Why this is an entirely new kind of credit crunch

Banks have made fat profits from securitising and syndicating debt, but recent market turmoil has exposed the dangers of this process. Laying hands on cheap money is about to get much harder.

"Say hello to a world without cheap money," says John Waples in The Sunday Times. For the past five years, big business has been "hijacked by a crowd of smart financiers" using easy debt to buy and sell companies "at their whim". But the world's big banks, which have made billions fuelling the boom, are now bringing down the curtain.

In recent years, banks have been making fat profits from securitising and syndicating debt essentially making loans then selling them on to other investors. But the turmoil in the markets has left the banks on the hook for an estimated $8bn after investors showed little interest in buying the loans used to back several large leveraged buyouts. And this figure may be only the tip of the iceberg according to bankers there is around $200bn in debt in the US that banks have agreed to lend but have yet to syndicate, while Europe accounts for a further e40bn.

This securitising process worked fine for a while, but two dangers have become obvious, says John Gapper in the FT. First, as lending standards loosened, banks became less cautious. Private equity funds, the "institutional equivalent of subprime mortgage holders", were willing to pay them big fees to arrange more exotic and riskier types of loan finance for their buyouts. Many bankers, such as JP Morgan Chase CEO Jamie Dimon, had grown nervous about such instruments albeit too late. Second, debt securities have become so complex that "investors in them have not understood precisely what kind of credit or market risks they are taking on" as was evidenced in June when two Bear Stearns hedge funds ran into trouble. Investors are now reading across from severe problems in mortgage-backed securities to other debt instruments, such as those used to fund buyouts, and "worrying that the latter face a similar reckoning".

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The impending credit crunch is not the traditional kind, in which banks that made losses pull back from lending. Instead, it's a new variety, "caused by debt investors worrying that they have been taken for a ride" and who are thus unwilling to buy more debt. Meanwhile, the banks' balance sheets are stuffed with loans that they may struggle to sell for a long time and so their ability to make new loans will be reduced. And who is the prime architect of this mess? Ex-Federal Reserve chairman Alan Greenspan, according to Tim Price, also in the FT. It was Greenspan who "practically drowned asset markets with a tidal wave of liquidity and easy money" after the dotcom bust and drove the Federal funds rate down to a four-decade low of 1% in 2003-2004. He also opened the "floodgates of liquidity" that saved the US equity market, but triggered "an unsustainable boom in government and corporate debt, residential property and a carnival of mortgage lending unimpaired by anything approaching prudence".

We're living with the consequences of a grave policy error, agrees Hamish McRae in The Independent On Sunday. But last week's break in the stockmarkets still looks like a correction, rather than a crash. The tightening of global monetary policy probably still has some way to run, making private equity a less eager buyer of public companies. But support for equities will come from other quarters the "most obvious of these will be Asian and Middle East savings", he argues. "Something else needs to go wrong before this cycle is brought to a close."

Still, at times like this, it may be better to invest in creditors than debtors, says Edward Hadas on Breakingviews. That means avoiding the overindebted US; instead, with their undervalued currencies and world-class big companies, "Japan and Korea look more secure". Korean stocks are cheap and Japan is inexpensive by local historical standards. And with positive trade balances of about 2% of GDP, both countries share a major attribute of being on the right side of the global balance sheet.