A poisoned chalice

Barack Obama has revelled - some might say arrogantly - in what has been a momentous victory. He is now the presumed Democratic Party nominee for President of the United States.

He has called it an historic moment, a moment of change, a moment for the United States to take a new direction.

In this, he seems to be right but the next four months and more especially the next four years may be historic in ways he may not yet have clearly identified.

The primaries showed convincingly that the first concern of the American people is the economy. This is likely to persist into the November elections. The average American voter may be woolly in his ideas of what precisely is wrong with his economy; and “expert” analysts who will try to explain what it is all about will only confuse him more. Those “expert” analyses will almost certainly continue to be distorted by “euphorisation” - a refusal to admit the realities - for some time yet.

However, time is already undermining the euphoria. The extreme and revolutionary action taken by the Fed and supported by the Secretary of the Treasury, together with stimulus packages and the like from the Bush Administration, has not resolved what has been variously known as “the sub-prime crisis”, the “credit crunch”, the bursting of the housing bubble and so on.

After months of effort and lavish outlays of not merely hundreds of billions but what may now be a trillion or more dollars by the Fed and others, the problems of the banking community, the financial system or whatever you may choose to call it remain doggedly in place.

Not only are the problems still there but they have grown ever more menacing. Almost certainly, the global credit crisis at mid-year in 2008 is entering - indeed, may already have entered - an even more turbulent phase then ever before.

In the last month, the cost of insuring against default on the bonds of Lehman Brothers, Merrill Lynch and other big banks and brokerages has surged, threatening to exceed the stress levels prior to the Bear Stearns debacle. Spreads on inter-bank Libor and Euribor rates in Europe stubbornly persist at or near record levels.

Credit default swaps (CDS) on Lehman debt have almost doubled from about 130 in late April to about 250 now, while Merrill debt has spiked to 196. Most analysts thought the tide had turned for such broker dealers after the Fed invoked an emergency clause in March so that they could borrow directly from its lending window.

However, the Fed may now be exhausting its potential. It has swapped almost $300 billion of 10-year Treasuries for poorer quality collateral, and provided Term Auction Credit of $130 billion. One senior financial-services practitioner commented that "The steep rise in swap spreads this [month] is ominous. The deterioration is in stark contrast to what investors have come to hope since March."

Lehman Brothers took write-downs of just $200 million on its $6.5 billion portfolio of sub-prime debt in the first quarter even though a quarter of the securities had "junk" ratings, typically worth a fraction of face value.

European banks and non-bank financial institutions have been showing similar signs of weakness and distress. Moreover, the prospect is for the global finance industry to endure waves of defaults on credit cards, car loans and corporate loans. "We believe we're entering Phase II,” said a credit analyst of Dresdner Kleinwort. “The liquidity crisis has eased a little, but the real credit losses are accelerating. The worst is yet to come."