Do Changes in Stock Prices Causes Recession? And Why Stock Market do not Directly Affect the Economy?

The economy and the stock market are closely related. Many people examine the stock market to find out how the economy is doing. It's long been known that if the stock market is in a period of decline, the economy is sure to follow. However there is little evidence that the stock market causes the economy to rise or fall. The stock market does not directly affect the economy. “It is simply a mirror of people's generally correct beliefs about what is about to happen in the economy”. The best way to understand this is to realize that a stock market index the Dow Jones Industrial Average (DJI) is simply a price. Because the value of index is a price, it only has two determinants: supply and demand.

Supply

Any first year college textbook in Economics states that for most goods if the supply increases in the short run then the price of the good should decline. For example, if the car companies suddenly doubled their supply of cars then we would expect the price of cars to fall.

If we thought that changes in the supply of stocks are the main cause of stock market rises and declines then, according to this rule, when a company issues new stock we would expect the price of stock to decline. If stock prices are largely determined by the supply of stocks and the market declines prior to an economic decline, we should see a flood of new stock issues before a recession. This does not happen in practice, as new stock issues tend to occur as the economy enters a growth period. This is because the money made from a stock issue is used to increase the output of the company, which causes economic growth to rise.

Demand

It appears that if we want to understand why the economy tends to move in the same direction as the stock market, we'll have to consider the demand for stocks. To do this, we'll need to understand what motivates an investors decision to buy or sell shares. Many investors such as Warren Buffett evaluate their stock portfolios on their inherent value. The inherent value is the total expected earnings of the company over a time period, discounted by the fact that a dollar today is not worth as much as a dollar tomorrow. If investors believe that a recession is coming, then they will believe that company earnings will be less in the future (since that typically takes place in a recession) which will decrease the inherent value of the stock. When the inherent value of the stock is far below its current price, investors will sell the stock, driving the price of the stock down. If investors believe a boom is coming, they will increase their estimates of the inherent value because future earnings should be higher than they previously expected. Often this will lead to the inherent value being far higher than the current price of the stock, so investors buy the stock. This leads the price of the stock to rise.

The belief that the stock market drives the economy is due to an error in logic. Generally we think that if A came before B that A caused B. Philosophers refer to this as the post hoc, propter hoc fallacy. In this case, the expectation of a decline in the economy causes the stock market to decline today. Or in logical terms, A came before B, because the expectation of B caused A. It's also important to realize that it's not the expectation of future economic changes that is causing changes in stock prices. It's the fact that people are acting on these expectations. If investors bought and sold stocks based on astrological factors or Barry Bonds'(baseball player) current homerun total then these would be causing the price of stocks to change. In a situation like that, it would seem that the stars are causing the price of stocks to change; the economy would have nothing to do with it.

It is because a large number of investors act on this inherent value principle that the economy tends to follow the stock market. Investors are constantly watching macroeconomic variables to try and determine when the next downturn in the economy will happen. Investors are often right when they predict the future growth rate of the economy. As a result, they often sell off their shares before the economy goes into a decline making it look like the stock market is causing a recession. In reality the causality runs the other way because the two things that causes price to change are changes in supply or changes in demand.

A sharp Decline in US imports & Exports

U.S. Imports and Exports Through December

The first graph shows the monthly U.S. exports and imports in dollars through December 2008. The recent rapid decline in foreign trade continued in December. Note that a large portion of the decline in imports is related to the fall in oil prices - but not all.

The graph includes both goods and services. The import and export of services has held up pretty well; most of the collapse in trade has been in goods. Imports of goods has declined by one third from the peak of last July!

 

The second graph shows the U.S. trade deficit, with and without petroleum, through January.

The blue line is the total deficit, and the black line is the petroleum deficit, and the red line is the trade deficit ex-petroleum products. 
Import oil prices fell to $39.81 in January, and import quantities decreased too - so the petroleum deficit declined by $4 billion. 
The trade deficit is now mostly China ($20.6 billion NSA in January) and oil.

A Sharp decline In U.S Import & Export

U.S. Imports and Exports Through December

The first graph shows the monthly U.S. exports and imports in dollars through December 2008. The recent rapid decline in foreign trade continued in December. Note that a large portion of the decline in imports is related to the fall in oil prices - but not all.

The graph includes both goods and services. The import and export of services has held up pretty well; most of the collapse in trade has been in goods. Imports of goods has declined by one third from the peak of last July!

The second graph shows the U.S. trade deficit, with and without petroleum, through January.

 

The blue line is the total deficit, and the black line is the petroleum deficit, and the red line is the trade deficit ex-petroleum products. 

Import oil prices fell to $39.81 in January, and import quantities decreased too - so the petroleum deficit declined by $4 billion. 

The trade deficit is now mostly China ($20.6 billion NSA in January) and oil.

Is It DEPRESSION?

 

You may have picked up on my change in terminology recently. I have gone from calling this rough patch in the global economy a rough patch, downturn, recession or some other euphemism to labeling it a Depression. Now, I am doing that for effect in part. Thinking of this as a longer-term downturn focuses one on mitigating downside risk rather than waiting for the eventual rebound. I think this is what we need to do.

However, I do believe it will be a depression in all likelihood — although we are not there yet with the data. What I find interesting is that a number of prominent figures have started to voice the same beliefs in public. David Rosenberg of Merrill Lynch was the first. And even UK Prime Minister Gordon Brown let the D-word slip from his mouth. Bond King Bill Gross recently said it was a depression with a small 'd.' Now, we can add Dominique Strauss-Kahn to the mix

International Monetary Fund chief Dominique Strauss-Kahn said the world's advanced economies — the U.S., Western Europe and Japan — are "already in depression," and that the IMF could slash its global growth forecasts further. The "worst cannot be ruled out," he said.

The IMF managing director's comments to reporters after a speech in Kuala Lumpur, Malaysia, represent the most dire estimate thus far of the state of the global economy by a major political figure, and were far more pessimistic than forecasts released by the IMF as recently Jan. 28.

Political figures generally avoid using the word depression because of the association with the Great Depression of the 1930s, when unemployment hit 25% in the U.S. and economic output fell even more steeply. Last week, when British Prime Minister Gordon Brown used the word "depression" to describe the global economy, his aides quickly said it was a slip of the tongue.

In the U.S., chief White House economic adviser Lawrence Summers said that while the economic situation was serious, it wasn't as bad as Mr. Strauss-Kahn seemed to suggest."We were really in a very different situation than" the Great Depression, he said on ABC television's "This Week with George Stephanopoulos." Since the events of the 1930s, there hasn't been a widely accepted definition of economic depression.

Former IMF Chief Economist Simon Johnson, a professor at MIT's Sloan School of Management, said the term refers to a significant contraction that lasts around five years. Under that definition, he said, Japan during the 1990s could have been classified as having been trapped in a depression.

Whatever the definition, by using the word "depression," Mr. Strauss-Kahn, a 59-year-old former French finance minister who has worked for decades on economic issues, has achieved shock value. That could increase political pressure on national leaders on at least two fronts, Mr. Johnson and several IMF officials said.

The IMF has been campaigning for months to get governments in many countries to boost fiscal spending by about two percentage points to fight the global downturn. It has recently pressed governments again to repair their banking systems, even at a steep cost.

But it has been frustrated by what it feels is an inadequate response, especially in Europe, where governments worry that additional spending will lead to unmanageable inflation. U.S. plans have brought more applause by IMF officials.

The IMF also has also begun to campaign to double its lending war chest to $500 billion, from $250 billion. The declaration of a depression could help Mr. Strauss-Kahn pressure reluctant IMF board members to pitch in and fund that plan. The IMF is close to finalizing a deal with Japan for a $100 billion loan that could be tapped in emergencies, and plans to call on other countries with large reserves, such as China and Saudi Arabia, to make emergency loans available too.

In addition, the IMF is considering issuing bonds for the first time in its history. It's likely that such bonds would be sold only to governments or central banks; in that way, they would become part of those nations' official reserves. The holders of the bonds could sell them to other nations, though probably not on the open market. That would make the bonds a more liquid version of loans to the IMF.

Issuing bonds is seen as a more controversial measure by some IMF members, especially the U.S., Germany and the Netherlands, which prefer to keep the IMF on a tighter leash by limiting its ability to lend.

Apparently, Strauss-Kahn has the same perspective I have here: politicians are seriously underestimating how bad things could become if they continue along the present course of inaction and half measures. Chief amongst my worries are the lack of a comprehensive banking solution in the U.S., the U.K and Ireland, the lack of any meaningful stimulus in the Eurozone, and the increasingly protectionist rhetoric from multiple parties. These are deflationary and depressionary forces. Nevertheless, there are pitfalls on either side of this debate because monetary aggregates are rising at rapid rates, suggesting an underlying inflationary pressure that will explode once the economy gains traction

Why I say Central bank should cut Interest Rates around the world!!

Central banks around the world are whacking interest rates at a breakneck clip. The Fed, the Reserve Bank of Australia, the Bank of Japan and now the ECB and the BoE. The BoE made the most dramatic move with an outsized 150 basis point cut. However, I am not convinced this is what the market needs.

Why are central banks cutting interest rates?

The conventional wisdom is that cutting interest rates provides monetary stimulus. Cutting interest rates will help prop up the economy at a time when commodity prices are plummeting, making inflation less of a concern. I do believe this is true and some easing might be just what we need at this delicate point. However, I also believe cutting rates has unintended consequences — and one of them is increasing the appetite for risk.

Before I go into why this is so, let me explain how I see interest rates with a blurb from a previous post.

The purpose of interest rates

Consider money to be just like any other good. Therefore, a loan is essentially an exchange of a 'present good' (money that can be used today) for a 'future good' (an IOU -money that can be used later). Because people will always prefer having a good straight away than receiving that good later, the present good commands a premium in the marketplace. That premium is the rate of interest.

Interest rates, therefore, represent thetime value of money. It is the mechanism through which individuals express 'time-preferences' i.e., how much more they value receiving money right now as opposed to a later date. The premium of present money over future money fluctuates according to people's time preferences; if people want money today very badly, the premium for money today (interest rate) will be high.

So, the purpose of credit and interest rates is clear. It is the mechanism by which one is compensated for deferring consumption today for later consumption.

The business cycle

Loans on credit also create the boom-bust business cycle. In our fractional reserve deposit banking system, banks must keep on hand only a portion of the money we deposit. The rest is lent out as credit. Therefore, if all depositors were to rush to the bank to redeem their deposits, the bank would not have enough cash on hand and would be declared insolvent. This is what happens in a bank run. To avoid a run, banks must maintain the confidence of depositors by acting prudently and cautiously in extending credit. If not, they risk insolvency.

The problem is that human nature steps in; as the business cycle progresses, the banks lend more and more money. Naturally, some of those loans are 'bad' loans i.e., the debtor cannot pay back the full principal at the required time. The banks must account for these bad loans in their loan loss reserves.

However, at some point, when the credit cycle has progressed too far, one of two things occurs:

• The economy 'overheats' and inflation starts to rise. Whispers start circulating that the central bank will raise interest rates and that inflation is spiraling out of control. The central bank does increase interest rates and many loans that looked good in a lower interest rate environment start to go sour.
  
• Banks simply start lending to too many questionable debtors and more loans go bad than anticipated.
  

As rumors circulate that this bank or that bank has been lending imprudently, the banks dig in their heels and pull back. Interest rates go up, credit contracts, and the economy goes into recession.

This is the business cycle. It is a natural part of our capitalist system and it is entirely created by the extension of credit.

In my view, cutting interest rates below their natural level distorts time preferences and investment decisions, causing individuals and companies to take on more risk — risk that they will later regret having taken. In effect, the central bank is goading people into misconstruing the riskiness of the decisions they are making by keeping interest rates artificially low.

A perfect example is the previous housing bubble. If interest rates should be 5% but they are 1%, then home builders are going to increase their indebtedness to take on more projects with longer and longer completion time frames. A project that comes online 5 years out looks much less risky when you can borrow money for 4 or 5% less.

Another example of this right now comes in the form of levered ETFs. These are exchange traded funds that allow investors speculators the opportunity to double or triple the gains from investing in the stock market. SeePaul Kedrosky's take on this here.

While gains are levered, so are losses and it seems amazing to me that investors are taking on that much risk after the drubbing we all took in October. But, when interest rates are cut to 1%, that is what happens.

Why don't central banks leave interest rates alone but lend freely against good collateral? Intervene in the commercial paper market if you must, but stop distorting investment decisions. The only reason that rate are being cut so low is political pressure, plain and simple.

And when politics drives economic and monetary policy, bad things happen.

 

China's Stimulus Plan Will Change the World

Brazil's President Lula told his country in September, "People ask me about the [financial] crisis, and I answer, go ask Bush. It is his crisis, not mine."

Fifty days later, British Treasury Secretary Stephen Timms told a conference of G-20 nations gathered in Sao Paulo, Brazil: "We are in extraordinary times, the global economy is facing shocks which are wholly without precedent and we need a new approach. … It is a global crisis. It therefore requires an international response."

In other words, what goes around, comes around. Global schadenfreude toward a stupid and greedy United States and its subprime mortgage meltdown has rapidly become global concern about how to rescue the world from an all-encompassing financial disaster. Here's just a smattering of companies large and small that recently announced lowered outlooks for the year: Under Armour (NYSE: UA), News Corp. (NYSE: NWS), Starbucks (Nasdaq: SBUX), Vodafone (NYSE: VOD), Electronic Arts (Nasdaq: ERTS), ADP (NYSE: ADP), and Hormel (NYSE: HRL). (Yes, in these tough times, even the outlook for Spam is grim.)

And if that were not enough, the International Monetary Fund (IMF) recently lowered its outlook for the entire global economy.

One country's plan to step up
Against that backdrop, China announced a 4-trillion-yuan ($586 billion) stimulus package for its domestic economy this past Sunday. It plans to fund extensive infrastructure construction, aid poor farmers, and cut export taxes.

While China's plan has clear beneficiaries, and should help keep more laborers in their jobs and prop up domestic consumer spending, the most important (and underreported) aspect of the plan is how it will fundamentally change the economic relationship between the U.S. and China.

Here's how it was
One of the big debates over the past half-decade was whether China had reached a point in its economic development at which its internal economic gravity would allow it to "decouple" from the global economy. If so, it could continue along its fantastic growth trajectory, even as growth in the U.S. or Europe ceased or reversed.

That may sound like gobbledygook, but it's important. The U.S. has a $20 billion monthly trade deficit with China. It's funded by China's willingness to hold U.S. treasuries in its Central Bank (essentially, we're borrowing the money). China manages the arrangement by pegging its currency (the yuan) to the dollar at an artificially low rate, and by not worrying so much about certain niceties like environmental regulation and labor protection.

It's a mutually beneficial arrangement -- a weak yuan supports Chinese exporters, helping the country industrialize and quickly integrate rural migrants into its urban workforce, with the salutary effect of keeping inflation and potential political unrest low. For its part, the U.S. has gotten dirt cheap financing, by virtue of China parking more than a trillion dollars in U.S. government securities. That has supported the dollar and allowed the Federal Reserve to fuel consumer spending by keeping interest rates low.

China's stimulus package heralds the unwinding of this relationship.

Here's how it will be
This is why the decoupling argument matters. Many analysts have pointed to the thousands of factories that have shut down in China in these past few months as evidence that a slowdown in American spending will cause a depression in China -- potentially even leading to regime change. But in fact, US trade imbalance with China is artificially preserved by the aforementioned currency peg, and by the decision of China's state-run banks to make uneconomic loans to businesses it deemed worth propping up.

China has paid heavily for this relationship. Rather than invest its surplus cash in its own country, the Chinese poured money back into the U.S. to further spur our debt-fueled consumption. (Put less artfully, some poor Chinese guy in Shaanxi province was essentially helping you pay your mortgage.)

The announced stimulus package reverses that. Hundreds of billions of dollars that would have gone to propping up the greenback are now being reinvested in China, helping it to transition from its reliance on exports to a self-sustaining economy. So while China isn't yet decoupled from its export markets, this new spending plan will help it along that path.

What you need to do to survive
China's huge currency reserves are about to be put to use, and while there will be some real and perhaps severe bumps along the way, the China that comes out on the other side will be a heck of a lot stronger, more independent, and more decoupled than the one we've seen up to now.

Chinese premier Wen Jiabao called his country's stimulus the "biggest contribution to the world." We don't know whether that's true, but we do know that China's ability to reach deep into its huge coffers to finance further growth gives it a significant advantage over the rest of the world's struggling economies.

Timeline: Global credit crunch

Timeline: Global credit crunch

A year ago, few people had heard of the term credit crunch, but the phrase has now entered dictionaries.

Defined as "a severe shortage of money or credit", the start of the phenomenon has been pinpointed as 9 August 2007 when bad news from French bank BNP Paribas triggered sharp rise in the cost of credit, and made the financial world realise how serious the situation was.

The problems, however, started much earlier.

GROWING SUB-PRIME PROBLEMS

After a two year period between 2004 and 2006 when US interest rates rose from 1% to 5.35%, the US housing market begins to suffer, with prices falling and a rise in homeowners defaulting on their mortgages.

Default rates on sub-prime loans - high risk loans to clients with poor or no credit histories - rise to record levels.

APRIL-AUGUST 2007: SUB-PRIME CONTAGION

April

The credit losses associated with sub-prime have come to light and they are fairly significant...Some estimates are in the order of between $50bn and $100bn of losses Ben Bernanke, Chairman US Federal Reserve, speaking on 20 July 2007

New Century Financial, which specialises in sub-prime mortgages, files for Chapter 11 bankruptcy protection and cuts half of its workforce.

As it sold on many of its debts to other banks, the collapse in the sub-prime market begins to have an impact at banks around the world.

July

Investment bank Bear Stearns tells investors they will get little, if any, of the money invested in two of its hedge funds after rival banks refuse to help it bail them out.

Federal Reserve chairman Ben Bernanke follows the news with a warning that the US sub-prime crisis could cost up to $100bn (£50bn).

 

 

 

AUGUST 2007: SCALE OF THE CREDIT CRISIS EMERGES

9 August 2007

BNP's statement is scary, to put it mildly BBC Business Editor, Robert Peston

Investment bank BNP Paribas tells investors they will not be able to take money out of two of its funds because it cannot value the assets in them, owing to a "complete evaporation of liquidity" in the market.

It is the clearest sign yet that banks are refusing to do business with each other.

The European Central Bank pumps 95bn euros (£63bn) into the banking market to try to improve liquidity. It adds a further 108.7bn euros over the next few days.

The US Federal Reserve, the Bank of Canada and the Bank of Japan also begin to intervene.

17 August

The Fed cuts the rate at which it lends to banks by half of a percentage point to 5.75%, warning the credit crunch could be a risk to economic growth.

21 August

UK sub-prime lenders begin to withdraw mortgages or put up the cost of borrowing for UK homeowners with poor credit histories.

28 August

German regional bank Sachsen Landesbank faces collapse after investing in the sub-prime market; it is sold to larger rival Landesbank Baden-Wuerttemberg.

 

 

 

SEPTEMBER 2007: A RUN ON A BANK

3 September

German corporate lender IKB announces a $1bn loss on investments linked to the US sub-prime market.

4 September

The rate at which banks lend to each other rises to its highest level since December 1998.

The so-called Libor rate is 6.7975%, way above the Bank of England's 5.75% base rate; banks either worry whether other banks will survive, or urgently need the money themselves.

13 September

The fact that it has had to go cap in hand to the Bank is the most tangible sign that the crisis in financial markets is spilling over into businesses that touch most of our lives

The BBC reveals Northern Rock has asked for and been granted emergency financial support from the Bank of England, in the latter's role as lender of last resort.

Northern Rock relied heavily on the markets, rather than savers' deposits, to fund its mortgage lending. The onset of the credit crunch has dried up its funding.

A day later depositors withdraw £1bn in what is the biggest run on a British bank for more than a century. They continue to take out their money until the government steps in to guarantee their savings.

18 September

The US Federal Reserve cuts its main interest rate by half a percentage point to 4.75%.

19 September

After previously refusing to inject any funding into the markets, the Bank of England announces that it will auction £10bn.

 

 

OCTOBER 2007: MAJOR LOSSES BEGIN TO EMERGE

1 October

Swiss bank UBS is the world's first top-flight bank to announce losses - $3.4bn - from sub-prime related investments.

The chairman and chief executive of the bank step down. Later, banking giant Citigroup unveils a sub-prime related loss of $3.1bn. A fortnight on Citigroup is forced to write down a further $5.9bn. Within six months, its stated losses amount to $40bn.

30 October

Merrill Lynch's chief resigns after the investment bank unveils a $7.9bn exposure to bad debt.

NOVEMBER 2007: UK HOUSING MARKET 'TURNS DOWN'

29 November

The Bank of England reveals the number of mortgage approvals has fallen to a near three-year low.

30 November

The Council for Mortgage Lenders (CML) issues the starkest warning yet of the impact of the credit crunch on the mortgage market, saying that without more funding available on financial markets, mortgage lenders will not be able to offer as many mortgages.

 

DECEMBER 2007: HELP IS AT HAND

6 December

US President George W Bush outlines plans to help more than a million homeowners facing foreclosure.

The Bank of England cuts interest rates by a quarter of one percentage point to 5.5%.

13 December

The US Federal Reserve co-ordinates an unprecedented action by five leading central banks around the world to offer billions of dollars in loans to banks.

The Bank of England calls it an attempt to "forestall any prospective sharp tightening of credit conditions". The move succeeds in temporarily lowering the rate at which banks lend to each other.

17 December

The central banks continue to make more funding available.

There is a $20bn auction from the US Federal Reserve and, the following day, $500bn from the European Central Bank to help commercial banks over the Christmas period.

NEXT UP: THE BOND INSURERS

19 December

Ratings agency Standard and Poor's downgrades its investment rating of a number of so-called monoline insurers, which specialise in insuring bonds. They guarantee to repay the loans if the issuer goes bust.

There is concern that insurers will not be able to pay out, forcing banks to announce another big round of losses.

9 January 2008

The World Bank predicts that global economic growth with slow in 2008, as the credit crunch hits the richest nations.

18 January

A rush to withdraw money from its commercial property funds forces Scottish Equitable to introduce delays of up to 12 months for investors wanting to take their money out.

It blames the rush of withdrawals on concerns about the US sub-prime mortgage collapse, recession worries and interest rates.

21 January

Global stock markets, including London's FTSE 100 index, suffer their biggest falls since 11 September 2001.

22 January

The US Fed cuts rates by three quarters of a percentage point to 3.5% - its biggest cut in 25 years - to try and prevent the economy from slumping into recession.

It is the first emergency cut in rates since 2001. Stock markets around the world recover the previous day's heavy losses.

31 January

A major bond insurer MBIA, announces a loss of $2.3bn - its biggest to date for a three-month period -blaming its exposure to the US sub-prime mortgage crisis.

 

 

FEBRUARY - MARCH 2008: BIG NAME CASUALTIES

7 February

US Federal Reserve boss Ben Bernanke adds his voice to concerns about monoline insurers, saying he is closely monitoring developments "given the adverse effects that problems of financial guarantors can have on financial markets and the economy".

The Bank of England cuts interest rates by a quarter of one percent to 5.25%.

8 February

Some investors forgot the golden rule of financing: 'Don't buy things that you don't understand' FSA chief executive Hector Sants, speaking on 27 February

In the UK, the latest CML figures show the number of homes repossessed in the UK rose to 27,100 in 2007, its highest level since 1999.

10 February

Leaders from the G7 group of industrialised nations say worldwide losses stemming from the collapse of the US sub-prime mortgage market could reach $400bn.

17 February

After considering a number of private sector rescue proposals, including from Richard Branson's Virgin Group, the government announces that struggling Northern Rock is to be nationalised for a temporary period.

7 March

In its biggest intervention yet, the Federal Reserve makes $200bn of funds available to banks and other institutions to try to improve liquidity in the markets.

17 March

Wall Street's fifth-largest bank, Bear Stearns, is acquired by larger rival JP Morgan Chase for $240m in a deal backed by $30bn of central bank loans.

A year earlier, Bear Stearns had been worth £18bn.

28 March

Nationwide predicts UK house prices will fall by the end of the year, revising its previous forecast of no change in prices.

APRIL 2008: THE 100% MORTGAGE IS CONSIGNED TO HISTORY

2 April

Moneyfacts, which monitors financial products, says 20% of mortgage products have been withdrawn from the UK market in the previous seven days.

I have a deep sense of shock at how deeply our successful industry has already been hit by these unprecedented funding market conditions Steven Crawshaw, chairman of the Council for Mortgage Lenders, speaking on 11 April 2008

Five days later the 100% mortgage disappears when Abbey withdraws the last home loan available without a deposit.

8 April

The International Monetary Fund (IMF), which oversees the global economy, warns that potential losses from the credit crunch could reach $1 trillion and may be even higher.

It says the effects are spreading from sub-prime mortgage assets to other sectors, such as commercial property, consumer credit, and company debt.

10 April

The Bank of England cuts interest rates by a quarter of one percent to 5%.

11 April

A warning is issued by the CML that the amount of funding available for mortgages in the UK could be cut in half this year.

It calls on the Bank of England to kick-start the money markets and ease the effects of the credit crunch.

The effects of the credit crunch are likely to be broader, deeper and more protracted than previously expected IMF global stability report, 8 April 2008

15 April

Confidence in the UK housing market falls to its lowest point in 30 years in March, according to the Royal Institution of Chartered Surveyors, because of the "unique liquidity blight".

But it does add that the situation is good news for buyers with large deposits who can buy property that was previously out of reach.

21 April

The Bank of England announces details of an ambitious £50bn plan designed to help credit-squeezed banks by allowing them to swap potentially risky mortgage debts for secure government bonds.

APRIL - JUNE 2008: BANKS PASS ROUND THE HAT

22 April

Royal Bank of Scotland announces a plan to raise money from its shareholders with a £12bn rights issue - the biggest in UK corporate history.

The firm also announces a write-down of £5.9bn on the value of its investments between April and June - the largest write-off yet for a British bank.

25 April

Persimmon becomes the first UK house builder to announce major cutbacks, citing the lack of affordable mortgages and a fall in consumer confidence.

It adds sales have fallen by a quarter since the beginning of the year.

 

Because of the uncertainties in the global economy and the UK lending environment, it is difficult to predict when the [housing] market will improve

29 April

The CML says number of new mortgages approved in March slipped 44% to 64, the lowest monthly number since records began in 1999.

30 April

The first annual fall in house prices for 12 years is recorded by Nationwide.

Prices were 1% lower in April compared to a year earlier after a "steep decline" in home buying over the previous six months.

Later in the week, figures from the UK's biggest lender Halifax, show a 0.9% annual fall for April.

2 May

More than 850 companies went into administration between January and March, government figures show, a rise of 54% on the previous year. Retail and construction firms are hardest hit.

22 May

Swiss bank UBS, one of the worst affected by the credit crunch, launches a $15.5bn rights issue to cover some of the $37bn it lost on assets linked to US mortgage debt.

19 June

There are significant developments in two major credit crunch-related investigations in the US, which it is hoped will restore confidence in the credit markets.

The FBI arrests 406 people, including brokers and housing developers, as part of a crackdown on alleged mortgage frauds worth $1bn.

Separately, two former Bear Stearns workers face criminal charges related to the collapse of two hedge funds linked to sub-prime mortgages.

It is alleged they knew of the funds' problems but did not disclose them to investors, who lost a total of $1.4bn.

25 June

Barclays announces plans to raise £4.5bn in a share issue to bolster its balance sheet.

The Qatar Investment Authority, the state-owned investment arm of the Gulf state, will invest £1.7bn in the British bank, giving it a 7.7% share in the business. A number of other foreign investors increase their existing holdings.

JULY 2008: MAJOR LENDERS ON THE EDGE

8 July

The gloomy findings of a survey of its members prompt the British Chambers of Commerce (BCC) to suggest that the UK is facing a serious risk of recession within months.

Meanwhile, the FTSE 100 stock index briefly dips into a "bear market", in which the market suffers a 20% fall from its recent highs.

The outlook is grim and we believe that the correction period is likely to be longer and nastier than expected British Chambers of Commerce, 18 July 2008

13 July

US mortgage lender IndyMac collapses - the second-biggest bank in US history to fail.

14 July

Financial authorities step in to assist America's two largest lenders, Fannie Mae and Freddie Mac. As owners or guarantors of $5 trillion worth of home loans, they are crucial to the US housing market and authorities agree they could not be allowed to fail.

The previous week, there had been a panic amongst investors that they might collapse, causing their share prices to plummet.

21 July

Just 8% of HBOS investors agree to take up the new shares offered in its £4bn rights issue, because they are priced higher than existing shares are trading on the stock market.

But HBOS still gets the £4bn it wanted, as the unsold new shares are bought by the issue's underwriters.

31 July

UK house prices show their biggest annual fall since the Nationwide began its housing survey in 1991, a decline of 8.1%.

The average home now costs £169,316. That is nearly £15,000 cheaper than in the same month last year.

Meanwhile, HBOS reveals that profits for the first half of the year sank 72% to £848m, while bad debts rose 36% to £1.31bn as customers failed to repay loans.

 

AUGUST - SEPTEMBER 2008: GIANTS SUFFER

4 August

Global banking giant HSBC warned that conditions in financial markets are at their toughest "for several decades" after suffering a 28% fall in half-year profits.

Of Europe's top banks, HSBC has among the heaviest exposure to the troubled US housing and credit markets.

22 August

The bad news continues with revised figures from the ONS revealing that the UK economy is a standstill.

28 August

Nationwide reveals that UK house prices have fallen by 10.5% in a year.

A day later Bradford and Bingley posts losses of £26.7m for the first half of 2008, blaming surging mortgage arrears for a rise in impairment.

Looking ahead, it warned it expected arrears to remain at high levels for the rest of the year.

30 August

Chancellor Alistair Darling warns that the economy is facing its worst crisis for 60 years in an interview with the Guardian newspaper, saying the current downturn would be more "profound and long-lasting" than most had feared.

1 September

Official figures from the Bank of England show a slump in approved mortgages for July.

Meanwhile, while the pound falls to record lows of 81.21 pence against the euro and two-year lows of $1.80.

2 September

In an effort to kick-start the UK housing market the Treasury announces a one year rise in stamp duty exemption, from £125,000 to £175,000.

But there is more bad news, as the Organisation for Economic Cooperation and Development forecasts that the UK will be in a full blown recession by the end of the next two quarters. A day later the European central bank cuts growth forecast 2009 to 1.2% from 1.5%.

4 September

The Bank of England leaves rates on hold at 5% while the latest figures from the Halifax show that house prices in England and Wales continue to fall.

5 September

A raft of negative news from around the world sees the FTSE notch up its steepest weekly decline since July 2002.

The US labour market figures - which showed the unemployment rate rising to 6.1% - were a further jolt to investors who have had to swallow a slew of poor economic data in recent days.

6 September

The Halifax warns that the impact of the credit crunch will be felt well into 2010. Chief executive Andy Hornby explains that British banks will continue to suffer major problems in offering loans until they can raise significant sums on wholesale markets, something that will not be possible until US house prices recover.

7 September

Mortgage lenders Fannie Mae and Freddie Mac - which account for nearly half of the outstanding mortgages in the US - are rescued by the US government in one of the largest bailouts in US history.

Treasury Secretary Henry Paulson says the two firms' debt levels posed a "systemic risk" to financial stability and that, without action, the situation would get worse.

At the same time, in the UK, the Nationwide announces it will merge with two smaller rivals, the Derbyshire and Cheshire Building Societies.

9 September

More bad news emerges for the UK economy as the ONS reveals manufacturing output fell by 0.2% between June and July, raising a real fear of recession.

Meanwhile, the British Retail Consortium reports UK retail sales values fell by 1.0% on a like-for-like basis from August 2007.

On the housing front, there were more negative headlines with the Royal Institute of Chartered Surveyors published figures showing house sales were at their lowest level for 30 years, while the CML reported that the number of first-time buyers has hit its lowest level since its survey began in January 2002.

10 September

Wall Street bank Lehman Brothers posts a loss of $3.9bn for the three months to August.

The announcement comes against a background of further dire economic warnings from the European Commission, which warned that the UK, Germany and Spain will go into recession by the end of the year.

15 September

After days of searching frantically for a buyer, Lehman Brothers files for Chapter 11 bankruptcy protection, becoming the first major bank to collapse since the start of the credit crisis.

Former Federal Reserve chief Alan Greenspan dubs failure as "probably a once in a century type of event" and warns that other major firms will also go bust.

Meanwhile fellow US bank Merrill Lynch, also stung by the credit crunch, agreed to be taken over by Bank of America for $50bn, the latest twist in a dramatic turn of events on Wall Street.

16 September

The US Federal Reserve announces an $85bn rescue package for AIG, the country's biggest insurance company, to save it from bankruptcy. AIG gets the loan in return for an 80% public stake in the firm.

17 September

Britain's biggest mortgage lender HBOS is taken over by Lloyds TSB in a £12bn deal creating a banking giant holding close to one-third of the UK's savings and mortgage market. The deal follows a run on HBOS shares.

25 September

In the largest bank failure yet in the United States, Washington Mutual, the giant mortgage lender which had assets valued at $307bn is closed down by regulators and sold to its JPMorgan Chase.

Analysts say much of its problems have been caused by the group's 2006 purchase of mortgage lender Golden West for $25bn at the height of the then US housing boom.

28 September

The credit crunch hits Europe's banking sector as the European banking and insurance giant Fortis is partly nationalised to ensure its survival. It is seen as too big a European bank to be allowed to go under.

Authorities in the Netherlands, Belgium and Luxembourg agree to pour in 11.2bn euros ($16.1bn; £8.9bn). Fortis' share price has fallen sharply amid concerns about its debts.

In the US lawmakers announce they have reached a bipartisan agreement on a rescue plan for the American financial system.

The package, to be approved by Congress, allows the Treasury to spend up to $700bn buying bad debts from ailing banks.

It will be the biggest intervention in the markets since the Great Depression of the 1930s.

29 September

In Britain the mortgage lender Bradford & Bingley is nationalised. The British government takes control of the bank's £50bn mortgages and loans, while its savings operations and branches are sold to Spain's Santander.

The Icelandic government takes control of the country's third-largest bank Glitnir after the company had faced short-term funding problems.

Wachovia, the fourth-largest US bank, is bought by its larger rival Citigroup in a rescue deal backed by the US authorities. Under the deal, Citigroup will absorb up to $42bn of Wachovia losses.

The US House of Representatives rejects a $700bn rescue plan for the US financial system - sending shockwaves around the world.

It opens up new uncertainties about how banks will deal with their exposure to toxic loans and how credit markets can begin to operate more normally. Wall Street shares plunge, with the Dow Jones index slumping 7% or 770 points, a record one-day point fall.

30 September

Dexia becomes the latest European bank to be bailed out as the deepening credit crisis continues to shake the banking sector.

After all-night talks the Belgian, French and Luxembourg governments said they would put in 6.4bn euros ($9bn; £5bn) to keep it afloat.

Separately, the Irish government says it will guarantee all deposits in the country's main banks for two years.

In the UK, Prime Minister Gordon Brown says the government is planning to raise the limit on guaranteed bank deposits from £35,000 to £50,000.

1 October

Stock markets stabilise ahead of a vote in the Senate, which eventually approves an amended $700bn financial rescue bill.

Market confidence that Lloyds TSB's takeover of HBOS will not be derailed by stock market volatility sees HBOS shares rise 20%.

A report says that French Finance Finister Christine Lagarde calls for an emergency EU bail-out fund for banks threatened with failure.

The EU says it is looking at whether Ireland's full guarantee of saving deposits is anti-competitive.

3 October

The house of representatives passes a revised bailout plan two days after the Senate. Wells fargo says it has agreed to buy Wachovia for about $16 billion, thwarting a planned Citigroup deal. The two are still locked in an intense battle

5 October

European leaders commit to ensure the soundness and stability of banking and financial systems. Germany struggles to rescue lender Hypo Real Estate

6 October

Dow sinks below 10, 000 for the first time in four years on fears of global recession

7 October

Iceland is forced to prop up its currency, take over Landsbanki, its second – biggest bank,. And ask Russia for a loan of 4 billion Euros to avoid "national bankruptcy"

8 October

Indian shares slide 8% to lowest since August 2006. Central banks around the world cut interest rates in a joint response to the crisis. The government is to put up to 250bn pounds into the banking system in an effort to keep banks lending.

It will also offer a guarantee to banks issuing medium term debt, which could mean backing a further 250bn pounds of bank borrowings. But it is unlikely to demand dividend cuts and the end of big bonuses at the banks in return. The plan effectively part- nationalized Brittan's biggest banks, including Lloyds TSB, Royal Bank of Scotland and Barclays.

The current financial crisis has thrown terminology from the business pages onto the front page of newspapers, with jargon now abounding everywhere from the watercooler to the back of a taxi.

 

Here is a guide to many of the business terms currently cropping up regularly, as well as some of the more exotic words coined to describe some of the social effects of the credit crunch.

A-C

Administration

A rescue mechanism for UK companies in severe trouble. It allows them to continue as a going concern, under supervision, effectively to try to trade out of difficulty.

A firm in administration cannot be wound up without permission from a court.

Bear market In a bear market, prices are falling and investors, anticipating losses, tend to sell. This can create a self-sustaining downward spiral.

Bond

A debt security - or more simply an IOU. The bond states when a loan must be repaid and what interest the borrower (issuer) must pay to the holder. Banks and investors buy and trade bonds.

Bull market

A bull market is one in which prices are generally rising and investor confidence is high.

Chapter 11

The term for bankruptcy protection in the US. It postpones a company's obligations to its creditors, giving it time to reorganise its debts or sell parts of the business, for example.

Commodities

Commodities are products that, in their basic form, are all the same so it makes little difference from whom you buy them.

That means that they have a market price. You would be unlikely to pay more for iron ore from a particular mine, for example.

Credit crunch

The situation created when banks hugely reduced their lending to each other because they were uncertain about how much money they had.

This in turn resulted in more expensive loans and mortgages for ordinary people.

Credit default swap

A swap designed to transfer credit risk. The buyer of the swap makes periodic payments to the seller in return for protection in the event of a default.

A bank which owns a lot of mortgage debt could swap it, but would have to make a pay-out if those mortgages were not repaid.

D-F

Derivatives

Derivatives are a way of investing in a particular product or security without having to own it. The value can depend on anything from the price of coffee to interest rates or what the weather is like.

Derivatives can be used as insurance to limit the risk of a particular investment.

Credit derivatives are based on the risk of borrowers defaulting on their loans, such as mortgages.

Equity

In a business, equity is how much all of the shares put together are worth.

In a house, your equity is the amount your house is worth minus the amount of mortgage debt that is outstanding on it.

Fakeaway

A home-made, belt-tightening version of a takeaway - think, a curry made with a jar of sauce, bag of rice and a packet of poppadoms from the supermarket.

Futures

A futures contract is an agreement to buy or sell a commodity at a predetermined date and price. It could be used to hedge or to speculate on the price of the commodity

H-K

Hedge fund

A private investment fund with a large, unregulated pool of capital and very experienced investors.

Hedge funds use a range of sophisticated strategies to maximise returns - including hedging, leveraging and derivatives trading.

Hedging

Making an investment to reduce the risk of price fluctuations to the value of an asset.

For example, if you owned a stock and then sold a futures contract agreeing to sell your stock on a particular date at a set price. A fall in price would not harm you - but nor would you benefit from any rise.

Hypermiling

Techniques used by drivers to get more miles to the gallon, such as coasting in neutral and keeping tyre pressure high.

Investment bank

Investment banks provide financial services for governments, companies or extremely rich individuals. They differ from commercial banks where you have your savings or your mortgage.

L-P

Leveraging

Leveraging, or gearing, means using debt to supplement investment.

The more you borrow on top of the funds (or equity) you already have, the more highly leveraged you are. Leveraging can maximise both gains and losses.

Deleveraging means reducing the amount you are borrowing.

Libor

London Inter Bank Offered Rate. The rate at which banks lend money to each other.

Liquidity

The liquidity of something is how easy it is to convert it into cash. Your current account, for example, is more liquid than your house.

If you needed to sell your house quickly to pay bills you would have drop the price substantially to get a sale.

Loans to deposit ratio

For financial institutions, the sum of their loans divided by the sum of their deposits.

Currently important because using other sources to fund lending is getting more expensive.

Mark-to-market

Recording the value of an asset on a daily basis according to current market prices.

So for a futures contract, what it would be worth if realised today rather than at the specified future date. Also marked-to-market.

Negative equity

Refers to a situation in which the value of your house is below the amount of the mortgage that still has to be paid off.

Profit warning

When a company issues a statement indicating that its profits will not be as high as it had expected. Also profits warning.

R-T

Rating

Bonds are rated according to their safety from an investment standpoint - based on the ability of the company or government that has issued it to repay.

Ratings range from AAA, the safest, down to D, a company that has already defaulted.

Recessionista

A person who manages to look fashionable on a tight budget.

Securitisation

Turning something into a security. For example, taking the debt from a number of mortgages and combining them to make a financial product which can then be traded.

Banks who buy these securities receive income when the original home-buyers make their mortgage payments.

Security

Essentially, a contract that can be assigned a value and traded. It could be a stock, bond or mortgage debt, for example.

Short selling

A technique used by investors who think the price of an asset, such as shares, currencies or oil contracts, will fall. They borrow the asset from another investor and then sell it in the relevant market.

The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference. Also shorting.

Spiv

A term popularised in World War II for flashily-dressed chancers involved in black market dealings. A fictional spiv is ladies' man Private Joe Walker in Dad's Army.

Newspaper headline writers use "spiv" as shorthand for traders who play for high stakes.

Stagflation

The dreaded combination of inflation and stagnation - an economy that is not growing while prices continue to rise.

Staycation

Staying at home for your holiday in a bid to save money.

Sub-prime mortgages

These carry a higher risk to the lender (and therefore tend to be at higher interest rates) because they are offered to people who have had financial problems or who have low or unpredictable incomes.

Swap

An exchange of securities between two parties. For example, if a firm in one country has a lower fixed interest rate and one in another country has a lower floating interest rate, an interest rate swap could be mutually beneficial.

U-Z

Unwind

To unwind a deal is to reverse it - to sell something that you have previously bought, or vice versa.

When administrators are called in to a bank, they must do the unwinding before creditors can get any money back.

Write-down

Reducing the book value of an asset to reflect a fall in its market value. For example, the write-down of a company's value after a big fall in share prices.