Will the Lehman Brothers collapse hit you?
Tuesday, 16 September 2008 12:00
The failure of an investment bank in New York may seem remote, but the fall of the Lehman Brothers could hit British consumers.
Daniel Barnes investigates the tentacles of international finance and how they affect you, your, investments, savings, mortgages and pensions.
The immediate effect of Lehman Brothers filing for bankruptcy - along with Merrill Lynch's rushed buyout by Bank of America and the struggle of AIG - has been a fall in world share prices.
Investors
On Monday the FTSE 100 dropped 3.29 per cent and today (Tuesday September 17th) the index dropped under 5,000 and the lowest level since June 2005.
The falls came a week after the markets were buoyed by the US bail out of Fannie Mae and Freddie Mac - which some said signalled the beginning of the end of the credit crunch.
Investors in FTSE will have seen falls, as well as those with cash in the FTSE 100 through pension funds.
David Jones, chief market strategist at IG Index, explains the problems are not just limited to Lehman Brothers.
"The worry for markets is not so much specific to Lehman - it is the fact that the uncertainty surrounding the credit crunch, and who has lost what exactly, continues to go on," he says.
"Some commentators felt that the bail out of Freddie and Fannie last week marked the beginning of the end for the financial crisis - but this Sunday's news has suggested that reports of the death of the crunch were somewhat premature."
Paul Niven, head of asset allocation at F&C Management, says the failure of the US government to step in to save Lehmans - as buyers had demanded some guarantees - has also contributed to traders' unease.
"The sheer scale of these failures has sent shock waves throughout the financial markets, and the fact that the Federal Reserve and US government refrained from intervening to save Lehman Brothers has removed the perceived safety net that such major institutions are 'too big to fail'," he said.
Mr Niven goes on to explain the credit crunch is now entering a new chapter.
"From a fundamental perspective, the credit crunch has now moved into a phase where financial consolidation (and failure) has begun," he says.
"This potentially has some way (and time) to run."
He adds, looking at history as a guide, we are likely to eventually see state-backed guarantees for depositors being extended and more government intervention.
"In summary, we believe that the short term will be tough for equities and credits and there is a good chance of further downside in prices in coming days. Lehman Brothers has proven that the bar for those 'too big to fail' has just been raised."
However, Sam Morse, fund manager of the Fidelity Moneybuilder Growth Fund, urges people to think before dragging cash out of the markets.
"When markets fall, understandably investors lose confidence and either stop investing new money or redeem their holdings," he says.
"But this may be like bolting the stable door after the horses have fled and any attempt to time the market is fraught with risk."
He claims investors should be reassured that growth in dividend payments means despite the turmoil of the past decade, total returns from UK shares have held up well in nominal and real terms, provided dividends are reinvested.
"Investors who are concerned about market volatility could consider a regular savings plan. By investing a consistent amount at regular intervals, investors can gradually 'drip-feed' into the market regardless of the price on any given day," he advises.
"This strategy is known as pound cost averaging and will help smooth out the effect of market changes on the value of investments."
Mortgages
Lehman Brothers has very limited contacts with British consumers, however, it did run two mortgage lenders - SPML and Preferred and sold some subprime deals through Alliance & Leicester.
These two brands stopped lending earlier in April, so choice on mortgage deals will not disappear, and borrowers are being told to keep repayments up as normal - as their debts will not disappear.
But the turbulence on the markets could well have an effect.
The Bank of England has already injected £25 billion into the markets to keep inter-bank lending rates close to the official base rate of five per cent.
If the central bank fails, mortgage rates pushed up by the original credit crunch could rise again.
"It is not just in America where the fallout from the Lehman Brothers bankruptcy will be felt: it will likely have an impact on the UK mortgage market," Michelle Slade, analyst at Moneyfacts.co.uk, says.
"In the last two months, mortgage rates had finally dropped to pre-credit crunch levels. As liquidity in the money markets eased, lender passed on the cuts in borrowing to consumers."
However, Katie Tucker, technical manager of Mortgage Force, explains Lehmans could now create a rise in mortgage rates.
"Some high street banks and Building Societies will have 'equity swaps' arranged with Lehmans, these are used like quick insurances against rate hikes," she says.
"Those lenders could now be left holding potentially worthless IOUs, which will be another blow to their cash flow."
She adds that although inter-bank lending rates - the Libor - are not rising, they could well do so soon.
"If Libor increases, many lenders with good deals won't be able to sustain them, and will only be able to replenish them with higher rates, so borrowers should act immediately on any rates they are considering," she warns.
"Despite a fortnight of gently improving mortgage deals, the lenders are still in a precarious position: many are operating with fewer staff and limited funding, meaning they can get overwhelmed quickly so if one lender has a sweet deal sticking out, they get so many applications that they have to replace it with something less attractive that will let them blend back into the market's flat landscape, like constantly shaking down a bowl of sugar."
Ms Tucker added: "The credit rationing is less to do with liquidity now, as lenders can exchange immoveable assets for moveable ones, it is more to do with the actual amount of cash in the pot. The banks of the UK will recover only through a diligent process of raising funding through savings and investments, a fact which will benefit savers."
Savers
As a new wave of the credit crunch pushes up interest rates, as banks find securing funds harder, savers could see rates rise.
However, while savings rates could increase, bonds could fall.
Michelle Slade, analyst at Moneyfacts.co.uk, says: "Some providers are withdrawing their bonds as they are fully subscribed, but others are doing so due to market conditions.
"As the fallout from the Lehman Brothers debacle continues, we may see further bonds being withdrawn."
However, those looking for a savings boost can still find some good products.
"There are still fantastic rates available, but anyone hoping to secure a rate of over seven per cent needs to act fast," Ms Slade advises.
"If the decline in fixed rate bonds in the last few weeks is anything to go by, these deals won't be around for too much longer.
"Those that do remain are mainly from providers with their parent company based overseas, which may put off some savers. However, these companies are all registered by the FSA and are therefore covered under the Financial Services Compensation Scheme (FSCS)."
Under the FSCS, the first £35,000 of any savings are protected if a member firm goes to the fall. Savers concerned should check a bank is a member of the FSCS and shift cash over £35,000 to other firms.
It is also important to check you are shifting cash to a second firm - as it is easy to move funds from one bank to a subsidiary of the same bank. In such a case - and the bank went bust - only £35,00 would be protected still.
Economy
Lehman Brothers employs some 5,000 people. Although many will find their jobs will stay - as parts of the business are sold off - the loss of jobs will hit the economy.
Jobs in the financial sector support other areas in the economy. The way financial firms are interlinked will also mean other firms will be put under pressure as cash expected to flow from Lehmans stops with a jolt.
With the CBI already expecting a mild recession for the UK economy - with negative growth in the second half of 2008 - Lehmans' fall could be the straw to break the camel's back.
"Heightened financial market turmoil adds to the already serious downside risks facing the struggling UK economy," says Howard Archer, chief UK economist at Global Insight.
"Indeed, the collapse of Lehman Brothers highlights the risk that financial market turmoil and very tight credit conditions could hit economic activity for some considerable time to come."
The British Chambers of Commerce (BCC) - representing small business - is now calling for the Bank of England to cut interest rates as a result of the turmoil.
David Kern, BCC economic adviser, said: "The UK economy and its financial system cannot remain immune to the worsening turmoil in the global financial markets.
"We have stressed repeatedly that the UK is very likely already in technical recession.. but the financial global turmoil worsens the threat of a deeper economic decline, and heightens the need for early action.
"The MPC should now consider a small interest rate cut in October."
Mr Archer, meanwhile, expects the Lehman crisis to prompt a 0.25 per cent interest rate cut in November.
"Regardless of whether the Bank of England does act in November or waits until early-2009, we expect interest rates to come down substantially in 2009 as extended very weak economic activity contains and then increasingly dilutes underlying inflationary pressures," he says.
Daniel Barnes
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