ALEX BRUMMER: Far from Iran, a hidden financial crisis is growing which reminds me of 2008. Rarely have I been so concerned
The world’s eyes are rightly focused on the closure of the Strait of Hormuz in the Persian Gulf, its dire impact on oil and gas prices, and its devastating consequences for both business and consumers.
This new economic challenge comes on top of existing and deep-rooted concerns about persistent inflation and higher inflation. interest rates and the real possibility of a global collapse.
But far from the current oil shock and flames engulfing the Middle East, there is another firestorm, albeit largely hidden, that could be as devastating as the great financial crisis (GFC) of 2008, when the world’s banking system had to be bailed out by Western governments.
Now the banks and fund managers who look after our retirement and savings are once again in panic.
Amid massive outflows from their funds, nervous investors seek the safety of cash, while the masters of the universe on both sides of the Atlantic are retreating and slamming the doors on those seeking escape. The possibility of a banking meltdown saps confidence and causes market values to fall.
As a financial editor who covered for this article the 2007 credit crisis that preceded the GFC a year later, the cracks in the financial system feel disturbingly familiar. I’ve rarely been this worried.
There is a growing sense of fear among senior financiers, economists and policymakers in the Western world. We’ve been here before.
A banker at Canary Wharf station on 12 September 2008, in the midst of the great financial crisis
In the wake of the GFC, financial regulators imposed strict new rules on banks requiring them to hold more capital. This was to protect depositors against future mistakes and to persuade banks to be more diligent in granting loans.
Explosion
Strict discipline led financiers in Mayfair, the City and midtown Manhattan to fill the gap by diving into unregulated, poorly regulated private markets.
Often known as ‘shadow banking’, this vast, little-understood financial backwater operates beyond the reach of central banks such as the Bank of England or official enforcers such as the British Financial Conduct Authority.
Jettisoning the visible, regulated financial sector in this way was an obvious risk, but there was serious money to be made.
There has been a boom in ‘Wild West’ private equity, private credit and hedge fund lending. And it is the toxic legacy of this largely clandestine activity that is now seeping to the surface and threatening the global economy.
The Washington-based International Monetary Fund (IMF) estimates that commercial banks in America and Europe have a massive $4.5 trillion (£3.4 trillion) exposure to this uncertain mountain of debt.
The IMF has already declared that the shadow banking system is the biggest threat to world financial stability.
Then, when the Iran crisis broke out in the last three weeks, ordinary retail investors, family wealth offices and professional asset managers became uneasy.
With the world in new turmoil, billions of pounds have flowed through the fund as investors try to protect their money.
And tremors are already shaking the financial system, including the major players.
American giants Morgan Stanley and JP Morgan expressed their concerns. Here in Europe, Barclays and Santander are feeling the aftershocks of the initial collapse and closure of funds.
The potential for financial disaster was clearly evident at a private dinner attended by top economists and regulators last week.
The guest speaker, who chairs one of the UK’s most respected forecasting groups, highlighted the potential for further collapses in the financial system.
My dining companions expressed concern that last month’s collapse of London-based mortgage lender Market Financial Solutions (MFS) was a canary in the coal mine and that Britain should brace itself for something much worse.
Many of those present were veterans of the 2008 GFC, and at least one of those who voiced concerns had sided with former Chancellor Denis Healey during the collapse of the pound in 1976, when national reserves were depleted and Britain had to turn to the IMF for a bailout.
The crash of 2008 was caused by US mortgage lending (subprime mortgages) to poorer borrowers; These loans were then divided into tranches and placed on the balance sheets of financial groups around the world.
This time banks are lending to private equity and hedge funds (the shadow sector) who use the loans to finance offers and deals, some of which have gone horribly wrong.
The purchased assets were injected into funds offering super high returns.
But for private investors and professional asset managers looking for exceptional returns, the reality is that if the rewards seem too good to be true, they almost certainly are.
Investors panicked during the 2008 financial crisis on the New York Mercantile Exchange
Last week Morgan Stanley, one of the world’s largest investment banks, limited withdrawals from its $7.6 billion North Haven Special Income Fund after experiencing a surge in ‘refund requests’ (meaning investors want to withdraw their money).
This follows similar moves by asset manager Blackstone, which deals with the savings of millions of people around the world.
shock waves
Christian Stracke of Pimco (an arm of giant German insurer Allianz, which manages assets worth £1.7 trillion) said the private equity industry was facing ‘a reckoning’. ‘This is not just a crisis of confidence, it’s also caused by poor underwriting.’
US-based fund manager Blue Owl has been at the heart of the growing disaster. It faced a liquidity crisis (shortage of cash) last month and was forced to immediately sell $1.4 billion in assets, causing shockwaves in the financial market as share prices plummeted. The failure of London mortgage lender MFS left Barclays and Santander with losses of £1.3bn.
During the Great Financial Crisis, the world’s most famous investor, the Oracle of Omaha Warren Buffett, sarcastically remarked: ‘Only when the tide goes out do you discover who was swimming naked.’
It won’t be a pretty sight.
The Bank of England is belatedly carrying out a ‘stress test’ to understand how British financial institutions would be affected by a major earthquake in private credit markets.
Unfortunately, I have little confidence that this Labor government is even beginning to understand what it is up against.
Pray
The guest speaker at last week’s financial dinner was particularly incensed by Chancellor Rachel Reeves’ appointment of new financial regulator Katharine Braddick as deputy governor of the Bank of England.
Braddick has been accused of encouraging ‘bolder’ (read riskier!) lending in the same private markets, which is now causing much justified concern.
Reeves even asked him to oversee the loosening of mortgage rules; This was another disturbing echo of 2008.
The world’s eyes are now on President Trump’s efforts to unseat Iran’s recalcitrant leaders.
But if the movement in the tectonic plates seen in the last few weeks turns out to be as deeply rooted as many believe, the economic crisis that is gripping us will be of a completely different order.
We must pray that this is not the case. Because if so, all of us with pensions, hard-earned savings and other investments will face life-changing losses. And the economy itself will be in ruins.
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