Recession fears mount due to uncertainty

Ref Gillian Tett, Financial Times March 5 2009

In the past few weeks, concerns about a sharp decline in global economic activity have mounted. In part, this can be blamed on tightening of credit by banks. But the sheer speed and global nature of this slump suggest that psychology is also to blame. People are feeling gloomy and uncertain on almost every front.

In the financial markets, the collapse of Lehman Brothers has created huge worries about counterparty risk. Also financiers are finding it increasingly hard to engage in the market “hedging” strategies they used to employ to mitigate risk. The pattern of deleveraging and forced sales has been so intense that traditional price relationships have completely broken down. Trading models have gone haywire.

Western governments do not seem to be doing much to remove this sense of uncertainty. The Lehman collapse has sown a sense of terror about creditors losing money on any bank bonds they hold. Governments must persuade investors that banks are so healthy they cannot collapse. Alternatively they must promise to protect creditors if they do.

The US and many European countries are rolling out piecemeal solutions. Meanwhile, efforts to persuade the public that banks are healthy, have been unconvincing mainly because there is still so much uncertainty about asset values.