Rudi's View | Apr 17 2008
(This story was sent out as an email to paying subscribers on Monday)
By Rudi Filapek-Vandyck, editor FNArena
Hope is an investor’s worst enemy during a bear market. The saying might prove to be as accurate as ever with market commentators and financial experts expressing their views the crisis in the global banking sector should soon be dealt with. Indications are, however, such a positive view might well turn out a little too rosy too early.
The name Jacques Attali does not immediately ring a bell in Australia and New Zealand, but in Europe, especially in the non-Anglo countries, the name is treated as a synonym for economic intelligence. The soon to be 65 year old Attali is probably best known as one of the founders, and first president, of the London-based European Bank for Reconstruction and Development (EBRD).
Throughout the troubled eighties Attali was top advisor to French president Francois Mitterand. More recently, newly elected president Nicolas Sarkozy appointed him as head of a commission that will look into reform necessary to make the French economy competitive.
Attali is a prolific writer on many historic, economic and socio-political matters. Many of these articles can be found on his personal website, Attali.com. Unfortunately, for most readers of my Weekly Insights, they are all in French.
However, there is one story Attali wrote recently in English. For some reason it is not available on his website. (For a link to the full story – see at the bottom of this analysis.) In this story, entitled “Imagining the worst-case scenario”, Attali describes a near-term future that sees the global financial system going through another phase of virtual meltdown, necessitating desperate actions by authorities and governments, pushing the US economy, and the rest of the world, into a deep malaise. At the end of this (fictitious) analysis the newly elected US president seeks to calm financial markets, which have taken another set of batterings by then, and announces a New Planetary Deal; “The idea is for the most powerful countries -China, Russia and other oil-producing countries- to finance major infrastructure projects in the developing world and for American companies to build them. Because of this program, global growth increases in less than two years.”
It would be easy to dismiss Attali’s frivolous analysis as nothing but just that, but I have a suspicion he is sending a message. This suspicion is fueled, among other things, by the fact that his story starts “in late April 2008, at a meeting of the Interim Committee of the International Monetary Fund in Washington”, when according to Attali, “all of the world’s financial and banking executives seem reassured”. Of course, it doesn’t take long before reality hits home, ultimately leading to the outcome as described above.
So is this the message? Will reality soon prove investors and authorities are still too optimistic in their assessments about the intensity, the duration and the possible solutions to the global credit and debt crisis? I think the answer to this question is “yes”.
The intelligent and insightful Attali is likely to have put enough clues in his writing to point out where he thinks the next problem is situated. Not surprisingly he specifically mentions Credit Default Swaps (CDS), a financial product originally designed to transfer risk on corporate debt so that, for example, the buyer of a credit swap will be entitled to the par value of a bond should the bond default in its coupon payments. To take on such risk, the buyer receives a reward. As one would have expected, these products have attracted many types of speculators and investors over the past years. And similar to that other disaster product, Collaterised Debt Obligation (CDO), the market for CDS contracts has yet to be tested for severe economic duress.
In theory, the buying and selling of these “swaps” is a neutral or zero-sum game. What one party buys, another one sold at the same time: no problem. And that has been the official line of authorities thus far. But such an assessment requires a logical and orderly, one could even say a fully balanced and structured approach to the market by all participants. In other words: nobody has taken on any extra risks or has possibly sought other ways to potentially achieve extra profits.
I feel like I only have to enter “normal human behaviour” in the mix to completely dismiss this theory. And I am not the only one. A growing number of market experts is starting to zoom in on the matter, and they seem worried. Just like Attali.
The International Monetary Fund (IMF) released its so-called Global Financial Stability Report last week in which it estimated total losses from the global credit deterioration could well reach as high as nearly US$1 trillion. Specifically, the report states “we estimate total losses from broad credit market deterioration of [US]$945 billion globally, $565 billion of which is due to losses on residential mortgage debt, $240 billion on commercial real estate debt, $120 billion on corporate debt, and $20 billion on consumer credit debt. Securitized debt (rather than whole loans) accounts for the bulk of losses.”
Of course, these estimates come with a lot of caveats and guesswork. So far total reported write-downs and losses by global banks are above US$200bn, leading to suggestions from some commentators that banks might be halfway through the process of weeding out the excesses of the past years. To be fair, the IMF calculations have a wider scope than just banks, but they nevertheless suggest we shouldn’t start dreaming yet of having approached the end of the banking sector’s misery.
Tough times for global banks are likely to persist simply because as economic growth is slowing rapidly, the amount of corporate defaults will rise too. This process is magnified during a recession. Watch what happens when companies start defaulting in larger numbers and banks and other investors are left holding the credit default “insurance”. Equity strategists at Credit Suisse had a look into this recently and their conclusion was unequivocal: trouble ahead. Where the IMF forecasts a rather modest loss of US$240bn (modest against the $565bn of residential mortgages), Credit Suisse believes the total fall-out could be much, much larger than that.
The report titled “Financial weapon of mass destruction?” concludes “system-wide losses could be anywhere in between $US100-900 billion” and “corporate debt crisis is likely the next phase of the credit market bubble demise, in our view and it threatens to be just as serious in terms of both magnitude and uncertainty”.
I have a strong suspicion this is exactly the message Attali and the IMF are trying to get across: this crisis has much further to go still. Maybe the fact that Attali suggests a solution will be worked out via coordinated, global action “in less than two years” might prove to be a more accurate assessment (compared with those who believe the crisis is about to end).
In an interview with French newspaper La Tribune, Attali said he thought the global credit crisis would prove to be “short-lived”, but just to make sure we understand what he means by that he explained “the global wave of growth is enormous. I am not pessimistic. The worst that could happen is a two-year recession”.
The message, if I am correct, seems clear: the end of the world is not about to happen. But neither is the end of this crisis.
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* To read Attali’s “Imagining the worst-case scenario” in full, copy the following address in your browser:
http://www.arabtimesonline.com/client/pagesdetails.asp?nid=15116&ccid=11