Monday, January 21, 2008
The Second Horseman of the Macropocalypse
Lots of talk about whether we're in a recession - all of it irrelevant.
Are we in a recession? Economists look at lagging indicators to gauge recessions.
In fact, when you look at leading indicators, we're way past the point of a simple, temporary recession.
The climate of fear across global financial markets is fast approaching hysteria.
The virus that was born on Wall St has now reached across the globe to the Bank of China, which has begun writing off subprime debt.
Merrill Lynch, in case you aren't keeping up, is actively - and furiously - being unbundled, in an attempt to keep it viable.
Here's a fun bit of analysis. My numbers indicate that the megabanks can endure about another 7-10 writeoffs of similar magnitude before the global financial system actually...ummm...breaks.
That might sound like a nice cushion.
But it's not. Because the fundamental problem still remains: no one has any idea of the actual magnitude of the losses.
Why not? Because the DNA of the Street is deeply, gangrenously rotten.
Today's Wall St and City of London exist to profit by "ripping your head off" - by doing deals where everyone else is worse off. That is, the hidden costs of capital have exploded.
The point is simple: an economy where the costs and risk of capital are increasingly costly in the long run cannot go on functioning.
Such an economy is a shell game; a masquerade - because the supply of value creation implodes in line with the cost of capital.
Just ask the small towns who got ripped off. Fooled me twice, etc. More to the point, take a look at Robert Mugabe - because Zimbabwe is the endgame of an economy where capital is prohibitively costly and securities & assets are dominated by total uncertainty.
So the cushion banks have can only hold the financial system together for so long - if the underlying problem of DNA isn't addressed, the centre cannot hold forever. The gears will grind to a creaking halt.
Despite sheikhs and "sovereign wealth funds" here and there pumping liquidity into the system - notwithstanding the fact that dumb money is perhaps a greater challenge a simple lack of liquidity - the deeper problem remains.
There's not enough dumb money in the world to keep this broken machine running indefinitely.
To mix metaphors - at the very least, we have to be able to diagnose the extent of the infection to be able to treat the disease. Until we can assess the damage done, arguments over whether we're in a recession are like fiddling while Rome burns - because the crisis will always and everywhere keep deepening and darkening.
NB - Got some heat for referring to SWFs as dumb money. Guys, that's not me being a jerk - unfortunately, it's reality.
SWF's don't deliver returns in line with risk. Even the stars, like Temasek, have consistently underperformed market indices, etc, etc. That shouldn't be a surprise - they don't face nearly the same discipline as other funds do etc, etc.
And that they're buying stakes in megabanks tells us just how deep the rot in the financial system really is; from an economic and strategic pov, the market is telling us that even these deeply inefficient institutions are more efficient allocators of capital than megabanks/institutional shareholders are.