A meltdown?

How truly does one begin to summarise effectively what has taken place over the past fortnight? I have waited (perhaps to little or no avail) to write the perfect riposte to the financial turbulence and earthquake that we, on main street and the high street have witnessed unfold before our very eyes and yet I’m still really unable to keep up. Let’s just have a clear picture of what’s going on. Financial institutions are failing miserably because they have taken on risky assets (or now what’s called toxic) that have clogged up the system due to illiquidity and counterparty risk. Many have looked to the wholesale money markets for funding and realised that this source has dried up. Turning to the central bank (the lender of last resort) to bail them out of a tight spot has meant failure for some (notably Lehman brothers, Washington Mutual etc) and the cries of ‘the decade of moral hazard has ceased’ resonates loudly amongst grumbling financiers. The fed has sought to tell the world that in order to keep our financial system from collapse, we need $700bn to buy these toxic assets by whatever means (such as reverse auctions), keep them, and resell once their values hopefully increase in the near future. Remove them from banking balance sheets, allow banks to recapitalise / increase further their tier 1 capital and get back to a modicum of confidence we all once knew and loved. Thought of by Hank Paulson, Treasury Secretary and Ben Bernanke , Federal Reserve Chairman, this has been formally endorsed by George Bush and sent forward to congress for approval. However this was initially rejected by angered republicans and democrats and now there is more warning from the president about the inevitability of failure and the crippling effect on many 'millions of ordinary Americans' should the plan (or a variation of it) not be implemented. However, last evening the Senate approved the plan and it now seeks backing from the House of Representatives on Friday 3 Oct 2008. Though it still could be blocked, the senate has made federal insurance for bank deposits more generous to reassure nervous depositors. It will now cover the first $250,000 anyone holds at any bank, up from the previous ceiling of $100,000. The bill also includes $100 billion of assorted tax breaks and handouts. Ireland did something similar yesterday as well, guaranteeing all deposits for a period of two years. But because of the large uncertainty that still surrounds this very critical decision, there has been a rush back to Gold as the commodity of certainty, US LIBOR at its highest at 4.025%, a lower oil price, gloomy economic data from all sides (notably most OECD countries), continued volatile equity markets with the FTSE 100 in London and the S&P 500 Broad index both dropping to their lowest levels since the 1987 crash, the VIX volatility gauge (the fear gauge/or barometer of the things going wrong on wall street) reaching an intraday high of 47 and a much weaker euro and pound. The dollar is however stronger at this point (because of increased pumping of liquidity into the system by central banks and on news of a possible positive outcome regarding the bailout plan, but how it will react to an increased trade deficit remains to be seen). I have left out a lot of detail and names with respect to failed institutions. But we all get the general idea. The financial system is in complete and utter crisis. Who would have been able to forecast the disappearance of that paradigm of Capitalism, the investment bank? Who ever could have believed that such institutions would fail? And it is that we all now wake up wondering who next? But it’s saying that the days of deregulated markets, profligate deals done by derivatives are coming to a sharp close. Witness Sarkozy’s recent remark that “The idea that markets are always right was a mad idea,” Witness too Peer Steinbrück, the German finance minister who stated, ‘America’s laissez-faire ideology, as practised during the subprime crisis, was as simplistic as it was dangerous,’ The taxpayer is being pressed to bail out capitalist ventures with the culprits hoping to sit up high and smile once again. A global monetary regulatory body may indeed be needed, with principles that hold such activities going forward to complete account. Dread as it sounds, should a bank engage in risk seeking ventures then it should be prepared to live or die by it henceforth and not seek a bailout Free markets have created a generation of greed power seeking individuals who now are running to 'mummy' for a cuddle and a lollipop' because they have been naughty and found out.I can’t make a prediction as to what will happen tomorrow, let alone the next fortnight or so but here is a question to contemplate: Isn’t it funny that the largest group to oppose the bill and being conscious of the impact on the tax payer and mainstreet were the republicans? Could we be prompted to think that this ‘no vote’ is in fact strategic to help push the presidential candidates more favourably forward to next month’s election being seen as the ‘human face’ of the crisis and that, ‘hey, we actually do care as we are the new (or renewed) guard of the republican part who will look after you in times of trouble.’The party may have just increased their chances somewhat further. Worth a thought.

The end of the road.

Who would ever have thought it? One hmmm.. two, not possible, three, what is going on? Three investment banks have failed this year because of the credit crunch. First there was Bear Stearns in March, that got help from the fed and JP Morgan and has managed to stay afloat and today we have witnessed the takeover of Merrill Lynch by Bank of America and the bankruptcy of Lehman Brothers, two of the behemoths of Investment Banking. I remember in my postgraduate class, all 30 of us wanted to be part of the top four as they were the most hotly sought after institutions many graduates wanted to join, that career in the city, the one that would either break or make you especially if you were to work in corporate finance or trading with the long hours, the arrogance, the inflated bonuses and of course, the legendary status attached to being an employee of this hallowed circle. The big four (Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers) always drove fear into me and as much as I wanted to be part of it, in the back of my mind, I just never really felt ready to join. It didn't stop me from having interviews however. I did have with Salmon Smith Barney (part of Citigroup) and Bear Stearns but they weren't to be. With hindsight, it was probably a good thing.

Lehman Brothers is now bankrupt and a lot of it has been to do with the large exposure of its assets to the credit crunch which commenced last year in the US housing market. Many are worried of possible contagion within the sector as a result of this collapse and take over (of Merrill) and a lot too has been said about the end of moral hazard, which means that the days of big banks, who find themselves in high counter party and systemic risk and being able to call on the fed to bail them out of trouble are effectively over. All eyes are now on Morgan Stanley and Goldman Sachs to see if they will withstand the tsunami in global financial markets. Needless to say, that as a result of this news (and not forgetting the worlds largest insurer AIG going to the fed for $40bn to help prop up its balance sheet and prevent credit downgrades), all major bourses are down with the exception of Asia (whose stock markets were closed today due to a public holiday), Bond yields are higher, the dollar is weaker because of the lack of confidence in the financial system, and commodities (seen to have been coming down in price because of a stronger dollar in the past month or so) have risen, albeit slowly.

However, I think that Goldman Sachs is likely to remain strong. Why? Because, Hank Paulson the US treasury secretary, learned his craft there and may be far too 'connected' to see its collapse and it seems to have been very smart in perhaps reducing its exposure almost immediately to the sub-prime crisis, unlike the CEO of Lehman who was always holding out for a better price or option despite the cracks and the warning signs.

What it is saying however is that irrational exuberance has surely come to the fore and Das Kapital may just have to be adjusted to include: ' What happens when profligate lifestyles vanish?'

A dollar revival?

In July, I was in New York for a week and had the distinct pleasure of a healthy forex rate to make my purchases. Then, the pound was $1.9894 per USD. Even with that, I bought nothing. I suppose my inherent disdain for 'filling up my suitcase' with things from Macy's (its the first all American store I could think of) was all too apparent and so, I abstained. But now if I were to go, I would regret not having done that. Why? Because now the pound is at a 10.8% low of $1.7631, the lowest its been in 2 years and those well intentioned Levi jeans suddenly have disappeared of my radar because quite simply, I can't afford them. A similar story has ensued for the euro. On the 25 July, it was $1.5703 and today it is at a 9.5% low at $1.4216.

The cause behind the acute strength in the dollar points to the sudden turn in fortune for the revival of the US economy and the consequent slump in the eurozone. Demand for crude from the US has declined as the latest inventory data released by the government show that stockpiles have surpassed expectation and that more and more people are putting off the purchase of SUVs and the very popular driving season showed a sharp decline this year. All this has in turn helped in crude's current low(er) price of $107.7 per barrel (compared to what it was in July 08, circa $148 per barrel). And with the staunch defence of the US financial system by the fed, not least the support of those mortgage behemoths, Fannie Mae and Freddie Mac, this has helped stimulate the dollar rally, which has in turn caused the current positive numbers on all Bloomberg machines with regard to most global bourses.

But is this really the beginning of the revival of the dollar, so out of favour for so many investors for so long and suddenly upon its bounce, eager market participants are now looking forward to getting into it as much as possible? In April 2008, I wrote a piece (in Business Money magazine) that suggested dollar strength is likely to regain momentum towards the middle of the last quarter straight into the first quarter of 2009 based on better economic news emanating from the US, the onset of a possible democrat victory in November as well as the fact that the financial sector would have priced in most losses of the credit crisis in respective balance sheets resulting in a 'bottoming out' of bad news, which in turn would lead to upside potential of the dollar. I even said crude is likely to be at around the $160+ level by year end. Oh well, 1 out of 4 cant be that bad can it?

I think I'm going to stick with my stance that we are likely to see continued dollar strength for the next 3-6 months until something more exciting comes along (economic revival in 6 months in the eurozone perhaps). A Market correction here it isn't. I think that the worst of the news within the States has been preached at, understood and met by the followers of economic theory and thought, and of course by us the every day people (well, more so those who live there). So we can perhaps expect happier Christmas shoppers in the US and well, forlorn ones here. As for me, my visit to the land of the free and the home of the brave has been placed on hold for the foreseeable future and my suitcase remains free from Macy's paraphernalia or anything else for that matter. Sign of the times, I say.

Russia's moment of truth

Russia's military action in Georgia has propelled it to centre stage. The Kremlin refuses to bow to US hegemony and as such, continues to seek to re-assert itself as a new and more economic and politically astute superpower. The rest of Europe has made token gestures towards chastisement but to no avail. A few slaps on the wrist is all that it has managed to serve on this rather stubborn nation. The so called threats of political alienation, divestment is all rather meaningless simply because Russia has nothing to lose. Oil and energy as foreign policy tools for the Putin and now the Medvedev administration have been used to place it in a position of control. Moscow has not liked the Western support of a country that has sought to join NATO as well as attacking ethnic Russians in the Caucasus and as such, by giving recognition of independence to South Ossetia and Abkhazia, it continues to show that it will not tolerate bully tactics from anyone. Having further stirred the ire of the West by stating Mikheil Saakashvili is a political 'corpse', Russia now has set itself the dubious task of perhaps placing their preferred candidate to be in charge of Georgia. This should not be. Georgia's important pipeline and strategic transatlantic and European alliances put it is a position of strength to become a political heavyweight that may in the future seek to resolve its differences with Moscow and help contribute further to even stronger economic growth as a total whole. While Russia does not necessarily need Georgia's economy to springboard itself into iconic prestige, if differences are put aside and there is a common goal of sharing of resources, the region stands to become an even more respected global player as opposed to one that has been created under the auspices of suspicion and greed. The negotiations scheduled for the months ahead should be aiming at multilateral exercise, but with Russia's stubborn 'personality' and the need to 'protect' its citizens in the aforementioned regions (and now possibly in the Crimea region), Europe and other allies will have to realise that fiery rhetoric (particularly from Britain and other eastern European countries) and diatribe soothe not the angry beast but push him further away, to likely isolation but still managing to maintain control of his purpose and direction. Moscow's moment of truth does indeed move closer.

What about BRIC economies?

It is quite interesting to note too how the decoupling theory with respect to the BRICS (referring to the ability of these emerging market economies - Brazil, Russia, India and China- to be independent of developed market activities in terms of growth) of earlier months has been almost obliterated as a result of weaker performances from their respective bourses. What remains in store for them for the rest of the year is anybody’s guess because perhaps, like the dot com phenomenon of 1999-2000, the bubble has burst and the euphoria has gone as it is clear that there is a strong link to developed economies. This is not to say that they are or can be deemed failures (Brazil has managed to contain inflation to single digits, China continues to invest at amazing rates everywhere and still has perhaps the largest currency reserve in the world at a $1 trillion dollars), but it is clear that they have been affected and this could be perhaps due to the fact that key importers have been unable to pay for goods and services in sums as in previous times having had to now finance domestic current account deficits, which would then have a knock on effect on their economies. The cost of capital to 'play' in risky assets in these economies is no longer as low as before and flight of investment capital has become evident as corporate valutions are no longer at discount rates and such markets have fallen sharply with India's Sensex 30 fallen circa 45% in the last few months. It is thus that market hype and overreaction surely continues to confound even the most astute of financial minds.

August Market Outlook

These are concluding remarks to a much larger article (available upon request)



Going into September 2008, it is perhaps safe to conclude that unless there is a significant turnaround and sharp lowering of food and energy prices, marked inprovement in the housing market and major relief for financials from governments and central banks, it is likely that the trend is quite certain to continue towards the end of the year and perhaps even into the first quarter of 2009 (as forecast in the April 2008 edition of Business Money). In other words, there is likely to be a conitnuation of extreme caution in terms of optimism, due to the incessant volatility and undertainty of the current economic environment. Inflationary pressures within the OECD and beyond are likely to continue to push upward and the real possibilty of stagflation deos exist, particulalry in the UK, where the economy has seen zero growth and has contracted for the past two quarters. This is perhaps going to give way to a sharp recession, something last felt here in the early 1990s. UK plc, thus has to really hope for the best going forward.