Is another market crisis possible?

When former US Treasury secretary Henry Paulson told a packed audience of bankers at a New York hotel early this week that many factors leading to the 2008 financial crisis still exist, it sent a chill down the spine of many.

The unease was not without a reason. The remark had come from a person who played a major role in rescuing the financial system after Lehman Brothers collapsed on September 15, 2008, that led to one of the worst global market turmoil in decades. Eerily, Paulson said this less than a week before the fifth anniversary of Lehman’s collapse.   

The trauma of the ensuing financial market crash is still fresh in the minds of investors and traders, many of whom were virtually wiped off in the mayhem. Some on Dalal Street could take comfort from the fact that benchmark indices—Sensex and Nifty—have returned to the heights before the Lehman crisis but they are aware that the existing elevated index levels are just a mirage, as the pain is much more widespread.

Still, they could choose to let bygones be bygones, as there are some steep battles to fight immediately—the closest being the outcome of the US Federal Reserve meeting on Wednesday that will discuss scaling down its monetary stimulus, known as quantitative easing (QE3).

Investors consider the decisions in the meeting as the single-biggest trigger for global financial markets in the near term, as the third round of QE has been key to billions of dollars flowing into various asset classes, including emerging market equities such as India’s. While a roll-back of QE3 is more or less expected, the fear is about the extent of the pull-out that might spark withdrawals from risky asset classes.

With the Fed very clear that there would not be another round of QE soon, investors fear the market cycle since later 2008 is coming full circle. Though the broader feeling is that a partial withdrawal of the Fed’s monetary stimulus is unlikely to create a Lehman-like crisis, the mood is jittery because of uncertainty about how markets would adjust to a scenario of lesser money sloshing around.   

“The probability of a Lehman-like event recurring is much lower because of the various checks and balances in the form of higher and purer capital requirements and more prudent liquidity framework by governments and central banks across the world,” said Hitendra Dave, managing director-global markets head India, HSBC. “That does not mean there is no chance of such an event recurring but the probability is surely far lower”.

With companies’ earnings this year set to grow at its slowest since 2001-02, there are worries that the likely QE3 withdrawal announcement could trigger a sell-off by FIIs.