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Last week we had to resist being carried away by what we judged as excessive optimism that the credit crisis was nearly over, when, as we explained last week, what was really happening was a reaction to confidence that central banks would rescue any bank in trouble. This week the situation is more subtle. The euphoria is over, but there is no collapse in credit or equity markets. Instead, a sombre mood reigns, in which most investors must be saying “the crisis could be on the way to a resolution, or this could be a gigantic bear trap”. We would tend towards the latter view. |
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The moves by Citibank to clear the books of leveraged loans and establish a market price by selling back the loans to private equity funds deserves moderate applause, as does the recapitalisation of banks like Washington Mutual. Of course, it may wondered whether Citi is taking a responsible strategic view or seeking to unload assets quickly to shore up its capital base. Such ostensibly sensible moves must however be set against the IMF’s assessment of the cost of the crisis at USD 1 trillion, Bernanke’s admission (without actually using the word) that the USA is in recession, and the realisation that Asian and Australasian banks are also in trouble from sub-prime and its consequences. |
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In Focus we mention that approaching 10% of the US population benefit from the “Food Stamp” social programme. That was headline news in “The Independent” on 1st April. We feared it was an April Fool’s joke, but no. This is in a country, allegedly the richest in the world, but with a skewed distribution of income comparable to Africa’s! |
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It is highly unlikely that problems as severe as those created by deficit financing, the housing bubbles, and excessive leverage will be resolved in “a couple of quarters” as suggested by Mack of MSI. The best that can be hoped for is that the situation be given the time and conditions for an orderly resolution. In that regard there is room for moderate optimism. The recent ‘clarification’ from the SEC on fair value reporting should give banks the time (but it may take years) to rebuild their capital bases. The guidance stated that fair value should be used ‘in orderly transactions...unless those (market) prices are the result of a forced liquidation or distressed sale’. As John Mauldin points out in his weekly, in today’s market conditions, virtually any debt price could be classified as a forced liquidation or sale. There is also the issue of moral hazard by central bankers (i.e. the implication that bank paper is safe because failing banks will always be rescued). All of this is disconcerting from a moral and transparency perspective, but may be one of the prices to pay for orderly rebalancing. |
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Some key requirements for resolution are already well advanced: |
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- The fall in the USD makes US exporters competitive and lowers the USA’s ability to over-consume
- The revelation of bank losses is (it is to be hoped anyway) well advanced, if not yet over (but a period of earnings disappointments is probable, which will depress stock markets for a long time to come)
- Deleveraging at company balance sheet level is advancing as new capital is being raised more by equity than debt
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Lest readers believe that we have taken leave of our senses, we must remind them of inflation, that is the result the USA is paying for its cheap money rescue policy and devalued dollar. While the rising prices of food and fuel irritate consumers in the developed countries, they are causing riots in the developing world. If the current rebalancing remains orderly, central banks – even the Fed – will have to concentrate more on bringing inflation back under control. (It might help if it were measured properly, too!) Thus recessionary and slow growth conditions are here to stay, for years not just a few quarters, and a trend to higher interest rates is not far away. |
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As we suggested a fortnight ago, the world is entering a new era. The rise of Asia, the fall in the USD, and the existence of an alternative reserve currency in the EUR, all make a return to the status quo impossible. There is a cost when a reserve currency is weakened and finally loses its status – witness the decline of the UK until the Sterling balances were finally eliminated. |
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Focus |
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(–) USA: rising unemployment; some 80,000 non-agricultural jobs lost each month so far in 2008. The Food Stamp Program now covers approximately 28 million Americans, the greatest number since the programme was introduced in 1960. 13% of Americans are reckoned to live in poverty, the highest proportion in the developed world |
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(–) Switzerland: inflation is at 2.6%, the highest in 15 years |
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(+) Financial paper: spreads have narrowed; the market may be covering shorts |
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(+) Russia: big increase in the trade surplus from USD 22.5 billion to 35.8 billion in the first two months of 2008 versus one year ago |
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(–) Baltic States: inflation in Latvia rose slightly in March to reach 16.8% and in Lithuania 11.3%, the highest level since January 1997 |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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