An Insolvency Practitioner's view on the downturn

Many people hope the current Credit Crunch will only be temporary.  They would like to see the financial markets return to a time when liquidity was never a problem, in fact obtaining credit was so easy whole economies were buoyed up by debt.
Personally, I think the Credit Crunch and, in many parts of the economy, a recession will be with us for several years.  I also believe that as things will get far worse before they get any better, and those areas of our economy that are in any way related to property or retail, and those people and companies that have over committed themselves, will suffer most during that time.  I expect house prices and house sales volumes to continue to fall for at least a year as prices and demand to buy starts to reflect the reduced sums of mortgages and loans available.  Attitudes to home buying are alteady changing, many are putting off buying until later on when they expect to buy properties cheaper – after all had it not been for the all too easy availability of 100% mortgages prices and the expectation for prices to continue rising prices would not have gone so high.
The real problem is the underlying financial system for the supply of cash into the economy.  It only really works well when lending is all full steam ahead – when lenders in an attempt to continue to outpace their competitors in terms of markets share and profits, adopt what I believe are lax lending practices that are unsustainable in the long term.  At the moment many lenders are sitting on their hands, they say they are open for business for the right deals, but in reality they are not – very few deals are being done and those that are being done are for far less than previously – many mortgage lenders have pulled back to loan to value ratios of 75% even for prime business – in other words they expect property prices, at least in a recovery scenario, to fall by about a fifth.  Realistically, such low advance rates will stifle the market from the very bottom upwards.  And the typical Jo and Joanne Public cannot save a 25% plus all associated costs of moving in quickly.  Thei family cannot help as they too are stymied by often already high LTVs on their own mortgage and an unwillingness by lenders to lend.  It’s happened in Italy, where many ‘children’ are forced to stay in the family home until they are in their late 20s, why would it be different here?
There are several other problems with the financial systems:
1)  Many banks are hoarding cash, rather than lending it out, in the hope of buying other banks or financial institutions cheaply, and thus increasing their market share.  For some banks, the crunch will enable them to grow to where they would ideally want to be quicker and cheaper.  This makes the crunch self perpetuating;
2)  The Bank of England and other central banks are virtually powerless, bystanders watching as the markets unravel.  No one fully understands the complex financial systems that have evolved over the last 20 years, nor has the introduction of huge amounts of cash into the systems by the central banks made one jot of difference overall.  With many banks operating globally, the systems are truly global – why should the Bank of England lend vast sums of cash to support a bank with UK operations when abroad it is sitting on huge sums of money – just look at Barclays, they went cap in hand to the US Central Bank yet a few months later had enough cash in the UK to make a huge acquisition.  Abbey are paying a huge, 9%, interst rate on monies investors pay into it – what is happening to that cash, I don’t see it being loaned out here in the UK, is it going to its parent Santander, and if it is, what is Santander doing with it?  The Central Banks have little or no control over the systems – even if they were to act together, the market is too big for them – and acting together and putting more huge sums in is both risky – putting a stickig plaster over a gaping wound will not make any difference.
3)  Banks do not trust each other.  They bought and sold huge amounts of packaged debt, virtually blind, only to find that poorly rated debt was missold as good triple rated debt.  That mistrust of each other, not knowing what is in each other’s balance sheets, is parasitic – they wil not readily lend to each other in the short term until the full extent of the misstatement of assets in each’s balance sheet is known – and that will take some years.  A week hardly goes by without some bank or other, having previously said that it had a full handle on its loan book, revisiting its provisions and making further huge bad debt provisions and asking the markets for more cash – and we are only part way into the Crunch!  And the banks are already looking for innovative ways of shifting problem books off their balance sheet without creating huge write offs – it was such off balance sheet transactions that enabled the system to go into overdrive in the first place, which bank will trust any other with this going on?
4)  So where did the cash that is all written off in sub-prime loans come from?  It did not appear out of mid-air!  I have not been able to form a definitive view on where all that cash came from, but suspect that much of it is not real, it was sitting in banks’ balance sheets as debts owed by or to several other banks, rather than say bank A having spent all its £ x billion cash.  If this is so, this would mean that the Crunch effects all banks far and wide, not just the few directly exposed.  So prcisely which banks are exposed and to what amount, and when that exposure will eventually come home to roost, is unclear – it will take some time to do so.
5)  Inflation is not helping, people have less spare cash, demand for products and services is falling, the downturn in the economy is real.  And lower demand = lower prices all round = lower company profits = lower pension fund values and tax revenues = lower personal and government spending.
So far most of the true pain has been felt by smaller companies – the larger companies with which they deal have used their commercial muscle by delaying paying debts and reducing prices, such that more and more smaller businesses are going to the wall, more often than not with few realisable assets.  The economy is, however, in such a hole that the bigger businesses will not be able to avoid going into insolvency themselves by merely not paying their smaller suppliers: they will suffer some time down the line, I suspect 6 – 9 months time will see an increase in larger businesses going bust.
All in all, I am sorry, but I think the Crunch / downturn is here to stay for some time yet.

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