Time to take stock of the credit crunch. Nouriel Roubini, a professor of economics and international business at NYU’s Stern School of Business, is decidedly downbeat:
It is now clear that the delusional hope that the severe credit and liquidity crunch that hit US and global financial markets would ease has been shattered by the events of the last few weeks. This credit crunch is getting much worse and its financial and real fallout will be severe.
And, he goes on, we need to stop calling this a subprime crisis. It’s far broader than that: not only has the contagion sread to near-prime and prime mortgages, it’s also well advanced into subprime and near-prime credit cards and car loans, and heading off into broader pastures still. “Every corner of the securitization world is now under severe stress, including so called highly rated and “safe” (AAA and AA) securities.”
And there appears to be the potential for it all to get a lot worse on November 15th, when a new accounting standard, FASB 157, comes into effect. FASB 157 is all about the valuation of illiquid assets – i.e. those assets where there isn’t necessarily a ready buyer and hence the asset is less readily convertible into cash. What it says, essentially, is that financial institutions will be much more limited in their ability to put these ‘illiquid’ assets into so-called “level 3” securities – a category of securities where the lack of market prices allows banks to use highly dubious models to price the securities instead. In English – until now, banks have basically been able to make up whatever estimate they like for the value of illiquid assets. And now that party looks set to come to an end.
Quite how bumpy a hangover there might be is illustrated by some back of an envelope calculations provided on Roubini’s blog, which look at various financial institutions and divide their level 3 assets – the ones vulnerable to this new valuation standard – by their overall equity capital base. As one of Roubini’s contributors puts it, “this will give us a better idea as to which of them may really remain solvent at the end of the day”.
Start then with Merrill Lynch, which has had to write down $7.9 billion of debt and seen the loss of its CEO, Stan O’Neal. Here, the totals were $16 billion in level 3 assets, and $42 billion in equity – a ratio, in other words, of 38%. Then look at Citigroup, which lost its CEO Chuck Prince on Sunday. Here, the figures are $135 billion in level 3 assets, against an equity base of $128 billion – a ratio of 105%. Ouch. But now look at a few other firms:
- Bear Stearns: $20 billion level 3, $13 billion equity base = 154%
- Lehman Brothers: $35 billion in level 3, $22 billion equity base = 159%
- Goldman Sachs: $72 billion in level 3, $39 billion equity base = 185%
- Morgan Stanley: $88 billion in level 3, $35 billion equity base = 251%
In other words, most of the media attention so far, and the two highest profile corporate scalps, are actually among the institutions with lowest exposure. Roubini’s summary: “Thus, you can expect that the ongoing credit crunch will get much worse in the year ahead and its fallout spread from the US to Europe and throughout Asia and the globe. Trillions of dollars of securitized assets that were sliced and diced in the long food chain of securitization are now at some risk. The first crisis of financial globalization and securitization is thus only at its beginning stage.”
It looks pretty likely that the current turmoil will lead on swiftly to a discussion about global financial regulation – this was apparently the clear consensus at a seminar on financial market turmoil held at the IMF / World Bank annual meetings last month. Commentators from the left like Will Hutton are already sharpening their claws (and, one suspects, rubbing their hands with glee) in preparation for such a discussion:
To get through this crisis, the American and British governments are going to have to think what hitherto has been unthinkable. Already the Americans are cutting interest rates careless of the inflationary consequences. Britain may have to follow suit. Both governments will have to devise new forms of regulation and control. Banks may have to be taken into public ownership.
Governments, though, so far seem reluctant to engage in such a debate. Here in the UK, Alistair Darling has admitted that the global banking industry is facing “an unparalleled period of financial uncertainty”, but he added that “I believe that we can get through that…our banking system is basically strong and…we have a very strong economy”. He must be hoping so.
