Suspension of a Stock Market - Russia
In 1942 Joseph A. Schumpeter, an Austro-Hungarian economist, popularised the idea that capitalism would destroy itself through the process of 'Creative Destruction'. Schumpeter, a fervent capitalist, argued that Karl Marx was in fact correct in his assertion that capitalism was a pre-cursor to the eventual birth of Socialism. While Schumpeter saw the means and justifications as different, the end he argued was the same as Marx had predicted.
Some will say that the recent nationalisation of banks on a global scale represents the failure of capitalism. The greed of the few has precipitated their downfall. Free-markets, forever guided by Adam Smith's invisible hand, have proven their inefficiency. This has been seen no-where more than in Russia, ironically a reformed Communist state.
What has happened?
The Federal Financial Markets Service, the regulatory body for Russian financial markets, announced the suspension of trading on all exchanges including the RTS (dollar dominated) and Micex (rouble dominated) on the 17th of September after the significant falls on the 16th continued on the morning of the 17th. The start of October saw near unprecedented bearish market sentiment which has led to precipitous falls in global stockmarkets. In Russia the falls were so severe that it was seen as a threat to the overall financial stability of the entire economy. The suspension was announced to give time for the Russian authorities to address liquidity concerns in the market.
What was the cause?
When the suspension was announced, the RTS was down 54% year to date and 32% in September alone.
The falls in Russia have largely been the result of short-term liquidity, credit issues and the country's exposure to oil and other commodity companies (the Russian market is made up of approximately 60% oil stocks). They have also been the result of a de-leveraging (reducing the exposure to debt) of positions in individual securities. Russian markets have been particularly reliant on leverage over the last few years and the inability to find finance in recent months has caused the Russian authorities and traders a financial nightmare.
The other major reasons for the falls have been the geo-political issues and Russia's belligerent attitude to neighbouring Georgia. Further concerns over corporate governance (Mechel & TKN/BP) coupled with sharp drops in commodity and oil prices have only exacerbated an already difficult situation.
What has been the response?
As has become increasingly common throughout Western economies, the Russian Government has taken decisive action in response to these problems:
- The government injected an estimated $44bn of liquidity into the markets.
- Rumours of a further $20bn were sounded to the markets.
- Reserve ratios (the amount the bank must keep on deposit) for banks have been cut by 4%, effectively injecting a further $12bn into markets.
- From 1st October 2008 there will be a cut in oil tax export duty to compensate for the 25% decline in oil prices.
What are the implications of suspending the market?
The Russian authorities made this decision in response to a genuine threat. Despite the fundamental economic assumption of rationality, markets in recent months have been acting on sentiment and to an extent panic. The suspension of the market meant that companies listed on the Russian exchanges were not exposed to significant falls in value. Had the trend been allowed to continue, good companies producing products and services with a genuine economic value could have been forced to file for bankruptcy and the situation would have worsened. This resolution meant that everyone, investors and boards, had time to review the reality of the situation.
Is this the death of a free-market?
Some economists, including the eminent John Maynard Keynes, argue that fiscal policy - the intervention of governments in markets - is not an option but a must. Capitalism left to its own devices will always result in some negative externalities - pollution being the perfect example. There will always be a role for governments in providing education, healthcare and other public goods. While an intervention of this scale and international depth is largely unprecedented, it is not anomalous. Ever since the Big Bang in 1987 gave financial traders and stockbrokers freedom to invest in almost any asset, greed and avarice have driven markets, and governments have had to bail out. Northern Rock and Lehman are names condemned as failures within the annals of finance history. They are, however, not the first, nor will they be the last.
In fact banking 'bailouts' are not even unprecedented. In the 1920's J.P.Morgan (the man who gave birth to the bank) is alleged to have locked the most important figures in New York in a room and demanded a resolution to banking problems in the US. While the story is perhaps apocryphal, the reality of the crisis was not. Similarly in the early 1990's the Swedish banking system neared collapse and the government nationalised the entire system. The bailout was hailed as a great success and the Swedish economy has gone from strength to strength.
This crisis has in part been driven by governments and their obsessive desire to maintain GDP growth and give everyone housing. In 1996 Bill Clinton proclaimed housing for all and drove the mortgage market to offer loans to those with less than rosy credit. Governments, greed, avarice and sociological and cultural trends have in part driven this crisis and we will all be left to pick up the pieces. The suspension of stockmarkets and recessions are all part of a healthy economic cycle; indeed, they are a welcome dash of rationality in a capitalism gone temporarily awry.
