Knock-On Effects Of Credit Crisis May Be Dire

Source : The Business Times, February 20, 2008

Painting a very dire picture of what could unfold from the current credit crisis, GIC Asset Management's director of economics and strategy Yeoh Lam Keong said there is a real chance of a systemic financial event and a deep and prolonged US and global recession should there be another round of de-leveraging in the structured credit market.

'The outlook is very difficult and confusing now - the ball is still in the air,' he said at the 9th annual conference of the Investment Management Association of Singapore yesterday.

But any further de-leveraging of the structured credit structure could have serious consequences. 'That is why the policy-makers are going all out to prevent further deterioration.'

Mr Yeoh said there is a 50 per cent chance of the US economy going into a recession. And if there is a recession, the probability is 60 to 70 per cent that it would be a mild one. The remaining 30 per cent probability is the prospect of a deep and prolonged US and global recession.

'If the current slowdown leads to labour shedding, there will be more forced selling of homes and house prices will fall that much faster. This will have severe implications.'

There will be knock-on effect on the other credit sectors, including US household debt which is the highest in the world. Financial institutions will chalk up more losses. 'A US$50 billion here, a US$30 billion there, and soon you are out of capital,' Mr Yeoh said of banks.

'So there is a risk of a severe recession, and it's a high and rising probability,' said Mr Yeoh, who qualified that the opinions were his and not GIC's.

The next sign-post investors should look for is massive layoffs. Once that happens, the question is can policy-makers respond fast enough and with the correct policy to stop the deflationary pressures from getting out of control?

The current credit downturn, added Mr Yeoh, is different from previous ones because the investors affected are very dispersed. 'The investors can't be gathered into a room to arrange for a bail-out. It cuts across jurisdictions.'

Also, coming in an election year, there is the risk that the crisis may develop while the political process carries on, he said.

Also sharing the similar cautious outlook is Aberdeen Asset Management Asia's managing director Hugh Young. 'This time round, it's more worrying than the dot-com bust and the Asian financial crisis. Markets can fall substantially from where they are today,' he said during his panel discussion on Trends in Asian Investments.

But there is some good news, said GIC's Mr Yeoh. For one thing, corporate balance sheets are strong and hence companies are able to hold on to labour. And inventory is lean.

So what could signal that the troubles are ending? When there is accounting and regulatory forbearance, when credit market undershoots its fundamental value and when financial institutions are recapitalised, said Mr Yeoh. A U-shape recovery is preferred over a V-shape one, as the latter will bring inflation to the fore.

'The long-term view is still positive. We are looking at the long-term recovery of investment cycles in Germany and Japan. The US would have worked out its imbalances. It would be a moderate inflation environment as the increase in labour supply will hold down costs,' he said.

Meanwhile during his keynote address, renowned investor Jim Rogers again expounded his well-known views that commodities is the place to be in the next 10 years or more. He is also bullish on Asia. Besides direct investments in commodities, other ways to play his investment ideas include investing in commodity-producing countries like Australia, Malaysia and Indonesia, or water-treatment or power-generation industries in countries like China, or the travel industry which will cater to the millions and millions of tourists from China, he said.