ALEX BRUMMER: Rate cuts, the only cure to this financial meltdown



What ought to have been a hopeful day on the world financial markets - with the rescue of the Bradford & Bingley and the progress of the America's $700billion bail-out scheme - turned into a nightmare.

The reality of globalisation is not just that it has brought the world undreamed-of prosperity, but that it is impossible to isolate a financial crisis in one country from that in another.

In a matter of a few short hours yesterday banks across the globe from Wachovia in North Carolina to the frozen wastes of Iceland fell under new ownership. And as the drama unfolded the share prices of banks, including those of the big four on Britain's high street - Royal Bank of Scotland, Lloyds TSB, Barclays and even HSBC - took a hammering.

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In the U.S., the House of Representatives rejected Treasury Secretary Hank Paulson's banking rescue package, leaving Wall Street in a state approaching panic and causing its biggest one-day fall in history.

Here in Britain B&B was nationalised with a difference in that the banking system, rather than the taxpayer, might have to pick up the eventual bill. In the United States Wachovia, a big retail bank, was swallowed by mighty Citibank with the assistance of the U.S. central bank the Federal Reserve.





And on the Continent banks based in Belgium, Germany and Iceland have been taken into public ownership by their respective central banks.

So what has been going on? The immediate causes of the rescues were falling share prices in the banks concerned and other banks, lenders and savers pulling out their deposits. In effect the banks concerned, Fortis in the Benelux countries, Glitnir in Iceland and Hypo Real Estate bank in Germany, had suffered invisible runs.

There were no queues, as when Northern Rock ran into trouble a year ago, but the withdrawal of deposits in the wholesale markets (where banks lend to each) made it difficult for the banks concerned to fund operations. So central banks across the world have been forced to nationalise in an effort to stabilise the system.

Until now many experts have sought to blame the escalating global banking crisis on the foolishness and greed of Wall Street and the packaging and selling-on of toxic sub-prime loans. But it is also becoming clear that it is not just the American banks and Anglo-Saxon capitalism which is responsible for the present catastrophe.

Europe's vulnerability to the credit crunch also stems from its own extravagant behaviour. Across Britain and Europe, over the last decade, there has been huge surge in corporate and household lending and debt. This has been layered on top of a banking system which believed it could operate with lower capital and liquidity than in the past.

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Instead of conserving banking profits for a downturn in the economy, gains were extravagantly distributed to executives, employees and shareholders.

It is not just the U.S. and Britain which experienced a housing boom. The subsequent drop in house prices has spread across Europe, too, with Ireland, France and Spain seeing serious declines spoiling the value of the mortgage security held on balance sheets.

This was the core of the problem at Bradford & Bingley and HBOS, Britain's biggest mortgage lender, which is being bought by Lloyds TSB.

As important has been corporate borrowing and debt levels. The last few years have seen record levels of mergers and acquisitions with prices driven up by private-equity deals as well as unusually high levels of capital spending. Across Europe this year there has been a serious deterioration in the balance sheets of companies, with the debt agencies downgrading the debt of 78 per cent of borrowing corporations - the worst period since the dot.com bubble burst in 2003.

The other factor which has caused problems to spread and worsen is the internationalisation of risk. Everyone is now aware that bad mortgage debts in Cleveland, Ohio ended up on the balance sheet of banks such as Barclays in Britain, BNP in France and IKB in Germany.

International Monetary Fund figures show that the exposure of European banks to American sub-prime mortgages is 73 per cent as big as that of the American banks.

So it is hardly surprising that the UK and the Continent are now feeling the effects of the same hurricane which has swept away great chunks of Wall Street and hundreds of years of venerable financial history.

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So when will it end? From the startling evidence of the widespread public ownership now taking place, the current storm still has along way to go before it blows itself out.

Until now we have seen a piecemeal response to the crisis, with banks being rescued or taken over one by one. What has been lacking is a coherent economic response.

The most far-reaching rescue package was put together by Mr Paulson, but now Congressional opposition has put this into serious doubt.

Central banks, including the European Central Bank and the Bank of England, have been nervous of cutting interest rates because of the inflation threat. That is now becoming the lesser of two evils.

What is needed now is cheaper money, which will ease the pressure on bank and corporate balance sheets. Instead of fighting last year's war against inflation, the new battle against banking collapse and economic implosion needs to be joined with decisive rate cuts.