Friday, December 21, 2007

Financial constipation: The big "dump" is coming

(Greed & Fear in FT Alphaville) The “gob-smacking provision” of U$500bn of liquidity by the ECB this week is proof, if it were still needed, that a large part of the festering structured excreta lies in Europe, says CLSA’s Christopher Wood, in his weekly client newsletter Greed & Fear.

Sure, he notes, this action will help defer meltdowns in the short term. “But central banks still seem to be acting as if this was a liquidity problem as opposed to a solvency problem. Yet the extension of such a vast amount of money, against doubtless all sorts of dubious collateral, strongly suggests this is a solvency issue.”

The fact is that there is “stuff” out there that people do not want to buy, seemingly at any price, says Wood. That is because “senior management of the banks put the financial world’s equivalent of mad scientists in charge of the casino and allowed them to operate with stupid amounts of borrowed money.”

In Wood’s (rather elegant) view: “This remains then a case of massive financial constipation. The big dump will come one day”.

But it has not happened yet. And when it does occur it is likely to be in the context of lower government bond yields globally. In the meantime, these simmering credit problems are going to discourage healthy new lending, though banks will continue to be forced to increase lending where they are taking securitised problems back on balance sheet; as has been the case with the liquidity guarantees in the asset-backed commercial-paper market.

Meanwhile, the other point to note about the ECB’s action is the almost total lack of disclosure as to why such dramatic financial manoeuvring is necessary, he notes:

In this sense, the more transparent American system is far healthier. Fed chairman Ben Bernanke is actually trying to do the right thing. It is also to his credit, even if it is not to Wall Street’s liking, that he lacks the slippery public relations and political skills of the ultra-cynical and ultra-egoistical Alan Greenspan.

On the subject of Greenspan, Wood comes back to a pet topic. It is “incredible”, he says, “that the world still takes Pinball seriously”:

Yet he continues to be quoted with almost religious fervor, most particularly his ludicrous predictions. Thus, it was in February 2007 that Pinball told investors at the CLSA Japan Forum that ‘the worst is over’ in the US housing market. Greed & Fear’s old friend Marc Faber has noted on more than one occasion that Greenspan was notorious for his bad predictions as a Wall Street consultant in the 1970s. Still, anyone can get market predictions wrong, including Greed & Fear.

What irritates Greed & Fear most about Pinball is the fundamental conflict between his espousal of free-market rhetoric and his activist efforts to prevent markets clearing on the downside; a policy which, in G&F’s view, was driven primarily by the desire to curry political favour. This asymmetrical monetary policy is, unfortunately, going to have dire consequences that will ultimately destroy the Greenspan myth. The first signs are already emerging of a reassessment of the ‘world’s greatest ever central banker’.

Well and truly warmed up now, Wood refers readers to a recommended article in the New York Times this week (’Fed Shrugged as Subprime Crisis Spread’, Dec 18 2007 by Edmund L. Andrews), which details “Greenspan’s activist efforts to stop well-meaning regulatory attempts to curb the obvious predatory lending excesses and wholesale scams being perpetrated in subprime mortgage lending”. Thus, says Wood, “warnings were being sounded within the Fed as early as 2000 by the highly respected and unfortunately now deceased Edward Gramlich, a former Fed governor”.

Finally, among other topics he tackles in his sweeping year-end newsletter, Wood notes that the “jolly old Economist” (his former employer) “seems to have done it yet again”. Its cover story on November 29 on the falling dollar appears to have coincided with the beginning of a countertrend rally in the US currency (”The panic about the dollar”, November 29 2007).

Greed & Fear expects the dollar to continue to rally as evidence mounts of slowing global growth. This should also coincide with growing weakness in commodities led by the industrial commodities. The most obviously vulnerable currencies remain the euro, sterling and the classic commodity currencies such as the Australian dollar and the New Zealand dollar.
Meanwhile, the latest US foreclosure data continues to look ugly in the extreme, he notes, citing a grim rise in mortgage default notices filed against Californian homeowners. Sure, actions from Washington can help at the margin. But Wood’s view is that “partisan politics in a presidential election year will prevent a meaningful federal government response to the housing crisis until after the inauguration of a new president on January 20 2009″.

That means there is more than a year of continuing pain before Hillary Clinton (if you believe Wood’s prediction) can take interventionist action, “be it banning foreclosures or launching aggressive fiscal stimulus most likely in the form of infrastructure spending.”

In other words, strapped US homeowners will have as happy a new year as big bond insurers and beleaguered investment bankers.

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