"As Alan Greenspan, the former head of the US Federal Reserve, has pointed out, these are seminal events. The week of the 15th of September 2008 was extraordinary.

"Amid a backdrop of the collapse of Lehman Brothers, the bail-out of AIG, the rescue takeover of Merrill Lynch, and then closer to home Lloyds TSB's acquisition of HBOS, markets have experienced wild swings. At one stage on Thursday the 18th, the FTSE 100 was down over 10% on the previous week's close. But news that US Treasury Secretary Hank Paulson had tabled a plan to take on banks' toxic assets sent share prices surging 8.8%. This scheme should alleviate the freeze in credit markets and provide the breathing space for banks to recapitalise and return to normal business.

"As yet, it is too early to establish what the full consequences of these events will be. The stock market is likely to remain volatile and investor confidence fragile as the true impact of these events and the wider effect on economic growth is assessed.

"History will judge whether the Fed's decision not to save Lehman Brothers proves to be the correct one. The authorities placed belief in the proposition that an investment bank such as Lehman can go out of business without triggering widespread panic in the rest of the system. Such inaction suggests that for the effective operation of shareholder capitalism, firms must be allowed to fail.

"However, it remains the key role of authorities in the US, Europe and the UK to ensure that while shareholders are exposed, individual depositors and the banking system are protected. Confidence in these must be maintained above all else, and action by the US Treasury at the end of the week went a long way to buttressing this. By the same token, the delay in implementing Paulson's plan has caused some nervousness.

"One would expect investors to reassess their portfolios in light of these events and seek out what they perceive as safe havens during this period of uncertainty. However, while the investment environment remains volatile, investors should recognise that it is in these sorts of conditions that significant investment opportunities can emerge. As such, they can present a buying opportunity for those prepared to take a long term view. It is also in such volatile conditions that the practice of drip-feeding investments into the stock market through regular savings schemes can prove beneficial.

"Our focus as fund managers remains on identifying high quality businesses with strong management teams and pricing power as these will retain the ability to grow and gain market share from their rivals despite the difficult environment."

Further background information
- What has happened?
- Questions and Answers

Monday 15th September
The Fed chose not to provide government support for Lehman Brothers. The investment bank filed for Chapter 11 bankruptcy. However, only the holding company filed for Chapter 11, meaning that some of Lehman's subsidiaries could continue trading. This has allowed time for buyers to be found for businesses such as its US broker-dealer arm, which has since been acquired by Barclays.
Meanwhile, Bank of America agreed to buy Merrill Lynch - probably with the encouragement of the Federal Reserve - as the central bank sought to avoid the domino effect of systemic collapse.

Tuesday 16th September
One of the world's biggest insurers, AIG, became subject to an $85bn rescue by the Federal Reserve after it struggled to raise capital. The insurer was connected to financial institutions across the world and the political and economic price of its collapse would have been heavy.

HBOS's shares were sold down heavily and concern grew about a potential run on the bank.

Wednesday 17th September
Lloyds TSB stepped in to takeover HBOS. There is little doubt as to the importance of the government-backed deal in avoiding a repeat of what happened to Northern Rock. 

Thursday 18th September
Ten of the world's largest banks agreed to establish a $70bn emergency fund in an attempt to stop the risk of financial collapse spreading. The Federal Reserve widened the type of bank loan collateral it would accept to include equities and injected emergency liquidity into credit markets. Major Western central banks also took combined steps to restore inter-bank lending markets to normal conditions.

Friday 19th September
Hank Paulson, US Treasury Secretary, announced plans to create a $700bn government backed vehicle that would help to alleviate the credit crunch and allow banks to return to normal business. The vehicle, modelled on the 1989 Resolution Trust Corporation that saw the US through the Savings and Loans crisis, would take on toxic assets, drawing a line under bank losses and restoring much needed confidence to credit markets.

What do these events mean for markets?
It is too early to tell whether the events of the last week mark the turning point in a financial crisis that has been deeper and longer than many had forecast. Investors will need some perspective, which only comes with time, to work out how the major shake-up of the US investment banking industry and US Treasury's planned intervention will affect markets and other institutions.

We have seen a series of aggressive steps by the US authorities since the start of the year in attempt to avert a deep recession and restore confidence and stability in the financial system. These have included sharp interest rate cuts, tax breaks and the bail-out of Bear Stearns and more recently mortgage lenders Fannie Mae and Freddie Mac.

The US Treasury's plan to establish a vehicle to take on toxic assets is significant because it tackles the main credit quality fears holding back debt markets. The importance of these markets in funding economic growth should not be underestimated. The move is not a panacea for current economic difficulties. It will, however, help to stabilise the US (and in turn global) economy and ease credit pressures faced by businesses and individuals.

We should also expect to see further reorganisation of the banking sector. The lack of Fed intervention in the Lehman case effectively draws a line in the sand as to how far the central bank is prepared to go to help investment banks (which do not take deposits from individuals). Tellingly, Goldman Sachs and Morgan Stanley, the last remaining investment banks at the end of the week, have since become regulated banks under the Federal Reserve.

How do these events affect individual investors?
While problems at individual institutions have been recognised since the credit crunch started, the coincidence of several major events happening simultaneously in so short a period has rocked world markets. This will result in a period of heightened volatility, almost regardless of the real prospects for individual companies.

At the same time, economic activity is expected to remain slow, in part due to the overall contraction in the investment banking sector. This increases the probability of interest rate cuts by central banks. This, combined with a return to more normal credit market activity, should help the struggling mortgage market, ease the pressure on consumers and eventually stimulate the economy into recovery.

Investors will need to look through these events and realise that such uncertainty can ultimately create the sort of exceptional buying opportunities that leads to sound long term investment, provided they are willing to accept that stock markets can fall as well as rise and are looking to invest over a reasonable period of time.

NOTE
Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM) are both authorised and regulated by the Financial Services Authority and their registered address is 1 Grosvenor Place London SW1X 7JJ. They are both subsidiaries of Jupiter Investment Management Group Limited and the group is collectively known as "Jupiter". The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.