Dateline Washington, DC, Columbus Day Weekend, IBRD/IMF Meetings
The markets were up sharply overnight and today on news that 15 European countries are taking moves to shore up stresses in their banking systems. However, volume was thin as it was a holiday Monday in parts of Asia and all of North America. This impressive relief rally belies significant unease in the investment markets and does nothing to dispel fears of the now generally acknowledged wider recession that is on the way and the fears that yet more stresses are in store.
How Times Change
In years past the IBRD/IMF meetings represented the “Gotta be There” Schmoozefest for A-List Investment Bankers, Lawyers, Fund Mangers and a variety of other hangers-on in the game of international finance. To say that this year’s affair was subdued would be a vast understatement. In fact at times it appeared that the host institutions and the various politicians in attendance would have welcomed news of a massive asteroid on a collision course with Earth or an outbreak of a new virulent flu bug as a welcome diversion from what is turning into a quagmire of thorny and seemingly intractable issues.
The non-party got going late last week when the Treasury announced that it was going to substantially rework the TARP Plan as it did not meet the requirements of the situation (See our last month’s post on this topic). The G20 communiquÃ© then announced that officials endorsed the idea of a coordinated response to the financial crisis, but offered no specifics on what this coordination might entail. The proceedings really started to fall apart when the Managing Director of the IMF, former French Finance Minister Dominique Strauss-Kahn declared that, rapidly growing “…… solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.” Our readers might well imagine how pumped up the audience was after that pronouncement.
As an interesting counterpoint, an ANIME (Japanese Cartoon) conference was being held in the hotel adjacent to mine coincident with the IBRD / IMF meetings. Wild wigs, brassy makeup and other getups were the order of the day. Taking a cue from this event, I was given to wonder whether any of the IBRD/IMF delegates were tempted to join the cartoon celebrations in place of the sombre proceedings taking place within the Perimeter.
And the Second Angel Blew his Trumpet
Sunday afternoon we learned that the lip service given to a coordinated a response among the G-7 and G-20 has resulted in European countries announcing plans to inject “billions of dollars into their banks.” This needs to be viewed in the context of UK Prime Minister Gordon Brown declaring that he plans to sue Iceland over the failure of its banking system and consequent impact on British depositors; while Russia is being looked to as a saviour by the Icelanders – ahead of the IMF – as it is bearing a possible EUR 4.0 Bn rescue loan package.
Rather than reinforcing confidence, the general lack of coordination up until last night’s announcement, the paucity of answers and surplus of buck-passing that appear to be the hallmarks of this year’s set of meetings, will likely significantly worsen the already very gloomy market sentiment, despite today’s uptick.
The bottom line is World Leaders, with the US at the forefront, seem to have squandered a major opportunity at these meetings to draw a line in the sand and calm market fears about the spread of the liquidity crisis and the seeming resistance of this credit virus to the policy tonics that have so far been applied .
As the realization that this crisis is far from over watch for the fear and loathing to spread:
Banks have already tightened lending conditions significantly. Expect further credit rationing as opposed to price-driven activity. This means that some well-capitalized borrowers will likely fail. No one is immune. (Note to the Unbelievers: When Lehman went to ground its leverage ratio was 10.5:1 , Hugely conservative for an I-bank and much less than Goldman’s contemporaneous 22:1);
Consequently, there will be a significant spike in corporate bankruptcies both as a result of the credit squeeze but also intimately related to the vast volumes of sub-investment grade debt issuance in the last 5 years.
Global Stock Markets will remain weak and IPO activity will continue at a low ebb, sapping banks of fee and spread income and foreclosing deal entry and exit points for private equity funds and corporations.
Expect a further strain on Government resources in the affected countries, with consequent implications for employment, profits, inflation and growth. In this connection it is worth noting that, on our count, the Fed has already blown its wad and exhausted its Balance Sheet. Thankfully, cooler heads are tempering the Treasury’s initial planned reliance on fixed income financings as a way out of the mortgage quagmire. In part this strategy would have caused a predictable spike in bond yields (no doubt a reason why the TARP is being reconsidered along the lines we first suggested). So watch for additional money creation…..and a more immediate reaction on global markets once they realize that the wheels were never even on the TARP or any other plan in the first place;
The witch hunt is only starting. This week we saw Dick Fuld, the former CEO of Lehman Brothers, being grilled by the House Oversight and Government Reform Committee. At the close of the sessions, Committee Chairman Henry Waxman ominously stated “Mr. Fuld, You say you will be haunted by the collapse of your firm until the end of your days, but you don’t seem to think that you did anything wrong. And that is troubling to me! (sic)” Will they call Fuld back to the Hill and then on to a courtroom for a slow “perp roast”, to be aired on C-SPAN? Maybe, maybe not. But you should expect a slew of corporate executives in a number of countries, but particularly the US, to be indicted, tried, convicted and led to the gibbet before the dust settles on this debacle.
The larger questions about this crisis still remain. The IMF’s resources at around USD 200 billion are woefully short of the amounts needed to make a dent in the problem. In fact the IMF appears to be holding its resources in reserve for a kind of “reverse triage” in case any of the emerging economies run into trouble. The G7 and G20 do not appear to be equipped or inclined to solve these problems. Therefore, questions must legitimately be asked as to whether the IBRD, the IMF and other global institutions are effective or even relevant any more, and moreover, whether the economic policy-making machinery and risk management systems in all of the major economies, should be in line for a major overhaul.
Don’t get sucked into today’s rally. It is primarily a technical bounce that will fade once the markets realize the scale and number all of the risks and obstacles that lie ahead.