STORES Global Powers of Retailing 2009 - (Page 40) 2009 global powers of retailing Global Economic Outlook, November 2008 As recently as early September, most analyses of the economy focused on whether the Federal Reserve might have to increase interest rates due to concern over inflation. Rising commodity prices and a perception that the worst of the credit crunch was behind us was the impetus for such discussion. How quickly things have changed. The world now faces a seriously frozen credit market, the prospect of a significant recession, massive government intervention in the financial markets, and a business environment for retailers far weaker and uncertain than recently expected. The government facilitated the rescue of several, but did allow one large institution to fail. This single act, which at the time seemed appropriate to many analysts, sparked panic. Credit spreads increased dramatically, credit market activity nearly ceased, and economic policymakers were forced to look into the abyss. In the autumn of 2008, the U.S. Federal Reserve and the U.S. Treasury undertook extraordinary measures aimed at restoring credit market activity. They acquired several large institutions, guaranteed the entire U.S. money market, and promised to purchase commercial paper in order to restore activity to this critical market. In addition, the U.S. Congress allocated $700 billion to the Treasury to acquire toxic assets and/or recapitalize banks. At the same time, as the crisis of confidence spread globally, governments in Europe and Asia chose to spend hundreds of billions of euros, pounds, and other currencies in order to recapitalize their banks. The UK government, in particular, started this process by spending money to acquire shares in publicly traded banks rather than merely purchase toxic assets. This act was soon followed by other governments, notably that of the United States. What on earth went wrong? In recent years, high levels of borrowing by government and consumers, combined with massive purchases of dollar-denominated assets by the government of China, created a mix of low interest rates, high liquidity, and readily available credit. This was a favorable environment for investment in residential property and property prices increased rapidly. Meanwhile, banks were eager to initiate mortgages that could be bundled, securitized, and sold off to investors hungry for high returns. Sub-prime mortgages, in particular, were of great interest to investors. Ultimately, however, the housing bubble burst when interest rates rose. House prices fell. No longer could homeowners simply sell their homes at a profit if they couldn’t service their sub-prime mortgages. Instead, defaults increased, causing the assets backed by sub-prime mortgages to decline in value. Banks holding these assets took write-downs and experienced a loss of capital. This, in turn, caused a contraction in the volume of credit. As banks and other financial institutions were caught holding toxic assets, other banks became wary of their credit worthiness. An increased perception of risk led to increased credit spreads so that, starting in August 2007, credit activity seized up. To remedy this, the Federal Reserve cut interest rates and flooded the market with liquidity. By the end of the summer of 2008, the credit crunch appeared to be under control. Yet as U.S. home prices continued to fall in the wake of poor credit conditions, an excess inventory of unsold homes began to build. With the volume of toxic assets increasing, some large financial institutions found themselves in an untenable position. Will government action work? Governments have the unique advantage of being able to print money. There is no limit to how much money they can spend or how many assets they can acquire as long as they control the supply of their own currency. In the case of the Eurozone, however, governments theoretically lack this power as they do not control their own supply of money. There is no doubt that, ultimately, the banks can be recapitalized and that capital markets can be made to function. Moreover, if confidence is not restored and banks refuse to lend, ultimately they can be nationalized and ordered to lend. Indeed, the British plan enables the UK government to do just that. In addition, if credit markets are restored, governments can eventually sell the assets they acquire. In the long-run, taxpayer liability might be far less than the notional amounts that have been spent. Past experience provides a mixed bag of successes and failures in terms of government intervention. In Japan in the early 1990s, the collapse of an enormous property bubble rendered many large banks insolvent. Yet it took seven years before the Japanese government intervened and assisted banks in cleaning up their balance sheets. At least the United States and European governments are acting more quickly today. A good model for success is what happened in Sweden in the 1990s, where a bank crisis was followed by massive government intervention that included some bank nationalization. The credit markets were restored quickly and the government ultimately sold most of the assets they had acquired. The liability of the Swedish taxpayer was actually minimal. G40 STORES / January 2009 www.deloitte.com/consumerbusiness http://www.deloitte.com/consumerbusiness
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