Judging by the comments, it seems many of you share my interest in understanding the recent economic news, at least Juha does. So I will continue covering that.
Yesterday, my brother Carlos, who works for BNP in Europe sent me this story: Apparently we are seeing a dumping of US related assets by what is speculated to be... the Chinese..
Forget the computer attacks, Asia's sovereign funds dumping US assets would have a real impact on the economy.
Credit and liquidity crises are not new and, when they turn bad, they turn bad. In 1929, the liquidity scare sparked a bank run. Banks didn't have enough cash and were defaulting, accelerating the mad dash and "bank-run" to get your money out while there was still liquidity. Then, the real economy wound up with no credit, and we all know the sad story from there.
2007 isn't like 1929. It isn't an "end-consumer" bank run. You and I are not going to the corner bank to take our savings out. Our confidence in the markets isn't shaken to that core. People are not freaking out yet. Even the equity markets have recaptured most of their summer losses. However, it would be a mistake to discount the close relationship between the equity and debt markets.
And, right now, the confidence in the credit markets seems seriously shaken. Already heads are rolling at credit rating agencies. Banks in Germany are defaulting. The heads are calling for "transparency in accounting" and "pricing balance sheets to market," per yesterday's FT. Meanwhile, the constipated credit markets are still not pricing. In other words, no one knows what the damage is and, more alarmingly, no one wants to know what the damage is.
So the subprime mess has gone nuclear, Chernobyl style, with fallout still to be determined. Meanwhile, the good, if edgy, mood prevails. Hedge funds are raising money, shrugging off their losses and appealing to our greed by saying: "Look, blood on the streets! Don't you want some?" The Quants' models are being re-tooled with a technological zeal that must dwarf the human genome project. Until the new math predictions come out, old skool is back in on the street. Experience is in vogue and experience with a math background says you are sexy. Period.
To be fair, reasons to remain optimistic include small data points such as global growth (+95% in a Chinese index for the year!)and the fact no one wants to see America Inc. default, not the EU, not Asia and certainly not the US of A.
But what are the police doing? The Fed is engaged in a game of "chicken" with Wall Street. The debate is raging over what the proper role for the Fed should be. From a distance, it looks something like:
The Feds: "We won't bail you out"
The Street: "Oh yes you will"
The Feds: "Oh no we won't, wink-wink,"
...effectively setting the futures market bet on "The Fed will cut interest rates."
But many are not so convinced. The Fed's main tool is interest rates, which is a rather blunt tool and many people point out that there is a limit to what monetary policy can achieve in this particular crisis.
Short of buying the debt and effectively setting a clearance price, the Fed is not helping the markets set a price for many of the debt assets sitting on balance sheets. Worse, as mentioned above, many market participants are actively avoiding price discovery for fear of establishing a market price that would be to their disadvantage. Meanwhile the Chinese are dumping assets? Are they the first ones to say "Gimme my money?"
Will Wall Street pay the price? Well, part of it, as balance sheets of the financial players lose their value due to a market repricing of the paper...if and when it happens.
Many point the fingers to Wall Street and argue that Wall Street's greed is the culprit for the subprime mess: burn them and their fancypants mechanisms for repackaging debt! But, frankly, aside from those who originate the loans, Wall Street was just spreading the risk not adding to it. They were a vehicle of risk, not a source. Arguing whether they add to stability or instability by spreading the risk is an academic discussion. There is, however, a certain Robin Hood morality to this mess by having the Hedgies funding the 'hoods.
But really, all of America participated in the debt binge. Cash-out refinancing of houses turns out to be half of what is considered subprime debt, I read somewhere. If that is the case, that right there is a straight link to the economic jugular and a path for the crisis to spread over the next 18 mos. Mainstream America will stop treating its real-estate as an ATM. It is a good thing, but one that may impact growth of end-consumption.
Many on Wall Street point out that the aftermath of the US debt binge was quietly supported by the political ambition of "Ownership America". Much like Communist Russia, it is an ideological place where everyone owns a house. So, fingers point back at the Fed, at Greenspan, and, gasp, at the complacent and slightly goofy administration in Washington. If the damage was politically underwritten, then it is fair that the bill fall back on the lap of the US tax payers. The morality here is that the ideology had economic consequences that now have to be paid for.
Hmmmh, I wonder what the future holds,