Tough times as disasters unfold

WE are living through a period of spectacular and costly bankruptcies here and in America as the telecoms and internet bubble bursts. Write-offs by companies run into the billions and the sheer scale of bankruptcy at the likes of Enron and WorldCom dwarfs anything seen before.

Yet despite all this money being lost, the banks show no pain. It is one of the great business mysteries of our time. Who stands on the other side of these debt disasters?

The banks say that they have kept out of trouble because they no longer hold loans on their books but instead break them up into small chunks and sell the parcels on, or pass the risk of default on to insurance companies through what are known as credit derivatives. In this way, any losses are spread widely throughout the system.

Well, up to a point. The difference between a bank and an insurance company is that when you ask a bank for your money, it gives it to you whereas when you ask an insurance company it sucks its teeth, delays, loses the file, threatens to litigate and then months later pays up considerably less then had been expected.

What intrigues me now is whether the allegations of collusion between failed power giant Enron and banks such as Citigroup and JP Morgan Chase changes the game.

If these or any other financial transactions can be demonstrated to be anything other than fully above board and for legitimate business purposes, those now holding the risk might well claim that they were misled. In the case of the insurance companies at least, they may refuse to pay up.

If they do refuse to pay up - and that is what insurance companies do best - the whole edifice of risk transfer comes into question, and the bills potentially revert to the banks that originated the deals.

The biq question over the next few months is whether these investment banks have been too clever for their own good.

Fed's bubble rap
IF YOU want to get a better idea of what America's Federal Reserve is up to, it is worth taking a look at its recently-published analysis of the errors the Japanese government made after its asset price bubble burst in 1990 - Preventing Deflation: Lessons from Japan's Experience in the 1990s.

The surprising conclusion which I draw from the report is that the once-staunch inflation fighter is now so worried about the perils of deflation it is anxious to see prices going up in the US. If so, it must be overjoyed by the recent fall in the dollar since a falling currency can help to increase the rate of inflation-The Fed says that if the Bank of Japan had cut interest rates more aggressively between 1991 and early 1995 after the bubble burst the deflation and recession that have dogged the economy since could have been avoided.

True, this could have led initially to higher-than-desirable inflation, the Fed says, but 'compared with the costs of entering deflation the costs of excessive monetary loosening would have been relatively limited' because inflation could have been swiftly brought under control.

What the Fed does not discuss is how the asset bubble got going in the first place. For the record, many European policymakers say it was caused largely by Washington bullying Japan into boosting its growth at the wrong time in the late 1980s to help to reduce the US current account deficit.