The US government still has not reached an agreement on raising the debt ceiling, the markets turn their backs on Spain and Italy, stocks worldwide erase all their recent month’s earnings in two days, gold is near its historic high again… Everybody seems to be expecting another big hit to the economy sooner rather than later. We have already been there, we should know what to do. Quoting the great Ray Charles “No peace I find, just this old sweet song keeps Georgia on my mind“. In this case the name may not be Georgia but Lehman Brothers, and the ‘song’ may not be sweet at all, but we should have it on our minds.
Because while preparing for this kind of impact, what people are not figuring out is that they are inadvertently paving the way for said impact to be much stronger. Nobody seems to trust anybody else these days, and this is bad, very bad for market stability. No matter how long you have traded or invested with a counter-party, no matter how strong and risk-averse you have been for years; in the eyes of others nobody seems safe against what is coming.
Lehman Brothers’ situation was really bad, but it was the mistrust from its clients, partners and rivals that put it into a corner and accelerated its demise. This mistrust seems to be the general rule in financial markets these days. Today everybody is hedging against everybody else, buying insurance and taking CDSs (Credit Default Swaps) through the roof. This mistrust has enough power to stall global financial markets; and as we recently became aware of, a financial crisis can transform into a full-fledged economic crisis in the blink of an eye. If that were to happen, we would find ourselves in the much feared double-dip recession. I do not want to even think about what another economic crisis would mean globally when we are still struggling to make our way out of the first one. However there is something I can be totally sure of: if such a double-dip recession happened, a lot of players would be out of the game very soon. A lot of companies, and most importantly some countries, would be unable to dodge a second punch when they are still dizzy from the first one.
You know the situation is bad when even the president of the United States, Mr. Obama, has had to explicitly say the US is not going to default on its debt obligations. While this would have seemed a joke some time ago (a really bad one), recent speculation about the possibility of the US having problems to keep up with its day-to-day obligations due to having reached the established debt ceiling, have made it necessary for Obama to step up and try to calm the markets with his announcement. At the time of writing this, I am sorry to say, he has been unable to do.
This is not totally Obama’s fault though, as the situation at the other side of the Atlantic is not helping at all. The European Union seems stuck in its talks for a second bailout for Greece. Speculators have instantly used this uncertainty to focus on their next prey, Spain and Italy, after devouring not only Greece but also Ireland and Portugal. If Lehman told us something, it is that the moment everybody turns their backs on you there is very little you can do to turn the situation around. The problem is Spain and Italy are really too big to fail, Europe (and the rest of the world for that matter) cannot afford both of them going down.
I am not saying everybody (yes, that includes rating agencies) should back off and let Spain and Italy do their thing, because they clearly have been doing things the wrong way. They have abused their debt issuing, and the European Union is also guilty by having looked away from the problem for a long time, but strangling them overnight is not the way to go, it is bad for anyone. Maybe some people are earning a lot of money from the situation, or maybe they have made some big-money bets on Spain and Italy going down. Either way, they risk killing the economy if they are not left some room to breathe and the opportunity to change course and make things right.
If we have really learned the lesson, we should keep the fall of Lehman on our minds.