Climbing Out of the Credit Crunch

Introduction

We are now more than a year into the ‘credit crunch’. An issue which began in one relatively obscure sector of the US housing market has unfolded over the last 12 months into a widespread credit and liquidity crisis which, combined with soaring commodity prices, appears to threaten a global slowdown.

While there is general agreement on what has happened, there is far less on why it has occurred and it seems that there is still much to learn about market liquidity.

The last few years have seen unprecedented growth in size and profitability of the global banking industry. Worldwide profits1 in 2006 were $788bn — more than $150bn greater than the next most profitable sector, oil, gas and coal. Global banking revenues were 6% of global GDP and profits per employee were 26 times higher than the average of all the other industries. Some have argued that such profitability is due in large part to market imperfections arising from the regulatory system such as lack of competition and information asymmetry between parties to transactions.

Independent surveys2 also point to a growing differential in remuneration packages for CEOs compared with other Board members. Also, over the last decade, remuneration of senior staff appears to be growing at a faster rate than dividends paid to shareholders.

The prosperity of the banking sector, nonetheless, positively influenced global growth in the so–called ‘real economy’. But while state aid for ailing industries in the UK and US is now largely a thing of the past, we appear to be in the curious position of seeing institutions in a sector, which in early 2007 was seemingly awash with liquidity, now relying on and securing public funding. This is in the form both of loans from central banks to provide liquidity and capital injections from other states’ sovereign wealth funds.

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