A Saint Patrick’s Day sell-off

New York’s Irish-Americans love to celebrate Saint Patrick’s Day with street parades and parties, but yesterday, I suspect, those who work on Wall Street were too busy watching the carnage taking place in the share prices of their most precious financial institutions. Forget the parades, this was the Saint Patrick’s Day massacre.

Even before the markets opened, traders were taking the axe to the likes of Lehman Brothers, Merrill Lynch and Goldman Sachs, with falls of as much as 30 per cent in pre-opening trades.

For the financial sector, the motor of the American economy, the scene was one of devastation. That is bad news for America, and, as earlier stock market slumps around the world bore witness, bad news for all of us.

What could have caused such chaos? You might have thought that by now, after months of bad news coming from America’s finest financial institutions in the wake of the sub-prime crisis, credit crunch and leverage loan woes, that it was all in the price, that the market would have already factored in all the negatives.

But not at all. The latest blow to the reeling US financials came in the form of a dramatic weekend intervention by the Federal Reserve, the guardian of the US financial system.

The Fed stepped in to “rescue” Bear Stearns via the forced sale of the troubled bank to JP Morgan Chase, and to cut the rates on which American banks lend money to each other. If this is what happens after a Fed rescue, you might wonder how bad it would get if Ben Bernanke sat back and did nothing.

That is unfair to the Fed chairman. He had to do something to avoid a meltdown at Bear Stearns, which struggled all last week against a tidal wave of share selling and increasing panic about the value of its assets.

But what spooked Wall Street and sparked yesterday’s run was one simple fact: the deal that the Fed brokered between JP Morgan and Bear Stearns was done at one tenth of the price at which it closed on Friday.

In 48 hours, one of America’s prime financial assets had lost 90 per cent of its value. If that could happen to Bear Stearns, the market reasoned, why not to anybody?

If that level of write-down were repeated across the financial sector, it would signal a collapse greater than 1929 proportions, and herald a world depression more severe than that of the 1930s. The world’s banking system would really be in meltdown.

It has not come to that yet, of course. Other structures of the US financial edifice are evidently stronger – like JP Morgan itself – and the Fed can take other measures to ward off the collapse. But what is worrying, really worrying, is the Fed seems to be running out of options.

It has intervened three times now in the course of the current crisis, and still share prices fall. It has already signalled another cut, perhaps by as much as a full one percentage point, as early as tomorrow. That cut was already in the price yesterday. And with the whole system in crisis, where does the Fed find another saviour like JP Morgan?

With the scope for action narrowing, there is the strong possibility that one bank or other will have to go to the wall. It is no longer a question of “if,” but “when”, an American or European blue-chip goes bust.

Then we will be in truly uncharted waters, and nowhere will be safe from the risk – even the cash-rich financial institutions of the region will begin to feel the squeeze.