1998 was a bad year for the banks. This was the year that Russia defaulted on its debts, and the hedge fund Long Term Capital Management collapsed. In the wake of the year’s turbulence banks’ profits plummeted, with investment banking and trading revenue down 31 percent in the second half, or so says Standard and Poor’s.

Forward wind the clock to today and we could see a re-run, or it could be even worse, warns Standard and Poor’s. The rating company conducted what it called a stress test into the banking scene and said, “There is a sense of déj#224; vu about the current environment for securities firms, which bears many similarities to that of the late summer and fall of 1998.” In fact, it suggested that this time it could be even worse.

“It concluded that this time around the largest investment banks could see revenue fall by as much as 47 per cent, and profits could collapse 70 per cent.

The Standard and Poor’s statement said, “Once again, we see sharp falls in stock markets following a strong run, a jump in volatility, sizeable losses at some large hedge funds, higher risk premia on bank debt, a liquidity crunch, asset valuation problems, and rumours of banks and broker-dealers getting into difficulties.”

Of course, the inevitable consequence of a fall in investment banking profits will be cuts in city bonuses, which according to the Guardian are up 30 per cent this year. And with that, maybe we will see the long awaited fall in the price of properties based in London’s more expensive areas.

There are many, of course, who will be quite happy to see the city boys’ fat bonuses shed a few pounds, but don’t expect the fallout to last.

1998 might have seemed like a major crisis at the time, but the business world soldiered on. And this time around Standard and Poor’s is pretty bullish about the medium term. “Given the still-favourable economic fundamentals, an extended downturn seems unlikely at present.”

It seems odd that we keep seeing comparisons being drawn with 1998, a blip year in a bull cycle. The real crisis occurred in the first few years of this century. Perhaps the underlying problem is that investment into business which adds to our ability to produce has gone out of fashion. Instead, low interest rates have encouraged us to pour out money into non-productive assets such as properties and provide funds for management buyouts.

While property prices to income ratios soar to new all-time highs, while debt reaches unprecedented heights, equity valuations to profits sit at their lowest level for around 15 years.

We have been having a jolly based on paper. The real economic growth story is occurring elsewhere, in China and in other developing countries, and we are living off that growth. The city does to an extent provide a legitimate service to the growing global economy but the build-up of so much debt brings with it problems for the future. The recent crisis in liquidity is just the first sneeze.
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