John Dizard in “Disquiet on the western front of the credit world,” discusses the politics of the credit crisis, depicting two opposed absolutist camps: those who’d have everyone take their lumps now, no matter how bad they turn out to be, versus those who think preventing a nasty recession is all-important, even if it means terminally trashing the dollar.
The article give a lively account of how this dynamic might play itself out, but makes an observation in passing toward the end that is more significant than what went before.
Dizard believes (and he’d pretty well plugged in) that financial firms will be unable to raise more money from sovereign wealth funds. The rest of their dough will have to come from domestic sources.
We noted nearly a month ago that sovereign wealth funds were quietly rebuffing requests for more funding, but we had taken that to be in part a negotiating ploy. After all, the banks rescuers are sitting on losses. Even the investments that weren’t straight stock purchases are worth less due to the fall in equity prices and rise in credit spreads over the last quarter. Investors would presumably demand much tougher terms and try to build in downside protection.
But SWF are not all that risk oriented and they don’t have a history of being hardball negotiators. So Dizard may well be right, that they’ve decided that this game is not for them. Not that it is quite as black and white as Dizard suggests. Qatar has made noises that it might be willing to make another investment in Credit Suisse, but so far, it also appears to be one of the least damaged major firms.
And if Dizard is correct, this has some serious implications for US firms. Virtually all the money for the last go-round of bank and investment bank capital came from abroad. While the equity markets are bizarrely sanguine relative to debt markets, this isn’t a good time to raise equity if you are a financial player. Even in robust times, private equity firms aren’t interested in bank equity (buying the occasional specialized financial operation is a different matter), and it’s unclear how much appetite the unwashed retail public will have for multiple, competiting offerings when the industry is hemorrhaging losses.
Now perhaps the optimists will prove correct and the credit crisis will be on the wane in six months. That would completely change the appetite for investment in financial firms. But if we still have firms taking losses with no clear picture as to where or when the bottom might be, any new funding will be costly indeed.
From the Financial Times:
The credit world is aligning itself into political factions, divided over the right approach to untangling the present mess. On one side are the trader-fundamentalists, with one hand on the Bloomberg keyboard, the other hand on a dog-eared copy of Atlas Shrugged . They believe in the literal interpretation of scripture, which in this case means that an asset is only worth what the bid side says it is. As far as they are concerned, the only way to deal with the excesses of the credit markets is to take the write-offs and start over, having accepted the revealed truth of what bankruptcy sale buyers are willing to pay.
Opposed to them are the would-be managers of systemic risk. They believe that the aggressive application of the mark-to-market rule would result in another Great Depression, only bigger. Their Qum is Washington DC, where the differences between the Republicans and the Democrats are small relative to their agreement that a deep recession, let alone a depression, must be avoided at all costs. One of those costs could be years of stagnation and low growth. You could call them Keynesians, except that Keynes was strongly opposed to currency debasement. As far as this group is concerned, currency debasement to the point of depravity is a good starting point. (Strangely, they still publicly proclaim adherence to a “strong dollar policy”, even at $1.50 to the euro. What would a “weak dollar policy” be?)
However, the anti-fundamentalists are not just a Washington group. They also have strong representation at the top of the major dealers and banks. While the dealers’ and banks’ trading desks are mostly populated by fundamentalists, management people and board members on the upper floors realise that any thorough “liquidation” would include them.
This political fight is most evident in the US. That’s because the US markets and institutions are further along in recognising the extent of the problems, on balance sheets and in business practices, that built up in the past decade. Up to now, European finance has appeared to be a happier place than its counterpart across the Atlantic. However, both the credit trading fundamentalists in New York and the systemic risk managers in Washington have done their own analyses of European balance sheets, and agree that it’s a matter of time until the storm moves to the east.
As one credit strategist for a major New York dealer says, “I was over doing client calls in Europe last week, and they told me that they believed the US financial system will recover faster because the loss recognition is swifter.” A mark-to-market fundamentalist, he believes that it follows that “Any move to retard loss recognition is, categorically, a mistake.” At the end of the day, the liquidations would win the argument on the integrity of their market economics, while the systemic risk managers, aka Keynesians, would have the politics right. Being politicians at heart, however, the systemic risk managers are going to try to split the difference. That is to say the regulators will try to have as much recognition of losses as possible without any contraction of credit availability for the real economy.
That means that while the central bank people and regulators may be willing to have “flexibility” in the mark-to-market accounting of structured credit product on the books of the financial sector, what they want is to accelerate the recapitalisation of the banks and dealers. Banks and dealers with bigger equity bases could afford to take mark-to-market losses while continuing to lend money and maintain liquid securities markets. Simple, right?
As one official told me: “The easiest way to solve for lack of capital is to go get capital. We are in the early stages of capital raising.” The first stage was that series of calls on the sovereign wealth funds in recent months. Unfortunately, the limit on that source of equity has probably been reached, both for the banks and the SWFs. Most of the new equity for the banks and dealers will have to come from their home markets.
As that official continued, “We have been encouraging institutions to get going and do road shows. There is no shortage of capital on the sidelines.” At some price that is true. Undoubtedly that new equity will have dividends and seniority superior to the old equity. Which is why the bank and dealer management may be hesitant to book those road shows. It’s easy for officialdom to say that the equity holders will be diluted, because it’s true. However, if you’re a C-suite executive or board member, you are supposed to be working to protect the interests of those existing equity holders. We could be talking career death here. So why not put off any decision until we see what the marks will be at the end of the quarter?
Even before the lowest marks-to-market are taken, there are probably some real values to be had in the credit markets. They are not, I believe, to be found in the junk market, which probably does not yet reflect the prospective hits to cash flow from the sinking. But the high-grade credit indexes should see some more tradable rallies.