Crunch warning: Timely reminder

Gary Duncan

Today’s ominous warning from Kenneth Rogoff, the IMF’s former chief economist, of continued peril from the credit crunch, is a timely admonition to unwary investors that in weighing the likely toll on America they should follow one of that country’s favourite rejoinders and “wake up and smell the coffee”.

Professor Rogoff, a distinguished macro-economist now at Harvard, is not the first, and is unlikely to be the last, to caution against a rash assumption that we are close to seeing the end of this crisis, or even the beginning of the end. In recent weeks, similar advice has been proferred by the IMF as well as several other prominent observers.

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Yet the professor’s assessment that we may not yet be even halfway through this crisis, that there may be worse upheavals to come and that these could yet claim a “whopper” among US banks as the latest casualty is another, much-needed dose of realism. It comes at a time when at least some investors had begun to be lulled into a misplaced sense of complacency by a rally in banking stocks — albeit one that had already run out of steam.

There are plenty of good reasons to believe that the professor’s prognosis is almost certainly correct. For one thing, the amount of fresh capital, some $400 billion (£216 billion) raised by banks since the crisis began, is still outstripped by the losses they have suffered. Many big institutions remain frail, in dire need of further infusions of funds, and exposed in an environment in which many banks remain reluctant to lend to each other.

Moreover, the danger is growing of a self-reinforcing downward spiral as banks’ plight leads them to curb further lending, further undermining the real economies of Western industrial nations, leading to more loan defaults and mortgage market woes, and yet another wave of credit tightening.

That risk remains very substantial in the US, where the housing slump persists, and may yet claim more victims among the banks. It is also still elevated in the UK, where, as David Miles of Morgan Stanley recently noted, banking groups remain more exposed than some of their international rivals.

It was Professor Rogoff who made it fashionable to quote the American poet Robert Frost’s apocalyptic visions of the world ending in either fire or ice as a way of capturing the conflicting dangers from flagging growth and rising inflation besetting the world economy. It seems the professor has now been reading another of Frost’s verses, where the poet alludes to woods that are “dark and deep”. As Professor Rogoff argues, we are very far from out of the woods.