Saturday, September 27, 2008

Touching the Elephant

"Shanghai is the largest city in China in terms of population and one of the largest urban areas in the world, with over 20 million people in its extended metropolitan area." -- "Ch'ung-ch'ing is the largest of ...China's four provincial-level municipalities, and ...has a registered population of 31,442,300 (2005)" These contradictory statements are in Wikipedia, which is more Factually reliable than many give it credit for. But, how many of you have heard of Chongqing (with today a pop. of c.35 millions - now the biggest megalopolis in the world, bigger than Tokyo (33m), and Seoul, Mexico City, New York, Mumbai, Dehli, Sao Paolo, and Shanghai, all with populations over 20m.
Even after the massive earthquake in Chongqing's region attended by the world's media, Chongqing is even now still totally off the global urbanism map; it is like a great hidden secret (google it).
After a year of credit crunch coverage and enquiries into shadow banking and credit derivatives markets, they too remain incomprehensively beyond the understanding of the vast majority of people, including even the vast majority of bankers and other financial experts. My sister in law says it is like watching a lot of blindfolded suits trying to pin the tail on the donkey. Actually, that's what she said after watching the McCain-Obama debate.
Shadow banking (meaning off balance sheet investment banking or what many might now choose to re-name shady banking) has been dragged into an incomprehending limelight. Hank Paulson repeats over and over how sincerely agitated, disgusted, annoyed, infuriated, angered, embarrassed, and irritated he feels personally about asking for hundreds of $billions, or any money at all. If investment banking, shadow banking especially, is the ultimate invisible hand of capitalism, it has now become very visible but only like in the parable of the blind men and the elephant, and so I would judge most people are still in denial and refusing to accede to experts who say this is really important stuff, a huge elephant, the ultimate elephant in the room! Hence, some politicians, some Congressmen etc., can brazenly say no, bailouts are wrong, it's a retail insurance problem only; let's just insure the mortgages - and of course the fact is that they don't even understand the costs and consequences of that either. And, do the bankers? Fact is, there has been so much specialisation in investment banking, silo-thinking, semi-detached self-serving businesses (and financially self-sufficent like prime brokerages, e.g. Lehman, re-hypothecating clients' margin collateral to play their own proprietary trading games) that precious few bankers have an integrated view of the big picture; a lot of blind leading the blind down dark alleyways that only now are getting spotlighted and daylighted. Therefore, is it any wonder nearly everyone is in denial? Media discussion about banking talks of the basics of 'normal' customer service banking as capitalism's plumbing and how what we the need is to get in a plumber to unblock the furred up pipes and clean out the sewer?
The most basic principle of the 'transmission' mechanism of converting savings into loans and future expectations into credit-worthiness are not understood. Most people do not know how capitalism works, no more than they know how a car engine functions or what electricity is, why the sky is blue, or the universality of gravity? (Though, actually, definitions of gravity are dividing even standard cosmology astro-physicists just now, hence the super-collider experiments at CERN!)
The European Parliament looked at the crisis in great detail very intelligently half a year ago, reading a fat report from Cambridge, but who noticed? US Congress is another matter. Its learning curve is as steep as can be. Right at this moment, in an attempt to prevent a catastrophic global meltdown beginning Monday, Congress is locked in a last-ditch to agree a bailout before Sunday evening when Asian markets open. To succeed or fail, three things are uppermost:
1. The U.S. credit engine and interbank funding globally is in melt-down, almost at a virtual standstill. Any businesses that depend on unsecured cash based only on their creditworthiness are at risk of instant bankruptcy.
2. The markets are now coiled so tight in nervous expectation that once the TARP bailout is passed, equities may rise so precipitously that it will only be sustained for a short period after which the inevitable correction (given the built-in kneejerk models) will be another shock to general confidence, and the respite to credit meltdown will be short-lived. This is despite the sensible and all-round profitable logic of TARP, a logic that many bankers and equity analysts may not yet appreciate, and may never get to appreciate?
3. Anxiety is so endemic in the banking industry, with a host of negative risk factors to be overcome, just like fences on the steeplchase course at Aintree, many investors will take profits early and, insofar as they can, pull out of the financial system entirely, shifting from weak to strong brands perhaps, in which case more bankruptcies and consolidations are yet to come regardless of Congress's decision. Any behavior that presupposes most market participants are ignorant and emotional as well as any kneejerk better-safe-than-sorry cynicism will be dangerous even when rational and irrational, both.
Hence, as soon as, assuming TARP is passed, much has to be done in educating investors and bankers. Politicians, central bankers and regulators will all need to rush into the broadcast studios and issue powerful messages of reassurance, all singing from the same US Treasury hymn sheet, and (not unlike educating everyone to the existence of the world's biggest city Chungqing) how hard can that be! Bankers may look like Cassandras and their critics like Jeremiahs. Who will be trusted above all others to tell the naked unvarnished truth of it; G.Brown, G.Bush, B.Obama, J.McCain, N.Pelosi, A.Merkl, JC Trichet, H.Paulson, B.Bernanke, C.Cox, M.Sarkozy, J.McCreevey, W.Buffett, G.Soros, who, or maybe N.Mandela or Bono? I'm on tenterhooks.
Plan B back-stops need to be in place. These include taking the caps off government borrowing limits, fully funding the lifeboats for the possibility of multiple bank failures occurring simultaneously, depositor protection scheme financing, liquidity windows, policyholder and bondholder insurance i.e. maximum short term funding all round. What scale are we talking. Well, take the case of WAMU. Over the 8 business days before its takeover by the regulators and instant sell-on to JP Morgan, depositors removed $16bn. We can conservatively multiply that a hundredfold as the precautionary support needed even if TARP is voted through!
A major factor may well be the $600bn that hedge funds have waiting in the wings to swoop vulture-like over the enxt weeks to convert this massive crisis (now that it has hit bottom and may be on the turn) into a massive profit opportunities of buying distressed assets and brands dirt cheap.
All is now coming to a head very quickly, a White followed by a Black October for stock markets and then the Alpine climb to Christmas. I'm personally in triple A bonds and AA- cash deposits plus 95% occupancy properties and thinking of taking an Autumn sunshine holiday in Chungqing (bigger population than Canada and Australia combined, though at $2,000 per capita GDP it is but the same size as England's City of Manchester - must be good place to create a thriving new business?) Good night, Good Luck and to all my American friends I hope you have a happy thanksgiving!

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