which can only depress us.
Politicians are quick to take the credit for brilliant economic policies when times are good, but blame events beyond their control for any economic downturns.
The actor, Henry Woolf, encouraged Harold Pinter to start writing plays. Woolf used to say, “It’s a funny old world,” to which Pinter would reply, “but the world isn’t entirely to blame.”