- NEW YORK (Reuters)
- Severe stress in global markets has nerve-wracked investors fearful that
one big shock could jam the gears of the financial system -- much like
the crisis days of 1998.
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- "People feel like gasoline has been dumped on the
floor and it wouldn't take much to ignite it," said James Glassman,
senior U.S. economist at J.P. Morgan Chase.
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- Plunging stocks and multibillion dollar bankruptcies
the past month have investors assessing the widespread damage to banks
and insurers. If more scandals or failures come to light further straining
capital markets, it could force central banks to jump to the rescue, pumping
money into the system through lower interest rates.
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- Fear is starting to hurt economies as well. The financial
market squeeze in both the United States and Europe is depriving businesses
of crucial capital and sharply increasing their cost of borrowing at a
time when global growth, led by the $10 trillion U.S. economy, appears
to be losing steam.
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- "The Fed has to get concerned about the capital
markets effectively tightening for the Fed at a time when it wants policy
to remain accommodative," said Brad Stone, chief U.S. market strategist
at Barclays Capital.
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- "The Fed may need to lean against that. Some weeks
ago that looked like a very low risk. Now it's definitely a real risk,"
he added.
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- MONEY HARD TO GET
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- Interest rates charged on high-quality corporate debt
right now stand at near-record levels -- 2.2 percentage points above risk-free
Treasuries, up more than half a percentage point since early June.
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- Investors, scared they cannot trust corporate balance
sheets, have proven reluctant to lend money. Corporate bond issuance by
investment grade companies sank in July to $22 billion, down 63 percent
from its January to June average. Last week investment grade debt suffered
its worst week since at least 1997, and junk bonds are set for their worst
year ever.
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- Funding through the short-term commercial paper market
also has become very difficult, with total outstanding issuance for nonfinancial
and financial firms falling a hefty $93 billion this year. Banks have turned
skittish about lending. Initial public offerings have dried up.
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- "The way the events are unfolding right now for
the near term, dealing with these many financial constraints is going to
impinge and impinge and impinge on economic activity," said prominent
Wall Street economist Henry Kauffman, who has argued the Fed should cut
interest rates.
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- Swap spreads -- a measure of banking sector risk that
signaled the systemic distress in 1998 -- popped out last week on the credit
anxiety about J.P. Morgan before stabilizing. Investors are even raising
risk premiums on assets usually considered very safe like mortgage-backed
securities.
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- With markets so stretched, harried traders are looking
anxiously for the one trigger that could set off an explosion.
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- "The markets continue to scan for a 'smoking gun'
to justify some emergency policy response," said Michael Wallace,
an economist at Standard & Poor's MMS.
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- Rattled markets showed their heightened state of anxiety
on Friday when rumors of an emergency central bank meeting in Europe to
help a failing bank or insurance company swept through trading desks, sparking
selling of stocks and powering gains in safe-haven short-term Treasuries.
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- Banking trouble fears hit a fever pitch on July 24 when
rumors spread of liquidity problems at J.P. Morgan Chase -- the largest
U.S. bank-- and Citigroup after congressional revelations of their dealings
with failed energy trader Enron Corp. The impact across credit markets
was harsh and swift.
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- Later that day ratings agency Standard & Poor's said
such talk was unfounded and reaffirmed the ratings of both banks, but investors
remain shaken and the damage to market conditions has not improved much.
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- Europe has also seen its fair share of worries about
the quality of its banks and insurance companies on the asset losses, providing
fodder for the rumor mill.
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- On July 25 Germany's second largest bank, HVB Group ,
posted a second-quarter loss and described business conditions as among
the worst since World War II.
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- '98 REDUX?
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- Economists are quick to point to the differences between
this episode and the late summer of 1998, when Russia's debt default sent
investors rushing out of risky assets globally and nearly brought the financial
system to its knees when the hedge fund Long-Term Capital Management almost
collapsed.
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- Conditions were so bad then that even the massive U.S.
government bond market -- considered the most liquid in the world and a
refuge from turmoil -- nearly froze as dealers demanded higher and higher
premiums to execute trades.
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- Eventually the Fed cut rates to restore investor confidence,
even though the economy was in good shape.
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- The current pain in capital markets has yet to reach
those extreme levels of distress, said J.P. Morgan's Glassman. But he said
the market sees conditions as deteriorating to the point where a crisis
could happen "at any moment."
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