Editors' Blog

Let’s get some perspective on the doom-filled kitchen sink

Posted 16/01/2008 by Alex Novarese

Having said that I was going to give the crystal ball-gazing a miss, a fresh round of melodramatic headlines in today’s papers regarding the impending economic collapse has prompted me to swiftly break that New Year’s resolution.

And what grim reading it is: America about to slide into recession, the housing market on the brink, shares sliding and investment banks unable to go a day without another multibillion-dollar write-off.

Well, while I’m not an economist but I have covered business and financial markets across a range of sectors for more than a decade and I can’t shake the feeling that a bit of perspective has vacated the building.

First, let’s turn to the credit turmoil and bank write-offs. The phoney war of talking down exposure is over and now banks are basically ‘kitchen sinking’ – chucking out every bit of bad news they can get their hands on in the hope investors will believe they have a true picture. This is going to continue for the next six weeks as the key banks’ trading statements approach and it won’t be pretty but, if the credit squeeze is ever going to be dealt with, it has to happen.

And so far there is no evidence that any bank of any international import is on the critical list. To see an end to a four-year run of record profits is not the same thing as calling in the liquidators - or borrowers going short, for that matter. (The giveaway that it’s not that bad yet is that the level of year-end bonuses were barely down on 2006.)

What about those tumbling shares moving as they did below the ‘psychologically important’ 6,000-level on Tuesday on fresh concerns of America tipping into recession? It seems grim - until you apply a little history. In the last boom, the FTSE 100 got to the 7,000-level, meaning equities were, in many sectors, massively over-valued. With seven years of reasonable economic growth since then and corporate profits that are still solid, share prices are currently entirely well in line with historical levels. They can fall further, of course, but a prolonged collapse looks unlikely.

Then there is that hero/bogeyman of middle England: houses prices. The latest reason for gloom here is the closely-watched survey from the Royal Institution of Chartered Surveyors, which came up with a confidence ratio that has fallen to levels not seen since the 1992 property market. In itself this is true but I’m not sure what it meaningfully tells you about the market as what looked gloomy in 1992 and 2008 are very different, thanks to expectations having changed so much. It may be the property market will face a full-blown crash but so far we have seen nothing more than a healthy and pretty mild correction.

And talking of unreasonable expectations, there are some people in law firms that, struggling to remember the last actual recession 15 years ago, think failure to see your top-line grow by 10% is a slump. For the record, the worst financial year in recent memory for top 50 UK law firms (2002-03) saw PEP contract by a massive, er, 1.1%, while revenue expanded by 5.1%.

None of which is to deny that the UK and legal advisers are facing more uncertain times or that the risks of a full-blown recession have grown. But it won’t be the credit crunch or housing market that decides which way it goes. That will be two things: the global economy and labour markets in Western economies.

If the global economy were to drastically slow – and we’re not talking about America bouncing in and out of a technical recession for a quarter or two like 2001 – the gloom-mongering will be justified. Likewise, if the level of unemployment was to start rising sharply in Western economies, you would get severe recessionary pressure and the housing market would collapse, further stoking the destructive spiral.

These things may yet happen – and the truth is no-one is really sure how Western economies will function in a downturn given the massive expansion of personal debt over the last decade. But it’s not the likely outcome by any means. While that economic disaster may be around the corner, it has not yet swung into view – so let’s keep a little perspective.

alex.novarese@legalweek.com