Despite the Fed's acrobatics, global financial markets remain severely stressed. This should hardly be surprising, though, because the real issue is the confidence, or lack of it, in the integrity of the balance sheets of large financial players, and while lower interest rates may slow down deterioration to some extent, the regular bolts of bad news have most people believing the crisis still has a long way to go. |
Indeed, even after over $12 billion from the Ay-rabs and the Chinese "" eeeuw, excuse me "" has been pumped in to shore up the biggest names in the business, the overhanging fear is that there is much more red ink to come, as succeeding dominos of the grand ratings-driven shell game of the past several decades begin to wobble. |
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The biggest immediate threat is the possible failure of monoline bond insurers "" arcane companies who lent their proud AAA balance sheets to enable borrowers to reduce their interest costs. Their profits came from fees charged for the service, which were some part of the difference between the cost of borrowing at an, say, AA rating and an AAA rating. These companies were staid, old greybeards "" till a year ago, none of them would have been able to find India on a map "" who made insurance companies look like Dalal Street punters. Well, during the last few head-banging years, the greybeards also got up to dance and "" for completely analytic reasons, of course "" diversified their portfolios, lending their hallowed names to certain structured exotica, all rated AAA, of course. |
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Till some of these what-are-they-called-again started unravelling and stopped paying the greybeards for the privilege of using their balance sheets. And as these payments slowed down "" or stopped "" our venerable bond insurers started suffering ohmygod losses. To the point, where the holier-than-their-own-dirty-feet rating agencies had to downgrade them. Heaven alive. |
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Which meant that the multitude of bonds guaranteed by these heretofore AAA companies "" and held by a wide array of financial players "" suddenly lost value sharply. Now, when investments you are holding on your balance sheet get downgraded, you either sell them, and take a loss, or mark them down to market. In either case, you need more capital to shore up your balance sheet. |
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And now comes the horrifying "" or exciting, depending on how you look at it "" part. So far, only two of these companies have been downgraded, and that, too, only to AA. Quick calculations by various bankers suggest that if all the bond insurers were downgraded to AA, the big banks would need an additional $10 bn of capital; if they were downgraded to junk (certainly a possibility in some cases), the big banks would need around $120 billion of additional capital to stay in business! |
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Which is why all the action right now is focused on a rescue plan being pushed by the US Treasury to get banks to invest up to $15 bn in these companies to prevent a much worse fallout. |
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But it is possible that, even if such a plan were to be implemented (and there are many ifs), it may still not be enough, as there are so many more dominos waiting in the wings "" US money market funds, the corporate debt market, where defaults are rising, and, of course, new hedge fund trades which are playing tranche spreads (buying the higher seniority tranches and shorting the lower ones) again. |
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It seems obvious that more capital infusions will be necessary at the big banks, which is intensifying the schizophrenia in the developed country financial establishment. On the one hand, the US Treasury is clear that it needs to keep the doors open to sovereign wealth funds "" I mean, what choice do they have. On the other, there is growing alarm, both from the US Treasury and a large and loud tribe of hypocritical free marketeers that somehow this spells capitalism going into reverse, that there may be political fallout since sovereigns may not work from purely commercial considerations, and, most remarkably, that these funds may not have the skills and experience to be effective investors and/or managers. |
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Well, I, for one, would rather have the money that the SWFs do than the skills and experience that have landed the bluest of blue chips deep in the doodoo. |
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In any event, it seems quite likely that this crisis could drag on for some time. More importantly, the world will not look the same when things calm down. After all, as the need for capital gets more excruciating, the currently benign investments may begin to become demanding, irrespective of clever investment agreements that have lock-ins, limit voting rights, etc. I mean if a consortium of Arab country funds owns, say, 30 per cent of a large US bank, who's to say how that banks policies would change. |
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As long as oil stays high for another year "" and, inshallah, it will "" it may well turn out that the recent market rumour "" that Citibank is changing its name to Bismillah Bank "" may simply be reflecting the shape of things to come. |
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