Lehman Brothers bankruptcy deals a blow to hopes of an end to the credit crunch

Lehman Brothers, the fourth largest investment bank in the US, has filed for bankruptcy protection, dealing a blow to the US chemical industry’s hopes of an end to the credit crunch.

The US government’s 8 September bailout of the two mortgage giants Fannie Mae and Freddie Mac had raised expectations in the US chemical industry of an easing to the lending squeeze, and a revival in its two key customer sectors of housing and automobiles.

However, Lehman’s bankruptcy has reinforced anxieties in Europe about weakening economic conditions. European chemicals companies fear that the full impact of the credit crunch has still not been felt, and could be greatly compounded by the reverberations of a steep fall in oil prices, which could reduce demand for bulk chemicals such as polymers. 

Hopes and fears

The decision by the US government to take control of the two struggling mortgage companies, which between them have liabilities of $5,400 billion (?3,015 billion), had temporarily boosted shares in stock markets across the world. The expectation had been that the rescue would release funds for house purchases and generally ease the availability of credit.

Now economists think that the bail-out of Fannie Mae and Freddy Mac could be even more important to the future of the US economy. The collapse of Lehman Brothers underlined that the US government is reluctant to use any more public funds to help ailing banks. With the rest of the financial system being left to sort out its problems by itself, the injection of cash into the two mortgage companies will have to provide the platform for a recovery of the US housing market, which hopefully will rub off on other sectors like automobiles.

’The rescue could not only be favourable for the housing sector but also the market for light vehicles, which is an important end-user of chemicals,’ said Kevin Swift, chief economist at the American Chemistry Council (ACC), speaking after the announcement of the aid to Fannie Mae and Freddie Mac last week but before the news of  Lehman’s filing for bankruptcy protection. 

The US economy is currently doing better than had been expected earlier in the year. In the second quarter its GDP grew by 3.3 per cent. So far it has avoided the predicted recession of two successive quarters with decreases in output.

’Any recovery in the housing and automobile markets could take time to work through to chemical sales,’ says Swift. ’It may not become evident until the first or second quarter of next year.’

US chemical companies have been able to offset decreases in domestic demand with increases in exports which have been stimulated by the depreciation of the dollar in foreign exchange markets. ’Chemical exports have gone up by 13-14 per cent so far, which is higher than we expected earlier in the year,’ adds Swift. 

European concerns

Even before the Lehman Brothers announcement, Europe’s chemical industry was bracing itself for a further weakening in demand amidst worries that some of the region’s main economies could go into recession. In its latest trends report, the European Chemical Industry Council (Cefic) has revealed a decline in chemicals output since March of this year, although sales have been rising due to an increase in selling prices. Optimism about future prospects among Europe’s chemical industry manager has been falling since June, according to Cefic.

The European Commission on 10 September lowered its estimates for growth in the EU from 2 per cent to 1.4 per cent. The UK and Spain, whose economies have been severely hit by a slump in the housing market following the credit crunch, are expected to fall into a recession over the rest of the year. More significantly the economy of Germany, which has by far the biggest chemicals sector in Europe, is predicted by the Commission to go into recession after showing relatively strong growth earlier in the year.

’Figures for chemicals output this year, excluding pharmaceuticals, will now probably be static and could even show a slight decline,’ says Henrik Meinche, senior economist at the German Chemical Industry Association (VCI). ’There is a possibility now that 2009 could be even worse for the industry than 2008. Initially Germany has not been affected so badly by the credit crunch as other European countries like the UK and Spain have been. The economic aftermath of the restrictions on lending has taken some time to reach us.’

The German chemicals sector is now concerned about the impact of the fall in oil prices, which could lead to a drop in orders by downstream chemicals users in the expectation that the prices for their raw materials will come down. ’Some downstream customers seem to be prepared to wait for a fall in chemical prices even though this could take some time,’ says Meinche. 

There is already evidence of a sharp fall in demand across Europe for bulk polymers, with plastic converters relying on supplies from their own stocks in the hope of being able to buy raw materials later at lower than existing prices. Saudi Basic Industries Corp (Sabic), which has polymer production plants in the Netherlands and northeast England, was reported this week to be cutting output of polyethylene because of poor demand.

’This could be the beginning of dangerous downward spiral, with downstream customers halting orders and bulk chemical producers having to reduce the operating rates of their plants,’ warns Paul Hodges, chairman of International eChem, a London-based petrochemicals consultancy. ’The outcome could be really scary if the US government’s rescue of Fannie Mae and Freddie Mac does not work and people lose confidence in the ability of the authorities to sort out the mess in the housing market.’

Sean Milmo

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