One Year after the Lehman Collapse
An update from the currency exchange firm World First
Because of the shortened trading week, this update will offer a retrospective of the previous year. It was 12 months ago that Lehman Brothers collapsed, and the subsequent fall out caused by years of malaise within the banking system is still being felt today.
Links to the subprime mortgage market lead to the onset of the rot in 2007 when it became obvious that defaults on loans would be larger than expected. This led banks to reassess their balance sheets in an attempt to ascertain their exposure to this toxic market. t was only at this stage that the inextricable complexity of the ownership of this debt became apparent. The debt had been packaged up into complex financial instruments that had become freely traded between banks, repackaged and traded again. Increasing default on subprime loans caused a landslide of escalating losses throughout the banking sector. Unsurprisingly, with hindsight, Lehman Brothers’ exposure to this market ended up being fatal. On 15th September 2008, Lehman Brothers one of the world’s oldest and most successful investment banks filed for Chapter 11 Bankruptcy.
Although the subprime mortgage is the most high profile factor leading to the credit crunch it is important to at least consider some of the other contributory factors that lead to a reduction in availability of credit. This then feeds forward into the consequences we have been experiencing in the currency markets.
It is undeniable that financial deregulation had its part to play in the crisis. However, the political and social debates this question raised are beyond the scope of our update. Certainly the two factors that contributed to harsher lending conditions and also caused aftershocks in the currency market are the over-leveraging and the subsequent commodity boom. Example of the consequences of over-leveraging are Fannie Mac and Freddie May in the US and Northern Rock in the UK. The commodity price bubble saw the price of Oil rise from $50 a barrel in 2007 to $150 a barrel at the end of 2008.
The most arresting effect on currency markets was unprecedented price volatility. Sterling for example lost approximately 18% of its value against the euro in the preceding four months. It saw sterling approach parity with the Euro around Christmas 2008. We also saw sterling collapse against the USD by approximately 25% in a similar time frame. The cause for sterling weakness was due to its reliance on the financial sector and the importance to the strength of UK GDP. Also, once the lender of last resort, the UK taxpayer, had been called in and Government firmly involved in the UK private financial sector, all bets were off on the scale of the damage caused to our nation. USD strength was another issue as the ‘flight to quality’ cause USD to strengthen beyond all reckoning as global investors sought a safe haven for their funds.
Commodity currency prices fluctuated wildly as traders unwound their positions. This initially saw a rapid and unsustainable depreciation in the value of these crosses. However, as the Chinese economy spluttered back into life their value slowly came back.
At the one year anniversary of this financial “perfect storm” of the new millennium markets are begging for stability and starting to contemplate moving in a much more comprehensible manner. We have seen this with the USD in particular. The dissolution of the relationships between risk appetite response to positive USD fundamentals and risk aversion to negative USD fundamentals is a positive sign. With markets responding to fundamental data more succinctly we believe this will in turn lead to more stable currency markets although volatility will continue linger.
If we compare the range of GBPEUR trading in the first 4 months of the crisis to the last 4 there has been a marked calm. A return to narrower trading bands and trading on fundamentals will signal the return to stability and emergence from crisis. However, as we always forewarn, we are not out of the woods yet. If proof were needed we need look no further than to the previous month of GBP trading in which the market has reacted to negative sterling news and not traded on positive UK data.
This week we see the first meeting of the BoE since the bombshell of quantitative easing policy expansion. With the minutes of August’s meeting revealing that 3 members, including Governor King, voted to increase the policy beyond the extra £25Bn agreed we should certainly not take anything for granted. Again, all eyes will be on Threadneedle St. on Thursday. While the storm has certainly abated, don’t expect calm seas to prevail for sometime yet.
For more information, see www.worldfirst.com.
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