In the run-up to the 2012 London Olympics, the New Labour government has put in a credible bid for victory in the financial events with the sums spent on bailing out the banks. The increasing size of the bail-outs shows one thing – the crisis is getting worse rather than better.
The Royal Bank of Scotland has so far received a world-record £53.5 billion since the onset of the crisis in 2007. That accounts for most of the total of £74 billion of taxpayers’ money the government has put into the banks, including Lloyds and HBOS, over the last two years.
The latest £25.5 billion for the RBS announced by Chancellor Darling yesterday is part of a second bank bail-out which adds up to nearly £40 billion, which is more than the amount handed over in 2008. The government is hoping this will keep the banks afloat whilst they tear themselves apart under direction from the EU’s competition commission.
The dismemberment of systemically important “too-big-too-fail”’ banks is a hot topic for the world’s financial community, but there is no agreement on a co-ordinated package of regulation and reform. Some want to return to the regime established in the wake of the 1929 crash which separated high-risk investment – gambling – from the relatively safer, but less profitable business of balancing deposits and lending.
Others, like the IMF, are busy trying to work out how to reduce the grossly unsustainable government deficits resulting from attempts to prevent global meltdown. All of the schemes under discussion concentrate their attention on repairs to the financial system. None of these can work however.
Martin Wolf, the Financial Times’ leading commentator puts it starkly: “It is idiotic to discuss the reduction of the huge fiscal deficits, without considering the nature of the offsetting adjustments in the private and external sectors.” What he implies is that the financial system can’t be fixed without either an “extremely perilous” return to credit-led growth.
Yesterday the Indian government gave its verdict on the health of the global economy. It swapped $6.7 billion of its US paper dollars for 200 tonnes of gold bullion put up for sale by the IMF. This is the latest and strongest indication that the Asian countries are moving away from a reliance on the declining dollar. India’s finance minister couldn’t have put his reasons clearer. He said the economies of the US and Europe have collapsed.
The contradictory movement of the tectonic plates of the capitalist financial and economic system is producing seismic shocks throughout the world. Even its most ardent defenders are losing faith in the possibility of a “solution” that is anything but an attempt to repeat the past.
Warren Buffet, the capitalist system’s most long-standing and successful investor of other people’s money has just bought a US railroad, in his biggest ever deal, describing it as “$an all-in wager on the future of the American economy”. Burlington Northern Santa Fe is a freight company. Its biggest cargo is coal for power stations. So much for concern about global warming.
Profit-motivated growth has brought us to an historical crossroads. The capitalist road leads to economic destruction, warfare and the collapse of life-support systems. If the historical process could speak to us directly, it would surely urge humanity to move forward to a co-operative social set-up where a financial system that serves only shareholders and speculators is put out of its misery and corporations that plunder the planet become the property of the people as a whole.
Gerry Gold
Economics editor
For revolutionary solutions to create a sustainable, not-for-profit economy in place of global capital alongside a real democracy based on People’s Assemblies. Visit our web site at www.aworldtowin.net
Showing posts with label global finance. Show all posts
Showing posts with label global finance. Show all posts
Wednesday, November 04, 2009
Monday, September 03, 2007
Things can only get worse
In 1997, New Labour’s election theme tune was Things Can Only Get Better. If Gordon Brown is thinking of calling a snap general election it is because the government knows that severe economic and political turbulence lies ahead and that things can only get worse. For the New Labour government faces a growing financial crisis, demands for a referendum on the new European Treaty and a rising tide of trade union militancy. Of prime concern to the Brown government is the state of global financial markets. The hurricane blowing through the markets will touch most of the population in one form or another in the next period. While Brown and his ministers repeat that the “fundamentals of the economy” are sound, as if the financial maelstrom was taking place on another planet, quite the reverse is true. The fact that a bank like Barclays is in difficulties is just one indication of how serious the situation is.
The entire financial system is now overwhelmed by a Mount Everest of debt that is increasingly “non-performing” – borrowers are unable to repay the interest, let alone the capital. Because the sums involved are astronomical, as well as the fact that the financial system is largely uncontrolled, unregulated and out of sight, central bank intervention makes little difference. As debt unravels, the impact on the “real” economy is palpable. Because capitalism requires credit and debt to oil the system of production for profit, as this lubricant dries up, so too does economic activity and we enter a period of recession. And because the global economy is deeply integrated and interconnected, the impact of an economic decline will be felt worldwide and in quick order.
At the personal, consumer level, the debt crisis is already taking its toll in Britain. The rise in interest rates has caught out people who borrowed five, six or even seven times their income to buy a home. Repossessions are rising at a rate not seen since the early 1990s. It may not yet have reached the levels of the United States, where over one million households face losing their homes because of mortgage default, but the signs are ominous. House prices are already falling outside London and the shake-out of City jobs forecast for later this year will take the heat out of prices in the capital too. So 2008 looks like being a year of negative equity – for bankers and ordinary people alike. In addition to all this, the Brown government is having to face down trade union wage demands, which produced the unprecedented and illegal walk-out by prison officers last week. Now even the police want the right to strike, something they lost in 1919 after laying down their truncheons for the first and last time.
Brown is presenting himself as a politician who speaks for all classes in society in a bid to woo Tory voters. In today’s Daily Telegraph, he says that people “are fed up with confrontational politics” and that his role is to reach “out to those who might not be thought of as our supporters or identified with us”. This is Brown the corporatist speaking, the politician who has done most to restructure the state so that it more directly serves big business and financial interests. These same interests are now in deep crisis and major shocks lie ahead. Whether he likes it or not, Brown will have to face up to “confrontation” as people fight to defend their own interests – their jobs, pensions, houses and standards of living.
Paul Feldman
AWTW communications editor
The entire financial system is now overwhelmed by a Mount Everest of debt that is increasingly “non-performing” – borrowers are unable to repay the interest, let alone the capital. Because the sums involved are astronomical, as well as the fact that the financial system is largely uncontrolled, unregulated and out of sight, central bank intervention makes little difference. As debt unravels, the impact on the “real” economy is palpable. Because capitalism requires credit and debt to oil the system of production for profit, as this lubricant dries up, so too does economic activity and we enter a period of recession. And because the global economy is deeply integrated and interconnected, the impact of an economic decline will be felt worldwide and in quick order.
At the personal, consumer level, the debt crisis is already taking its toll in Britain. The rise in interest rates has caught out people who borrowed five, six or even seven times their income to buy a home. Repossessions are rising at a rate not seen since the early 1990s. It may not yet have reached the levels of the United States, where over one million households face losing their homes because of mortgage default, but the signs are ominous. House prices are already falling outside London and the shake-out of City jobs forecast for later this year will take the heat out of prices in the capital too. So 2008 looks like being a year of negative equity – for bankers and ordinary people alike. In addition to all this, the Brown government is having to face down trade union wage demands, which produced the unprecedented and illegal walk-out by prison officers last week. Now even the police want the right to strike, something they lost in 1919 after laying down their truncheons for the first and last time.
Brown is presenting himself as a politician who speaks for all classes in society in a bid to woo Tory voters. In today’s Daily Telegraph, he says that people “are fed up with confrontational politics” and that his role is to reach “out to those who might not be thought of as our supporters or identified with us”. This is Brown the corporatist speaking, the politician who has done most to restructure the state so that it more directly serves big business and financial interests. These same interests are now in deep crisis and major shocks lie ahead. Whether he likes it or not, Brown will have to face up to “confrontation” as people fight to defend their own interests – their jobs, pensions, houses and standards of living.
Paul Feldman
AWTW communications editor
Thursday, August 16, 2007
The global pyramid scam
After a week of attempts by central banks to resuscitate global financial markets by injecting cash, the contagion continues to spread around the world, driving stock markets sharply lower. As is the fate of all pyramid-selling scams, the global economic structures built upon an addiction to credit and its inseparable opposite debt, are unwinding fast with devastating impact. Adding to the current crisis is the fact that financial institutions are now scared of each other. No one really knows the level of exposure each investment and commercial bank holds. As a result, inter-bank trading has ground to a halt because no one wants to be left holding the debt hand grenade when the music stops.
Central banks have been trying to restore confidence, with the Bank of Japan announcing on Thursday that it would inject a further 400bn yen ($3.4bn) into its banking system. The US Federal Reserve made another $7bn (£3.5bn) of reserves available to the banking system on Wednesday. The Fed has injected $71bn into the system since 9 August. However, such moves, along with comments by US Treasury Secretary Henry Paulson that the economy was strong enough to withstand the turmoil, have done little to appease investors.
The current market volatility has been triggered by the US sub-prime mortgage sector, which offers higher-risk loans to people with a poor credit history. This particular bubble has burst as a result of higher US interest rates combined with falling house prices. The number of people defaulting on their loans has soared. While some estimates say $300bn in loans could be at risk, the eventual scale of the problem is thought to be much greater. The original loans were sold on as debt by mortgage companies to other institutions, who in turn have loaned out money against the expected income. Yesterday the situation worsened after Merrill Lynch told its clients to sell any shares they own in the country's largest mortgage lender, Countrywide Financial. It warned that Countrywide could face bankruptcy if the availability of credit in the market gets any worse and there were market rumours that the lender had failed to raise some money it needed.
No less devastating are the extremes of weather which are linked to climate change, itself a product of over-producing global, capitalist corporations whose products are largely bought on credit. Events in and around Wall Street on, August 8th, little reported in British media, provide a striking illustration of the intimate connection between the turmoil in the markets and wild climate. Hours before the financial storm broke, the Financial Times investment editor was commenting that futures and stock markets “reflect a belief that crisis will be averted. Both are vulnerable to bad news from the credit market. Once Wall Streeters calm down after their commute from hell, that will again be their greatest concern”. That morning a fierce morning storm disrupted transport throughout much of the region and unleashed a rare and destructive tornado that whipped the area with winds of up to 135 miles an hour, dropping 3 inches of rain on the New York metropolitan area in about an hour. Whilst there has so far been little attention to the direct impact of the Brooklyn tornado on the next day’s panic trading across the bridge in Wall Street, both are clear signs of a system in crisis, even meltdown.
Gerry Gold, economics editor
Central banks have been trying to restore confidence, with the Bank of Japan announcing on Thursday that it would inject a further 400bn yen ($3.4bn) into its banking system. The US Federal Reserve made another $7bn (£3.5bn) of reserves available to the banking system on Wednesday. The Fed has injected $71bn into the system since 9 August. However, such moves, along with comments by US Treasury Secretary Henry Paulson that the economy was strong enough to withstand the turmoil, have done little to appease investors.
The current market volatility has been triggered by the US sub-prime mortgage sector, which offers higher-risk loans to people with a poor credit history. This particular bubble has burst as a result of higher US interest rates combined with falling house prices. The number of people defaulting on their loans has soared. While some estimates say $300bn in loans could be at risk, the eventual scale of the problem is thought to be much greater. The original loans were sold on as debt by mortgage companies to other institutions, who in turn have loaned out money against the expected income. Yesterday the situation worsened after Merrill Lynch told its clients to sell any shares they own in the country's largest mortgage lender, Countrywide Financial. It warned that Countrywide could face bankruptcy if the availability of credit in the market gets any worse and there were market rumours that the lender had failed to raise some money it needed.
No less devastating are the extremes of weather which are linked to climate change, itself a product of over-producing global, capitalist corporations whose products are largely bought on credit. Events in and around Wall Street on, August 8th, little reported in British media, provide a striking illustration of the intimate connection between the turmoil in the markets and wild climate. Hours before the financial storm broke, the Financial Times investment editor was commenting that futures and stock markets “reflect a belief that crisis will be averted. Both are vulnerable to bad news from the credit market. Once Wall Streeters calm down after their commute from hell, that will again be their greatest concern”. That morning a fierce morning storm disrupted transport throughout much of the region and unleashed a rare and destructive tornado that whipped the area with winds of up to 135 miles an hour, dropping 3 inches of rain on the New York metropolitan area in about an hour. Whilst there has so far been little attention to the direct impact of the Brooklyn tornado on the next day’s panic trading across the bridge in Wall Street, both are clear signs of a system in crisis, even meltdown.
Gerry Gold, economics editor
Monday, August 13, 2007
A universe of fantasy finance
The turmoil in the world’s financial and stock markets that erupted at the end of last week prompted a panic release of funds into the system from the leading central banks. But their actions only add to the underlying cause of this crisis. The European Central Bank, the US Federal Reserve and the Banks of Japan and Australia stepped in to try to stem the massive loss of confidence in the share markets and the financial system as a whole. The intention was to loosen the seizure that had cut the flow of funds between banks, which are needed to keep the global economy operating. The hundreds of billions of dollars pumped into the system was the biggest such intervention since the crisis following the 9/11 terror attacks.
Some financial observers, as well as the International Monetary Fund, are claiming that last week’s events, whilst serious, do not greatly damage the fundamentals and will not impede continuing global growth. But this time the problem is not only a liquidity crisis - a sudden shortage of available cash known as a credit crunch. No, this time, the problem is greatly compounded by a crisis of insolvency. People can’t pay their debts. The three decades or so of continuing growth, albeit interrupted by many crises, has been made possible by low interest rates set by central banks, easy and easier credit, and the virtual elimination of control or regulation on the operation of financial institutions.
All of this was necessary to fund the profit-led capital expansion which offered a way out of the political upheavals of the late 1960s, the US defeat in Vietnam, and a wave of action centred on Paris in 1968, which threatened to undermine the capitalist system. A watershed in this process was the decision 36 years ago this week – on 15 August 1971 – to separate the dollar from gold, thus freeing the currency from any nominal connection with real value. Globalising corporations emerged able to optimise opportunities worldwide and dictate terms to national governments. In widening and exploiting inequality they greatly expanded production. Consumers, needed to buy the products, were seduced by marketing and then enslaved by unsustainable debt. To keep the whole thing growing required a universe of fantasy finance - apparently with a life of its own - expanding far faster than the real economy. Every day in the year to April 2006, in the foreign currency markets around 60 times the value of a whole year’s global production changed hands. Hardly a shortage of cash.
In particular, it is the globalisation of unpayable debt in the US housing market as well as other forms of debt, packaged into hedge funds and leveraged buy-out deals which has destabilised the entire system and which sparked the latest crisis. The world’s largest publicly quoted hedge fund manager, Man, lost nearly a quarter of its market value last month, with the worst two-day drop in its history before the weekend. The current crisis began to emerge from the murky depths of unsecured “sub-prime” mortgage lending. Sub-prime simply means borrowers with a poor credit history – usually low-wage earners who have trouble repaying their debts. Wall Street, burnt by its latest bonfire of the vanities, is now describing loans to risky borrowers as “toxic waste”.
The contagion is certain to spread as there are very many over-borrowed, over-stretched corporations - not just financial institutions - as well as the millions upon millions of individuals who find themselves in trouble in every country. The British economy is particularly vulnerable, as it is now dominated by financial services and speculation to the exclusion of manufacture and production. Some observers are comparing the situation to 1929, when the Wall Street crash led to a world-wide slump. But today, the world financial system is far more integrated as a result of globalisation and the consequences will be far more devastating for international capitalism.
Gerry Gold, economics editor
Some financial observers, as well as the International Monetary Fund, are claiming that last week’s events, whilst serious, do not greatly damage the fundamentals and will not impede continuing global growth. But this time the problem is not only a liquidity crisis - a sudden shortage of available cash known as a credit crunch. No, this time, the problem is greatly compounded by a crisis of insolvency. People can’t pay their debts. The three decades or so of continuing growth, albeit interrupted by many crises, has been made possible by low interest rates set by central banks, easy and easier credit, and the virtual elimination of control or regulation on the operation of financial institutions.
All of this was necessary to fund the profit-led capital expansion which offered a way out of the political upheavals of the late 1960s, the US defeat in Vietnam, and a wave of action centred on Paris in 1968, which threatened to undermine the capitalist system. A watershed in this process was the decision 36 years ago this week – on 15 August 1971 – to separate the dollar from gold, thus freeing the currency from any nominal connection with real value. Globalising corporations emerged able to optimise opportunities worldwide and dictate terms to national governments. In widening and exploiting inequality they greatly expanded production. Consumers, needed to buy the products, were seduced by marketing and then enslaved by unsustainable debt. To keep the whole thing growing required a universe of fantasy finance - apparently with a life of its own - expanding far faster than the real economy. Every day in the year to April 2006, in the foreign currency markets around 60 times the value of a whole year’s global production changed hands. Hardly a shortage of cash.
In particular, it is the globalisation of unpayable debt in the US housing market as well as other forms of debt, packaged into hedge funds and leveraged buy-out deals which has destabilised the entire system and which sparked the latest crisis. The world’s largest publicly quoted hedge fund manager, Man, lost nearly a quarter of its market value last month, with the worst two-day drop in its history before the weekend. The current crisis began to emerge from the murky depths of unsecured “sub-prime” mortgage lending. Sub-prime simply means borrowers with a poor credit history – usually low-wage earners who have trouble repaying their debts. Wall Street, burnt by its latest bonfire of the vanities, is now describing loans to risky borrowers as “toxic waste”.
The contagion is certain to spread as there are very many over-borrowed, over-stretched corporations - not just financial institutions - as well as the millions upon millions of individuals who find themselves in trouble in every country. The British economy is particularly vulnerable, as it is now dominated by financial services and speculation to the exclusion of manufacture and production. Some observers are comparing the situation to 1929, when the Wall Street crash led to a world-wide slump. But today, the world financial system is far more integrated as a result of globalisation and the consequences will be far more devastating for international capitalism.
Gerry Gold, economics editor
Friday, July 27, 2007
Global financial hurricane starts to blow
Turmoil on the world’s stock markets, induced by yesterday’s sharp falls in New York, is directly connected to a crisis at the heart of the global banking system. The implications for the everyday lives of ordinary working people in every country are enormous in terms of jobs, housing and living standards. In the US, the Dow Jones Industrial Average plunged more than 440 points in late trading - on course for its biggest fall since 9/11. The FTSE 100 suffered its worst day for five years while the FTSE 250 recorded its biggest points fall in history.
This instability has its roots in the frantic globalisation process. As the transnational corporations grew in size, so the need for credit ballooned to expand activities. Loans enabled corporations to buy out other companies through mergers and acquisitions. This in turn spawned a web of inter-connected complex financial markets, all eager to share in this easy “wealth”. Corporate debt was recycled over and over by a financial sector that has come to dominate the major economies. In Britain, for example, financial services account for of a third of the value of UK output, more than twice that of manufacturing. In parallel, ordinary consumers have been encouraged to borrow as much as they want on the promise that interest rates would stay low and the party would go on for ever.
But the music has suddenly stopped. Interest rate rises have made borrowing more expensive and bad debts are mounting up. In the United States, the crisis centres around loans to people with bad credit histories to help them buy homes. This is euphemistically known as the sub-prime market. A turndown in the US economy combined with rising rates has produced increasing levels of default. This leaves lenders exposed to large amounts of debt on loans which themselves are financed by borrowings from other institutions! In Britain, the consumer boom is over. Yesterday companies ranging from retailers Kingfisher, JD Sports and Kesa Electricals to Bradford & Bingley, the buy-to-let mortgage specialist, and insurer Legal & General all warned that five interest rate hikes in the past year are beginning to take their toll. Robin Evans, global strategist at Fox-Pitt Kelton, warned that "growth in the UK could slow quite sharply into the end of this year and the beginning of next year".
The capitalist press is trying to take a sanguine view. As a comment in today’s Daily Telegraph put it: “Yesterday's market falls were just an intensifying of the bad weather engulfing markets. The flood of debt that American consumers have been adrift on for years has finally turned toxic thanks to rapidly rising interest rates… To use one of the choicer quotes from a trader yesterday: ‘We're watching the slow-motion suicide of the capital markets.’ " There have been more than $3,000 billion (£1,500bn) announced acquisitions so far this year, more than 50pc above last year's levels. That activity has sent stock markets around the world sharply higher. But with banks now struggling to raise the money to finance these takeovers, investors are selling shares and fleeing to the relative security of government bonds.
The bursting of the global speculative bubble has unpredictable consequences. Banks failing, companies running out of credit, consumers spending less – it all points to an emerging global economic slump. The Brown government is aware of this and may plan an autumn election in a bid to beat the storm. Having stolen the Tories’ clothes on immigration, and wooing Conservative voters with reactionary policies on drugs, terrorism and crime, Brown calculates that New Labour could win an election with the support of right-wing Daily Mail and Daily Express readers. The financial storm of today is, however, a prelude to tomorrow's global hurricane.
Paul Feldman, communications editor
This instability has its roots in the frantic globalisation process. As the transnational corporations grew in size, so the need for credit ballooned to expand activities. Loans enabled corporations to buy out other companies through mergers and acquisitions. This in turn spawned a web of inter-connected complex financial markets, all eager to share in this easy “wealth”. Corporate debt was recycled over and over by a financial sector that has come to dominate the major economies. In Britain, for example, financial services account for of a third of the value of UK output, more than twice that of manufacturing. In parallel, ordinary consumers have been encouraged to borrow as much as they want on the promise that interest rates would stay low and the party would go on for ever.
But the music has suddenly stopped. Interest rate rises have made borrowing more expensive and bad debts are mounting up. In the United States, the crisis centres around loans to people with bad credit histories to help them buy homes. This is euphemistically known as the sub-prime market. A turndown in the US economy combined with rising rates has produced increasing levels of default. This leaves lenders exposed to large amounts of debt on loans which themselves are financed by borrowings from other institutions! In Britain, the consumer boom is over. Yesterday companies ranging from retailers Kingfisher, JD Sports and Kesa Electricals to Bradford & Bingley, the buy-to-let mortgage specialist, and insurer Legal & General all warned that five interest rate hikes in the past year are beginning to take their toll. Robin Evans, global strategist at Fox-Pitt Kelton, warned that "growth in the UK could slow quite sharply into the end of this year and the beginning of next year".
The capitalist press is trying to take a sanguine view. As a comment in today’s Daily Telegraph put it: “Yesterday's market falls were just an intensifying of the bad weather engulfing markets. The flood of debt that American consumers have been adrift on for years has finally turned toxic thanks to rapidly rising interest rates… To use one of the choicer quotes from a trader yesterday: ‘We're watching the slow-motion suicide of the capital markets.’ " There have been more than $3,000 billion (£1,500bn) announced acquisitions so far this year, more than 50pc above last year's levels. That activity has sent stock markets around the world sharply higher. But with banks now struggling to raise the money to finance these takeovers, investors are selling shares and fleeing to the relative security of government bonds.
The bursting of the global speculative bubble has unpredictable consequences. Banks failing, companies running out of credit, consumers spending less – it all points to an emerging global economic slump. The Brown government is aware of this and may plan an autumn election in a bid to beat the storm. Having stolen the Tories’ clothes on immigration, and wooing Conservative voters with reactionary policies on drugs, terrorism and crime, Brown calculates that New Labour could win an election with the support of right-wing Daily Mail and Daily Express readers. The financial storm of today is, however, a prelude to tomorrow's global hurricane.
Paul Feldman, communications editor
Monday, June 25, 2007
Financial 'Katrina' begins to blow
For some days now, banks and finance houses have been watching the unfolding crisis at major investment bank Bear Stearns, as it tries to limit the fallout from the failure of two of its hedge funds. Like many such investors, Bear Stearns had a lot of products riding on the back of property-related debt, and, notably, the US "subprime" mortgage market. Subprime refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history.
The two failed funds have grand titles: the High-Grade Structured Credit Strategies Enhanced Leverage Fund, and the High-Grade Structured Credit Strategies Fund. These meant-to-be reassuring names hide a high risk reality. In the trade, such products offered are based on credit with a quality rating politely referred to as "junk", or less politely, "nuclear" or "toxic" waste. The buyer gets the possibility of high returns, but runs the risk of getting little or none of his principal back. The "enhanced leverage" fund was worst hit because, as its name implies, the underlying capital represented only 10%, the rest being borrowed from other sources.
As we have discussed previously, the housing market in the US has been in decline for many months. It is leading the way down not just for the American economy but, behind the misleading appearance of continued worldwide growth, is having a major impact on the rest of the global economy. Subprime mortgages are the most risky ones where the homeowners are at least able to make the monthly payments. The rate of default has been accelerating, and many of the lenders have been forced into bankruptcy. This is a problem for the so-called securities houses like Bear Stearns which despite its reputation as one of the shrewdest actors in the mortgage market, with the best set of controls in place, finds its funds failing, and its customers and creditors scrambling to sell.
As the swirling clouds of credit and debt that have swelled the markets in hedge funds, and more recently private equity, have ballooned in recent years, it could only have been a matter of time before the iron law of value began to make itself felt. There is much speculation about the extent of the impact on the rest of the world’s financial markets. One of Bear Stearn’s investors put it like this: "They didn’t realise this was Katrina, they thought it was just another storm." According to The Economist "perhaps the most worrying thing for financial institutions holding mortgage-backed paper is not the subprime market itself, but the unnerving parallels with an even bigger one to which they are also exposed: leveraged loans to companies. As Daniel Arbess of Xerion Capital Partners points out, corporate lending's giddy leverage echoes the high loan-to-value ratios in subprime; … subprime, says Mr Arbess, might well be ‘a dress rehearsal for something bigger and scarier’."
Gerry Gold, economics editor
The two failed funds have grand titles: the High-Grade Structured Credit Strategies Enhanced Leverage Fund, and the High-Grade Structured Credit Strategies Fund. These meant-to-be reassuring names hide a high risk reality. In the trade, such products offered are based on credit with a quality rating politely referred to as "junk", or less politely, "nuclear" or "toxic" waste. The buyer gets the possibility of high returns, but runs the risk of getting little or none of his principal back. The "enhanced leverage" fund was worst hit because, as its name implies, the underlying capital represented only 10%, the rest being borrowed from other sources.
As we have discussed previously, the housing market in the US has been in decline for many months. It is leading the way down not just for the American economy but, behind the misleading appearance of continued worldwide growth, is having a major impact on the rest of the global economy. Subprime mortgages are the most risky ones where the homeowners are at least able to make the monthly payments. The rate of default has been accelerating, and many of the lenders have been forced into bankruptcy. This is a problem for the so-called securities houses like Bear Stearns which despite its reputation as one of the shrewdest actors in the mortgage market, with the best set of controls in place, finds its funds failing, and its customers and creditors scrambling to sell.
As the swirling clouds of credit and debt that have swelled the markets in hedge funds, and more recently private equity, have ballooned in recent years, it could only have been a matter of time before the iron law of value began to make itself felt. There is much speculation about the extent of the impact on the rest of the world’s financial markets. One of Bear Stearn’s investors put it like this: "They didn’t realise this was Katrina, they thought it was just another storm." According to The Economist "perhaps the most worrying thing for financial institutions holding mortgage-backed paper is not the subprime market itself, but the unnerving parallels with an even bigger one to which they are also exposed: leveraged loans to companies. As Daniel Arbess of Xerion Capital Partners points out, corporate lending's giddy leverage echoes the high loan-to-value ratios in subprime; … subprime, says Mr Arbess, might well be ‘a dress rehearsal for something bigger and scarier’."
Gerry Gold, economics editor
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