Credit crunch Analysis

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The credit crunch is a year old and shows no sign of easing. What do accountants make of it all? Brian Hanney reports
xactly a year ago, the country witnessed a sight it had not seen since the wartime rationing of the 1940s snaking queues on the high street. This time, people were not queuing for meat or vegetables. They were outside branches of Northern Rock, desperate to withdraw their savings. This was the first run on a retail bank since the 1860s. The credit crunch had arrived in Britain. The problem, of course, had begun in the US, where demand for cheap home loans had resulted in banks lending money to high-risk borrowers. These so-called subprime mortgages were then repackaged into securities known as collateralised debt obligations and sold on to other financial institutions. But the subprime borrowers began to default on their debts and the banks, unsure of who was nursing heavy losses, stopped lending to one another. The European Central Bank injected billions into the money markets, but it was not enough to save the Rock, which relied on the wholesale markets to raise money for loans. view the situation? And how can they help? The Insolvency Service recently announced that administrations were up 60% on last year. Nick Wood, a partner at Grant Thornton, comments: Businesses that a year ago had been able to paper over the cracks are now being fully exposed. Unfortunately this feels like just the beginning. Andrew Ratcliffe, an audit partner at PricewaterhouseCoopers, says the issue of going concern reviews are now more important, not just the financing of the audit client itself. About six months ago, we were focusing on bank lines. In the last month, the problem has hit the real economy. From an audit point of view, the important things are the valuation of property and the valuation of receivables. Ratcliffe adds that in a downturn the motivation for fraud increases. It is an unfortunate statement on the world we live in, he says. Concerning accountants own jobs, Ratcliffe comments: As far as I know, its not a case of switching off the recruitment tap, and there are certain parts of the economy doing well. For example, in retail, take discounters like Lidl and Aldi. There are more people coming into the store. In the downturn, its about how youre managing your cash cash is king.

Ongoing uncertainty
One year on, and we are still fraught with uncertainty. So how do accountants and economists who have to deal with things as they are, not how they would like them

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Analysis Credit crunch

Businesses that a year ago had been able to paper over the cracks are now being fully exposed
Chris Temple, partner, PwC Strategy, says: People are concerned about their ability to borrow. For instance, in the housing marketplace, when it is going strong, even if they dont do equity release, people feel wealthier. Its the same in the commercial market. When it comes to downsizing, whatever they do, they need to do it hard and fast. He adds: Of course, unemployment is a major issue here. If you have to cut staff, cutting more people earlier means youre less likely to have to go in for a second cut later. Businesses facing a downturn should also look abroad, particularly to Eastern Europe, he says. That should be on businesses agenda. They should consider expansion, though there are cultural and language problems and its not that straightforward. But Temple accepts that M&A activity has slowed down enormously and we expect that to continue.

Rocky moments in history

1720 The South Sea bubble bursts, sparking massive panic and a major financial crash in the City of London.
1873-1896 The collapse of the Vienna Stock
Exchange caused a depression that spread throughout the world.

1987 Shocking borrowing figures in the US brought a crash on Wall Street, which subsequently hit major stock markets around the world. 1991 A recession in Japan rocked property markets and halted that countrys once astronomical growth. 1992 Black Wednesday occurred when the UK was forced out from the European Exchange Rate Mechanism, and the government failed to prevent a devaluation of the pound. 2001-2002 These years saw the bursting
of the dotcom bubble, along with the 9/11 attacks on the World Trade Center. There were also a number of accounting scandals, including a major fraud at Enron, which led to the collapse of Andersen.

1918-1921 Severe hyperinflation in Europe

was caused by the ending of the Great War, and hence wartime production. There were also problems caused by the influx of labour from returning troops.

1929-1939 In the Great Depression, stock

markets crashed worldwide and sparked a global downturn. The US witnessed a banking collapse.

Winners and losers

Even with a credit crunch there are still winners and losers. Those businesses that are manufacturing products encouraged by the government will be winners, says Temple. This applies particularly to green products, such as those that promote energy efficiency. Anything that plays into the sustainable agendas and is backed by the government will succeed. Losers are those who do not innovate. Gerry Loftus, head of Deloitte London Advisory & Investigations, said the credit crunch only hit the real world quite recently. Even up till March or April, it was confined to financial services. Only now has it hit consumers. But for accountancy firms, in some areas like transaction business, its started to pick up in the last few months. At the moment, though, businesses are not looking at downsizing. The word now is rightsizing. Loftus says: Theyre looking at a more effective structure. Theyre not looking to get rid of large parts of the workforce. Stephen Herring, tax partner at BDO Stoy Hayward, sees a positive side. Weve started to see counter-cyclical investors as people go bottom-fishing. Even in areas like construction, which has been hit on the property side, there are major infrastructure projects, such as Crossrail, the London Olympics, and the west coast mainline. Herring agrees that fraud is likely to rise in a recession, but in a vibrant economy controls are also relaxed. Of course, one area expected to do well in a downturn is recovery and insolvency, and Begbies Traynor is no exception. Mark Fry, head of the companys London office, says the downturn is principally driven by the fall in the property sector, which affects solicitors, conveyancing, estate agencies and contractors. Even discretionary spend areas like IT and print are hit. Fry says: The number of companies facing critical problems is starting to increase, though it takes a while to filter through. This creates solid business for the likes of

1973-1975 A quadrupling of oil prices by

the Organisation of Petroleum Exporting Countries led to an economic crisis, coupled with stagflation. Begbies Traynor. Theres also a tendency for businesses to shelve risky projects and look at margin, not turnover. David Kern, economic adviser to the British Chambers of Commerce, says: Theres a risk that well move into negative territory, creating a technical recession. He believes construction, services and retail will be hit, as will banks. But it is also important that there is no increase in interest rates. He adds: Also, you dont raise taxes in a downturn.

End in sight?
So, the next question is: when will it all end? Opinions in the profession vary widely. Deloittes Loftus says: We reckon the downturn will be longer than anticipated, but not as deep as people expect, and Herring of BDO says: There may be another year or two of downward movement. Meanwhile, Begbies Fry says: Were seeing a big tightening of credit. That could last until 2010, but BCC adviser Kern says: My view is that this is going to go on for nine to 12 months. However, PwCs Ratcliffe says: I wouldnt be in this job if I knew. Nobody knows.

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