by Alex Evans | Oct 6, 2008 | Cooperation and coherence, Global system, Influence and networks
Two excellent columns in the FT last week explored the extent to which the credit crunch is a crisis of trust – and not just in the obvious sense of whether you trust your bank to be able to pay you back your deposit, or whether banks trust each other as counterparties.
As Chrystia Freeland notes, one dimension of the broader crisis of trust is the collapse of faith between electorate and political establishment in the US, seen in vivid colour in the House of Representatives’ initial refusal to approve Paulson’s bailout. For all that “the nearly unanimous verdict of what we might once have called the wise men in both parties, in government and in business, in academia and in the so-called MSM (mainstream media), was that the Paulson plan definitely, absolutely, undoubtedly should be approved”, 228 members of Congress – and countless voters on the phone to their offices – “decided they didn’t believe their country’s political and economic establishment”. She continues,
Americans have good reason to distrust their elite. The country’s political rulers, led by George W. Bush’s strong-arm White House, have made it easy to believe that the US government just doesn’t work. From Katrina to the war in Iraq (at least before the surge), to the budget deficit, to the lack of a national energy policy, Washington doesn’t seem to be delivering very good value to its citizens.
Nor do the nation’s business leaders appear particularly trustworthy at the moment. Even before the credit crunch bit, median wages were stagnating while the incomes of the super-rich soared, creating a gap bigger than at any time since the Gilded Age.
All of this makes the nation’s widely felt, bipartisan impulse to just “kick the bastards out” easy to understand. [But] here’s the rub: the current financial crisis is global, fast-moving and fiendishly complicated. It is precisely the sort of thing it takes selfless, sophisticated technocrats to fix. But, even if America can find the necessary, honourable financial wizards – no mean feat – can it bring itself to trust them?
Luke Johnson, on the other hand, explores the collapse of trust that led to the credit crunch in the first place. Most commentators, he notes, blame Wall Street for the crisis – and yet,
…the heart of this wealth destruction is a collapsing subprime property market. And in that dark and catastrophic place, I suspect that there have been more lies told than by all the world’s bankers put together. It is inconceivable that the many thousands of realtors, mortgage brokers, valuers, developers, builders and other members of the great daisy chain were not in on the game.
Moreover, the homeowners themselves were also willing participants. Many lied to get mortgages and paid more for properties than they could afford, thinking they would flip them for a profit – because property only goes up in value, right?
We may be witnessing the greatest financial fraud of all time – on many levels. Western societies have been guilty of living beyond their means, and the reckoning we face is a sobering jolt. As they say: I have seen the enemy, and it is us.
The breakdown of trust in financial services is fraying the basic systems we rely on to conduct our daily lives. If citizens cannot rely upon multinational banks to safeguard their money then our way of life will grind to a halt. So many participants – executives, regulators – appear to have been negligent and some perhaps worse. In this miasma, who is delusional and who is deliberately misleading? Many of the players are themselves the losers: the staff of Lehman Brothers held $10bn worth of their own shares – now worthless.
The biggest victim in the whole shambles is not the foreclosed householder, the sacked investment banker or the devastated shareholder. It is our self-confidence and belief in the institutions that help fund almost everything.
The current collapse of trust in institutions is not new, and has been well documented for a while now. But we’ve rarely seen the effects of that collapse in quite such sharp relief, or in quite so many dimensions, as during the current financial crisis.
by Alex Evans | Oct 1, 2008 | Climate and resource scarcity, Conflict and security, Global system
Oh, so you thought that the torrent of criticism directed at US Congressmen for voting ‘no’ on the bail-out meant that Senators would be more likely to vote yes tonight, and that this would finally bring some reprieve?
Well, Javier Blas at the FT has news for you: the world’s super-rich don’t share your optimism.
Investors in gold are demanding “unprecedented” amounts of bullion bars and coins and moving them into their own vaults as fears about the health of the global financial system deepen. Industry executives and bankers at the London Bullion Market Association annual meeting said the extent of the move into physical gold was unseen and driven by the very rich.
“There is an enormous pick-up in investment demand. I have never seen a market like this in my 33-year career,” said Jeremy Charles, chairman of the LBMA. “The gold refineries cannot produce enough bars.” The move comes as fears grow among investors over the losses at investment vehicles previously considered almost risk-free, such as money funds. Philip Clewes-Garner, associate director of precious metals at HSBC, added that investors were not flying into gold simply because they saw it as a haven amid Wall Street’s woes. “It is a flight into gold because it is a physical asset,” he said.
Well, that’s a vote of confidence, eh readers? They’ve probably been perusing Nouriel Roubini, who reckons (bailout prospects notwithstanding) that “we are now back to the risk of a total systemic financial meltdown”:
The next step of this panic could become the mother of all bank runs, i.e. a run on the trillion dollar plus of the cross border short-term interbank liabilities of the US banking and financial system as foreign banks as starting to worry about the safety of their liquid exposures to US financial institutions; such a silent cross border bank run has already started as foreign banks are worried about the solvency of US banks and are starting to reduce their exposure. And if this run accelerates – as it may now – a total meltdown of the US financial system could occur.
We are thus now in a generalized panic mode and back to the risk of a systemic meltdown of the entire financial system. And US and foreign policy authorities seem to be clueless about what needs to be done next. Maybe they should today start with a coordinated 100 bps reduction in policy rates in all the major economies in the world to show that they are starting to seriously recognize and address this rapidly worsening financial crisis.
Doom, gloom. Still, readers may also like to be aware that in noting the ongoing travails of Morgan Stanley and Goldman Sachs, Nouriel suggests that “the only institution sound enough to swallow Goldman may be HSBC”. Another reason – as though one were needed! – why those of us who bank with HSBC’s lovely First Direct can shake our heads in bewilderment at those of you who choose not to.
Now, if they only offered safe deposit boxes…
by Alex Evans | Sep 23, 2008 | Global system, North America
Via Steve Clemons, this excerpt from a speech by Leo Hindery – an Obama economic adviser and Chair of the New America Foundation’s Smart Globalisation Initiative – which is due to be delivered later today at a conference organised by NAF:
As we all know, the Bush administration is asking Congress to let the government buy $700 billion in troubled mortgages, which would raise the statutory limit on the national debt to $11.3 trillion from $10.6 trillion. This $700 billion is over and above the $85 billion already committed to AIG, the $29 billion related to Bear Stearns, and the very conservative $25 billion associated with the bailouts of Fannie Mae and Freddie Mac.
The solutions being proposed are the most expensive combined bailout in the nation’s history and will sharply curtail the ability of the next president to push for tax cuts or new spending. And yet I believe they are not nearly enough, since they do not adequately cover the exposure associated with leveraged loans and, especially, the credit-default swaps market which has ballooned to a nearly unimaginable $45.5 trillion, from $900 billion in 2001.
This credit-default swaps market, which was developed by financiers who hired the best lobbyists they could to keep regulators away, is essentially nothing more than insurance on debt, but because there are now many more credit-default swaps outstanding than there are bonds for them to cover, it could potentially be a black hole of distress at least as large as the sub-prime mortgage crisis. Tens of trillions of dollars ago these swaps became nothing more than a way to gamble with almost no money down.
Alan Blinder suggested over the weekend that “the root cause of all of [our credit problems] is declining house prices”, and he is correct – but his observation ignores the fact that to this particular root ball were grafted a lot of other financial instruments which have together grown into one heck of a tree.
Senators Kent Conrad, Byron Dorgan and Richard Shelby of Alabama, and others, were more right than wrong when they said last week that more than likely “we’re talking about a trillion dollars.”
by Jules Evans | Mar 11, 2008 | Global system
Dark times in western markets. The financial press at the moment reads like a particularly gloomy prophesy from the Middle Ages. This from Euroweek:
Undreamt of volatility in dollar swap spreads…Debt professionals watched in disbelief as dollar swap spreads shot out to their widest level in years. ‘Now the world is definitely coming to an end, right? It’s been nuts, just nuts’, said a stunned swaps dealer on Thursday in New York.
The surge in levels was so savage that some onlookers suggested it presaged the failure of a major US financial institution…Citigroup has taken a terrible beating through subprime, and its failure, or that of a big bank like it, is whispered as a possibility in the corridors of Wall Street.
The market was also upset by the news from Ambac, the troubled monoline bond insurer. It’s not getting a bailout from the banks after all, but intends to raise $1.5 bn of new capital in the stock market. If Ambac is downgraded, over $1 trillion of securities it has insured face a rating downgrade as well, which could spark a vast bond firesale and consequent losses for banks holding that paper.
Mortgage bonds are screwed too, as are hedge funds who own lots of mortgage bonds, including the Carlyle Group’s hedge fund, Carlyle Capital, which owned several billion dollars’ worth of mortgage bonds, and which now appears to be heading for default. And who is the biggest investor in Carlyle Capital? Citigroup.
Meanwhile, in other markets, things are looking fantastic. The IPO of China Railways managed to attract $68 billion in Chinese retail orders. $68 billion! The Middle East is also completely flush with cash. Russia is embarking on a $1 trillion infrastructure renovation programme.
And these investors are now buying up Wall Street bit by bit – Credit Suisse has sold a big stake in itself to Qatar’s sovereign wealth fund, while Citigroup is being propped up by other big Middle East investors at the moment.
This may not be enough to save it though. Even they think it might go down without US government support. This from Dow Jones last week:
Mideast sovereign wealth funds may fail to save troubled U.S. banking giant Citigroup unless more cash is pumped into the lender, the head of a $13 billion Dubai-owned investment firm said Tuesday.
Sameer Al Ansari, Chief Executive of Dubai International Capital told delegates at a private equity conference that it will take more than the combined efforts of the Abu Dhabi Investment Authority, the Kuwait Investment Authority and Saudi investor Prince Alwaleed bin Talal to save the bank.
“It’s going to take more than that to rescue Citi,” Ansari said. He added that more write downs are expected and that Gulf investors would be required to bolster Citi.
We’re seeing a major shift in the balance of power. Just 15 years ago, western financial institutions like the IMF, the US Treasury and Citigroup called the shots in emerging markets, and emerging market countries had to go to them on their best behaviour, like Oliver Twist saying ‘please sir, could I have some more!’.
Now, as one banker from the beleagured UBS told me today, ‘these developing countries don’t need us anymore’. No, I replied. They don’t need you…they own you.
by Alex Evans | Feb 11, 2008 | Global system
Time to remind ourselves that while we’ve all been cooing over Obama and fretting over NATO cohesion, the small matter of the security of the world’s financial system has continued to smoulder. At dinner with a group of hedge fund analysts last week, it was abundantly clear that just because the issue has disappeared from the front pages for a time doesn’t mean it’s gone away: au contraire, one analyst was bluntly stating that all we’ve seen so far has been no more than the trailer.
Nouriel Roubini, bearish as ever (though let’s remember that he’s been consistently right so far), asks the big question:
Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.
To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.
So to cheer you on your way on a foggy London morning in February, here’s Roubini’s 12-step “‘nightmare’ or ‘catastrophic’ scenario that the Fed and financial officials around the world are now worried about” – which “has a rising and significant probability of occurring”. Here’s the executive summary for those of you too lazy to set up a free subscription to read the whole thing:
1. This is already the worst housing recession in US history; prices will fall 20-30% from their peak. That would imply about 10 million homes in negative equity.
2. Financial system subprime losses are now estimated at $250 to $300 billion; and now spreading to near-prime and prime, through the same lax lending criteria: “this is a generalized mortgage crisis and meltdown, not just a subprime one”. And don’t forget all the off-balance sheet Structured Investment Vehicles etc., and the fact that “because of securitization the securitized toxic waste has been spread from banks to capital markets and their investors in the US and abroad, thus increasing – rather than reducing systemic risk – and making the credit crunch global”.
3. “The recession will lead – as it is already doing – to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans.” All of which makes the credit crunch even more severe – and takes it from large banks through to smaller banks. [Loan companies are already scrambling to tighten up lending criteria in the UK, as the FT set out over the weekend.]
4. “While there is serious uncertainty about the losses that monolines will undertake on their insurance of RMBS, CDO and other toxic ABS products, it is now clear that such losses are much higher than the $10-15 billion rescue package that regulators are trying to patch up.” As a result, their debt rating will probably get downgraded; which will lead to large losses for funds that invested in them, and another sharp drop in US equity markets. [For more background, here’s a story about monolines from last week that made the front page of the FT.]
5. Next, “the commercial real estate loan market will soon enter into a meltdown similar to the subprime one”, thanks to – guess what? – similarly reckless lending criteria. So, “the housing crisis will lead – with a short lag – to a bust in non-residential construction as no one will want to build offices, stores, shopping malls/centers in ghost towns”. [FT last week: outflows from UK commercial property up 76 per cent from third quarter.]
6. It’s entirely possible that a large regional or even national bank will go bust. “The Fed will have to reaffirm the implicit doctrine that some banks are too big to be allowed to fail. But these bank bankruptcies will lead to severe fiscal losses of bank bailout and effective nationalization of the affected institutions.” [Sound familiar?]
7. Bank losses on leveraged loans are already large, and rising – “leading to a freezing up of the CDO market and to growing losses for financial institutions”.
8. “Once a severe recession is underway a massive wave of corporate defaults will take place.” Roubini adds, “in a typical year US corporate default rates are about 3.8% (average for 1971-2007); in 2006 and 2007 this figure was a puny 0.6%. And in a typical US recession such default rates surge above 10%.”
9. The “shadow financial system” – non-bank financial institutions – will shortly get into serious trouble. And unlike proper banks, “these non-bank financial institutions don’t have direct or indirect access to the central bank’s lender of last resort support as they are not depository institutions”.
10. Stock markets in the US and abroad will start pricing in a severe recession rather than just a slowdown. Roubini notes that “in a typical US recession the S&P 500 falls by about 28%”.
11. Liquidity in financial markets will dry up all over again; the easing pf the liquidity crunch after central banks’ massive interventions in December and January will reverse.
12. “A vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction”.
All in all:
A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt. A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress. Monetary and fiscal easing will not be able to prevent a systemic financial meltdown as credit and insolvency problems trump illiquidity problems. The lack of trust in counterparties – driven by the opacity and lack of transparency in financial markets, and uncertainty about the size of the losses and who is holding the toxic waste securities – will add to the impotence of monetary policy and lead to massive hoarding of liquidity that will exacerbates the liquidity and credit crunch…
Can the Fed and other financial officials avoid this nightmare scenario that keeps them awake at night? The answer to this question – to be detailed in a follow-up article [here] – is twofold: first, it is not easy to manage and control such a contagious financial crisis that is more severe and dangerous than any faced by the US in a quarter of a century; second, the extent and severity of this financial crisis will depend on whether the policy response – monetary, fiscal, regulatory, financial and otherwise – is coherent, timely and credible. I will argue – in my next article – that one should be pessimistic about the ability of policy and financial authorities to manage and contain a crisis of this magnitude; thus, one should be prepared for the worst, i.e. a systemic financial crisis.
