WE HAVE just ended one of the most unpredictable weeks ever on Wall Street and in markets across the world.
So what do the events of last week mean to the medium-term future and to investors outside the shell-shocked community of Wall Street?
As Lehman's unimaginably complex web of transactions is unravelled over the coming months, many institutions ac
ross the world will feel the pain. The bank's demise is an important event in this chapter of the world market story and underlines that the Federal Reserve has the protection of systemic risk, not particular institutions, at the top of its agenda. But it's not the concluding paragraph and alone is not the turning point some people are calling it.
So much has happened since the credit squeeze started that it is easy to forget that the banking crisis began with a collapse in US house prices. Many low-income American households took loans they could not afford and are now suffering negative equity. These mortgages were repackaged and sold up the finance food chain and when the homeowners were unable to keep up their repayments and the value of the properties fell, the value of the repackaged investment plummeted. Institutions with the greatest exposure to these products have suffered the most; among Wall Street's banks, Lehman Brothers had the biggest appetite.
So the turning point will only come when normality returns to the US housing market. I'm watching very closely two pieces of data that indicate 'normality'. Cheap mortgages offered on lax criteria created an unprecedented demand for new homes. Demand led to a boom in building and eventually the forces that created the demand destroyed it: we had an oversupply of houses which accelerated price falls as there was simply too much stock.
Fewer new homes are now being built than at any time since the early Nineties. This is positive for the housing market as it indicates that the oversupply will now eventually flow through the system.
The second datum is more important. For many decades, Americans have lived in houses valued between 2.5 and three times the household's income. In 2002/3, this started to change and peaked around four times household income in 2005. At this point, as in the UK, lenders were throwing money at anyone applying for a loan and began offering deals based not on sensible multiples of income but on the expected rise in property prices.
This unsustainable model has begun to reverse. House prices are already falling and because generally incomes should rise, the preferred ratio should be arrived at where the two meet in the middle. The expectation of a slowing economy, however, has led to a flattening of wages, so house prices may need to fall further to achieve the balance.
The alternative to this happening would be a return to more relaxed lending standards, which seems unlikely.
Unfortunately, so much has spilled out of the housing crash, normality returning to the housing market alone will not cure the volatile markets.
Not only are US consumers embattled by the falling value of their homes, their incomes are under threat as unemployment is rising, recently hitting 6%. Rising unemployment is an ominous sign for a country's economy and usually signals a drop in GDP growth.
But while US consumers have been tightening their belts, the emerging world has been expanding rapidly and US exports have so far balanced easing domestic demand. Growth rates have begun to slow in Asia and this week China recognised this and cut interest rates in a bid to sustain the high growth rates it has enjoyed over recent years.
The dire situation on Wall Street might feel very scary, but it is necessary to shake out the bad news. The US economy is vast and behind the headlines are companies that continue to prosper. These companies have been swept up by the tidal wave of the past week but represent good value now as a result.
Sunday has become a very active day in New York in recent weeks; the deal to save Freddie and Fannie was reached on a Sunday as was Lehman's bankruptcy filing. And we know that Hank Paulson and his colleagues at the US Treasury are spending this weekend hammering out the detail of their solution to the banks' bad assets.
Whatever happens, professional investors across the globe are still searching for good investment opportunities for long-term growth.
Bob Haber is manager of the Fidelity American Special Situations Fund
