The Brown package is not enough. After initial turn-ups in stockmarket indices in response to the plan, skittish markets have renewed their downward plunge. Recapitalisation, extended liquidity and lending guarantees were clearly needed, but they are not sufficient. The central problem remains, so far unaddressed, that the scale of banking (and governmental) exposure to the unimaginably colossal liabilities buried deep within the financial markets is still acting as an insuperable barrier to any permanent return of confidence.
The origin of the problem lies in the pyramid of creative financial products designed to massively enhance returns and the speed of their being realised. Over the last decade the use of complex credit derivatives – structured investment vehicles and collateralised debt obligations – has grown exponentially both because of its enormous profitability and because risk could be passed on by securitising the assets, i.e.trading them in arcane bundles which mixed them up with income flows from other wholly different sources. Because these bundles were clearly risky, the markets then devised another product to protect unwary buyers – credit default swaps. Then another layer of uncertainty was placed on top because these credit default contracts were also tradeable. This then attracted frenetic speculation in these contracts by hedge funds ready to accept much bigger risks in the hope of exceptional gains.
All this new-fangled machination has now produced two very big dangers. One is that this multi-layering of risk has enormously expanded the instability inherent in the markets. The other is the sheer size of the pyramid created. Securitised assets have exploded from a tiny base a decade ago to some $10 trillions today, while the market in credit default swaps now stands at about $23 trillions and in credit derivatives as a whole at around $55 trillions. The scale of the latter market amounts to more than double the combined GDP of the three largest economies in the world – the US, Japan, and the EU.
The question then arises: are the write-offs from these near-worthless assets so gigantic that not even Governments will be able to stem the tide of collapse? The evidence is already beginning to look worrying. The Icelandic State cannot honour the obligations of the Icelandic banks which made loans more than three times the value of the country’s GDP. Two British banks, Barclays and RBS, each hold $ 2.4 trillions of credit default swaps, which together equals nearly twice British GDP. The collapse of Lehman Brother has left $440 bn of credit default swaps unhonoured, and who will pick up that tab?
The new Bretton Woods conference, called for December, need to make the global regulation of the credit derivative markets its first priority. New rules to govern their role and application tightly, where they are not outright banned, are desperately needed. But even before then (and two months in today’s unending hurricane is a very long time), if the international collapse continues to ricochet round the world, British GDP may not be sufficient to stave off the run on capital flowing out of the City. In that case, there may be no alternative to full nationalisation of the banks combined with a return to capital and exchange controls.

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