This great article was provided today by Financial Alert. It is great reading and the visual of the market share for the banks is fantastic.
The road(s) to recovery
by Graham Rich | Monday, 23
February 2009
Capitalism is in the throes of its most severe crisis of our
lifetime – and then some more years. A combination of deep global recession,
global economic dislocations and effective nationalisation of large swathes of
the financial sector in the world’s developed economies has deeply traumatised
the balance between markets, economies and countries. Professor Dani Rodrik of
Harvard University JFK School of Government, believes that it’s anybody’s guess
as to where the new balance will be struck.
So, it’s fair to
say that no one knows the one road to recovery!
Investment legend
George Soros reckons that the salient feature of the current financial crisis is
that it was not caused by some external shock like OPEC – but that the crisis
was generated by the system itself. A survey of experts by the Times of
London concludes that the top three individual villains at fault are Dick Fuld
of Lehman Brothers, Hank Paulson former US Secretary of the Treasury and Alan
Greenspan, former head of the Fed. But was it them…or all of us?
With hindsight,
we can now see that the mixed-economy model was the crowning achievement of 20th
century capitalism. The new balance that it established between state and market
set the stage for an unprecedented period of social cohesion, stability and
prosperity in the advanced economies that lasted until the mid 1970s.
The model became
frayed from the 1980s on, and now appears to have almost completely broken down.
The reason can seemingly be expressed in one word: globalisation. Financial
globalisation emanating from the 1980s has played particular havoc with the
“old” rules. The crisis originated in the US, the heart of the world’s financial
system and the source of much of its financial innovation and globalisation. The
global financial crisis (GFC) is indeed a crisis of globalisation.
Professor Rodrik
contends that when Chinese-style capitalisation met American-style capitalism,
with few safety valves in place, it gave rise to an explosive mix. There were no
protective mechanisms to prevent a global liquidity glut and then, in
combination with US regulatory failings, from producing a spectacular housing
boom and crash. Nor were there any international roadblocks to prevent the
crisis from spreading. Thirty years of globalisation has hit the rocks because
its champions have tried to reap the benefits without accepting enough of its
disciplines.
At Davos recently,
Russian Prime Minister Vladimir Putin said that the entire economic growth
system, where one regional centre prints money without respite and consumes
material wealth, while another regional centre manufactures inexpensive goods
and saves money printed by other governments, has suffered a major setback. And
Chinese Premier Wen Jiabao commented on just one side of that equation when he
blamed the GFC on the inappropriate macro-economic policies of some economies
and their unsustainable model of development, characterised by prolonged low
savings and high consumption, excessive expansion of financial institutions in
blind pursuit of profit; lack of self discipline among financial institutions
and ratings agencies ensuring distortion of risk information and asset pricing;
and the failure of financial supervision and regulation to keep up with
financial innovations, which allowed the risk of derivatives to build and
spread.
But, argues
Professor Rodrik, those who predict capitalism’s demise have to contend with one
important historical fact: capitalism has an almost unlimited capacity to
reinvent itself. He says that the lesson is not that capitalism is dead. It is
that we need to reinvent it for a new century in which the forces of economic
globalisation are much more powerful than before.
So, forget
decoupling… it’s coupling… interdependency… the G2 of the US and China,
and then the rest.
This means
imagining a better balance between markets and their supporting institutions at
the global level. Designing the next capitalist regime will not be easy, but we
do have history on our side, says Professor Rodrik.
Separately, author
Robert Skidelsky and others argue that the crisis also represents a moral
failure: that of a system built on debt. At the heart of the moral failure is
the worship of growth for its own sake, rather than a way to achieve a “good
life”. As a result, economic efficiency – the means to growth – has been given
absolute priority in our thinking and policy.
Some saw the
impending crisis, others claim they did, and most of us failed to listen to
warnings and our instincts, and held the course, hoping beyond hope. Perhaps
that’s part of human nature.
Also know as Dr
Doom, Dr Nouriel Roubini is an economics professor at New York University. Two
and a half years ago on 7 September 2006 at an International Monetary Fund
meeting, he announced that a crisis was brewing. He said that the United States
was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply
declining consumer confidence and, ultimately, a deep recession. Homeowners
would default on mortgages, trillions of dollars of mortgage-backed securities
would unravel worldwide and the global financial system would shudder to a halt.
These developments, he said, would cripple major financial institutions like
Fannie Mae and Freddie Mac.
Why did no one
listen?
And there was
Stephen Roach, respected Morgan Stanley economist.
Closer to home
there was Jonathan Pain, an Australian investment strategist. In July 2004, he
brought a NINJA mortgage advert back from America and read it out at every
single presentation through late 2004 and into 2005, until such time as it
disintegrated. It read “No income or job required. Personal bankruptcy? No
problem.” At every presentation in 2005 and 2006 Jonathan used the Robert
Shiller chart of US house prices from 1890 to 2005 which showed that America was
experiencing a housing bubble. In his January 2006 Pain report, he wrote
“The imbalances in the US are simply unsustainable. The housing market is set to
fall which in turn will weaken the economy. America has spent too much and saved
too little. In contrast, Asia has spent too little and saved too much. Over the
next decade, these trends will, through necessity, be reversed.”
A quote he used in
many presentations through 2005 and 2006 was “Too many Americans have gorged at
the debt trough for far too long.” In his August 2007 Pain report he
wrote “My first big picture observation is that we have moved from a period of
credit expansion to one of credit contraction. Growth is set to slow
significantly in the months ahead and I now believe an American recession lies
ahead in the next 12 months. I hope I’m wrong.”
And then in his
November 2007 Pain report he wrote “We need to ring the alarm bell on
what we see in the UK and Spanish housing markets. The UK housing market has
just peaked and is set for a nasty correction. Will the last one out turn the
lights out!”
Why did no one
listen and why were more not saying this?
And nearly a
century ago in the early 1920s, Nikolai Kondratiev, a Russian Marxist economist
proposed a theory that Western capitalist economies have long-term (50 to 60
years) cycles of boom followed by depression. These business cycles are now
called “Kondratiev waves”, or grand supercycles. He predicted an imminent dip,
and he was proved right with the Wall Street Crash in 1929. The current crisis
may mean he is about 10 years out – still, not a bad prediction for a man who
died in 1938.
In the run-up to
the 2007 Australian federal election, Peter Costello, as Treasurer, warned that
a financial tsunami was on the way, when the ASX was near its record highs. He
made specific reference to the impact of the US sub-prime crisis. Wayne Swan,
then Shadow Treasurer (now Treasurer) was simultaneously reacting and saying
that rather than desperately exploiting financial market movements for political
purposes, Costello should roll up his sleeves and start tackling the
inflationary pressures that he had clearly failed to contain. And Reserve Bank
of Australia Governor Glenn Stevens, supported by a board of “eminent business
people and experts”, was raising rates.
Nothing exemplifies
the fallout from all of the issues I’ve covered above better than the purchase
of ABN AMRO by Royal Bank of Scotland – finalised a little over a year ago with
a payment of USD100bn, 80% in cash. For this same amount today, RBS could buy
Citibank (USD18.9bn), Morgan Stanley (USD22.5bn), Goldman Sachs (USD41.8bn) and
Deutsche Bank (USD15.2bn) – and still have $1.6bn in change (no doubt for senior
exec bonuses to celebrate a job well done!). What a difference a year
makes!
And take a look at
the impact on global banks…
Banks’ market
capitalisation (US$bn) Q2’07 vs Jan 2009
source: JP
Morgan
And on the
markets…
source:
farrelly’s
source:
farrelly’s
source:
farrelly’s
source:
farrelly’s
source:
farrelly’s
source:
farrelly’s
source:
farrelly’s
Dominique
Strauss-Kahn, head of the IMF, believes that the “whole of society” is going to
suffer during the coming years, and has indicated that there is likely to be
social unrest. “We see 2009 being a really bad year with recession for most
advanced economies and growth decreasing for most emerging economies,” he
stated.
Is it any wonder
that the sequel to the movie Wall St is being made? Is it any wonder that
individuals and investors are concerned? And that Australia’s own Sam Kekovich
is pointing the finger of blame directly at one group, and one group only:
“over-paid fat-cat bankers”. Fairly or not, consumers are now realising that
there is a crisis, and do not believe that it’s their responsibility or
fault!
In his recent
Australia Day address to the nation, Sam emptied both barrels at the
“unAustralian” behaviour of “bottom feeding, billionaire bankers”. “We need to
return to the egalitarian values that made Australia great, embodied in our
national dish: the barbecued lamb chop,” Sam said. “A chop tastes the same in a
designer outfit as it does in stubbies and thongs. Which reminds us you don’t
need to be an overpaid, pin-striped parasite from a millionaire’s factory. The
short-selling, rogue-trading, corporate crooks may disagree with me, but they
can go jump. And if they don’t know the way, I’ll push them in the right
direction.”
Our fellow
Australians have their superannuation and investment funds smashed, their are
houses worth less and their jobs are under threat. They are rightly confused and
concerned, and looking for answers. They certainly know that spending needs to
stop.
So, where does this
leave us? What should be done by whom at a macro political and regulatory level
to reform, and what are the consequences for those managing investors’
portfolios? What should our “reform” be, as portfolio construction
practitioners, or product providers… and as individual investors? I suspect
that cash, low-risk, uncomplicated and vanilla will be key themes that find
ready acceptance.
Rupert Murdoch
argues that governments need to take quick and drastic action because all of the
world financial markets are in disarray, and whole populations are depressed and
traumatised to see their life savings, including homes and retirement funds,
disappearing – not to mention their jobs. Now we have a rapid decline of real
economic activity on our hands. For example, the third quarter orders for Volvo
trucks in Europe fell from 41,970 in 2007 to just 115 in 2008!
And so we have the
paradox solution. The individual’s solution (to quit debt and surplus assets) is
almost entirely contrary to what governments want!
Politicians clearly
see that their positioning and survival depends on a correct response. Prime
Minister Kevin Rudd is advocating new regulation and government intervention for
financial markets, but warns that the advantages of the free market should not
be thrown out with the bath water. In arguing that the new epoch is about using
state power to save itself, and holding “neo-liberal” policies responsible, of
which the Liberal’s Howard, Costello and now Turnbull have been the local reps,
commentators believe that Rudd aims to have Labor as the ultimate political and
ideological winner from the crisis. Time will tell – and the outcome will depend
on how they perform in coming months.
Not that everyone’s
been a loser!
Andrew Lahde, a
California based hedge-fund manager, made 888% profits last year when his
company Lahde Capital bet against US sub-prime mortgage assets. Last September,
Lahde decided he was rich enough to retire, closed his fund and released a
letter, which became an Internet sensation. The opening paragraph begins: “Today
I write not to gloat, given the pain that nearly everyone is experiencing, that
would be entirely inappropriate. Nor am I writing to make further predictions,
as most of my forecasts in previous letters have unfolded or are in the process
of unfolding. Instead, I am writing to say goodbye. A colleague said “What I
have learned about the hedge fund business is that I hate it.” I could not agree
more with that statement. I was in this game for the money. The low hanging
fruit, i.e. idiots whose parents paid for prep school, Yale, and then the
Harvard MBA, was there for the taking. These people who were (often) truly not
worthy of the education they received (or supposedly received) rose to the top
of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our
government. All of this behaviour supporting the Aristocracy, only ended up
making it easier for me to find people stupid enough to take the other side of
my trades. God bless America.”
Last year, John
Paulson, a New York-based hedge fund manager, outsmarted Wall Street and made
nearly $2 billion by betting against mortgage backed securities. Much derided
for cashing in on others’ misery, he has shown few regrets, telling the Wall
Street Journal: “I’ve never been involved in a trade that had such unlimited
upside with a very limited downside.”
And then there’s
McDonalds which is selling hamburgers like hotcakes, and bookshops who stock Das
Kapital, the works of Karl Marx, where sales have gone through the
roof.
It’s clear that the
next couple of years, at least, will be difficult (to say the least!) for the
world economy… and its citizens.
However, it’s also
clear that governments and central banks around the world will do “whatever it
takes” to deal to the crisis, via whatever means possible. Some of what they do
will prove to be wrong, and will need re-doing. There will be lasting effects
and consequences. Some things will never be the same – but, over time, some
will. How do we know which is which, and what the consequences are? And, what
are the possible “road(s) to recovery”? And, what are the sign posts? What are
the implications for portfolios, and how do we communicate them to investors?
These are the
things that prompted brillient!, publishers of PortfolioConstruction Forum to
present a GFC one-day program, the PortfolioConstruction Investment Markets
Summit… the road(s) to recovery.
Graham Rich is publisher of PortfolioConstruction Forum. The above
was the opening speech presenting an introductory review and synopsis of recent
commentary on the global financial crisis, for the PortfolioConstruction
Investment Markets Summit on 17 February 2009.
© 2009 Portfolio
Construction Forum, Brillient Investment Publishing Pty Ltd ABN 19 122 531 337.
All rights reserved. Refer Terms & Conditions of Use.
