Source : The Business Times, Jun 30, 2008
ONE of the most striking things about the past couple of months is how quickly the phrases 'sub-prime crisis' and 'credit crunch' have disappeared from mainstream consciousness, both replaced by 'inflationary worries' and 'oil crisis' as the stock market's main bogeymen.
In its 'Third Quarter Strategy Outlook' dated June 27 for instance, BCA Research said the outlook will be greatly influenced by how oil prices behave: 'The sustained advance in oil is choking off growth in the G-7 universe and could send equities to new lows. A reprieve in the oil crisis is needed for global equities to regain traction but there is no guarantee that such a reprieve will come anytime soon.'
As a result, the research outfit recommended going defensive and that 'portfolio managers should further reduce their equity weightings below benchmark'.
There was virtually no discussion as to whether there could be more sub-prime shocks to come or whether the financial system has really recovered from the huge losses caused by a still-collapsing US housing market.
Similarly, most other outlook reports and stock market updates have assumed that the Bear Stearns bailout and the Fed's actions in March/April have been sufficient to ensure that the sub-prime crisis is a thing of the past.
Readers would do well to ask themselves this question: how likely is it that a credit bubble that was about six years in the making (when the US Federal Reserve started an aggressive rate cutting campaign after the Internet bubble burst) can be so quickly and gently deflated in the space of two to three months?
Although most of the headlines over the past few weeks have focused on oil's relentless climb and the inflationary-cum-growth implications, it is the complacency surrounding the sub-prime crisis that could well be the main problem equities will face over the next few months.
In fact, Wall Street may well be now waking up to this possibility - Bloomberg on Friday reported that it was sharp drops in financial stocks AIG and Merrill Lynch that dragged the S&P 500 to its five-year low and that the reason for the selling was mounting realisation that there are more sub-prime losses to come.
Bloomberg also reported that Lehman Brothers analyst Roger Freeman increased his second-quarter loss estimate for Merrill on expectations that sub-prime-related writedowns will be more than twice as big as previously projected.
The concerns over oil, inflation and growth are of course justified. BCA's 'Emerging Markets Strategy' dated June 27 said these economies will witness a period of slower growth in the months ahead as inflationary pressures rise.
Although a major slump is unlikely, BCA said near-term risks are high and recommended investors 'stay on the sidelines'.
Interestingly, US newspaper Barron's June 23 issue reports (in the 'Up & Down Wall St' column) that fund manager Dewey Kessler from SDK Capital believes that the sub-prime crisis is now moving into its second phase, a phase that will see emerging markets transformed into 'submerging markets'.
The process is said to have only just begun, starting with China, which although it is 50 per cent off its all-time highs, has still a long way to go.
Here, investors may derive some consolation from the relative resilience the Straits Times Index displayed last week, largely thanks to strong support for the banks (OCBC and UOB actually rose over the five days while DBS only lost 2 cents).
However, it is possible that this support came via window-dressing activities ahead of the end of the first half and if so, the start of the second half could see this support withdrawn.
Moreover, US financial stocks are now being sold off as the realisation grows that the sub-prime credit crunch has not yet run its course. If the same realisation and selling spreads to the local banks, the STI will not be able to display the resilience it did last week.
All told, it looks like the worst is still not over yet. Forecasts earlier this year that the second half will be better than the first may well have to be revised.
Showing posts with label US Sub-Prime Crisis. Show all posts
Showing posts with label US Sub-Prime Crisis. Show all posts
Wednesday, July 2, 2008
Friday, April 18, 2008
Sub-Prime Crisis Not Over Yet
Source : The Business Times, April 18, 2008
By SURESH MENON, FOREIGN EDITOR
HOWARD Davies, the director of the London School of Economics (LSE), has served the global financial community in various ways. He was the deputy governor of the Bank of England, chairman of the UK's Financial Services Authority, director general of the Confederation of British Industry and Controller of the Audit Commission. In 2004 he joined the board of Morgan Stanley as a non-executive director. To top it all in a literary way, in 2007 he chaired the jury of the Man Booker Prize for fiction.
'The crisis is not over. Fed actions may have reduced the panic, but the downturn scenario for the rest of the year still remains.'- Mr Davies
Last week in Singapore for the LSE Asia Forum 2008, he spoke to Business Times exclusively on the sub-prime contagion and the global financial architecture.
Excerpts from the interview:
Are we anywhere near an end to the sub-prime crisis?
We are not fully through this crisis. In the US, big investment banks have now taken most of the pain. A little bit more is possible if house prices continue to tumble. Mainly, they have provided for that. They have also taken most of the heat from the leveraged financing and private equity loans they committed to in good times, which are now loss-making. But still more remains to be disclosed in other parts of the market and some US regional banks or European ones have not reported, or written down, their exposure to adequate levels.
Big banks are not in such a bad position after the Federal Reserve opened the discount window. Liquidity fears are dying compared to the time of the Bear Stearns debacle. Things are getting better on Wall Street. But with the US economy into a recession, you have different classes of losses emerging - not the exotic types like financial engineering, etc ... Ordinary corporate loans are bound to rise. Consumer credit will decline in quality. So a second wave of losses is emerging. Also, one cannot really see any signs of big hedge funds saying things have bottomed out. So in that sense this crisis is not over. Fed actions may have reduced the panic, but the downturn scenario for the rest of the year remains.
Talk about central bank intervention, government supervision and regulatory regimes is becoming more pronounced.
It's clear that there will be regulatory changes in the US as a result of the Fed opening the discount window and accepting more collateral etc.. The Fed is not likely to carry out that regime without wanting something in return. That something could be reduced leverage in the investment banks. There are already discussions between the Fed and the investment banks on that. Also the rating agencies would be required to segregate their business and their consultancy to avoid conflicts of interest. That is pretty much inevitable.
Changes to Basle II (the 2004 accord on banking laws and regulations including capital adequacy ratios, etc) to make it more sensitive to liquidity are underway as well. All these are natural consequences to what happened. Also, there is a lot of political noise by people who do not know what they are talking about. That will take time to settle down.
Leaders and institutions feel they need to come out with some statement about regulatory initiative. Most of it does not mean anything. What emerges from the Financial Stability Forum is likely to be the key. There is also this big agenda for the banks themselves to pursue. Banks will have to improve themselves.
Do you expect any more Bear Stearns? Citibank going bust, for instance?
Well, not Citibank. The Fed would step in or else that would cause problems all over, including in Singapore. Also, big banks have access to liquidity. But it would be surprising if there were no other failures in the US and elsewhere - but probably not systemic bank failures. Germany and UK have witnessed some failures. More could happen elsewhere and even in Asia because many have been slow to report.
Where do China and India fit in? Do they have the ability to cushion the shock?
Chinese and Indian banks have not been massively affected. They were not big in the sub-prime market. One consequence of the US slowdown would be reduction in the US trade deficit, which is already happening. Chinese exports grew only 6 per cent last year against 20 per cent before. India is more reliant on domestic demand than exports, unlike China. But China's growth also is more rebalanced now towards domestic demand. But one cannot decouple globalisation and all the other things happening around. There will be an impact. If the US recession is not long and deep, there will be only a shaving of growth rates in India and China and not a complete collapse.
What about headlines like 'Is capitalism dead'? Do you expect pressure on countries and leaders not to let free markets prevail in the long term?
There are both political and technical debates on this. The technical debate is, to what extent central banks take into account asset prices while setting the monetary policy. That is a 'bloodless' way of asking the question whether capitalism is dead. In other words, the debate is whether central banks should take notice when irrational exuberance is underway in the market. People who say 'yes' are winning the argument. They are persuasively arguing that central banks should not ignore asset prices like before. Inflation in stock prices or property need to be taken into account.
A change in central banking orthodoxy is likely because of this crisis. That may lead to a more interventionist approach by them in the asset market. A massive reaction against 'Anglo-Saxon capitalism' is probably not likely.
The distribution model is under some threat. A tilt back towards more conventional banking practices is possible. Legislation to ban certain practices in capital markets are relatively unlikely. What we will see is a variety of technical central banking responses depending on the recession and pick-up scenario. If the world falls into a major recession, political forces then will become much stronger. That scenario is hard to predict. Despite the pessimistic scenario I don't see a deep or global recession.
In your book (Global Financial Regulation, The Essential Guide) you argued that there should be more participation of developing countries in global financial institutions.
There is a big issue there of legitimacy. The Basel committee has 13 members, 10 from Europe. In the banking system, three of the top 10 banks are Chinese. It's pretty crazy they are not involved. Western governments have been very slow to recognise the implications of globalised financial markets. For instance, the Basel II capital accord was devised entirely without reference to Islamic financial institutions. We need to have more representative bodies.
You cannot expect countries like India and China to follow these rules when they were not consulted in the first place. But it also requires countries brought in to behave in a different way. You now have emerging market representatives in some international bodies who sit there and think how does this affect their interest. You can't be like that. You have to leave your Chinese or Indian attire at home and cooperate to make global rules for the general good. Europeans and Americans do that. But one must admit it's also part of a general issue, as is the case with the UN Security Council representation.
One consequence of this crisis will be that people will say we really have to overhaul these institutions.
What is happening to the commodity markets and food prices?
There have been some curious market interventions. Subsidies to produce bio-fuels in the US have diverted corn production to oils. There are some very peculiar goings on in commodity markets. The root of the problem is misguided government interventions.
The yuan is appreciating; Singapore, for instance, is pursuing a strong currency policy to combat inflation. What are the implications amid the current slowdown?
Depreciation of the US dollar is serving to offset recessionary pressures in the US. That is welcome. Massive deflationary effect from the housing market is flowing to consumer spending. But you got some offset in the form of American manufacturing. US cars are being exported, for a change, after a long time. And the rest of the world should not seek to resist. That would perpetuate global imbalances.
Since last year or so the Chinese have been behaving statesman-like. It's no coincidence that the renminbi started moving when Americans stopped shouting about it. All this is generally beneficial. Any sharp currency movements, however, will cause casualties. But generally the movements have been quite positive. Of course one has to watch the inflationary consequences of these moves. But given the economy is slowing globally, inflation should not be a worry. Manufacturers will get a nasty surprise if they tend to raise prices now.
By SURESH MENON, FOREIGN EDITOR
HOWARD Davies, the director of the London School of Economics (LSE), has served the global financial community in various ways. He was the deputy governor of the Bank of England, chairman of the UK's Financial Services Authority, director general of the Confederation of British Industry and Controller of the Audit Commission. In 2004 he joined the board of Morgan Stanley as a non-executive director. To top it all in a literary way, in 2007 he chaired the jury of the Man Booker Prize for fiction.
'The crisis is not over. Fed actions may have reduced the panic, but the downturn scenario for the rest of the year still remains.'- Mr DaviesLast week in Singapore for the LSE Asia Forum 2008, he spoke to Business Times exclusively on the sub-prime contagion and the global financial architecture.
Excerpts from the interview:
Are we anywhere near an end to the sub-prime crisis?
We are not fully through this crisis. In the US, big investment banks have now taken most of the pain. A little bit more is possible if house prices continue to tumble. Mainly, they have provided for that. They have also taken most of the heat from the leveraged financing and private equity loans they committed to in good times, which are now loss-making. But still more remains to be disclosed in other parts of the market and some US regional banks or European ones have not reported, or written down, their exposure to adequate levels.
Big banks are not in such a bad position after the Federal Reserve opened the discount window. Liquidity fears are dying compared to the time of the Bear Stearns debacle. Things are getting better on Wall Street. But with the US economy into a recession, you have different classes of losses emerging - not the exotic types like financial engineering, etc ... Ordinary corporate loans are bound to rise. Consumer credit will decline in quality. So a second wave of losses is emerging. Also, one cannot really see any signs of big hedge funds saying things have bottomed out. So in that sense this crisis is not over. Fed actions may have reduced the panic, but the downturn scenario for the rest of the year remains.
Talk about central bank intervention, government supervision and regulatory regimes is becoming more pronounced.
It's clear that there will be regulatory changes in the US as a result of the Fed opening the discount window and accepting more collateral etc.. The Fed is not likely to carry out that regime without wanting something in return. That something could be reduced leverage in the investment banks. There are already discussions between the Fed and the investment banks on that. Also the rating agencies would be required to segregate their business and their consultancy to avoid conflicts of interest. That is pretty much inevitable.
Changes to Basle II (the 2004 accord on banking laws and regulations including capital adequacy ratios, etc) to make it more sensitive to liquidity are underway as well. All these are natural consequences to what happened. Also, there is a lot of political noise by people who do not know what they are talking about. That will take time to settle down.
Leaders and institutions feel they need to come out with some statement about regulatory initiative. Most of it does not mean anything. What emerges from the Financial Stability Forum is likely to be the key. There is also this big agenda for the banks themselves to pursue. Banks will have to improve themselves.
Do you expect any more Bear Stearns? Citibank going bust, for instance?
Well, not Citibank. The Fed would step in or else that would cause problems all over, including in Singapore. Also, big banks have access to liquidity. But it would be surprising if there were no other failures in the US and elsewhere - but probably not systemic bank failures. Germany and UK have witnessed some failures. More could happen elsewhere and even in Asia because many have been slow to report.
Where do China and India fit in? Do they have the ability to cushion the shock?
Chinese and Indian banks have not been massively affected. They were not big in the sub-prime market. One consequence of the US slowdown would be reduction in the US trade deficit, which is already happening. Chinese exports grew only 6 per cent last year against 20 per cent before. India is more reliant on domestic demand than exports, unlike China. But China's growth also is more rebalanced now towards domestic demand. But one cannot decouple globalisation and all the other things happening around. There will be an impact. If the US recession is not long and deep, there will be only a shaving of growth rates in India and China and not a complete collapse.
What about headlines like 'Is capitalism dead'? Do you expect pressure on countries and leaders not to let free markets prevail in the long term?
There are both political and technical debates on this. The technical debate is, to what extent central banks take into account asset prices while setting the monetary policy. That is a 'bloodless' way of asking the question whether capitalism is dead. In other words, the debate is whether central banks should take notice when irrational exuberance is underway in the market. People who say 'yes' are winning the argument. They are persuasively arguing that central banks should not ignore asset prices like before. Inflation in stock prices or property need to be taken into account.
A change in central banking orthodoxy is likely because of this crisis. That may lead to a more interventionist approach by them in the asset market. A massive reaction against 'Anglo-Saxon capitalism' is probably not likely.
The distribution model is under some threat. A tilt back towards more conventional banking practices is possible. Legislation to ban certain practices in capital markets are relatively unlikely. What we will see is a variety of technical central banking responses depending on the recession and pick-up scenario. If the world falls into a major recession, political forces then will become much stronger. That scenario is hard to predict. Despite the pessimistic scenario I don't see a deep or global recession.
In your book (Global Financial Regulation, The Essential Guide) you argued that there should be more participation of developing countries in global financial institutions.
There is a big issue there of legitimacy. The Basel committee has 13 members, 10 from Europe. In the banking system, three of the top 10 banks are Chinese. It's pretty crazy they are not involved. Western governments have been very slow to recognise the implications of globalised financial markets. For instance, the Basel II capital accord was devised entirely without reference to Islamic financial institutions. We need to have more representative bodies.
You cannot expect countries like India and China to follow these rules when they were not consulted in the first place. But it also requires countries brought in to behave in a different way. You now have emerging market representatives in some international bodies who sit there and think how does this affect their interest. You can't be like that. You have to leave your Chinese or Indian attire at home and cooperate to make global rules for the general good. Europeans and Americans do that. But one must admit it's also part of a general issue, as is the case with the UN Security Council representation.
One consequence of this crisis will be that people will say we really have to overhaul these institutions.
What is happening to the commodity markets and food prices?
There have been some curious market interventions. Subsidies to produce bio-fuels in the US have diverted corn production to oils. There are some very peculiar goings on in commodity markets. The root of the problem is misguided government interventions.
The yuan is appreciating; Singapore, for instance, is pursuing a strong currency policy to combat inflation. What are the implications amid the current slowdown?
Depreciation of the US dollar is serving to offset recessionary pressures in the US. That is welcome. Massive deflationary effect from the housing market is flowing to consumer spending. But you got some offset in the form of American manufacturing. US cars are being exported, for a change, after a long time. And the rest of the world should not seek to resist. That would perpetuate global imbalances.
Since last year or so the Chinese have been behaving statesman-like. It's no coincidence that the renminbi started moving when Americans stopped shouting about it. All this is generally beneficial. Any sharp currency movements, however, will cause casualties. But generally the movements have been quite positive. Of course one has to watch the inflationary consequences of these moves. But given the economy is slowing globally, inflation should not be a worry. Manufacturers will get a nasty surprise if they tend to raise prices now.
Thursday, April 10, 2008
Global Sub-Prime Losses Hit A Trillion: IMF
Source : TODAY, Thursday, April 10, 2008
The International Monetary Fund estimates worldwide losses stemming from the sub-prime mortgage crisis in the United States could reach US$945 billion ($1.3 trillion) as the impact spreads globally.
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In a particularly stark report, the IMF said falling US housing prices and rising delinquencies on the residential mortgage market could lead to losses of US$565 billion.
Combined with other categories of loans originating in the US and securities issued in the country that are related to commercial real estate, the consumer credit market and corporations “increases aggregate potential losses to about US$945 billion”.
“The crisis is spreading beyond the US sub-prime market - namely to the prime residential and commercial real estate markets, consumer credit and the low- to high-grade corporate credit markets,” the IMF said in its Global Financial Stability Report. While the US remains the epicentre, “financial institutions in other countries have also been affected”.
It was the first time the multilateral institution has made an official estimate of the global losses suffered by banks and other financial institutions in the credit squeeze that began eight months ago in the US, amid rising defaults on sub-prime, or high-risk, home loans.
The staggering estimate represents roughly US$142 per person worldwide and 4 per cent of the $23.21 trillion credit market.
The IMF said that global banks would probably shoulder about half of the losses, at US$440 billion to US$510 billion.
“Leading indicators point to a tightening of credit conditions across many economic activities,” said IMF’s head of Monetary and Capital Markets Department Jaime Caruana.
The unusually precise and harsh report comes ahead of the IMF and the World Bank spring meetings this weekend in Washington.
The IMF, whose core mission is to promote global financial stability, said there was “a collective failure to appreciate the extent of leverage taken on by a wide range of institutions - banks, monoline insurers, government-sponsored entities, hedge funds - and the associated risks of a disorderly unwinding.
“It is now clear that the current turmoil is more than simply a liquidity event, reflecting deep-seated balance sheet fragilities and weak capital bases, which means its effects are likely to be broader, deeper and more protracted.” - AFP
The International Monetary Fund estimates worldwide losses stemming from the sub-prime mortgage crisis in the United States could reach US$945 billion ($1.3 trillion) as the impact spreads globally.
+Logo.jpg)
In a particularly stark report, the IMF said falling US housing prices and rising delinquencies on the residential mortgage market could lead to losses of US$565 billion. Combined with other categories of loans originating in the US and securities issued in the country that are related to commercial real estate, the consumer credit market and corporations “increases aggregate potential losses to about US$945 billion”.
“The crisis is spreading beyond the US sub-prime market - namely to the prime residential and commercial real estate markets, consumer credit and the low- to high-grade corporate credit markets,” the IMF said in its Global Financial Stability Report. While the US remains the epicentre, “financial institutions in other countries have also been affected”.
It was the first time the multilateral institution has made an official estimate of the global losses suffered by banks and other financial institutions in the credit squeeze that began eight months ago in the US, amid rising defaults on sub-prime, or high-risk, home loans.
The staggering estimate represents roughly US$142 per person worldwide and 4 per cent of the $23.21 trillion credit market.
The IMF said that global banks would probably shoulder about half of the losses, at US$440 billion to US$510 billion.
“Leading indicators point to a tightening of credit conditions across many economic activities,” said IMF’s head of Monetary and Capital Markets Department Jaime Caruana.
The unusually precise and harsh report comes ahead of the IMF and the World Bank spring meetings this weekend in Washington.
The IMF, whose core mission is to promote global financial stability, said there was “a collective failure to appreciate the extent of leverage taken on by a wide range of institutions - banks, monoline insurers, government-sponsored entities, hedge funds - and the associated risks of a disorderly unwinding.
“It is now clear that the current turmoil is more than simply a liquidity event, reflecting deep-seated balance sheet fragilities and weak capital bases, which means its effects are likely to be broader, deeper and more protracted.” - AFP
Friday, March 28, 2008
Low Point Of Crisis May Be Over, Feels Temasek Unit
Source : The Business Times, March 28, 2008
Investors have reached the point of maximum fear, says Fullerton CEO
Temasek Holdings' fund management unit says investors have passed 'the point of maximum fear' amid the global credit squeeze. Fullerton Fund Management sees the US Federal Reserve's decision to rescue Bear Stearns as a turning point in the crisis.
'The Fed coming in to facilitate JPMorgan Chase & Co's purchase of Bear Stearns is a watershed event, and most bottoms are found during watershed events,' Fullerton CEO Gerard Lee said in an interview here yesterday. 'From that perspective, we could have already crossed the point of maximum fear.'
The Fed stepped in with JPMorgan on March 14 to provide emergency funding to Bear Stearns in the biggest government bailout of a US securities firm. The move is now being probed by the Senate.
Before the announcement, Bear Stearns' clients withdrew US$17 billion in two days amid speculation that the firm was running short of cash.
Templeton Asset Management's Mark Mobius said he 'generally' agrees with Temasek's assessment that the markets have reached a bottom.
'If we haven't achieved it, we're damn close,' Mr Mobius, who oversees US$47 billion in emerging- market equities, said in a phone interview from Hong Kong yesterday.
'With the kind of liquidity that's pouring into the system, with the Fed, and now the European Central Bank and others putting more money into the system, we think stock prices are not going to remain down. We think there's a good chance of growth going forward.'
Some funds are already planning to buy shares in Asia, where stocks have tumbled this year even as economies in China and India continue to grow. The MSCI Asia Pacific Index trades at 14 times estimated earnings, after slumping 13 per cent the past six months as fallout from the US sub-prime crisis spread through Asia, making stocks in the benchmark 36 per cent cheaper than the five-year average.
Value Partners Group, Asia's second-largest hedge fund manager, is buying stocks in the region that were battered by the collapse of the US sub-prime mortgage market, chief investment officer Cheah Cheng Hye said this week. The Hong Kong-based asset manager aims to start a new fund in the second quarter to invest in Greater China property stocks, Mr Cheah said.
Funds such as Clariden Leu AG, which manages US$300 million, said the recovery from the US housing crisis may take 1-2 years.
'What we have seen in the last couple of weeks culminating in the rescue of Bear Stearns by the Fed and a further pump of liquidity in the market may somewhat signal an inflexion point in the crisis - but this bottoming-out phase, we reckon, will take a long time,' Michael Foo, head of Asian portfolio management at Clariden, said in an interview yesterday.
Fullerton, which oversees US$2.5 billion of third- party money, is still bullish on prospects in Asia, where it has most of its assets. It said the goal to manage US$3 billion excluding Temasek's funds by mid-year is achievable. Temasek manages a portfolio worth more than US$100 billion.
'The fundamental reasons for this secular growth are all in place,' Mr Lee said. 'The few of the big economies are found in Asia. I'm talking about China, India, Vietnam and South Korea. So Asia, being a destination for investment money from the developed world, will continue to grow.'
Fullerton's main customers are wealthy individuals in Japan, South Korea, Taiwan, Hong Kong and institutions in Singapore, where it became a separate unit of Temasek in 2003. It aims to expand in the US, Europe, Australia and the Middle East. -- Bloomberg
Investors have reached the point of maximum fear, says Fullerton CEO
Temasek Holdings' fund management unit says investors have passed 'the point of maximum fear' amid the global credit squeeze. Fullerton Fund Management sees the US Federal Reserve's decision to rescue Bear Stearns as a turning point in the crisis.
'The Fed coming in to facilitate JPMorgan Chase & Co's purchase of Bear Stearns is a watershed event, and most bottoms are found during watershed events,' Fullerton CEO Gerard Lee said in an interview here yesterday. 'From that perspective, we could have already crossed the point of maximum fear.'The Fed stepped in with JPMorgan on March 14 to provide emergency funding to Bear Stearns in the biggest government bailout of a US securities firm. The move is now being probed by the Senate.
Before the announcement, Bear Stearns' clients withdrew US$17 billion in two days amid speculation that the firm was running short of cash.
Templeton Asset Management's Mark Mobius said he 'generally' agrees with Temasek's assessment that the markets have reached a bottom.
'If we haven't achieved it, we're damn close,' Mr Mobius, who oversees US$47 billion in emerging- market equities, said in a phone interview from Hong Kong yesterday.
'With the kind of liquidity that's pouring into the system, with the Fed, and now the European Central Bank and others putting more money into the system, we think stock prices are not going to remain down. We think there's a good chance of growth going forward.'
Some funds are already planning to buy shares in Asia, where stocks have tumbled this year even as economies in China and India continue to grow. The MSCI Asia Pacific Index trades at 14 times estimated earnings, after slumping 13 per cent the past six months as fallout from the US sub-prime crisis spread through Asia, making stocks in the benchmark 36 per cent cheaper than the five-year average.
Value Partners Group, Asia's second-largest hedge fund manager, is buying stocks in the region that were battered by the collapse of the US sub-prime mortgage market, chief investment officer Cheah Cheng Hye said this week. The Hong Kong-based asset manager aims to start a new fund in the second quarter to invest in Greater China property stocks, Mr Cheah said.
Funds such as Clariden Leu AG, which manages US$300 million, said the recovery from the US housing crisis may take 1-2 years.
'What we have seen in the last couple of weeks culminating in the rescue of Bear Stearns by the Fed and a further pump of liquidity in the market may somewhat signal an inflexion point in the crisis - but this bottoming-out phase, we reckon, will take a long time,' Michael Foo, head of Asian portfolio management at Clariden, said in an interview yesterday.
Fullerton, which oversees US$2.5 billion of third- party money, is still bullish on prospects in Asia, where it has most of its assets. It said the goal to manage US$3 billion excluding Temasek's funds by mid-year is achievable. Temasek manages a portfolio worth more than US$100 billion.
'The fundamental reasons for this secular growth are all in place,' Mr Lee said. 'The few of the big economies are found in Asia. I'm talking about China, India, Vietnam and South Korea. So Asia, being a destination for investment money from the developed world, will continue to grow.'
Fullerton's main customers are wealthy individuals in Japan, South Korea, Taiwan, Hong Kong and institutions in Singapore, where it became a separate unit of Temasek in 2003. It aims to expand in the US, Europe, Australia and the Middle East. -- Bloomberg
Monday, March 24, 2008
A Sub-Primer For Dummies
Source : The Business Times, March 20, 2008
RAISE your hand if you don't quite understand this whole financial crisis.
It has been going on for seven months now, and many people probably feel as if they should understand it. But they don't, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn't afford, and now they are falling behind on their mortgages.
But the overwhelming majority of homeowners are still doing just fine. So how is it that a mess concentrated in one part of the mortgage business - sub-prime loans - has frozen up the credit markets, sent stock markets gyrating, caused the collapse of Bear Sterns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?
I'm here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.
'We're exposing parts of the capital markets that most of us had never heard of,' Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former treasury secretary and current Citigroup executive, has said that he hadn't heard of 'liquidity puts', an obscure financial contract, until they started causing big problems for Citigroup.
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, 'Can you try to explain this to me?' When they finished, I often had a highly sophisticated follow-up question, 'Can you try again?' I emerged from it thinking that all the uncertainty has created a panic that is partly irrational.
That said, the crisis isn't close to ending. Ben Bernanke, the Fed chairman, won't be able to wave a magic wand and make everything better, no matter how many more times he cuts rates and cheers Wall Street. As Mr Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust.
Back to the beginning
So let's go back to the beginning of the boom. It really began in 1998, when large numbers of people decided that real estate, which still hadn't recovered from the early 1990s slump, had become a bargain.
At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centred around banks, to a global one, in which investors from almost anywhere could pool money to lend.
The new competition brought down mortgage fees and spurred innovation, much of which was undeniably good. Why, after all, should someone who knows that they're going to move after just a few years have no choice but to take out a 30-year, fixed-rate mortgage? As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia's boom or rising oil prices, demanded good returns. Wall Street had an answer: sub-prime mortgages.
Because these loans go to people stretching to afford a house, they come with higher interest rates - even if they're disguised by low initial rates - and higher returns. These mortgages were then sliced into pieces and bundled into investments, often known as collateralised debt obligations, or CDOs. Once bundled, different types of mortgages could be sold to different groups of investors.
Investors then goosed their returns further through leverage, the oldest strategy around. They made US$100 million bets with only US$1 million of their own money and US$99 million in debt. If the value of the investment rose to just US$101 million, the investors would end up doubling their money.
Homebuyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody's Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.
All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people - by 'people,' I'm referring here to Mr Greenspan, Mr Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners - decided that the usual rules didn't apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher, so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy.
And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it.
Last summer, many policymakers were hoping that the crisis wouldn't spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.
Many of these bets were not huge. But they were often so highly leveraged that any loss became magnified. If that same US$100 million investment I described above were to lose just US$1 million of its value, the investor who put up only US$1 million would lose everything. That's why a hedge fund associated with the prestigious Carlyle Group collapsed last week.
'If anything goes awry, these dominos fall very fast,' said Charles R Morris, a former banker who tells the story of the crisis in a new book, The Trillion Dollar Meltdown. This toxic combination - the ubiquity of the bad investments and their potential to mushroom - has shocked Wall Street into a state of deep conservatism.
The soundness of any investment firm rests in large part on the confidence of other firms that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns.
The conservatism has gone so far that it's affecting many solid, would-be borrowers, which, in turn, is hurting the broader economy and aggravating Wall Street's fears. A recession could cause automobile loans, credit card loans and commercial mortgages to start going bad.
Many economists now argue the only solution is for the federal government to step in and buy some of the unwanted debt, as the Fed began doing last weekend. This is called a bailout, and there is no doubt that giving a handout to Wall Street lenders or foolish homebuyers - as opposed to, say, laid-off factory workers - is deeply distasteful. At this point, though, the alternative may, in fact, be worse.
Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns, which is why the Fed has been taking unprecedented actions to restore confidence. 'You say, my goodness, how could sub-prime mortgage loans take out the whole global financial system?' Mr Zandi said. 'That's how.' - NYT
RAISE your hand if you don't quite understand this whole financial crisis.
It has been going on for seven months now, and many people probably feel as if they should understand it. But they don't, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn't afford, and now they are falling behind on their mortgages.
But the overwhelming majority of homeowners are still doing just fine. So how is it that a mess concentrated in one part of the mortgage business - sub-prime loans - has frozen up the credit markets, sent stock markets gyrating, caused the collapse of Bear Sterns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?
I'm here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.
'We're exposing parts of the capital markets that most of us had never heard of,' Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former treasury secretary and current Citigroup executive, has said that he hadn't heard of 'liquidity puts', an obscure financial contract, until they started causing big problems for Citigroup.
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, 'Can you try to explain this to me?' When they finished, I often had a highly sophisticated follow-up question, 'Can you try again?' I emerged from it thinking that all the uncertainty has created a panic that is partly irrational.
That said, the crisis isn't close to ending. Ben Bernanke, the Fed chairman, won't be able to wave a magic wand and make everything better, no matter how many more times he cuts rates and cheers Wall Street. As Mr Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust.
Back to the beginning
So let's go back to the beginning of the boom. It really began in 1998, when large numbers of people decided that real estate, which still hadn't recovered from the early 1990s slump, had become a bargain.
At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centred around banks, to a global one, in which investors from almost anywhere could pool money to lend.
The new competition brought down mortgage fees and spurred innovation, much of which was undeniably good. Why, after all, should someone who knows that they're going to move after just a few years have no choice but to take out a 30-year, fixed-rate mortgage? As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia's boom or rising oil prices, demanded good returns. Wall Street had an answer: sub-prime mortgages.
Because these loans go to people stretching to afford a house, they come with higher interest rates - even if they're disguised by low initial rates - and higher returns. These mortgages were then sliced into pieces and bundled into investments, often known as collateralised debt obligations, or CDOs. Once bundled, different types of mortgages could be sold to different groups of investors.
Investors then goosed their returns further through leverage, the oldest strategy around. They made US$100 million bets with only US$1 million of their own money and US$99 million in debt. If the value of the investment rose to just US$101 million, the investors would end up doubling their money.
Homebuyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody's Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.
All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people - by 'people,' I'm referring here to Mr Greenspan, Mr Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners - decided that the usual rules didn't apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher, so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy.
And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it.
Last summer, many policymakers were hoping that the crisis wouldn't spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.
Many of these bets were not huge. But they were often so highly leveraged that any loss became magnified. If that same US$100 million investment I described above were to lose just US$1 million of its value, the investor who put up only US$1 million would lose everything. That's why a hedge fund associated with the prestigious Carlyle Group collapsed last week.
'If anything goes awry, these dominos fall very fast,' said Charles R Morris, a former banker who tells the story of the crisis in a new book, The Trillion Dollar Meltdown. This toxic combination - the ubiquity of the bad investments and their potential to mushroom - has shocked Wall Street into a state of deep conservatism.
The soundness of any investment firm rests in large part on the confidence of other firms that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns.
The conservatism has gone so far that it's affecting many solid, would-be borrowers, which, in turn, is hurting the broader economy and aggravating Wall Street's fears. A recession could cause automobile loans, credit card loans and commercial mortgages to start going bad.
Many economists now argue the only solution is for the federal government to step in and buy some of the unwanted debt, as the Fed began doing last weekend. This is called a bailout, and there is no doubt that giving a handout to Wall Street lenders or foolish homebuyers - as opposed to, say, laid-off factory workers - is deeply distasteful. At this point, though, the alternative may, in fact, be worse.
Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns, which is why the Fed has been taking unprecedented actions to restore confidence. 'You say, my goodness, how could sub-prime mortgage loans take out the whole global financial system?' Mr Zandi said. 'That's how.' - NYT
Anatomy Of A Crisis
Source : The Sunday Times, Mar 23, 2008
Confused by the current financial turmoil? You are not alone. Why are some central banks cutting interest rates even as others raise theirs? And what’s the difference between cutting the main Fed funds rate and the discount rate? Bryan Lee says the key to understanding the crisis is to see it as a three-headed monster: a credit problem in the banking sector, a US-led economic slowdown worldwide, and sky-high inflation the world hasn’t seen in a while.
THE CREDIT CRISIS
Dodgy investments in sub-prime mortgages mean billions in losses that the market cannot even calculate. The result is near paralysis in lending markets and a paranoia which has led to runs on banks like the storied US investment bank Bear Stearns and Britain’s Northern Rock.
What caused this?
THE current woes faced by the United States financial sector have their roots in a housing bubble that formed between 2001 and 2005, when the Federal Reserve kept interest rates low to help the US economy recover after the dot.com bubble burst.
When the housing market started to falter in late 2005, homebuyers who had borrowed beyond their means began to default on their loans. And they were unable to refinance their mortgages as planned when times were better.
By early last year, specialist lenders who gave loans to these risky or ’sub-prime’ borrowers started to collapse as defaults accelerated.
A few months later, the debacle caught up with regular banks and hedge funds around the world, which had indirectly funded the sub-prime loans by buying into complex financial instruments such as ‘CDOs’ (collateralised debt obligations).
Although these investments comprised more than just sub-prime debt, and often were packaged with good loans, entire tranches of these investments have become almost worthless as mortgage defaults mount.
The complexity of the securities makes it impossible for investors to separate the grain from the chaff and give a market value to them.
How is this a threat?
MANY banks bought into sub-prime debt and the market has been left guessing exactly how much losses each financial institution might sustain.
Banks have therefore become more reluctant to lend to one another, even for regular trading activities, as they fear that commitments once assumed vault-safe may not be honoured.
If paranoia sets in and the reluctance to extend credit becomes indiscriminate, the whole financial system could seize up and become paralysed.
Even though banks have collectively written down about US$150 billion (S$207 billion) in sub-prime related losses, there remains much nervousness that more losses may be unveiled.
Aggressive players which fund their activities primarily by borrowing money from other banks are especially at risk of failure, as was the case with the No.5 US investment bank Bear Stearns.
But the heavy reliance on credit by the financial sector in general means that no bank is safe from a run.
Bear Stearns has been rescued with help from the US Federal Reserve. But had it gone under, it would have had serious knock-on effects on the rest of the industry as banks today are intricately linked with one another.
The fall of Bear Stearns has exacerbated the crisis of confidence and adds to fears that no bank is too big to fall.
So far, the credit crunch has been felt most acutely in the US, although there are fears that the malaise is spreading to Europe and Asia, where several banks have already taken big hits on their sub-prime investments.
Indeed, British bank Northern Rock suffered a run last September when it fell foul to tightening credit conditions that emerged soon after the US sub-prime fiasco erupted.
If the US housing market continues to tank, the risk of a global melt-down will rise.
That’s because higher quality mortgage instruments, which European and Asian banks have invested money in bigger quantities, will also be in jeopardy.
What’s being done?
TO ENCOURAGE banks to lend to one another, the US Federal Reserve has been pumping cash, or liquidity, into the banking sector.
It has done this by making available hundreds of billions of dollars in emergency loans since last December.
Last Sunday, it extended the facility to non-deposit-taking banks to 20 primary dealers including investment banks and securities firms. This was the first time it has done so since the Great Depression.
The Fed has also made these emergency funds cheaper. Since last August, it has been slashing what is known as the ‘discount rate’, reducing the interest it charges for these emergency loans from 6.25 per cent to 2.75 per cent.
The Fed also played a key role in keeping Bear Stearns afloat, putting up a US$30 billion guarantee for buyer JPMorgan Chase on Bear Stearn’s most illiquid assets.
It argued that if Bear Stearns had collapsed, it would have led to a larger crisis of confidence that might have taken other banks down with it.
Elsewhere, other central banks have similarly been pumping cash into their financial sectors. A number, such as the Bank of England, have had to bail out failed banks in their jurisdictions.
What’s next?
MORE sub-prime losses seem to be on the cards, with the International Monetary Fund predicting that total write-downs in the global financial world could swell to US$800 billion eventually, from about US$150 billion already reported.
Experts say that there is ample liquidity to go around, but paranoia is still high, preventing the money from circulating within financial markets.
The Fed’s actions have so far had limited effect in preventing confidence from worsening, and economists say the crisis will continue until the US housing market bottoms out.
Only then will the market be able to assess the full extent of losses sustained by mortgage-related investments.
The market can then price these securities and accurately evaluate how much this has hit banks’ bottom lines.
Only then, they say, will the paralysing fear that has kept many investors on the sidelines abate.
Experts say there is ample liquidity to go around, but paranoia is still high, preventing the money from circulating within financial markets.
U.S.-LED GLOBAL SLOWDOWN
The housing slump and the credit crisis in the US has eroded consumer confidence and is plunging the US into a recession. If the recession is deep, economic growth in the rest of the world will also slow down given the US economy’s size and influence in the world order.
What caused this?
AGAIN, it is the housing slump that is at the root of the US downturn, which many now believe has deteriorated into a recession.
Consumer spending, which constitutes about 70 per cent of the US gross domestic product (GDP), is starting to slow as household wealth is falling - for the first time in five years - with declines in home values.
During the recent boom years, many US consumers had depended on the buoyant property market to feed their spending appetites. They re-mortgaged their homes to buy second homes or cars, and banks were willing to lend them the money because house prices were on the rise.
But now that the market has gone south, US consumers are starting to curb their expenditures, especially those who had taken up mortgages beyond their means and are now forced to abandon their new homes.
Households and businesses are being further hit by the credit crisis in what the US Federal Reserve has called a ‘negative feedback loop’.
As banks grow increasingly cautious, their reluctance to provide credit will crimp household consumption and business investment, worsening the slowdown.
How is this a threat?
US GROSS domestic product growth has slowed to a crawl since the final quarter of last year.
The slowdown has hit both the manufacturing and services sectors. Unemployment, which many consider to be the ultimate barometer of economic health, is on the rise.
A slowdown in the US economy will invariably have a significant impact on the world, especially export-dependent countries.
Investment bank Goldman Sachs, for instance, has projected that a 1 percentage point decline in US consumption could hit Singapore’s economic growth by close to 0.6 percentage point. That said, many economists also agree that the emergence of China and other economic fast-growers in the developing world will provide some buffer to a US slowdown.
Also, economies with robust domestic sectors should weather the weaker external environment better.
Experts also note that since the current US slowdown is not focused on the technology sector, unlike the 2001 downturn, electronics-heavy Asia may have a slightly easier time weathering the current slowdown.
What’s being done?
THE Fed has been cutting its funds rate since last September, bringing down the benchmark interbank rate from 5.25 per cent to 2.5 per cent. This interest rate, which is different from the discount rate, is the primary monetary pool that the Fed employs to address economic growth and inflation issues.
It works by directly lowering short-term borrowing costs faced by households and companies. Lower rates spur economic activity by making it cheaper for individuals and companies to borrow money for consumption and investments.
But experts note that the Fed’s rate cuts this time round have had little impact. That’s because long-term rates, which are more relevant to homebuyers and businesses, are still high as banks rein in lending as part of the ongoing credit crisis.
Beyond interest rates and other monetary policy efforts, the US government is also employing fiscal measures to boost the economy.
A US$152 billion (S$210 billion) package comprising tax rebates and business incentives has been planned. There is talk of a second stimulus package as recession risks increase.
What’s next?
THE US recession means that global growth this year will undoubtedly be slower than last year. Much will depend on the severity of the credit crisis and the speed of its recovery.
In the US, economists will be watching for signs of a housing turnaround, which is key for normalcy to return to the financial sector.
The European Union and Japan - the other two economic heavyweights - are expected to suffer slower growth. A weakening US dollar has made the euro and yen strong, and is hurting European and Japanese exporters.
The euro zone’s central bank could lower rates to boost the region’s economies, but appears right now to be more committed to keeping rates high to fight inflation.
The Bank of Japan has fewer options since interest rates are already near zero in the country. Furthermore, the central bank faces a vacuum of leadership as politicians are stuck in a stalemate over who should fill the bank’s top job.
The silver lining is that economists are most optimistic about developing countries in Latin America and Asia.
Strong domestic growth could keep emerging economies in both regions on the boil, they say.
And this would support theories that the developing world is ‘decoupling’ from the fortunes of the wealthy nations.
INFLATION
Red-hot growth in economies like China and India are combining with supply disruptions and speculative fervour to send oil and food prices through the roof. Inflation raises the cost of living and doing business and poses political problems for governments worldwide.
What caused this?
THE world economy has been booming in the past few years, led by the United States, which bounced back from the dot.com debacle on the back of cheap credit provided by the Fed.
At the same time, nationalistic trade barriers were reduced and the resulting soaring of world trade has helped spread the good times to emerging economies, which tapped on cheap land and labour resources to become key beneficiaries of the global manufacturing outsourcing phenomenon.
The extended period of growth has caused aggregate demand for goods and services to catch up with - and in some cases exceed - supply capacities, putting pressure on prices to rise.
In particular, the growing economies of China and India have been sucking up much of the world’s commodities, such as steel, as both countries race to build up infrastructure with their new-found wealth.
The rapid development of the two economies has given rise to the emergence of a significant middle class that is further accelerating consumption growth, from food to luxury goods.
Inflation is also on the rise because of several supply shocks to key commodities such as oil and food.
Ongoing tensions in the Middle East and production disruptions elsewhere have added to price pressures.
Crop failures caused by bad weather, such as the recent devastating winter storms in China, and farmers switching the use of their farmland to the growth of biofuel crops, instead of crops for consumption, have also exacerbated food inflation.
Experts add that the record-breaking commodity prices of late are also partly due to speculative trading by investors who are betting on the price rises to accelerate.
More recently, the US Federal Reserve’s rate cuts and liquidity injections have devalued the US dollar significantly. As commodity prices are denominated in the greenback, the falling dollar means higher prices.
How is this a threat?
INFLATION around the world is sending the cost of living and doing business into an upward spiral.
Energy costs have surged on record oil prices, while food inflation is fast becoming a social and political hot potato for many governments.
Crude oil has gone past the US$100 (S$139) a barrel level, while wheat prices are 2.5 times higher than a year ago.
The problem seems acute in China, which saw inflation hit a 12-year high of 8.7 per cent in February. And since the mainland has become one of the key manufacturing locations for the world, there are fears that inflation there will eventually be passed on to other countries.
Concerns are growing that persistently high inflation could trigger a ‘wage-price spiral’.
As workers become convinced that prices will keep rising, they demand higher wages to protect their purchasing power.
But this in turn would fuel inflation further in a vicious circle that will be hard to break.
While some amount of price increase is inevitable in a growing economy, high inflation rates ultimately hurt as they create uncertainty over how much money earned today will buy tomorrow.
As a result, consumers may hold back on long-term commitments like home purchases, while businesses hold back on investments as they are unsure about their bottom line.
Economists also say that in times of runaway prices, companies and individuals may end up spending more time and resources avoiding inflation, instead of productive activities.
What’s being done?
THE typical way policymakers deal with inflation is to cool economic activity by tightening credit conditions.
But coming at a time when economic growth is slowing and credit is tight because of paranoia in the markets, central bankers are finding it tricky to employ tried and tested means to solve the problem.
The dilemma they have is how to strike a balance between stimulating growth and curbing inflation.
Most of the world’s central banks have decided that inflation is the bigger threat. Many (like in Australia) have therefore raised interest rates, while others (like in China) have reined in lending by requiring banks to keep more cash on hand.
The clear exception is the Fed, which has been doing just the opposite, cutting rates aggressively.
As the US is the epicentre of the financial crisis and the economic slowdown, the Fed has little choice in this.
Still, it has sought to affirm its commitment to the inflation-busting part of its mandate by flagging price rise concerns in its public statements.
Some say that inflation concerns are already causing it to hold back on even bigger rate cuts.
What’s next?
INFLATION pressures are likely to persist at least until the middle of the year, when slowing economic growth could take some pressure off prices.
Indeed, commodity prices had eased last week as investor concerns over the US financial sector and the weakening dollar rose.
Central banks outside of the US, especially those in Asia, will likely continue to prioritise inflation in their policy actions.
For Asia’s export-heavy economies, keeping costs low for manufacturers will be key at a time when their most important customers are suffering.
Confused by the current financial turmoil? You are not alone. Why are some central banks cutting interest rates even as others raise theirs? And what’s the difference between cutting the main Fed funds rate and the discount rate? Bryan Lee says the key to understanding the crisis is to see it as a three-headed monster: a credit problem in the banking sector, a US-led economic slowdown worldwide, and sky-high inflation the world hasn’t seen in a while.
THE CREDIT CRISIS
Dodgy investments in sub-prime mortgages mean billions in losses that the market cannot even calculate. The result is near paralysis in lending markets and a paranoia which has led to runs on banks like the storied US investment bank Bear Stearns and Britain’s Northern Rock.
What caused this?
THE current woes faced by the United States financial sector have their roots in a housing bubble that formed between 2001 and 2005, when the Federal Reserve kept interest rates low to help the US economy recover after the dot.com bubble burst.
When the housing market started to falter in late 2005, homebuyers who had borrowed beyond their means began to default on their loans. And they were unable to refinance their mortgages as planned when times were better.
By early last year, specialist lenders who gave loans to these risky or ’sub-prime’ borrowers started to collapse as defaults accelerated.
A few months later, the debacle caught up with regular banks and hedge funds around the world, which had indirectly funded the sub-prime loans by buying into complex financial instruments such as ‘CDOs’ (collateralised debt obligations).
Although these investments comprised more than just sub-prime debt, and often were packaged with good loans, entire tranches of these investments have become almost worthless as mortgage defaults mount.
The complexity of the securities makes it impossible for investors to separate the grain from the chaff and give a market value to them.
How is this a threat?
MANY banks bought into sub-prime debt and the market has been left guessing exactly how much losses each financial institution might sustain.
Banks have therefore become more reluctant to lend to one another, even for regular trading activities, as they fear that commitments once assumed vault-safe may not be honoured.
If paranoia sets in and the reluctance to extend credit becomes indiscriminate, the whole financial system could seize up and become paralysed.
Even though banks have collectively written down about US$150 billion (S$207 billion) in sub-prime related losses, there remains much nervousness that more losses may be unveiled.
Aggressive players which fund their activities primarily by borrowing money from other banks are especially at risk of failure, as was the case with the No.5 US investment bank Bear Stearns.
But the heavy reliance on credit by the financial sector in general means that no bank is safe from a run.
Bear Stearns has been rescued with help from the US Federal Reserve. But had it gone under, it would have had serious knock-on effects on the rest of the industry as banks today are intricately linked with one another.
The fall of Bear Stearns has exacerbated the crisis of confidence and adds to fears that no bank is too big to fall.
So far, the credit crunch has been felt most acutely in the US, although there are fears that the malaise is spreading to Europe and Asia, where several banks have already taken big hits on their sub-prime investments.
Indeed, British bank Northern Rock suffered a run last September when it fell foul to tightening credit conditions that emerged soon after the US sub-prime fiasco erupted.
If the US housing market continues to tank, the risk of a global melt-down will rise.
That’s because higher quality mortgage instruments, which European and Asian banks have invested money in bigger quantities, will also be in jeopardy.
What’s being done?
TO ENCOURAGE banks to lend to one another, the US Federal Reserve has been pumping cash, or liquidity, into the banking sector.
It has done this by making available hundreds of billions of dollars in emergency loans since last December.
Last Sunday, it extended the facility to non-deposit-taking banks to 20 primary dealers including investment banks and securities firms. This was the first time it has done so since the Great Depression.
The Fed has also made these emergency funds cheaper. Since last August, it has been slashing what is known as the ‘discount rate’, reducing the interest it charges for these emergency loans from 6.25 per cent to 2.75 per cent.
The Fed also played a key role in keeping Bear Stearns afloat, putting up a US$30 billion guarantee for buyer JPMorgan Chase on Bear Stearn’s most illiquid assets.
It argued that if Bear Stearns had collapsed, it would have led to a larger crisis of confidence that might have taken other banks down with it.
Elsewhere, other central banks have similarly been pumping cash into their financial sectors. A number, such as the Bank of England, have had to bail out failed banks in their jurisdictions.
What’s next?
MORE sub-prime losses seem to be on the cards, with the International Monetary Fund predicting that total write-downs in the global financial world could swell to US$800 billion eventually, from about US$150 billion already reported.
Experts say that there is ample liquidity to go around, but paranoia is still high, preventing the money from circulating within financial markets.
The Fed’s actions have so far had limited effect in preventing confidence from worsening, and economists say the crisis will continue until the US housing market bottoms out.
Only then will the market be able to assess the full extent of losses sustained by mortgage-related investments.
The market can then price these securities and accurately evaluate how much this has hit banks’ bottom lines.
Only then, they say, will the paralysing fear that has kept many investors on the sidelines abate.
Experts say there is ample liquidity to go around, but paranoia is still high, preventing the money from circulating within financial markets.
U.S.-LED GLOBAL SLOWDOWN
The housing slump and the credit crisis in the US has eroded consumer confidence and is plunging the US into a recession. If the recession is deep, economic growth in the rest of the world will also slow down given the US economy’s size and influence in the world order.
What caused this?
AGAIN, it is the housing slump that is at the root of the US downturn, which many now believe has deteriorated into a recession.
Consumer spending, which constitutes about 70 per cent of the US gross domestic product (GDP), is starting to slow as household wealth is falling - for the first time in five years - with declines in home values.
During the recent boom years, many US consumers had depended on the buoyant property market to feed their spending appetites. They re-mortgaged their homes to buy second homes or cars, and banks were willing to lend them the money because house prices were on the rise.
But now that the market has gone south, US consumers are starting to curb their expenditures, especially those who had taken up mortgages beyond their means and are now forced to abandon their new homes.
Households and businesses are being further hit by the credit crisis in what the US Federal Reserve has called a ‘negative feedback loop’.
As banks grow increasingly cautious, their reluctance to provide credit will crimp household consumption and business investment, worsening the slowdown.
How is this a threat?
US GROSS domestic product growth has slowed to a crawl since the final quarter of last year.
The slowdown has hit both the manufacturing and services sectors. Unemployment, which many consider to be the ultimate barometer of economic health, is on the rise.
A slowdown in the US economy will invariably have a significant impact on the world, especially export-dependent countries.
Investment bank Goldman Sachs, for instance, has projected that a 1 percentage point decline in US consumption could hit Singapore’s economic growth by close to 0.6 percentage point. That said, many economists also agree that the emergence of China and other economic fast-growers in the developing world will provide some buffer to a US slowdown.
Also, economies with robust domestic sectors should weather the weaker external environment better.
Experts also note that since the current US slowdown is not focused on the technology sector, unlike the 2001 downturn, electronics-heavy Asia may have a slightly easier time weathering the current slowdown.
What’s being done?
THE Fed has been cutting its funds rate since last September, bringing down the benchmark interbank rate from 5.25 per cent to 2.5 per cent. This interest rate, which is different from the discount rate, is the primary monetary pool that the Fed employs to address economic growth and inflation issues.
It works by directly lowering short-term borrowing costs faced by households and companies. Lower rates spur economic activity by making it cheaper for individuals and companies to borrow money for consumption and investments.
But experts note that the Fed’s rate cuts this time round have had little impact. That’s because long-term rates, which are more relevant to homebuyers and businesses, are still high as banks rein in lending as part of the ongoing credit crisis.
Beyond interest rates and other monetary policy efforts, the US government is also employing fiscal measures to boost the economy.
A US$152 billion (S$210 billion) package comprising tax rebates and business incentives has been planned. There is talk of a second stimulus package as recession risks increase.
What’s next?
THE US recession means that global growth this year will undoubtedly be slower than last year. Much will depend on the severity of the credit crisis and the speed of its recovery.
In the US, economists will be watching for signs of a housing turnaround, which is key for normalcy to return to the financial sector.
The European Union and Japan - the other two economic heavyweights - are expected to suffer slower growth. A weakening US dollar has made the euro and yen strong, and is hurting European and Japanese exporters.
The euro zone’s central bank could lower rates to boost the region’s economies, but appears right now to be more committed to keeping rates high to fight inflation.
The Bank of Japan has fewer options since interest rates are already near zero in the country. Furthermore, the central bank faces a vacuum of leadership as politicians are stuck in a stalemate over who should fill the bank’s top job.
The silver lining is that economists are most optimistic about developing countries in Latin America and Asia.
Strong domestic growth could keep emerging economies in both regions on the boil, they say.
And this would support theories that the developing world is ‘decoupling’ from the fortunes of the wealthy nations.
INFLATION
Red-hot growth in economies like China and India are combining with supply disruptions and speculative fervour to send oil and food prices through the roof. Inflation raises the cost of living and doing business and poses political problems for governments worldwide.
What caused this?
THE world economy has been booming in the past few years, led by the United States, which bounced back from the dot.com debacle on the back of cheap credit provided by the Fed.
At the same time, nationalistic trade barriers were reduced and the resulting soaring of world trade has helped spread the good times to emerging economies, which tapped on cheap land and labour resources to become key beneficiaries of the global manufacturing outsourcing phenomenon.
The extended period of growth has caused aggregate demand for goods and services to catch up with - and in some cases exceed - supply capacities, putting pressure on prices to rise.
In particular, the growing economies of China and India have been sucking up much of the world’s commodities, such as steel, as both countries race to build up infrastructure with their new-found wealth.
The rapid development of the two economies has given rise to the emergence of a significant middle class that is further accelerating consumption growth, from food to luxury goods.
Inflation is also on the rise because of several supply shocks to key commodities such as oil and food.
Ongoing tensions in the Middle East and production disruptions elsewhere have added to price pressures.
Crop failures caused by bad weather, such as the recent devastating winter storms in China, and farmers switching the use of their farmland to the growth of biofuel crops, instead of crops for consumption, have also exacerbated food inflation.
Experts add that the record-breaking commodity prices of late are also partly due to speculative trading by investors who are betting on the price rises to accelerate.
More recently, the US Federal Reserve’s rate cuts and liquidity injections have devalued the US dollar significantly. As commodity prices are denominated in the greenback, the falling dollar means higher prices.
How is this a threat?
INFLATION around the world is sending the cost of living and doing business into an upward spiral.
Energy costs have surged on record oil prices, while food inflation is fast becoming a social and political hot potato for many governments.
Crude oil has gone past the US$100 (S$139) a barrel level, while wheat prices are 2.5 times higher than a year ago.
The problem seems acute in China, which saw inflation hit a 12-year high of 8.7 per cent in February. And since the mainland has become one of the key manufacturing locations for the world, there are fears that inflation there will eventually be passed on to other countries.
Concerns are growing that persistently high inflation could trigger a ‘wage-price spiral’.
As workers become convinced that prices will keep rising, they demand higher wages to protect their purchasing power.
But this in turn would fuel inflation further in a vicious circle that will be hard to break.
While some amount of price increase is inevitable in a growing economy, high inflation rates ultimately hurt as they create uncertainty over how much money earned today will buy tomorrow.
As a result, consumers may hold back on long-term commitments like home purchases, while businesses hold back on investments as they are unsure about their bottom line.
Economists also say that in times of runaway prices, companies and individuals may end up spending more time and resources avoiding inflation, instead of productive activities.
What’s being done?
THE typical way policymakers deal with inflation is to cool economic activity by tightening credit conditions.
But coming at a time when economic growth is slowing and credit is tight because of paranoia in the markets, central bankers are finding it tricky to employ tried and tested means to solve the problem.
The dilemma they have is how to strike a balance between stimulating growth and curbing inflation.
Most of the world’s central banks have decided that inflation is the bigger threat. Many (like in Australia) have therefore raised interest rates, while others (like in China) have reined in lending by requiring banks to keep more cash on hand.
The clear exception is the Fed, which has been doing just the opposite, cutting rates aggressively.
As the US is the epicentre of the financial crisis and the economic slowdown, the Fed has little choice in this.
Still, it has sought to affirm its commitment to the inflation-busting part of its mandate by flagging price rise concerns in its public statements.
Some say that inflation concerns are already causing it to hold back on even bigger rate cuts.
What’s next?
INFLATION pressures are likely to persist at least until the middle of the year, when slowing economic growth could take some pressure off prices.
Indeed, commodity prices had eased last week as investor concerns over the US financial sector and the weakening dollar rose.
Central banks outside of the US, especially those in Asia, will likely continue to prioritise inflation in their policy actions.
For Asia’s export-heavy economies, keeping costs low for manufacturers will be key at a time when their most important customers are suffering.
Friday, March 7, 2008
Falling Prey To Herd Mentality
Source : The Straits Times, Mar 7, 2008
U.S. HOUSING WOES
By Robert J. Shiller
ONE great puzzle about the recent housing bubble is why even most experts didn't recognise the bubble as it was forming.
Mr Alan Greenspan, a very serious student of the markets, didn't see it, and, moreover, he didn't see the stock market bubble of the 1990s either. In his 2007 autobiography, The Age Of Turbulence: Adventures In A New World, he talks at some length about his suspicions in the 1990s that there was irrational exuberance in the stock market. But in the end, he says, he just couldn't figure it out: 'I'd come to realise that we'd never be able to identify irrational exuberance with certainty, much less act on it, until after the fact.'
With the housing bubble, Mr Greenspan didn't seem to have any doubt: 'I would tell audiences that we were facing not a bubble but a froth - lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy.'
The failure to recognise the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world.
If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.
Were all these people stupid? It can't be. We have to consider the possibility that perfectly rational people can get caught up in a bubble. In this connection, it is helpful to refer to an important bit of economic theory about herd behaviour.
Three economists, professors Sushil Bikhchandani, David Hirshleifer and Ivo Welch, in a classic 1992 article, defined what they call 'information cascades' that can lead people into serious error.
They found that these cascades can affect even perfectly rational people and cause bubble-like phenomena. Why? Ultimately, people sometimes need to rely on the judgment of others, and therein lies the problem. The theory provides a framework for understanding the real estate turbulence we are now observing.
Prof Bikhchandani and his co-authors present this example: Suppose that a group of individuals must make an important decision, based on useful but incomplete information. Each one of them has received some information relevant to the decision, but the information is incomplete and 'noisy' and does not always point to the right conclusion.
Let's update the example to apply it to the recent bubble: The individuals in the group must each decide whether real estate is a terrific investment and whether to buy some property. Suppose that there is a 60 per cent probability that any one person's information will lead to the right decision.
In other words, that person's information is useful but not definitive - and not clear enough to make a firm judgment about something as momentous as a market bubble. Perhaps that is how Mr Greenspan assessed the probability that he could make an accurate judgment about the stock market bubble.
The theory helps explain why he - or anyone trying to verify the existence of a market bubble - may have squelched his own judgment.
The fundamental problem is that the information obtained by any individual - even one as well-placed as the chairman of the Federal Reserve - is bound to be incomplete.
If people could somehow hold a national town meeting and share their independent information, they would have the opportunity to see the full weight of the evidence. Any individual errors would be averaged out, and the participants would collectively reach the correct decision.
Of course, such a national town meeting is impossible. Each person makes decisions individually, sequentially, and reveals his decisions through actions - in this case, by entering the housing market and bidding up home prices.
Suppose houses are really of low investment value, but the first person to make a decision reaches the wrong conclusion (which happens, as we have assumed, 40 per cent of the time). The first person, A, pays a high price for a home, thus signalling to others that houses are a good investment.
The second person, B, has no problem if his own data seems to confirm the information provided by A's willingness to pay a high price. But B faces a quandary if his own information seems to contradict A's judgment. In that case, B would conclude that he has no worthwhile information, and so he must make an arbitrary decision - say, by flipping a coin to decide whether to buy a house.
The result is that even if houses are of low investment value, we may now have two people who make purchasing decisions that reveal their conclusion that houses are a good investment.
As others make purchases at rising prices, more and more people will conclude that these buyers' information about the market outweighs their own.
Prof Bikhchandani and his co-authors worked out this rational herding story carefully, and their results show that the probability of the cascade leading to an incorrect assumption is 37 per cent. In other words, more than one-third of the time, rational individuals, each given information that is 60 per cent accurate, will reach the wrong collective conclusion.
Thus we should expect to see cascades driving our thinking from time to time, even when everyone is absolutely rational and calculating.
This theory poses a major challenge to the 'efficient markets' view of the world, which assumes that investors are like independent-minded voters, relying only on their own information to make decisions.
The 'efficient markets' view holds that the market is wiser than any individual: In aggregate, the market will come to the correct decision. But the theory is flawed because it does not recognise that people must rely on the judgments of others.
Now, let's modify the Bikhchandani-Hirshleifer-Welch example again, so that the individuals are no longer purely rational beings. Instead, they are real people, subject to emotional reactions.
Furthermore, these people are being influenced by agencies like the National Association of Realtors, which is conducting a public-relations campaign intended to show that putting money into housing is a reliable way to build wealth.
Under these circumstances, it is easy to understand how even experts could come to believe that housing is a spectacular investment.
It is clear that just such an information cascade helped to create the housing bubble. And it is now possible that a downward cascade will develop - in which rational individuals become excessively pessimistic as they see others bidding down home prices to abnormally low levels.
The writer is professor of economics and finance at Yale University and co-founder and chief economist of MacroMarkets LLC.
Copyright: New York Times
U.S. HOUSING WOES
By Robert J. Shiller
ONE great puzzle about the recent housing bubble is why even most experts didn't recognise the bubble as it was forming.
Mr Alan Greenspan, a very serious student of the markets, didn't see it, and, moreover, he didn't see the stock market bubble of the 1990s either. In his 2007 autobiography, The Age Of Turbulence: Adventures In A New World, he talks at some length about his suspicions in the 1990s that there was irrational exuberance in the stock market. But in the end, he says, he just couldn't figure it out: 'I'd come to realise that we'd never be able to identify irrational exuberance with certainty, much less act on it, until after the fact.'
With the housing bubble, Mr Greenspan didn't seem to have any doubt: 'I would tell audiences that we were facing not a bubble but a froth - lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy.'
The failure to recognise the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world.
If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.
Were all these people stupid? It can't be. We have to consider the possibility that perfectly rational people can get caught up in a bubble. In this connection, it is helpful to refer to an important bit of economic theory about herd behaviour.
Three economists, professors Sushil Bikhchandani, David Hirshleifer and Ivo Welch, in a classic 1992 article, defined what they call 'information cascades' that can lead people into serious error.
They found that these cascades can affect even perfectly rational people and cause bubble-like phenomena. Why? Ultimately, people sometimes need to rely on the judgment of others, and therein lies the problem. The theory provides a framework for understanding the real estate turbulence we are now observing.
Prof Bikhchandani and his co-authors present this example: Suppose that a group of individuals must make an important decision, based on useful but incomplete information. Each one of them has received some information relevant to the decision, but the information is incomplete and 'noisy' and does not always point to the right conclusion.
Let's update the example to apply it to the recent bubble: The individuals in the group must each decide whether real estate is a terrific investment and whether to buy some property. Suppose that there is a 60 per cent probability that any one person's information will lead to the right decision.
In other words, that person's information is useful but not definitive - and not clear enough to make a firm judgment about something as momentous as a market bubble. Perhaps that is how Mr Greenspan assessed the probability that he could make an accurate judgment about the stock market bubble.
The theory helps explain why he - or anyone trying to verify the existence of a market bubble - may have squelched his own judgment.
The fundamental problem is that the information obtained by any individual - even one as well-placed as the chairman of the Federal Reserve - is bound to be incomplete.
If people could somehow hold a national town meeting and share their independent information, they would have the opportunity to see the full weight of the evidence. Any individual errors would be averaged out, and the participants would collectively reach the correct decision.
Of course, such a national town meeting is impossible. Each person makes decisions individually, sequentially, and reveals his decisions through actions - in this case, by entering the housing market and bidding up home prices.
Suppose houses are really of low investment value, but the first person to make a decision reaches the wrong conclusion (which happens, as we have assumed, 40 per cent of the time). The first person, A, pays a high price for a home, thus signalling to others that houses are a good investment.
The second person, B, has no problem if his own data seems to confirm the information provided by A's willingness to pay a high price. But B faces a quandary if his own information seems to contradict A's judgment. In that case, B would conclude that he has no worthwhile information, and so he must make an arbitrary decision - say, by flipping a coin to decide whether to buy a house.
The result is that even if houses are of low investment value, we may now have two people who make purchasing decisions that reveal their conclusion that houses are a good investment.
As others make purchases at rising prices, more and more people will conclude that these buyers' information about the market outweighs their own.
Prof Bikhchandani and his co-authors worked out this rational herding story carefully, and their results show that the probability of the cascade leading to an incorrect assumption is 37 per cent. In other words, more than one-third of the time, rational individuals, each given information that is 60 per cent accurate, will reach the wrong collective conclusion.
Thus we should expect to see cascades driving our thinking from time to time, even when everyone is absolutely rational and calculating.
This theory poses a major challenge to the 'efficient markets' view of the world, which assumes that investors are like independent-minded voters, relying only on their own information to make decisions.
The 'efficient markets' view holds that the market is wiser than any individual: In aggregate, the market will come to the correct decision. But the theory is flawed because it does not recognise that people must rely on the judgments of others.
Now, let's modify the Bikhchandani-Hirshleifer-Welch example again, so that the individuals are no longer purely rational beings. Instead, they are real people, subject to emotional reactions.
Furthermore, these people are being influenced by agencies like the National Association of Realtors, which is conducting a public-relations campaign intended to show that putting money into housing is a reliable way to build wealth.
Under these circumstances, it is easy to understand how even experts could come to believe that housing is a spectacular investment.
It is clear that just such an information cascade helped to create the housing bubble. And it is now possible that a downward cascade will develop - in which rational individuals become excessively pessimistic as they see others bidding down home prices to abnormally low levels.
The writer is professor of economics and finance at Yale University and co-founder and chief economist of MacroMarkets LLC.
Copyright: New York Times
Sub-Prime: Six Lessons, And Counting
Source : The Business Times, March 7, 2008
The more things change, the more they stay the same - the US fiasco has thrown up mostly old lessons to be re-learned.
EVERY financial crisis has its lessons. Most of them are old lessons which need to be relearned. Here are six (and still counting) from the United States sub-prime crisis:
1. Financial innovation is not always innovative, nor benign
Many of the so-called financial innovations at the root of the sub-prime crisis have been seen before, in previous crises. For example, the securitisation of credit (the packaging of loans and other financial assets into marketable securities) and the ‘originate and distribute’ model (whereby financial institutions create various financial instruments and then distribute them to investors) were in evidence during the run-up to the great stockmarket crash on Wall Street in 1929. At that time, banks originated and ingeniously repackaged highly speculative loans and marketed them through their own networks.
Similarly, in the run-up to the current crisis, financial institutions creatively sliced up sub-prime mortgages and packaged them into ‘collateralised debt obligations’ (CDOs), which ultimately found their way into the portfolios of investors around the world, including many large banks.
Many other features of the sub-prime crisis - the use of leverage, the opaqueness of investment instruments and their multi-layered structures - evoke, likewise, a sense of deja vu.
Amid boom times, the lessons of the past are not always remembered. As one of the sharpest observers of financial crashes through history, late economist John Kenneth Galbraith pointed out: ‘In the world of high and confident finance, little is ever really new. The controlling fact is not the tendency to brilliant invention; the controlling fact is the shortness of the public memory, especially when it contends with a euphoric desire to forget.’
2. Gatekeepers tend to be behind the curve
In the sub-prime crisis, the main ‘gatekeepers’ can be said to have been the credit rating agencies. They were unable to spot the excesses when it really mattered. This again is not new. It also happened before the crash of 1929, when credit raters were too liberal with their seals of approval and were unable to anticipate the sharp drop in bond values or the defaults that were to come.
More recently, we saw during the Asian financial crisis of 1997 how many Asian economies enjoyed high sovereign ratings prior to the crisis, even on the eve of the crisis itself. But once the crisis hit and the rating blunders became obvious, the credit raters overcompensated in the opposite direction, subjecting Asian economies to downgrades of extreme severity - which made the crisis worse.
Rating agencies were again caught flatfooted by the collapse in 1999 of US energy giant Enron - which they had also rated highly. US Senator Joseph Lieberman, whose Senate committee held the first public hearings on Enron, described the credit raters as ‘dismally lax’. ‘They didn’t ask probing questions and generally accepted at face value whatever Enron’s officials chose to tell them,’ he said.
Similarly in the sub-prime crisis, most CDOs - despite being highly opaque - were rated AAA (the highest rating, which explains their popularity among investors). After the soundness of CDOs and other mortgage-related bonds became obviously suspect, their ratings were furiously downgraded. Remarkably, the bond insurers who insured CDOs were also given AAA ratings. When the insurers’ exposure to these toxic instruments became clear, the rating agencies threatened to downgrade the bond insurers as well. But if this happens (and it already has, in a few cases), the latter’s business model - and, indeed, very survival - is threatened, because few entities would want to be insured by a insurer that is less than financially sound.
At least when it comes to their ratings of the bond insurers, the credit rating agencies can be said to have been not just behind the curve, but asleep on the job. As Professor Nouriel Roubini of New York University (and one of the first to raise the alarm about the sub-prime crisis) put it: ‘Any business that needs a triple-A rating to remain in business doesn’t deserve a triple-A rating in the first place.’
3. Self regulation does not work
Prior to the sub-prime crisis, US financial markets relied heavily on self-regulation, even for highly leveraged entities such as hedge funds and private equity funds. Financial institutions have been free to ‘innovate’, including to create highly complex and opaque instruments and various ‘off-balance sheet’ vehicles like conduits and ’structured investment vehicles’ or SIVs (which are in fact driven precisely by the desire to avoid regulatory requirements, such as minimum capital and liquidity standards). A number of ‘innovative’ loans (such as ‘liar loans’ which did not need any income verification and ‘piggyback loans’, which involved no downpayments) also became common.
Self regulation was also de rigueur in the run-up to previous crises. Before the Asian crisis, for instance, regulation of banks was either light or not enforced, which enabled such excesses as lending based on relationships rather than creditworthiness to flourish and unregulated entities like finance companies to operate with wanton disregard for risk. The years before the 1929 stockmarket crash were likewise attended by extremely lax regulations on financial institutions which led to the proliferation of all manner of wondrous investment schemes and structures.
Each crisis has been followed by regulatory catch-up, as the lesson is re-learned that voluntary codes of conduct and self-regulation is no regulation without vigilant official surveillance, at a minimum. Also, that some rules are needed to protect investors and financial institutions - ultimately, from themselves - and to guard against systemic risk.
4. Consumer spending can be artificial
Much of the US economic boom since 2002, in particular, has been driven by consumer spending, which accounts for more than 70 per cent of US GDP. The exuberance of the American consumer has been considered a litmus test of the health of the US economy. However, much of consumer spending was financed not out of savings but out of debt, in an era of super-low interest rates. It was also inflated by rising home prices: consumers with mortgages were able to draw ‘cash out’ by refinancing, often repeatedly; the bigger the mortgage, the more the home could be used as an ATM. The high ratings given to mortgage-backed securities which the banks peddled to investors fuelled ever more generous terms on mortgages, further inflating the home -equity-financed consumer spending binge.
A lesson: beware of debt-financed consumption as a sustainable driver of economic growth, and/or financial markets - all the more so if the debt is based on rising home prices.
5. You can bet against the Fed
There’s a popular saying in the markets: ‘Never bet against the Fed.’ Some of the events of the sub-prime crisis prove that this is not always true. Throughout 2006 and most of 2007, the US Federal Reserve’s assessments of the risks facing the US economy and financial markets - particularly the assertion that the US sub-prime crisis would be ‘contained’ - were way off the mark. Anybody who bet otherwise (and some did) and went short in the markets would have done well. Also, repeated interest rate cuts by the Fed (by 2.25 percentage points in the last six months) have failed to lift either the US economy or the stock markets. Part of the reason is that the Fed cannot do much in the short term to help troubled banks recapitalise. Its rate cuts also cannot directly resolve the problems facing non-depository financial institutions like hedge funds, investment banks and off-balance sheet entities like SIVs.
Whether the Fed’s rate cuts can avert a US recession during the current crisis also remains to be seen. On some previous occasions (most recently, the period following the dotcom bust of 2001), they were unable to do so.
6. When in trouble, bankers embrace socialism
The often spectacular gains that bankers make during boom times accrue to shareholders, employees and, above all, top bank executives. But in terrible times, such as now in the US, losses are, more often than not, sought to be dumped on governments - in other words, on taxpayers.
In the current crisis, the most prominent case so far has been the nationalisation of the British bank Northern Rock, for whose imprudence British taxpayers will end up paying tens of billions of pounds. In the US, while there have been no comparably overt bailouts (although we could yet see some), banks have been getting low-cost loans from the Fed and other government agencies, using collateral of questionable value. There are also various bank-supported plans afoot to expand the guarantees provided by US federal agencies for mortgage refinancings by delinquent borrowers.
At the end of the day, the final tab picked up by the US government to pay for the banks’ recklessness could well end up being several times as large as the approximately US$150 billion spent on the bailouts of the US savings and loan (S&L) institutions during the last significant banking crisis - the S&L crisis of the 1990s.
Similar bailouts have taken place over and over in the history of the banking industry, going back decades. As Martin Wolf, chief economics commentator of the Financial Times, put it recently: ‘No industry has a comparable talent for privatising gains and socialising losses.’
The more things change, the more they stay the same - the US fiasco has thrown up mostly old lessons to be re-learned.
EVERY financial crisis has its lessons. Most of them are old lessons which need to be relearned. Here are six (and still counting) from the United States sub-prime crisis:
1. Financial innovation is not always innovative, nor benign
Many of the so-called financial innovations at the root of the sub-prime crisis have been seen before, in previous crises. For example, the securitisation of credit (the packaging of loans and other financial assets into marketable securities) and the ‘originate and distribute’ model (whereby financial institutions create various financial instruments and then distribute them to investors) were in evidence during the run-up to the great stockmarket crash on Wall Street in 1929. At that time, banks originated and ingeniously repackaged highly speculative loans and marketed them through their own networks.
Similarly, in the run-up to the current crisis, financial institutions creatively sliced up sub-prime mortgages and packaged them into ‘collateralised debt obligations’ (CDOs), which ultimately found their way into the portfolios of investors around the world, including many large banks.
Many other features of the sub-prime crisis - the use of leverage, the opaqueness of investment instruments and their multi-layered structures - evoke, likewise, a sense of deja vu.
Amid boom times, the lessons of the past are not always remembered. As one of the sharpest observers of financial crashes through history, late economist John Kenneth Galbraith pointed out: ‘In the world of high and confident finance, little is ever really new. The controlling fact is not the tendency to brilliant invention; the controlling fact is the shortness of the public memory, especially when it contends with a euphoric desire to forget.’
2. Gatekeepers tend to be behind the curve
In the sub-prime crisis, the main ‘gatekeepers’ can be said to have been the credit rating agencies. They were unable to spot the excesses when it really mattered. This again is not new. It also happened before the crash of 1929, when credit raters were too liberal with their seals of approval and were unable to anticipate the sharp drop in bond values or the defaults that were to come.
More recently, we saw during the Asian financial crisis of 1997 how many Asian economies enjoyed high sovereign ratings prior to the crisis, even on the eve of the crisis itself. But once the crisis hit and the rating blunders became obvious, the credit raters overcompensated in the opposite direction, subjecting Asian economies to downgrades of extreme severity - which made the crisis worse.
Rating agencies were again caught flatfooted by the collapse in 1999 of US energy giant Enron - which they had also rated highly. US Senator Joseph Lieberman, whose Senate committee held the first public hearings on Enron, described the credit raters as ‘dismally lax’. ‘They didn’t ask probing questions and generally accepted at face value whatever Enron’s officials chose to tell them,’ he said.
Similarly in the sub-prime crisis, most CDOs - despite being highly opaque - were rated AAA (the highest rating, which explains their popularity among investors). After the soundness of CDOs and other mortgage-related bonds became obviously suspect, their ratings were furiously downgraded. Remarkably, the bond insurers who insured CDOs were also given AAA ratings. When the insurers’ exposure to these toxic instruments became clear, the rating agencies threatened to downgrade the bond insurers as well. But if this happens (and it already has, in a few cases), the latter’s business model - and, indeed, very survival - is threatened, because few entities would want to be insured by a insurer that is less than financially sound.
At least when it comes to their ratings of the bond insurers, the credit rating agencies can be said to have been not just behind the curve, but asleep on the job. As Professor Nouriel Roubini of New York University (and one of the first to raise the alarm about the sub-prime crisis) put it: ‘Any business that needs a triple-A rating to remain in business doesn’t deserve a triple-A rating in the first place.’
3. Self regulation does not work
Prior to the sub-prime crisis, US financial markets relied heavily on self-regulation, even for highly leveraged entities such as hedge funds and private equity funds. Financial institutions have been free to ‘innovate’, including to create highly complex and opaque instruments and various ‘off-balance sheet’ vehicles like conduits and ’structured investment vehicles’ or SIVs (which are in fact driven precisely by the desire to avoid regulatory requirements, such as minimum capital and liquidity standards). A number of ‘innovative’ loans (such as ‘liar loans’ which did not need any income verification and ‘piggyback loans’, which involved no downpayments) also became common.
Self regulation was also de rigueur in the run-up to previous crises. Before the Asian crisis, for instance, regulation of banks was either light or not enforced, which enabled such excesses as lending based on relationships rather than creditworthiness to flourish and unregulated entities like finance companies to operate with wanton disregard for risk. The years before the 1929 stockmarket crash were likewise attended by extremely lax regulations on financial institutions which led to the proliferation of all manner of wondrous investment schemes and structures.
Each crisis has been followed by regulatory catch-up, as the lesson is re-learned that voluntary codes of conduct and self-regulation is no regulation without vigilant official surveillance, at a minimum. Also, that some rules are needed to protect investors and financial institutions - ultimately, from themselves - and to guard against systemic risk.
4. Consumer spending can be artificial
Much of the US economic boom since 2002, in particular, has been driven by consumer spending, which accounts for more than 70 per cent of US GDP. The exuberance of the American consumer has been considered a litmus test of the health of the US economy. However, much of consumer spending was financed not out of savings but out of debt, in an era of super-low interest rates. It was also inflated by rising home prices: consumers with mortgages were able to draw ‘cash out’ by refinancing, often repeatedly; the bigger the mortgage, the more the home could be used as an ATM. The high ratings given to mortgage-backed securities which the banks peddled to investors fuelled ever more generous terms on mortgages, further inflating the home -equity-financed consumer spending binge.
A lesson: beware of debt-financed consumption as a sustainable driver of economic growth, and/or financial markets - all the more so if the debt is based on rising home prices.
5. You can bet against the Fed
There’s a popular saying in the markets: ‘Never bet against the Fed.’ Some of the events of the sub-prime crisis prove that this is not always true. Throughout 2006 and most of 2007, the US Federal Reserve’s assessments of the risks facing the US economy and financial markets - particularly the assertion that the US sub-prime crisis would be ‘contained’ - were way off the mark. Anybody who bet otherwise (and some did) and went short in the markets would have done well. Also, repeated interest rate cuts by the Fed (by 2.25 percentage points in the last six months) have failed to lift either the US economy or the stock markets. Part of the reason is that the Fed cannot do much in the short term to help troubled banks recapitalise. Its rate cuts also cannot directly resolve the problems facing non-depository financial institutions like hedge funds, investment banks and off-balance sheet entities like SIVs.
Whether the Fed’s rate cuts can avert a US recession during the current crisis also remains to be seen. On some previous occasions (most recently, the period following the dotcom bust of 2001), they were unable to do so.
6. When in trouble, bankers embrace socialism
The often spectacular gains that bankers make during boom times accrue to shareholders, employees and, above all, top bank executives. But in terrible times, such as now in the US, losses are, more often than not, sought to be dumped on governments - in other words, on taxpayers.
In the current crisis, the most prominent case so far has been the nationalisation of the British bank Northern Rock, for whose imprudence British taxpayers will end up paying tens of billions of pounds. In the US, while there have been no comparably overt bailouts (although we could yet see some), banks have been getting low-cost loans from the Fed and other government agencies, using collateral of questionable value. There are also various bank-supported plans afoot to expand the guarantees provided by US federal agencies for mortgage refinancings by delinquent borrowers.
At the end of the day, the final tab picked up by the US government to pay for the banks’ recklessness could well end up being several times as large as the approximately US$150 billion spent on the bailouts of the US savings and loan (S&L) institutions during the last significant banking crisis - the S&L crisis of the 1990s.
Similar bailouts have taken place over and over in the history of the banking industry, going back decades. As Martin Wolf, chief economics commentator of the Financial Times, put it recently: ‘No industry has a comparable talent for privatising gains and socialising losses.’
Monday, February 25, 2008
Investment Flows Within ASEAN Not Affected By Sub-Prime Crisis
Source : Channel NewsAsia, 25 February 2008
The sub-prime crisis in the United States has not affected investment flows within ASEAN countries.
Trade and Industry Minister Lim Hng Kiang who was responding to a question from MP for West Coast GRC Ho Geok Choo, in Parliament on Monday, said feedback from companies show interest within the region remains strong.
As at 2006, the total foreign direct investment (FDI) from other ASEAN countries to Singapore stood at over S$10 billion with the top investors being Malaysia, Thailand and Indonesia.
Mr Lim added that ASEAN also remains as the top investment region for Singapore companies.
The city-state's key investment countries are Malaysia, Indonesia, Thailand, the Philippines and Vietnam.
Singapore companies’ investment in Malaysia and Indonesia, its top two investment destinations within ASEAN, amounted to S$16 and S$15 billion respectively.
Mr Lim said: "The stock of direct investment for Singapore companies into ASEAN stood at S$50 billion as at end 2006, accounting for nearly one quarter of Singapore's total direct investment stock abroad.
“We will continue to encourage companies to invest in ASEAN and draw on the unique strength of each ASEAN nation. Increased intra-ASEAN investments flows are important as they will result in tighter regional integration. That will enhance the overall competitiveness of ASEAN." -CNA/vm
The sub-prime crisis in the United States has not affected investment flows within ASEAN countries.
Trade and Industry Minister Lim Hng Kiang who was responding to a question from MP for West Coast GRC Ho Geok Choo, in Parliament on Monday, said feedback from companies show interest within the region remains strong. As at 2006, the total foreign direct investment (FDI) from other ASEAN countries to Singapore stood at over S$10 billion with the top investors being Malaysia, Thailand and Indonesia.
Mr Lim added that ASEAN also remains as the top investment region for Singapore companies.
The city-state's key investment countries are Malaysia, Indonesia, Thailand, the Philippines and Vietnam.
Singapore companies’ investment in Malaysia and Indonesia, its top two investment destinations within ASEAN, amounted to S$16 and S$15 billion respectively.
Mr Lim said: "The stock of direct investment for Singapore companies into ASEAN stood at S$50 billion as at end 2006, accounting for nearly one quarter of Singapore's total direct investment stock abroad.
“We will continue to encourage companies to invest in ASEAN and draw on the unique strength of each ASEAN nation. Increased intra-ASEAN investments flows are important as they will result in tighter regional integration. That will enhance the overall competitiveness of ASEAN." -CNA/vm
Wednesday, February 20, 2008
S'pore Central Bank Says Challenge To Stop Credit Crisis Spiral
Source : The Straits Times, Feb 19, 2008
SINGAPORE'S central bank on Tuesday warned that the global credit crisis may spread and said the main challenge was to stop it from bleeding the real economy.
'At this point there is a risk of being caught in a negative spiral. Tightening credit standards and reduced credit availability will be mutually reinforcing with the slowing of the macro economy,' Heng Swee Keat, managing director of the Monetary Authority of Singapore, said in a speech.
'The immediate challenge for policy makers is to contain the spread of the credit crisis to the real economy, to prevent this spiral,' he said at the IMAS investment conference.
Mr Heng said that limiting the scope of the crisis was difficult as the level of exposure to risky debt was unclear, and because central bankers faced different degrees of slowing growth and inflationary pressures in their economies.
'This time last year, the global economic outlook was positive. Today, it has become a lot more uncertain.'
Swiss bank Credit Suisse became the latest casualty of the credit crisis on Tuesday, when said it wrote $2.85 billion off the value of its asset-backed investments and found mismarking and pricing errors on its books, sending its shares plummeting.
Mr Heng said that while only a few investment funds had experienced withdrawals of funds but that this could change if markets carried on falling.
'If asset prices continue to decline, investors may react differently.This is a risk we need to watch.'
'In this state of flux, central banks and financial regulators need to be on heightened alert and respond decisively to developments that might further threaten global growth or financial stability.' -- REUTERS
SINGAPORE'S central bank on Tuesday warned that the global credit crisis may spread and said the main challenge was to stop it from bleeding the real economy.
'At this point there is a risk of being caught in a negative spiral. Tightening credit standards and reduced credit availability will be mutually reinforcing with the slowing of the macro economy,' Heng Swee Keat, managing director of the Monetary Authority of Singapore, said in a speech.
'The immediate challenge for policy makers is to contain the spread of the credit crisis to the real economy, to prevent this spiral,' he said at the IMAS investment conference.
Mr Heng said that limiting the scope of the crisis was difficult as the level of exposure to risky debt was unclear, and because central bankers faced different degrees of slowing growth and inflationary pressures in their economies.
'This time last year, the global economic outlook was positive. Today, it has become a lot more uncertain.'
Swiss bank Credit Suisse became the latest casualty of the credit crisis on Tuesday, when said it wrote $2.85 billion off the value of its asset-backed investments and found mismarking and pricing errors on its books, sending its shares plummeting.
Mr Heng said that while only a few investment funds had experienced withdrawals of funds but that this could change if markets carried on falling.
'If asset prices continue to decline, investors may react differently.This is a risk we need to watch.'
'In this state of flux, central banks and financial regulators need to be on heightened alert and respond decisively to developments that might further threaten global growth or financial stability.' -- REUTERS
Tuesday, February 12, 2008
Write-Downs From Sub-Prime Problems Could Touch $568b
Source : The Straits Times, Feb 12, 2008
THE bloodbath is not over yet.
Sub-prime-related write- offs may hit US$400 billion (S$567.8 billion) - more than treble the US$130 billion losses that Wall Street banks and other financial institutions have revealed in recent weeks, according to the world's top finance officials.
Speaking on Saturday after last weekend's Group of Seven (G-7) meeting in Tokyo, German Finance Minister Peer Steinbrueck said the grouping now feared that write-offs of losses on securities linked to United States sub-prime mortgages could reach US$400 billion.
This is also far bigger than the US Federal Reserve's estimates for sub-prime losses last year of US$100 billion to US$150 billion.
According to Bank of Italy governor Mario Draghi, the next two weeks will be critical in revealing how much damage the credit crisis has done to the global financial system.
'The next 10 days to two weeks will be crucial because we are going to have the first audited accounts from financial institutions since the crisis started,' said Mr Draghi, who is the chairman of the Financial Stability Forum (FSF). The FSF, a committee of international regulators and central bankers, is heading an international inquiry into the crisis.
Some of the world's biggest banks have already disclosed billions of dollars of bad credits related to the US sub-prime mortgage market collapse, but these are only preliminary estimates, he added.
'Auditors have become more vigilant' as the fallout from the sub-prime crisis continues to spread and audited accounts for last year could reveal a grimmer picture, Mr Draghi told The Business Times.
The FSF's preliminary report at the G-7 meeting warned that 'there remains risk that further shocks may lead to a recurrence of the acute liquidity pressures experienced last year', adding that 'it is likely we face a prolonged adjustment, which could be difficult'.
Mr Draghi also said regulators were ready to force banks to reveal their losses and replenish their equity ratios.
He did not rule out the possibility that governments might eventually need to inject capital into banks, although he stressed that market solutions should take precedence. The FSF will issue its full report on the causes of the credit crisis and ways to tackle it in April.
The G-7 policymakers, in their statement, painted a grim picture, saying the US economy may slow further, eroding global growth, while banks, despite falling interest rates, will tighten credit even further.
While the G-7 did not propose specific measures, European Central Bank (ECB) president Jean-Claude Trichet said countries will do what was necessary, both individually and collectively, to counter a 'significant market correction'.
Economists, however, said the ECB is held back from cutting interest rates by its fears of rising inflation.
'The problems are going right through all parts of the financial markets and there's not much the G-7 can do about this,' Mr Gilles Moec, an economist at Bank of America in London, told Australia's The Age newspaper.
'There's a danger that the downturn will become a self- fulfilling prophecy,' he was quoted as saying.
THE bloodbath is not over yet.
Sub-prime-related write- offs may hit US$400 billion (S$567.8 billion) - more than treble the US$130 billion losses that Wall Street banks and other financial institutions have revealed in recent weeks, according to the world's top finance officials.
Speaking on Saturday after last weekend's Group of Seven (G-7) meeting in Tokyo, German Finance Minister Peer Steinbrueck said the grouping now feared that write-offs of losses on securities linked to United States sub-prime mortgages could reach US$400 billion.
This is also far bigger than the US Federal Reserve's estimates for sub-prime losses last year of US$100 billion to US$150 billion.
According to Bank of Italy governor Mario Draghi, the next two weeks will be critical in revealing how much damage the credit crisis has done to the global financial system.
'The next 10 days to two weeks will be crucial because we are going to have the first audited accounts from financial institutions since the crisis started,' said Mr Draghi, who is the chairman of the Financial Stability Forum (FSF). The FSF, a committee of international regulators and central bankers, is heading an international inquiry into the crisis.
Some of the world's biggest banks have already disclosed billions of dollars of bad credits related to the US sub-prime mortgage market collapse, but these are only preliminary estimates, he added.
'Auditors have become more vigilant' as the fallout from the sub-prime crisis continues to spread and audited accounts for last year could reveal a grimmer picture, Mr Draghi told The Business Times.
The FSF's preliminary report at the G-7 meeting warned that 'there remains risk that further shocks may lead to a recurrence of the acute liquidity pressures experienced last year', adding that 'it is likely we face a prolonged adjustment, which could be difficult'.
Mr Draghi also said regulators were ready to force banks to reveal their losses and replenish their equity ratios.
He did not rule out the possibility that governments might eventually need to inject capital into banks, although he stressed that market solutions should take precedence. The FSF will issue its full report on the causes of the credit crisis and ways to tackle it in April.
The G-7 policymakers, in their statement, painted a grim picture, saying the US economy may slow further, eroding global growth, while banks, despite falling interest rates, will tighten credit even further.
While the G-7 did not propose specific measures, European Central Bank (ECB) president Jean-Claude Trichet said countries will do what was necessary, both individually and collectively, to counter a 'significant market correction'.
Economists, however, said the ECB is held back from cutting interest rates by its fears of rising inflation.
'The problems are going right through all parts of the financial markets and there's not much the G-7 can do about this,' Mr Gilles Moec, an economist at Bank of America in London, told Australia's The Age newspaper.
'There's a danger that the downturn will become a self- fulfilling prophecy,' he was quoted as saying.
Friday, January 25, 2008
Sub-Prime Crisis Will Hit Singapore In Indirect Way
Source : The Straits Times, Jan 25, 2008
I REFER to the article, ‘China bank may incur loss on US sub-prime write-offs’ (ST, Jan 22).
Last August, Minister of State for Trade and Industry S. Iswaran told Parliament that the exposure of Singapore financial institutions to the troubled US sub-prime mortgage market is small and problems from it have been contained.
A key fact for this optimism is that Singapore banks held S$2.6 billion worth of collateralised debt obligations (CDOs), of which only 25 per cent may contain some exposure to US sub-prime mortgages.
In the same month Nobel laureate Joseph Stiglitz, speaking in Kuala Lumpur, said that the US sub-prime mortgage crisis will probably ‘get worse’ as banks tighten lending rules and borrowing rates increase. ‘The countries which are most adversely affected are the countries like Indonesia,’ he said.
Last month, the Monetary Authority of Singapore revealed that three local banks had set aside S$434 million in extra provisioning for losses on collateralised debt.
In the same month, the Swiss bank UBS announced losses of 6.8 billion euros due to exposure to the US sub-prime mortgage crisis. The bank, which is the biggest in Europe in terms of assets, obtained emergency funds from the Government of Singapore and an unnamed Middle East investor.?
This week, we hear that the Bank of China is likely to suffer a 2007 loss because of a big write-down on billions of dollars of US sub-prime related investments. Two other state banks will also make provisions for assets hit by US mortgage defaults.
The direct effects of the sub-prime crisis may seem harmless to Singapore’s economy due to the very low exposure of assets, including CDOs, that are subject to its adverse effects.
However, it may be worthwhile to consider the systemic and indirect effects of the sub-prime crisis. For example, if China’s economy and the economies of other regional countries are affected then Singapore may not be able to escape its adverse effects. Its open economy is closely integrated with the world’s economy. The effects of the sub-prime crisis will therefore more likely impact Singapore’s economy in an indirect way.
We urge the Government to consider the indirect and systemic effects of the sub-prime crisis on Singapore’s economy in order to fully address all the risks associated with this deepening crisis.
Penelope Phoon (Ms) Country Head, Singapore ACCA Singapore
I REFER to the article, ‘China bank may incur loss on US sub-prime write-offs’ (ST, Jan 22).
Last August, Minister of State for Trade and Industry S. Iswaran told Parliament that the exposure of Singapore financial institutions to the troubled US sub-prime mortgage market is small and problems from it have been contained.
A key fact for this optimism is that Singapore banks held S$2.6 billion worth of collateralised debt obligations (CDOs), of which only 25 per cent may contain some exposure to US sub-prime mortgages.
In the same month Nobel laureate Joseph Stiglitz, speaking in Kuala Lumpur, said that the US sub-prime mortgage crisis will probably ‘get worse’ as banks tighten lending rules and borrowing rates increase. ‘The countries which are most adversely affected are the countries like Indonesia,’ he said.
Last month, the Monetary Authority of Singapore revealed that three local banks had set aside S$434 million in extra provisioning for losses on collateralised debt.
In the same month, the Swiss bank UBS announced losses of 6.8 billion euros due to exposure to the US sub-prime mortgage crisis. The bank, which is the biggest in Europe in terms of assets, obtained emergency funds from the Government of Singapore and an unnamed Middle East investor.?
This week, we hear that the Bank of China is likely to suffer a 2007 loss because of a big write-down on billions of dollars of US sub-prime related investments. Two other state banks will also make provisions for assets hit by US mortgage defaults.
The direct effects of the sub-prime crisis may seem harmless to Singapore’s economy due to the very low exposure of assets, including CDOs, that are subject to its adverse effects.
However, it may be worthwhile to consider the systemic and indirect effects of the sub-prime crisis. For example, if China’s economy and the economies of other regional countries are affected then Singapore may not be able to escape its adverse effects. Its open economy is closely integrated with the world’s economy. The effects of the sub-prime crisis will therefore more likely impact Singapore’s economy in an indirect way.
We urge the Government to consider the indirect and systemic effects of the sub-prime crisis on Singapore’s economy in order to fully address all the risks associated with this deepening crisis.
Penelope Phoon (Ms) Country Head, Singapore ACCA Singapore
Thursday, January 24, 2008
Recession? What Recession?
Source : TODAY, Thursday, January 24, 2008
The global market panic driving Tuesday’s United States Federal Reserve rate cut is rooted in the still controversial idea that the US economy has slipped into a recession.
Many market participants now take it as an article of faith that the US economy is, or will soon be, in a contractionary phase of economic activity. Some even argue that as long as it “feels” like a recession, it is one. But that sentiment obscures the reality that thus far, there is no definitive view among economists about how weak the economy is or might become.
That’s not to say anxiety is not riding high. The Fed, which cut interest rates by an unprecedented margin on Tuesday, has consistently downplayed and underestimated economic and market conditions over recent months. Clearly, policy-makers have grown more anxious.
Since September, the Fed has cut its key overnight target rate by nearly two percentage points and engineered novel mechanisms aimed at getting liquidity into financial markets. In turn, the institution’s good works have been washed away by weakening economic data, most notably on the employment and manufacturing fronts, and by a seemingly-endless stream of bad news from financial markets.
Views held by forecasters have been unusually diverse. In recent weeks, several major investment banks, including Goldman Sachs and Merrill Lynch, have officially endorsed the view that the US economy is contracting.
Merrill’s frequently-bearish chief economist David Rosenberg said the four factors watched by official business-cycle-dating body, the National Bureau of Economic Research, are each on the way down. Employment, manufacturing and retail sales, along with industrial production and income, all appear to be coming off cycle high points: Mr Rosenberg sees this as a clear sign of a recession.
What’s worse, “the healing phase involved in expunging all the excesses left over from a multi-year leveraged boom in asset values takes time,” Mr Rosenberg said. He reckons the current year will scrape by with an average growth rate of 0.8 per cent - the year will likely see three contractionary quarters - with 2009 limping by at a 1-per-cent pace.
Mr John Silvia, Wachovia Securities chief economist, sees 50-50 odds of a recession but believes if policy-makers move aggressively, a downturn need not take place.
Miller Tabak strategist Tony Crescenzi sees reasons to be hopeful. The monetary policy stance and the prospect of fiscal stimulus are reasons to believe any contraction will be short-lived. Low inventories, rising exports, healthy corporate cash positions and possible new mortgage refinancings now that rates are moving lower are other positives.
Mr Joel Naroff, who helms forecasting firm Naroff Economic Advisors, said the economic data now in hand “does not tell us we are in a recession yet”.
While he’s cautious about the outlook, he argued that Tuesday’s rate cut was forced as much by market expectations as anything else. It is entirely possible that the upcoming January jobs report may be stronger than many think, which could make the size of Tuesday’s action seem over the top, he said.
While Tuesday’s action clearly shows that Fed officials are at least mindful of worst-case outcomes, even there, one finds diversity. Mr William Poole, who will soon retire as president of the Federal Reserve in St Louis, Missouri, used his final vote as a Federal Open Market Committee member to say that the apocalypse is not now.
Mr Poole has been an unreliable guide on monetary policy, but he also represents the views of many when he argued that as bad as things are for markets, the real economy has not lost its bearings.
The global market panic driving Tuesday’s United States Federal Reserve rate cut is rooted in the still controversial idea that the US economy has slipped into a recession.
Many market participants now take it as an article of faith that the US economy is, or will soon be, in a contractionary phase of economic activity. Some even argue that as long as it “feels” like a recession, it is one. But that sentiment obscures the reality that thus far, there is no definitive view among economists about how weak the economy is or might become.
That’s not to say anxiety is not riding high. The Fed, which cut interest rates by an unprecedented margin on Tuesday, has consistently downplayed and underestimated economic and market conditions over recent months. Clearly, policy-makers have grown more anxious.
Since September, the Fed has cut its key overnight target rate by nearly two percentage points and engineered novel mechanisms aimed at getting liquidity into financial markets. In turn, the institution’s good works have been washed away by weakening economic data, most notably on the employment and manufacturing fronts, and by a seemingly-endless stream of bad news from financial markets.
Views held by forecasters have been unusually diverse. In recent weeks, several major investment banks, including Goldman Sachs and Merrill Lynch, have officially endorsed the view that the US economy is contracting.
Merrill’s frequently-bearish chief economist David Rosenberg said the four factors watched by official business-cycle-dating body, the National Bureau of Economic Research, are each on the way down. Employment, manufacturing and retail sales, along with industrial production and income, all appear to be coming off cycle high points: Mr Rosenberg sees this as a clear sign of a recession.
What’s worse, “the healing phase involved in expunging all the excesses left over from a multi-year leveraged boom in asset values takes time,” Mr Rosenberg said. He reckons the current year will scrape by with an average growth rate of 0.8 per cent - the year will likely see three contractionary quarters - with 2009 limping by at a 1-per-cent pace.
Mr John Silvia, Wachovia Securities chief economist, sees 50-50 odds of a recession but believes if policy-makers move aggressively, a downturn need not take place.
Miller Tabak strategist Tony Crescenzi sees reasons to be hopeful. The monetary policy stance and the prospect of fiscal stimulus are reasons to believe any contraction will be short-lived. Low inventories, rising exports, healthy corporate cash positions and possible new mortgage refinancings now that rates are moving lower are other positives.
Mr Joel Naroff, who helms forecasting firm Naroff Economic Advisors, said the economic data now in hand “does not tell us we are in a recession yet”.
While he’s cautious about the outlook, he argued that Tuesday’s rate cut was forced as much by market expectations as anything else. It is entirely possible that the upcoming January jobs report may be stronger than many think, which could make the size of Tuesday’s action seem over the top, he said.
While Tuesday’s action clearly shows that Fed officials are at least mindful of worst-case outcomes, even there, one finds diversity. Mr William Poole, who will soon retire as president of the Federal Reserve in St Louis, Missouri, used his final vote as a Federal Open Market Committee member to say that the apocalypse is not now.
Mr Poole has been an unreliable guide on monetary policy, but he also represents the views of many when he argued that as bad as things are for markets, the real economy has not lost its bearings.
Wednesday, January 23, 2008
Fed Cuts Rates In Emergency Move
Source : TODAY, Wednesday, January 23, 2008
But this won't dispel bear's shadow over loss-ridden markets
WITH the world staring down the throat of what billionaire investor George Soros called its worst financial crisis yet, and its biggest economy driven to possible recession by fallout from sub-prime mortgage losses, the United States Federal Reserve yesterday slashed interest rates by 75 basis points — the biggest cut in 23 years.
The central bank lowered the federal funds rate target to 3.5 per cent from 4.25 per cent, the policy-making Federal Open Market Committee (FOMC) announced, in its first such emergency move since Sept 2001.
Policymakers were not scheduled to meet to set rates until Jan 29-30. The FOMC said it took the action yesterday "in view of a weakening of the economic outlook and increasing downside risks to growth".
It was a move some commentators said smacked of panic, but perhaps, panic that was called for.
"While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate," the committee said.
The FOMC also lowered the discount rate by 0.75 percentage point to 4 per cent.
The emergency measure helped stem major losses in the Dow Jones Industrial Average (DJIA) after trading resumed following the long weekend.
US markets were closed on Monday to mark Dr Martin Luther King's birthday. At press time yesterday, the DJIA was down 260.77 points, or 2.14 per cent, at 11,838.53, after the futures contract had indicated a decline of as much as 5.3 per cent earlier.
But despite yesterday's rate cut — the largest single shift in interest rates since November 1994 — questions remain as to when the global crisis of confidence will end.
That's a US$300-billion ($430-billion) question, according to the Organisation for Economic Cooperation and Development, which said there might be that much in losses sitting in the market for collateralised debt obligations, which include the infamous US sub-prime mortgages.
So far, the tally of losses from Wall Street is about US$100 billion — so, the end to the stock market woes may yet be several hundred billion dollars away.
And the potential for exposure to these bad investments to turn up in unexpected places now hangs like a Sword of Damocles over the world's markets.
Until investors know where most or all of the remaining bad debt in the world resides — or until they have priced in the potential for this to turn up anywhere — the market's crisis of confidence is likely to continue.
"Many investors appear to believe the write-downs are far from over," said Lehman Bros' chief regional equity strategist Paul Schulte.
Yesterday's inter-meeting rate cut was the first since Sept 17, 2001, when the Fed lowered borrowing costs in the aftermath of the terrorist attacks — that was the third emergency reduction in a year which saw the last US recession.
Last Thursday, Fed chairman Ben Bernanke warned in testimony to Congress that the US economic outlook had worsened and "the downside risks to growth have become more pronounced". Still, he said, the Fed wasn't forecasting a recession this year.
US retail sales fell last month, unemployment rose and housing markets are mired in the worst slump in 16 years. Homebuilders in the US broke ground on the fewest homes since 1991, according to the Commerce Department. Building permits — a sign of future construction — declined by the most in 12 years, suggesting the housing slump will deepen.
US Treasury Secretary Henry Paulson called yesterday's rate cut by the Fed "very constructive" and a "confidence builder". He said it was a sign to the rest of the world that the US central bank is "nimble". — Agencies
But this won't dispel bear's shadow over loss-ridden markets
WITH the world staring down the throat of what billionaire investor George Soros called its worst financial crisis yet, and its biggest economy driven to possible recession by fallout from sub-prime mortgage losses, the United States Federal Reserve yesterday slashed interest rates by 75 basis points — the biggest cut in 23 years.
The central bank lowered the federal funds rate target to 3.5 per cent from 4.25 per cent, the policy-making Federal Open Market Committee (FOMC) announced, in its first such emergency move since Sept 2001.Policymakers were not scheduled to meet to set rates until Jan 29-30. The FOMC said it took the action yesterday "in view of a weakening of the economic outlook and increasing downside risks to growth".
It was a move some commentators said smacked of panic, but perhaps, panic that was called for.
"While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate," the committee said.
The FOMC also lowered the discount rate by 0.75 percentage point to 4 per cent.
The emergency measure helped stem major losses in the Dow Jones Industrial Average (DJIA) after trading resumed following the long weekend.
US markets were closed on Monday to mark Dr Martin Luther King's birthday. At press time yesterday, the DJIA was down 260.77 points, or 2.14 per cent, at 11,838.53, after the futures contract had indicated a decline of as much as 5.3 per cent earlier.
But despite yesterday's rate cut — the largest single shift in interest rates since November 1994 — questions remain as to when the global crisis of confidence will end.
That's a US$300-billion ($430-billion) question, according to the Organisation for Economic Cooperation and Development, which said there might be that much in losses sitting in the market for collateralised debt obligations, which include the infamous US sub-prime mortgages.
So far, the tally of losses from Wall Street is about US$100 billion — so, the end to the stock market woes may yet be several hundred billion dollars away.
And the potential for exposure to these bad investments to turn up in unexpected places now hangs like a Sword of Damocles over the world's markets.
Until investors know where most or all of the remaining bad debt in the world resides — or until they have priced in the potential for this to turn up anywhere — the market's crisis of confidence is likely to continue.
"Many investors appear to believe the write-downs are far from over," said Lehman Bros' chief regional equity strategist Paul Schulte.Yesterday's inter-meeting rate cut was the first since Sept 17, 2001, when the Fed lowered borrowing costs in the aftermath of the terrorist attacks — that was the third emergency reduction in a year which saw the last US recession.
Last Thursday, Fed chairman Ben Bernanke warned in testimony to Congress that the US economic outlook had worsened and "the downside risks to growth have become more pronounced". Still, he said, the Fed wasn't forecasting a recession this year.
US retail sales fell last month, unemployment rose and housing markets are mired in the worst slump in 16 years. Homebuilders in the US broke ground on the fewest homes since 1991, according to the Commerce Department. Building permits — a sign of future construction — declined by the most in 12 years, suggesting the housing slump will deepen.
US Treasury Secretary Henry Paulson called yesterday's rate cut by the Fed "very constructive" and a "confidence builder". He said it was a sign to the rest of the world that the US central bank is "nimble". — Agencies
Asian Markets Crash While US Totters - Recession Fears Hit Home In Plunges Reminiscent Of Post-9/11 Debacle
Source : The Business Times, January 22, 2008
It was blood on the floor across Asian bourses yesterday as investors dumped stocks amid intensifying fears of a US economic meltdown.
This, despite President George W Bush last week announcing a massive US$145 billion stimulative tax relief plan and Federal Reserve boss Ben Bernanke stating that more interest rate cuts were in the works.
But all this fell on deaf ears of panic-stricken investors.
The result: a series of institutional programme selling and waves of margin calls which resulted in the most intense one-day rout across Asian bourses in recent memory.
Singapore’s recently revamped Straits Times Index (STI) plunged a massive 6.03 per cent to end at its lowest levels since March 2007 at 2,917.15 points as bellwether stocks and blue chips took a beating. It was its steepest single-day fall since the September 2001 New York bombings, when it had fallen 7.47 per cent.
In Hong Kong, the Hang Seng also posted its worst one-day fall since the same tragedy, as it plunged 5.49 per cent to 23,818.86 - its lowest close since last September. And in Tokyo, the Nikkei 225 sank 3.86 per cent to 13,325.94, while Mumbai’s BSE Sensex 30 plunged 7.41 per cent to 17,605.35 points.
The same depressing scenario was played out in Seoul, Kuala Lumpur, Jakarta, Sydney and elsewhere.
And as Asian investors licked their wounds after a massive beating, European bourses started the day in similar vein in negative territory.
Analysts attributed the selldown to intensifying fears of a US economic recession, brought about by knock-on factors from the widening sub-prime crisis.
That had prompted President Bush to unveil his US$145 billion tax plan over the weekend - which many had hoped would help calm nerves and stabilise markets.
‘Letting Americans keep more of their money should increase consumer spending,’ he declared.
But many in the market now say the plan was too little, too late.
‘We are just seeing the beginnings of what could be a downward spiral which could take months to flatten out,’ said a European fund manager who spoke anonymously on account of the bank’s internal compliance requirements. ‘The real crunch-time could come some time during the middle of this year, when the US adjustable rate mortgages come up for review. That could hit the wider US housing market, especially if banks start tightening up.’
Others noted that this was a long overdue correction, with the markets having largely recovered in November and December, after being hit last July and August.
And even while the US economy comes into focus, new fears are emerging about a massive economic slowdown in the euro- zone, no thanks to a sharp appreciation in the euro which is already hurting exports.
Meanwhile in China, there are fears that Chinese banks which have until now remained largely silent about their sub-prime exposure could now start unveiling losses. Some market insiders reckon large players like Bank of China have substantial exposure, which could come to light in the coming weeks.
Meanwhile, the flight to cash has already started across Asian markets and looks likely to continue for the foreseeable future.
It was blood on the floor across Asian bourses yesterday as investors dumped stocks amid intensifying fears of a US economic meltdown.
This, despite President George W Bush last week announcing a massive US$145 billion stimulative tax relief plan and Federal Reserve boss Ben Bernanke stating that more interest rate cuts were in the works.
But all this fell on deaf ears of panic-stricken investors.
The result: a series of institutional programme selling and waves of margin calls which resulted in the most intense one-day rout across Asian bourses in recent memory.
Singapore’s recently revamped Straits Times Index (STI) plunged a massive 6.03 per cent to end at its lowest levels since March 2007 at 2,917.15 points as bellwether stocks and blue chips took a beating. It was its steepest single-day fall since the September 2001 New York bombings, when it had fallen 7.47 per cent.
In Hong Kong, the Hang Seng also posted its worst one-day fall since the same tragedy, as it plunged 5.49 per cent to 23,818.86 - its lowest close since last September. And in Tokyo, the Nikkei 225 sank 3.86 per cent to 13,325.94, while Mumbai’s BSE Sensex 30 plunged 7.41 per cent to 17,605.35 points.
The same depressing scenario was played out in Seoul, Kuala Lumpur, Jakarta, Sydney and elsewhere.
And as Asian investors licked their wounds after a massive beating, European bourses started the day in similar vein in negative territory.
Analysts attributed the selldown to intensifying fears of a US economic recession, brought about by knock-on factors from the widening sub-prime crisis.
That had prompted President Bush to unveil his US$145 billion tax plan over the weekend - which many had hoped would help calm nerves and stabilise markets.
‘Letting Americans keep more of their money should increase consumer spending,’ he declared.
But many in the market now say the plan was too little, too late.
‘We are just seeing the beginnings of what could be a downward spiral which could take months to flatten out,’ said a European fund manager who spoke anonymously on account of the bank’s internal compliance requirements. ‘The real crunch-time could come some time during the middle of this year, when the US adjustable rate mortgages come up for review. That could hit the wider US housing market, especially if banks start tightening up.’
Others noted that this was a long overdue correction, with the markets having largely recovered in November and December, after being hit last July and August.
And even while the US economy comes into focus, new fears are emerging about a massive economic slowdown in the euro- zone, no thanks to a sharp appreciation in the euro which is already hurting exports.
Meanwhile in China, there are fears that Chinese banks which have until now remained largely silent about their sub-prime exposure could now start unveiling losses. Some market insiders reckon large players like Bank of China have substantial exposure, which could come to light in the coming weeks.
Meanwhile, the flight to cash has already started across Asian markets and looks likely to continue for the foreseeable future.
Friday, January 18, 2008
Merrill CEO Thinks Worst Is Over For Subprime Woes - For Now
Source : The Straits Times, Jan 18, 2008
NEW YORK - JOHN Thain, presiding over his first set of earnings as the new leader of Merrill Lynch & Co, cleared the decks with some US$15 billion (S$21.6 billion) of subprime mortgage related write-downs that led to the largest quarterly loss since the the world's largest brokerage was founded 94 years ago.
And, while it was among the most aggressive moves on Wall Street to deal with bad bets on subprime mortgages, Mr Thain is still not ready to say the worst of the credit crisis is over.
With a possible recession looming, Merrill Lynch and other Wall Street investment houses might still be saddled with unforeseen turmoil. While taking steps to minimize future disruptions, Mr Thain is still wary about challenges that face the global financial markets.
'We will continue to take risks - you don't make money if you don't take risk,' Mr Thain said.
'But the risk will be sized appropriate for the business. Nobody should be taking risks that wipe out the entire annual earnings of a business, and certainly not the entire firm.'
That's exactly what happened under former CEO Stan O'Neal, whose heavy bets in subprime mortgage securities backfired as homeowners defaulted on their loans at an alarming rate. That strategy led to a nearly US$10 billion loss during the fourth quarter, on top of US$2.31 billion during the previous period.
Merrill Lynch posted a net loss after preferred dividends of US$9.91 billion, or US$12.01 per share, compared to a profit of US$2.3 billion, or US$2.41 per share, a year earlier. It also recorded negative revenue of US$8.19 billion, down from revenue of US$8.39 billion a year earlier.
The New York-based brokerage marked down US$11.5 billion from mortgage-backed securities, and an additional US$3.1 billion in adjustments to hedge positions on them.
Exposure to risky collateralized debt obligations, or CDOs, was US$4.8 billion at the end of 2007, down from US$15.8 billion three months earlier.
For the same periods, exposure to subprime-residential mortgages fell to US$2.71 billion from US$5.66 billion.
The huge housing-driven shortfalls come as weak economic data have intensified fears of a recession, and have increased pressure on the government for an economic stimulus plan.
There is growing evidence that the late payments and defaults that torpedoed the mortgage industry might be bleeding into other parts of the economy. Consumers are falling behind on all kinds of loan payments - like automobiles, credit cards and home-equity lines - that could tip the economy's scale toward recession.
Merrill Lynch joins rival Wall Street investment houses Morgan Stanley and Bear Stearns Cos. in posting losses in the last three months of fiscal 2007.
Citigroup Inc., the nation's largest bank, reported on Tuesday a quarterly loss of almost US$10 billion, the largest in its 196-year history.
'We believe risky assets (at Merrill) were conservatively marked, the exposures are still significant, and further deterioration in pricing so far in January means write-downs may not be over,' said Mr Roger Freeman, an analyst with Lehman Brothers, in a note to clients.
Problems will be identified
Mr Thain, who was CEO of NYSE Euronext and a former Goldman Sachs Group Inc president, said he's taking steps to help identify where the problems are. He brought in a new co-head of risk management, who was a former Goldman executive, and is also bringing in a senior executive to oversee all trading to get better control over the business.
He's also pledged to clear the brokerage's books and shore up its capital base to better position it amid the credit market turmoil.
Merrill Lynch secured almost US$13 billion worth of fresh capital, mostly from foreign wealth funds in Singapore, Korea, and Kuwait.
It also addressed the balance-sheet woes by selling a commercial-finance unit, and could make more divestitures in future quarters.
The brokerage also plans to move some trading assets into funds that will be sold to outside investors - essentially removing them from the company's books. Merrill is raising money for a real-estate fund in the Pacific Rim and hopes to create some private equity, and possibly infrastructure, funds.
Merrill Lynch shares tumbled US$5.64, or 10.2 per cent, to US$49.45 on Thursday when Wall Street tumbled after a regional Federal Reserve report showed a sharp decline in manufacturing activity and as investors feared that downgrades of key bond insurers could trigger further trouble with souring debt.
Merrill's shares have fallen almost 50 per cent since their high of US$98.68 last year, wiping out some $40 billion in shareholder value along the way. -- AP
NEW YORK - JOHN Thain, presiding over his first set of earnings as the new leader of Merrill Lynch & Co, cleared the decks with some US$15 billion (S$21.6 billion) of subprime mortgage related write-downs that led to the largest quarterly loss since the the world's largest brokerage was founded 94 years ago.
And, while it was among the most aggressive moves on Wall Street to deal with bad bets on subprime mortgages, Mr Thain is still not ready to say the worst of the credit crisis is over.
With a possible recession looming, Merrill Lynch and other Wall Street investment houses might still be saddled with unforeseen turmoil. While taking steps to minimize future disruptions, Mr Thain is still wary about challenges that face the global financial markets.
'We will continue to take risks - you don't make money if you don't take risk,' Mr Thain said.
'But the risk will be sized appropriate for the business. Nobody should be taking risks that wipe out the entire annual earnings of a business, and certainly not the entire firm.'
That's exactly what happened under former CEO Stan O'Neal, whose heavy bets in subprime mortgage securities backfired as homeowners defaulted on their loans at an alarming rate. That strategy led to a nearly US$10 billion loss during the fourth quarter, on top of US$2.31 billion during the previous period.
Merrill Lynch posted a net loss after preferred dividends of US$9.91 billion, or US$12.01 per share, compared to a profit of US$2.3 billion, or US$2.41 per share, a year earlier. It also recorded negative revenue of US$8.19 billion, down from revenue of US$8.39 billion a year earlier.
The New York-based brokerage marked down US$11.5 billion from mortgage-backed securities, and an additional US$3.1 billion in adjustments to hedge positions on them.
Exposure to risky collateralized debt obligations, or CDOs, was US$4.8 billion at the end of 2007, down from US$15.8 billion three months earlier.
For the same periods, exposure to subprime-residential mortgages fell to US$2.71 billion from US$5.66 billion.
The huge housing-driven shortfalls come as weak economic data have intensified fears of a recession, and have increased pressure on the government for an economic stimulus plan.
There is growing evidence that the late payments and defaults that torpedoed the mortgage industry might be bleeding into other parts of the economy. Consumers are falling behind on all kinds of loan payments - like automobiles, credit cards and home-equity lines - that could tip the economy's scale toward recession.
Merrill Lynch joins rival Wall Street investment houses Morgan Stanley and Bear Stearns Cos. in posting losses in the last three months of fiscal 2007.
Citigroup Inc., the nation's largest bank, reported on Tuesday a quarterly loss of almost US$10 billion, the largest in its 196-year history.
'We believe risky assets (at Merrill) were conservatively marked, the exposures are still significant, and further deterioration in pricing so far in January means write-downs may not be over,' said Mr Roger Freeman, an analyst with Lehman Brothers, in a note to clients.
Problems will be identified
Mr Thain, who was CEO of NYSE Euronext and a former Goldman Sachs Group Inc president, said he's taking steps to help identify where the problems are. He brought in a new co-head of risk management, who was a former Goldman executive, and is also bringing in a senior executive to oversee all trading to get better control over the business.
He's also pledged to clear the brokerage's books and shore up its capital base to better position it amid the credit market turmoil.
Merrill Lynch secured almost US$13 billion worth of fresh capital, mostly from foreign wealth funds in Singapore, Korea, and Kuwait.
It also addressed the balance-sheet woes by selling a commercial-finance unit, and could make more divestitures in future quarters.
The brokerage also plans to move some trading assets into funds that will be sold to outside investors - essentially removing them from the company's books. Merrill is raising money for a real-estate fund in the Pacific Rim and hopes to create some private equity, and possibly infrastructure, funds.
Merrill Lynch shares tumbled US$5.64, or 10.2 per cent, to US$49.45 on Thursday when Wall Street tumbled after a regional Federal Reserve report showed a sharp decline in manufacturing activity and as investors feared that downgrades of key bond insurers could trigger further trouble with souring debt.
Merrill's shares have fallen almost 50 per cent since their high of US$98.68 last year, wiping out some $40 billion in shareholder value along the way. -- AP
Thursday, January 17, 2008
US Subprime Losses Grow, Top Japan Bank Hit Too
Source : The Straits Times, Jan 17, 2008
NEW YORK - CREDIT losses tied to troubled subprime mortgages continued to mount at major United States financial institutions on Wednesday, while Japan's top bank also took a sizable hit.
JPMorgan Chase, the No. 3 US bank, reported fourth-quarter net fell 34 per cent as it recorded US$1.3 billion (S$1.9 billion) in markdowns on subprime positions and saw sharply higher credit costs.
JPMorgan's write-down sent its net income down to US$2.97 billion, or 86 cents a share, in the period from October to December, from US$4.53 billion, or US$1.26 a share, in the same period a year earlier.
'We remain extremely cautious as we enter 2008,' CEO Jamie Dimon, said in a statement as his bank quadrupled to US$1.1 billion the provision it needs to cover ongoing problems on home equity and high risk mortgage loans.
That said, JPMorgan provided comparative relief from the gloom cast by Tuesday's colossal US$18.1 billion write-down by Citigroup.
Also on Wednesday, bond insurer Ambac Financial Group said it expects a US$5.4 billion pretax write-down in the fourth quarter and will cut its quarterly dividend by two-thirds.
Ambac also announced plans to raise US$1 billion in equity and equity-linked securities and named an interim chief executive as it scrambled to maintain its prized triple-A credit ratings.
Its shares plunged nearly 40 per cent on the day.
If that weren't enough, Wells Fargo said its fourth-quarter profit fell 38 per cent, the first decline in more than six years, hurt by rising losses from home equity loans. But the decline at the San Francisco-based bank was smaller than expected.
'What we are starting to see is the flushing out of all these credit problems and an admission that there are losses,' said Mr Tom Atteberry, a partner at First Pacific Advisors, with assets under management of US$11 billion. 'This is a part of the healing process.' Damage was not contained to the United States.
Japan's largest bank, Mitsubishi UFJ Financial Group, may have lost as much as 50 billion yen (S$666 million) on subprime investments last year, up from the 4 billion yen it reported for the six months to September, according to executives with direct knowledge of the matter.
Shares in Japan's big banks, which have ridden the credit crisis relatively unscathed so far, fell sharply in response.
'Sentiment is bad because no one knows if there will be further losses,' said Mr Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.
Merrill looms
Investors are already looking to results on Thursday from troubled Merrill Lynch, following the massive write-off by Citigroup, America's largest bank.
Wall Street analysts' scenarios range from US$10 billion to US$25 billion in write-downs for investment bank Merrill, which wrote off US$8.4 billion in the third quarter.
Banks, wrestling with huge losses stemming from US mortgages lent to people ill-equipped to repay them, have been actively seeking cash from abroad from sovereign wealth funds.
Merrill said on Tuesday it would raise US$6.6 billion from selling preferred shares to an investor group that included the Kuwait Investment Authority.
That is on top of the US$6.2 billion capital infusion announced last month in a deal with Singapore's Temasek Holdings and US-based Davis Selected Advisers.
Citigroup announced an overall fourth-quarter loss of US$9.83 billion - its first quarterly loss since its creation in 1998 - and said it was raising US$14.5 billion from offerings of convertible preferred securities.
Saudi Arabian Prince Alwaleed and the government of Singapore were among the investors. In November, Citigroup raised US$7.5 billion by selling a 4.9 per cent stake to Abu Dhabi.
The Government of Singapore Investment Corp, Singapore's biggest sovereign wealth fund, said on Wednesday its large investment in Citigroup and US$9.75 billion injection into credit-hit Swiss Bank UBS AG were unique at a time of financial turmoil and did not represent a strategy shift.
Many experts say ongoing losses at major banks means the crisis is far from over as crucial lending between commercial banks remains patchy at best.
With fears of a US recession growing, interest rate futures are pricing in an almost 1-in-2 chance of a hefty 75 basis points cut in US interest rates, when the Federal Reserve meets at the end of the month - or possibly even earlier. -- REUTERS
NEW YORK - CREDIT losses tied to troubled subprime mortgages continued to mount at major United States financial institutions on Wednesday, while Japan's top bank also took a sizable hit.
JPMorgan Chase, the No. 3 US bank, reported fourth-quarter net fell 34 per cent as it recorded US$1.3 billion (S$1.9 billion) in markdowns on subprime positions and saw sharply higher credit costs.
JPMorgan's write-down sent its net income down to US$2.97 billion, or 86 cents a share, in the period from October to December, from US$4.53 billion, or US$1.26 a share, in the same period a year earlier.
'We remain extremely cautious as we enter 2008,' CEO Jamie Dimon, said in a statement as his bank quadrupled to US$1.1 billion the provision it needs to cover ongoing problems on home equity and high risk mortgage loans.
That said, JPMorgan provided comparative relief from the gloom cast by Tuesday's colossal US$18.1 billion write-down by Citigroup.
Also on Wednesday, bond insurer Ambac Financial Group said it expects a US$5.4 billion pretax write-down in the fourth quarter and will cut its quarterly dividend by two-thirds.
Ambac also announced plans to raise US$1 billion in equity and equity-linked securities and named an interim chief executive as it scrambled to maintain its prized triple-A credit ratings.
Its shares plunged nearly 40 per cent on the day.
If that weren't enough, Wells Fargo said its fourth-quarter profit fell 38 per cent, the first decline in more than six years, hurt by rising losses from home equity loans. But the decline at the San Francisco-based bank was smaller than expected.
'What we are starting to see is the flushing out of all these credit problems and an admission that there are losses,' said Mr Tom Atteberry, a partner at First Pacific Advisors, with assets under management of US$11 billion. 'This is a part of the healing process.' Damage was not contained to the United States.
Japan's largest bank, Mitsubishi UFJ Financial Group, may have lost as much as 50 billion yen (S$666 million) on subprime investments last year, up from the 4 billion yen it reported for the six months to September, according to executives with direct knowledge of the matter.
Shares in Japan's big banks, which have ridden the credit crisis relatively unscathed so far, fell sharply in response.
'Sentiment is bad because no one knows if there will be further losses,' said Mr Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.
Merrill looms
Investors are already looking to results on Thursday from troubled Merrill Lynch, following the massive write-off by Citigroup, America's largest bank.
Wall Street analysts' scenarios range from US$10 billion to US$25 billion in write-downs for investment bank Merrill, which wrote off US$8.4 billion in the third quarter.
Banks, wrestling with huge losses stemming from US mortgages lent to people ill-equipped to repay them, have been actively seeking cash from abroad from sovereign wealth funds.
Merrill said on Tuesday it would raise US$6.6 billion from selling preferred shares to an investor group that included the Kuwait Investment Authority.
That is on top of the US$6.2 billion capital infusion announced last month in a deal with Singapore's Temasek Holdings and US-based Davis Selected Advisers.
Citigroup announced an overall fourth-quarter loss of US$9.83 billion - its first quarterly loss since its creation in 1998 - and said it was raising US$14.5 billion from offerings of convertible preferred securities.
Saudi Arabian Prince Alwaleed and the government of Singapore were among the investors. In November, Citigroup raised US$7.5 billion by selling a 4.9 per cent stake to Abu Dhabi.
The Government of Singapore Investment Corp, Singapore's biggest sovereign wealth fund, said on Wednesday its large investment in Citigroup and US$9.75 billion injection into credit-hit Swiss Bank UBS AG were unique at a time of financial turmoil and did not represent a strategy shift.
Many experts say ongoing losses at major banks means the crisis is far from over as crucial lending between commercial banks remains patchy at best.
With fears of a US recession growing, interest rate futures are pricing in an almost 1-in-2 chance of a hefty 75 basis points cut in US interest rates, when the Federal Reserve meets at the end of the month - or possibly even earlier. -- REUTERS
IMF Warns Subprime Crisis Losses 'May Be Higher'
Source : The Straits Times, Jan 17, 2008
WASHINGTON - THE United States subprime mortgage crisis will likely produce deeper problems than expected because not all market players have 'come out clean' about their losses, the International Monetary Fund said.
'Some analytical work modelled on conservative assumptions suggests that potential losses may be higher and further capital injections are likely,' Mr Manmohan Singh and Mr Mustafa Saiyid wrote in an IMF report.
'Most banks in the United States have not yet marked their assets to genuine transaction prices,' the report said on Wednesday.
Some market participants 'have come out clean such as a few US hedge funds that have written off the value of all junior notes issued by its structured vehicles,' the report said.
The global markets turmoil that erupted last year amid rising defaults on US subprime mortgages was in part due to a lack of appropriate measures to evaluate the risk of new financial products.
Subprime mortgages - home loans given to people with poor credit histories - were packaged into structured securities such as collateralised debt obligations, of CDOs.
Following the collapse of the US subprime market in mid-2007, market worries about the exposure of the structured securities to the subprime crisis caused a credit freeze that made many market players use valuation models that no longer worked in the meltdown, the report said.
Recent moves by financial institutions to bring off-balance-sheet structures like CDOs on the balance sheet are not at explicit 'transfer prices' and thus 'may not be a full reflection of potential losses'.
The IMF report suggested that market participants seek to regularly put a portion of their complex structured securities on the market to obtain a valid valuation.
Some market players 'increasingly relied on ratings as a measure of default risk and inappropriately compared them to those on plain vanilla corporate debt, which has different sensitivities to market conditions'. -- AFP
_________________________________________________
US banks seeing higher delinquencies on more than just mortgage payments
NEW YORK - THE bill for America's excessive borrowing during the housing boom has arrived, and more people are having trouble paying it.
JPMorgan Chase and Wells Fargo, two of the biggest United States banks, on Wednesday joined a growing chorus warning that the subprime mortgage mess is just the start of a sweeping lending crisis. And some fear that consumers falling behind on all kinds of loan payments could tip the economy's scale toward recession.
Strapped consumers are having a tough time making payments on credit cards, home-equity loans, and even for their cars. This has caused three of the top five US commercial banks that have already reported damaging fourth-quarter results to set aside some US$12.5 billion (S$17.9 billion) to cover future loan losses - and that number will likely grow as the year wears on.
Problems in the subprime mortgage market are rapidly spilling over into other areas of the economy. No matter what the experts call it - a recession, slowdown or even the makings of a depression - it's clear banks are under mounting pressure to be more cautious about lending.
'If consumption growth stagnates, the odds of a recession are incredibly high,' said Mr Andrew Bernard, director of the Center for International Business at the Tuck School of Business at Dartmouth.
'All the pieces of household financial health are starting to be shakier, especially at the low end.'
He and others are paying close attention to what top US banks say about their customers' payment habits. Many view this as an early indicator about where the overall economy is headed, but there are other signs that are troublesome.
The stock market has had its worst start to the year in three decades, with investors rattled by signs from the Labor Department that unemployment is on the rise and retail sales are on the decline.
Further, the Commerce Department reported on Wednesday that higher costs for energy and food in 2007 pushed inflation for the year up by the largest amount in 17 years.
There was no sign of a turnaround in the last few months of the year. The Federal Reserve reported that the economy grew at a slower pace in late November and December as credit problems intensified and consumers tightened their spending.
To some, it appears that the Fed came to its rate-cutting decision in August a bit too late. Others point to the falling dollar and surging oil prices, factors that usually prevent the central bank from easing its monetary policy.
While debate persists about the Fed's timing and the extent of the slowdown, bank executives - who have scrambled to prepare for another tumble in home prices and higher unemployment in 2008, feel academic definitions are beside the point.
'We're not predicting a recession - it's not our job - but we're prepared,' JPMorgan Chase CEO Jamie Dimon told analysts after the nation's third-largest bank wrote down US$1.3 billion and said profit dropped 34 per cent.
His financial institution did not do all that bad. Rival Citigroup fared the worst during the fourth quarter, losing US$9.83 billion after writing down the value of its portfolio of mortgage and mortgage-backed products by US$18.1 billion.
Wells Fargo, a more traditional bank that avoided last year's trading woes, saw its profit fall 38 per cent due to troubles with home equity loan and mortgage defaults.
JPMorgan is girding for home prices to decline further in 2008 by 5 per cent to 10 per cent; Citigroup's estimate of 7 per cent falls within that range, too.
'The banks are the infrastructure for everything, the heartbeat of the market,' said Mr Chris Johnson, president of Johnson Research Group. 'They need to be fixed before the market, and economy, can move forward with confidence. They need to get all their dirty laundry out there.'
Banks and card companies like American Express - which warned last week that it would add US$440 million to loan loss provisions - said in the regions where home prices are declining, card default rates are rising faster. The same goes for auto loans, subprime mortgages and home equity loans in these areas, which include Florida, Michigan and California.
A big reason for the rise in credit card default rates is that they are returning to more usual levels following a change in bankruptcy law that sent rates lower for a time. But the fact that more losses are being seen in the weaker parts of the country shows the increase is economically driven as well.
Analysts believe this means one thing: Consumers will be the ones paying for years of lax lending standards by US financial institutions. Many will become more restrictive about who gets credit in a bid to stem future losses - and that could curb consumer spending, which accounts for more than two-thirds of the economy.
'We've pushed the envelope,' Mr Johnson said. 'Along with the joy of a market that goes as high as ours is the agony of when it starts to correct itself.' -- AP
WASHINGTON - THE United States subprime mortgage crisis will likely produce deeper problems than expected because not all market players have 'come out clean' about their losses, the International Monetary Fund said.
'Some analytical work modelled on conservative assumptions suggests that potential losses may be higher and further capital injections are likely,' Mr Manmohan Singh and Mr Mustafa Saiyid wrote in an IMF report.
'Most banks in the United States have not yet marked their assets to genuine transaction prices,' the report said on Wednesday.
Some market participants 'have come out clean such as a few US hedge funds that have written off the value of all junior notes issued by its structured vehicles,' the report said.
The global markets turmoil that erupted last year amid rising defaults on US subprime mortgages was in part due to a lack of appropriate measures to evaluate the risk of new financial products.
Subprime mortgages - home loans given to people with poor credit histories - were packaged into structured securities such as collateralised debt obligations, of CDOs.
Following the collapse of the US subprime market in mid-2007, market worries about the exposure of the structured securities to the subprime crisis caused a credit freeze that made many market players use valuation models that no longer worked in the meltdown, the report said.
Recent moves by financial institutions to bring off-balance-sheet structures like CDOs on the balance sheet are not at explicit 'transfer prices' and thus 'may not be a full reflection of potential losses'.
The IMF report suggested that market participants seek to regularly put a portion of their complex structured securities on the market to obtain a valid valuation.
Some market players 'increasingly relied on ratings as a measure of default risk and inappropriately compared them to those on plain vanilla corporate debt, which has different sensitivities to market conditions'. -- AFP
_________________________________________________
US banks seeing higher delinquencies on more than just mortgage payments
NEW YORK - THE bill for America's excessive borrowing during the housing boom has arrived, and more people are having trouble paying it.
JPMorgan Chase and Wells Fargo, two of the biggest United States banks, on Wednesday joined a growing chorus warning that the subprime mortgage mess is just the start of a sweeping lending crisis. And some fear that consumers falling behind on all kinds of loan payments could tip the economy's scale toward recession.
Strapped consumers are having a tough time making payments on credit cards, home-equity loans, and even for their cars. This has caused three of the top five US commercial banks that have already reported damaging fourth-quarter results to set aside some US$12.5 billion (S$17.9 billion) to cover future loan losses - and that number will likely grow as the year wears on.
Problems in the subprime mortgage market are rapidly spilling over into other areas of the economy. No matter what the experts call it - a recession, slowdown or even the makings of a depression - it's clear banks are under mounting pressure to be more cautious about lending.
'If consumption growth stagnates, the odds of a recession are incredibly high,' said Mr Andrew Bernard, director of the Center for International Business at the Tuck School of Business at Dartmouth.
'All the pieces of household financial health are starting to be shakier, especially at the low end.'
He and others are paying close attention to what top US banks say about their customers' payment habits. Many view this as an early indicator about where the overall economy is headed, but there are other signs that are troublesome.
The stock market has had its worst start to the year in three decades, with investors rattled by signs from the Labor Department that unemployment is on the rise and retail sales are on the decline.
Further, the Commerce Department reported on Wednesday that higher costs for energy and food in 2007 pushed inflation for the year up by the largest amount in 17 years.
There was no sign of a turnaround in the last few months of the year. The Federal Reserve reported that the economy grew at a slower pace in late November and December as credit problems intensified and consumers tightened their spending.
To some, it appears that the Fed came to its rate-cutting decision in August a bit too late. Others point to the falling dollar and surging oil prices, factors that usually prevent the central bank from easing its monetary policy.
While debate persists about the Fed's timing and the extent of the slowdown, bank executives - who have scrambled to prepare for another tumble in home prices and higher unemployment in 2008, feel academic definitions are beside the point.
'We're not predicting a recession - it's not our job - but we're prepared,' JPMorgan Chase CEO Jamie Dimon told analysts after the nation's third-largest bank wrote down US$1.3 billion and said profit dropped 34 per cent.
His financial institution did not do all that bad. Rival Citigroup fared the worst during the fourth quarter, losing US$9.83 billion after writing down the value of its portfolio of mortgage and mortgage-backed products by US$18.1 billion.
Wells Fargo, a more traditional bank that avoided last year's trading woes, saw its profit fall 38 per cent due to troubles with home equity loan and mortgage defaults.
JPMorgan is girding for home prices to decline further in 2008 by 5 per cent to 10 per cent; Citigroup's estimate of 7 per cent falls within that range, too.
'The banks are the infrastructure for everything, the heartbeat of the market,' said Mr Chris Johnson, president of Johnson Research Group. 'They need to be fixed before the market, and economy, can move forward with confidence. They need to get all their dirty laundry out there.'
Banks and card companies like American Express - which warned last week that it would add US$440 million to loan loss provisions - said in the regions where home prices are declining, card default rates are rising faster. The same goes for auto loans, subprime mortgages and home equity loans in these areas, which include Florida, Michigan and California.
A big reason for the rise in credit card default rates is that they are returning to more usual levels following a change in bankruptcy law that sent rates lower for a time. But the fact that more losses are being seen in the weaker parts of the country shows the increase is economically driven as well.
Analysts believe this means one thing: Consumers will be the ones paying for years of lax lending standards by US financial institutions. Many will become more restrictive about who gets credit in a bid to stem future losses - and that could curb consumer spending, which accounts for more than two-thirds of the economy.
'We've pushed the envelope,' Mr Johnson said. 'Along with the joy of a market that goes as high as ours is the agony of when it starts to correct itself.' -- AP
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