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In normal times, news like the
breach of Liechtenstein’s
banking secrecy to expose tax fraud at high level in Germany, and the nationalisation of a major bank
in the UK would receive more attention in
our Weekly. However, the ever widening wave of damage to financial markets from
the US sub-prime market is really where
we think it best to focus our readers’ attention. Two really big issues stand
out this week: geographic widening of the crisis and monoline insurers.
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Take the first. For about one week
Crédit Suisse was able to bask in the glory of having been so much wiser than
UBS in limiting sub-prime damage. That glory has now evaporated, along with the
CHF 3.1 billion of new announced sub-prime write-downs. Every major European
country has its crisis-hit bank, but did both the major universal Swiss banks
have to combine their forces to tarnish the reputation of the entire Swiss
banking industry? In France, Crédit Agricole is also
moving towards announcing sub-prime write-offs, setting a new French record. It
is becoming apparent that up to half of the (so far) expected total losses from
sub-prime of USD 400 billion is occurring outside the USA, and most of that half is in Europe. What an opportunity for cash-heavy Asian and
Mideast investment funds to buy their way into
Western banks! |
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The supposed USD 400 billion may or
may not be the maximum loss exposure to sub-prime problems, but that number
covers only the CDOs and SIVs directly vulnerable to mortgages turning sour. The
second big issue, the monoline debacle, is slowly working its way towards making
its contribution, too – probably of a similar order of magnitude.
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Last week we considered how the
Buffett proposal to take over municipal bond insurance and leave the monolines
to sink under the weight of CDOs and corporate bonds would hasten the
downgrading of the existing bond insurers. Now at least three of the monolines
(MBIA, Ambac and FGIC) are seeking to split their businesses into two legal
entities: one for municipals, one for corporates. It certainly looks as if our
supposition that the municipal bond market is to be defended and the corporate
market allowed to go hang is proving correct. It is scarcely surprising that
spreads on corporates are rising. The first impact will be increased default in
corporate bonds and the inability of the bond insurers to honour their contract.
In turn that will put the monolines into Chapter 11.
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It will not stop there. The loss of
insurance cover will reduce the rating of a myriad of corporate bonds to their
“true” and much lower level. The reduction in their value will reflect not just
their lower rating, but also the forced selling by many holders who are obliged
to sell their bonds if their rating falls.
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It sounds like a blood bath, and we
have deliberately written in the future tense (as distinct from the conditional)
because it seems more likely than not. A mere fortnight ago we thought this
scenario unrealistic as the US authorities could not allow such a
disaster to occur. Now the evidence is mounting that the authorities’ policy is
indeed to let it happen and to move towards damage limitation. They are also
slowing the unrolling of events by encouraging the rating agencies to start at
the bottom, i.e., with the smaller bond insurers, and to downgrade bit by bit,
leaving the two biggest monolines, MBIA and Ambac, till last. There may be some
hope left of finding a solution by capital infusion from abroad, but could
anyone wish to take on this large but unknown exposure even at a USD 1 symbolic
purchase price? |
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In addition to these two major
themes, the spread of the credit crunch is leading to severe tightening of
lending conditions to small companies, students, and households. The effect is
slow to show up in household consumption, but it is just a matter of time.
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A further indignity for some banks
is that hedge funds, regarded as banks’ most unstable clients, are calling banks
to account and questioning the credit worthiness of their prime brokers. Some
funds are removing assets from banks who have reported massive sub-prime losses
lest the banks start to blow up and take hedge funds with them.
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Focus
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(–) China :
inflation is at 7.1% per annum, the highest level since September 1996
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(!) Brazil: with a total of USD 128.8 billion,
Brazil has become the 4th largest
holder of US T-Bonds |
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(+) Mexico : foreign
investments reached USD 23.2 billion in 2007, the highest since 2001
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(–) South Africa :
coal prices have risen to USD 115 per tonne under the need of the generating
company Eskom’s requirement to increase by 50% its coal consumption of 90
million tonnes per annum |
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(–) Corporate bonds : GE’s spread,
especially for GECC, has widened to some 80 bps over swaps. This may reflect the
banking activities of this major industrial company
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(!) Wheat: price has almost doubled
to almost USD 20/bushel over the last 50 days.
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(–) Bank borrowing: in the
USA the “Term Auction Facility” is
allowing banks to borrow quietly against many types of (possibly poor)
collateral, whereas European banks are struggling in traditional wholesale money
markets |
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(+) positive
for bonds (–) negative for bonds (!) watch out (?) begs a question
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A verse from a poem by Housman
matches nicely the mood of the cautious investor today. He wrote this at 63
years of age at the end of the 19th century:
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The thoughts of
others were light and fleeting, |
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Of lovers'
meeting or luck or fame. |
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Mine were of
trouble, and mine were steady, |
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So I was ready
when trouble came. |
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