Some readers would have a go at me whenever I’d post articles by the Telegraph’s Ambrose Evans-Pritchard. Although he has a tendency to hyperventilate and sometimes oversimplifies, he regularly points to data and research that I haven’t seen covered elsewhere.
More important, his major calls this year have been correct. He predicted the oil price decline, was vehement that deflation, not inflation was the risk to the global economy, and pointed to evidence of near zero money supply growth in major economies, an early warning that the credit crunch was intensifying.
Today, Evans-Pritchard and the Financial Times editorial page are in agreement on the the dangers of the debt crisis and the need for swift action, although Evans-Pritchard spends more time on the long-term outlook.
First, from the Financial Times (boldface ours):
Banks are not to be trusted. This is not just the view of the public and policymakers, but that of the banks themselves. Spreads on unsecured inter-bank lending have reached unprecedented levels, particularly in dollars and, to a lesser degree, sterling. Such stresses cannot continue for long, without serious damage to both the financial system and the economy….
This dire situation makes decisive action essential. Beyond doubt, failure by the US Congress to pass a rescue package would court catastrophe. But the plan proposed by Hank Paulson, US treasury secretary, is inadequate. This, too, is the banks’ view. They know his plan is likely to pass, in some form, yet seem increasingly nervous.
So what is to be done? The response must have three elements.
First, in the absence of private funding, central banks must do the intermediation among banks. Moreover, banks cannot fund ongoing operations overnight. So all central banks must shift liquidity provision away from overnight lending, towards much longer maturities.
Second, the US Congress must pass a version of the Paulson plan. This must promise to make the distressed securitised mortgage assets now on the books of the banks more liquid. While the initial plan needed improvement, a better version must be enacted extremely soon.
Yves here. With the need to placate House Republicans, we are sure to get a worse version, save the oversight provisions.
Finally, not only the US, but also other countries, and particularly the UK, need to put in place a credible plan for the forced recapitalisation, or closure, of weakened banks. Banks unable to borrow are zombies. They must be restored to health or allowed to perish quietly.
Some of these actions are going to be highly unpopular with powerful interests, including the banks themselves. So be it. With the banking system in dire distress, effective action is needed right now.
Now to the characteristically more colorful reading from Evans-Pritchard:
Even if Congress backs the Paulson bail-out, the $700 billion blast cannot save the US, Britain or the world from the deepest economic slump since the Thirties. If Congress balks, God help us. The credit system is suffering a heart attack…
Wherever you look – dollar, euro, sterling Libor (the rate at which banks lend to each other), or spreads on credit derivatives – the stress has reached breaking point. If borrowers cannot roll over the three-month loans that are the lifeblood of business, they will default en masse.
“Money markets are imploding. If no action is taken very soon, there is a significant risk that the global economy will collapse,” says BNP Paribas. Almost every trader says much the same thing….
Republican refuseniks – defying their president – have a grim responsibility if they now tip America over the edge, setting off the “adverse feedback loop” that so terrifies the US Federal Reserve. Like players in a Greek tragedy, they seem determined to repeat the “liquidation” policy that led to the Great Depression – and to Democrat ascendancy for years.
Lehman Brothers’ collapse showed the chain of inter-connections that can cause mayhem across a clutch of different markets. That was just one bank – albeit with $630 billion or so in liabilities.
Credit is the lubricant of a modern economy. A seizure now would probably lead to the bankruptcy of General Motors and Ford in short order, but it would not stop with the US car industry. Waves of job losses would set off a self-feeding spiral. Yet more people would default on their mortgages (and car loans), driving house prices down even further. That, in turn, would threaten the solvency of the best banks. That is the way to Armageddon.
As Mr Paulson says, US taxpayers are on the hook whether they like it or not. A $700 billion fund to soak up toxic debt and stabilise the credit market is the cheapest way out. It is certainly cheaper than Depression.
Hopes that the world can cruise happily on as the US buckles have been dashed by the violent downturn across Europe and Asia over the summer. The Baltic Dry Index measuring freight rates for ships has plummeted by two thirds since May. Japan’s economy is already contracting. China’s may be close behind: a third of all textile factories in Guangdong have closed this year. House prices are tumbling in Shenzen, Beijing, Shanghai.
Albert Edwards, global strategist at Société Général, says Asia built its boom on shipping goods to the US: “The emerging market boom is going to collapse and this will shake investors to the core. The great unwinding has only just begun.”…
This is debt deflation – partly imported from America, partly home-grown. It is global. There is nowhere to hide. Even oil-rich Norway took emergency action this week to shore up its banks.
How will it all end? Europe assumed – wrongly – in the early Thirties that it could withstand the Atlantic gales after the collapse of the Bank of the United States in December 1930. However, Austria’s Credit-Anstalt failed in the early summer of 1931, setting off contagion across the central European banking system….
America’s serial bail-outs – nearing $1.6 trillion, or 12 per cent of GDP – are playing havoc with the US budget. The deficit is above 6.7 per cent, near a 60-year peak. But claims that the US is going bust are frivolous. The US Treasury is not taking on permanent debt: it is behaving like a giant wealth fund, hoovering up mortgage securities selling far below their real value for reasons of panic. Famed investor Warren Buffett expects it to make “a considerable amount of money”.
The system will recover, but it may take a slow purge for a decade or more to rid us of the debt toxins. There will be no quick rebound this time.
Unfortunately, Evans-Pritchard is wrong about the prices at which the Treasury will buy banks’ dodgy paper, but the sad fact is that the Treasury’s denial and its failure to recognize the knock-on effects of the Freddie/Fannie conservatorship and the Lehman failure have led it to put forward a half-baked plan. The time pressures plus the obstinancy that there were no other options leave us with choosing between bad and worse.
Update 2:40 AM: John Jansen posted some excerpts from a research report by HSBC that comes to the same conclusion, namely, the plan isn’t big enough:
We take a look at the top 20 US banks by assets and make a rough stab at how much of their assets will be eligible for the USD700bn Troubled Assets Relief Program (TARP), assuming it ultimately passes Congress in one form
or another. Although many of the assets should have only limited impairment over the long run, we suggest that approximately USD3trn in assets could feasibly meet the conditions required to be eligible to be sold to the government, assuming Treasury Secretary Henry Paulson gets wide leeway in deciding what assets to purchase. The bottom 80% of US
banks and the pure-play investment banks may have an additional USD1.5trn of eligible assets, for a total of roughly USD4.5trn. The USD700bn TARP, while helpful, would represent only 15% of this. We have our doubts about whether that would be enough to unclog the financial system.
But even if TARP did have better-than-expected results, it will not jump-start lending, as house prices appear likely to keep falling for some time, TARP will not completely rebuild trust between banks, risk reduction at money market funds still pose systemic problems despite recent government investor insurance, and mark-to-market rules will still increase capital needs even if TARP acts to reduce some strains. In other words, the forces of deleveraging are overwhelming, and so the credit crunch will remain over the next few quarters.
As a result, the economy would be virtually stalled over the next year, we forecast that the unemployment rate will rise to at least 7% in 2009, and therefore core inflation is likely to fall next year. On a “cash-deficit” basis, the budget deficit is likely to soar to USD1.2trn for 2009, we estimate.