Credit crunch to sting into next year

On the eve of its one-year anniversary at the start of August the credit crisis is still spitting out victims and darkening the outlooks from global central banks.

Most of the 87 economists polled from across Europe, the U.S. and Canada said the worst was not over and most felt that the fallout would last for another six to 12 months at least.

The sudden rescue plan for U.S. mortgage finance agencies Freddie Mac and Fannie Mae arranged by the U.S. Treasury and the collapse of IndyMac bank last week has 34 economists forecasting the crisis will roll on for another year or even more.

"There are still additional shoes to drop off of this centipede. So long as home prices continue to fall, bank losses will not stop," said Eric Lascelles at TD Securities.

It's clear too that policymakers are worried.

U.S. Federal Reserve Chairman Ben Bernanke said on Wednesday his top priority is restoring financial calm even as weak growth and now-surging inflation grip the economy amid an historic housing bust that has yet to abate in intensity.

Indeed, the fundamental root of the problem was aggressive lending to swathes of U.S. homeowners who had no hope of paying back the money. But that came against a backdrop of the lowest central bank interest rates in generations.

The crunch started off hitting institutional firms in the form of multi-billion dollar writedowns and claimed British lender Northern Rock in the first UK bank run in over 140 years.

It led to the hastily-arranged firesale of one of Wall Street's best-known names, Bear Stearns, to JP Morgan Chase. Bank of America recently swallowed up former U.S. mortgage heavyweight Countrywide in a rescue purchase. And financial shares have plummeted, in some cases as much as 80 percent.

HIGHER RISK PREMIA HERE TO STAY

The poll found that credit markets are not likely to return to conditions seen before the crisis erupted any time soon. Some argue that where they are now is more normal given that before the credit crunch began they were too low.

Three-month Euribor interbank lending rates saw their widest premium to the base rate of around 90 basis points last December compared with around five basis points before the credit crisis. It has since only eased slightly to around 65 basis points.

In the poll, 33 economists said the spread between three-month money rates and base rates will not "normalise" until six to 12 months have passed. But thirty-seven said one to two years or even longer would be more likely.

Indeed, many economists argue that borrowers will have to get used to paying a higher risk premium to access capital, while institutions doing the lending inevitably adapt stricter risk practices.

"We are unlikely to return to the very tight levels seen at times during this period but as the crisis eases over the next year, spreads should narrow somewhat," said John Ryding, formerly of Bear Stearns and now economist at RDQ Economics.

AGGRESSIVE LENDING

The survey showed analysts were split about whether the credit crunch marked the definitive end to a roughly two-decade era of declining interest rates. Thirty-nine said it had, 45 said the opposite.

Indeed, while banks have scrambled to protect themselves by tightening lending standards, many analysts say the main reason for the jump in world borrowing costs stems from soaring food and energy costs pushing up inflation.

"The era of declining interest rates has certainly come to an end - but this is more due to resurging global inflation risks than to the credit crunch," said Thomas Hempell at Generali Investments in Frankfurt.

Most economists agree that despite the crisis, the aim of central bank monetary policy should not be overhauled to include preventing financial crises, instead of just providing the funds necessary to mop up the mess.

Forty-nine of 82 said so, but a significant minority, 33, said that some change to policy objectives was needed.

The Fed, and to a lesser extent the Bank of England, has received harsh criticism for leaving interest rates too low for too long, which caused asset prices, particularly home prices, to balloon to unrealistic levels.

In many countries, like the U.S., Britain and Spain, they are now crashing back down to earth, putting economies at risk.

"The credit debacle demands a critical analysis of the role and objectives of the central banks," said Stephen Lewis of Monument Securities in London who has been forecasting interest rates for 38 years. "They have failed in a major way."