Liquidity crunch – ripples, waves or tsunami?
In recent months financial markets of the world witnessed another episode of credit related problems. While this is not something completely new or unexpected, this is peculiar in the sense that the markets had largely ignored the warning signs flashed near the end of the last year by various banks when they issued profit warnings. The main reason for such warnings was the expected losses from the sub-prime lending in the US.
Those early warnings did not indicate the magnitude of the on coming waves and were largely considered to be restricted to only a specific lending sector and, in view of the moderately positive US economic outlook in the first quarter of this year, did not represent any significant threat to the system as a whole. However, as the events unfolded, it was not long before the true nature of the problem started to sink in.
The shock waves started in the US by the end of the first quarter of the year and despite reassurances from the Fed continued to grow stronger as the economic data started to show signs of economic slow down. It continued to gain momentum and by June Merrill Lynch sold collateral to recover its investments in two hedge funds managed by Bear Sterns that had invested in securities backed by sub-prime loans. However, US markets still remained positive of the future and Dow Jones gained 2.2% on 6 August despite the country’s 10th largest mortgage lender American Home Mortgage Investment Corporation’s filing for Chapter 11 bankruptcy protection on this date. The reason for the filing was inability of the company to raise new funds for its business and demand from existing investors to return their money.
The fear of losses from the sub-prime credit started to manif ...