Diseased sector won’t recover easily

A sense of apocalypse pervades the financial services sector. Deleveraging is a scourge sweeping all before it. In the US, the seemingly immovable objects that were Fannie Mae and Freddie Mac have been unceremoniously shunted into government ownership.

In the UK, Nationwide has stepped in to shelter the Derbyshire and the Cheshire from the credit crunch storm. Rivers of ink have flowed as commentators have attempted to divine what all this means but given the systemic uncertainties facing the industry I will steer clear of augury in favour of analysis.

As successive lenders, brokers, banks and investment funds have failed in the US, many talented staff have lost their jobs. Lawyers, accountants and other service providers are feeling the squeeze too. Deleveraging is systematically devouring the human and operational infrastructure required to keep the finance industry functioning. This is happening in the US and to a lesser extent here too.

Companies are purging staff from the top down. In isolation this makes sense. Basic operations chug along without much oversight while new chief executive officers reinvigorate leadership and steer businesses towards better times – and if they don’t, competitors step in to take advantage. But if all CEOs are fired industries are left leaderless and daily operations grind to a halt. So with all companies making decisions that add up to a crisis, an external force is re-quired to make things right.

The credit crunch has been defined by externalities – the nationalisation of Northern Rock and now Freddie and Fannie, the mergers of societies and changes to housing market support here and in the US.

The problem now is that governments may recognise the dangers of the crunch but the operational infrastructure required to deliver relief has been badly damaged.

There are still pockets of infection in the market that could wreak further damage. The balance sheets of many financial institutions contain mortgage exposure and as the global economy slows down more mortgages are likely to destabilise, causing more problems.

The US government’s action over Fannie and Freddie is intended to heal the patient, safeguard against further infections and allow recovery to begin in earnest. This may work but it will take time because the mechanisms for delivering it are broken.

Processes, companies, funds and markets all have to recover to a point where normal operations can resume. But even if this occurs, the US Treasury has just swallowed a massive gulp of risk that may yet cause a serious bout of food poisoning.