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A month ago we described the Fed's dilemma in that it has simultaneously to fight inflation and seek to rekindle a faltering economy. This week's 25 bps cut in the Fed rate showed how a compromise to steer between the two objectives satisfies no one. Inflation is not being checked, and the economy will not be rekindled by somewhat cheaper money (which even the stock markets recognised!). |
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Having to cut even by 25 bps must have left Bernanke very dissatisfied too, and feeling the victim of his predecessor's policies. However, political and market pressures to save the stock markets and the financial system are hard for Fed members to ignore, especially when the foolhardy actions of mortgage lenders, banks and rating agencies in proposing a silk purse made from a sow's ear (= an AAA investment built on mortgages unlikely to be repaid) will likely come to a head around the time of next year's Presidential election. We believe Bernanke to know in his heart of hearts that a slow down in the US economy due to a cut back in consumer borrowing and spending is desirable in the long run, though painful in the short. Eventually he will accept this, at least tacitly; if he does not, he will have it forced upon him by foreign holders of USD. |
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In fact, foreigners are coming to the rescue now via their equity participations in banks exposed to the sub-prime crisis, such banks being not only American of course. For example, UBS obtained investments from the Singapore Sovereign Wealth Fund, managing to delay announcing the latest write-down until the new funds had been secured. Nevertheless, it is mainly the USA that is now selling off its assets on the cheap in a vain attempt to bail out a financial crisis of yet unrevealed but enormous proportions. We suspect a few more "foreign saviours" will be needed. |
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"SIVs are being reorganised", we read, "that will reduce the need for the fire sale of assets". "Of course", we reply, "but reorganisation is just another way of saying that the SIVs are being brought back onto the banks' balance sheets, and that means fewer funds available for lending". The credit squeeze is continuing. Eventually consumer spending will be curtailed (there are now signs of that). GDP growth will slow and probably turn negative, and stock markets are likely to fall as householders liquidate assets to stay afloat, since they can no longer rely on remortgaging. It may seem perverse, but all these things will be for the long-term good of the USA and the world as whole, as rebalancing is so necessary. By maintaining their current overspending the USA can only delay the correction and make the pain greater. |
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How distasteful it is to read of the rating agencies pushing the banks to reorganise their SIVs by threatening to downgrade these off-balance sheets entities when they themselves are responsible for giving a triple A rating to "sow's ears". Whilst banks and mortgage lenders may have come up with the ideas, the agencies' names are attached to the rating of these products and vehicles. How strange that they duck accountability by exercising “freedom speech”. Every one else directly associated with financial markets is accountable! |
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The policy of central banks, led by the Fed, in accepting inflation as a price to pay for avoiding a recession implies that investors are going to have to live with inflation. That conclusion is still ahead of market awareness, which will show up when long-term yields begin to climb. That may yet be a few weeks away, which is why we have not yet shortened our recommended maturities. We may well have to soon, and indeed many of our clients are already in cash or very short maturities. Last week we saw inflation-linked bonds as an important part of the defence against dollar inflation; our sense this week is that they also have a role in other currencies, albeit a lesser one. |
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How intriguing it is to read of San Francisco lawyer, Sean Olender, insisting that the sale of highly rated CDOs was fraudulent because of the high probability of sub-prime borrowers not being able to keep up their mortgage repayments (plus of course the misleading AAA rating). (We are just astonished that the legal profession was so slow to jump on that horse.) He points out that the fraudulent sale of a security means the underwriter must buy it back at par. He also asks how a leading bank was able both to take steps to protect itself against the forthcoming sub-prime crisis and also to continue underwriting the very securities they thought so dangerous all at the same time. Too bad that the crisis will probably be over by the time the courts hear the cases, let alone rule on them. We may expect the "Chinese wall" defence. |
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Focus |
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(+) USA: George Bush has presented a plan to assist house buyers unable to reimburse their sub-prime mortgages |
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(–) Europe: Sarasin Bank believes the consensus in Europe on the economy is too optimistic, and that the knock-on effect of US problems will be severe |
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(–) USA: some commentators can see nationalisation of Fannie Mae and Freddie Mac coming if their situation worsens further (already losses estimated between USD 10 and 14 billion each) |
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(+) Kazakhstan: recent excessive growth has at least provided Kazakh banks with sufficient reserves to weather the current problems |
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(–) China: consumer price inflation reached 6.9% per annum in November, the highest rate in eleven years |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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