Sunday, August 26, 2007

The Liquidity Problem: Where's George Bush?

In a mid-length blog, Ambrose Owens-Pritchard of the London Telegraph sees an American plot to denude Europe of liquidity. He didn't mention George Bush...yet.

First he reviews the money situation around the Western world:

The liquidity crunch is not yet over: the insolvency crunch has hardly begun.

...And yes, speculators have renewed their leveraged bets on the yen and Swiss franc carry trades, borrowing cheap in Tokyo and Zurich to play global assets. The core belief is that nothing has really changed, that the world economy is still in rude good health.

Be very careful. Interest rates in Europe and Asia are that much higher now, with delayed effects starting to bite hard. Japan’s economy has stalled to 0.1pc growth in Q2; the euro-zone has slowed to 0.3pc; and China’s refusal to import (by currency manipulation) makes it a drain on world demand. Above all, the credit bubble that perpetuated the rally of the last eighteen months beyond its natural life has definitively burst.

...Credit spreads on the iTraxx Crossover (a good barometer of corporate bonds) have ballooned 180 basis points since February. The cost of borrowing for most firms in Europe and North America has jumped from circa 6.5pc to 8.3pc, if they can get it


...Ben Bernanke is looking hawkish to me, given the shock of what happened on Monday when yields on 3-month US Treasury notes plunged at the fastest pace ever recorded, a panic flight to safety that no living trader had ever seen before.

Why? Because trust had collapsed to such a degree that players with a lot of cash no longer believed it safe to leave wealth in bank accounts, or the money market funds of brokerage companies - (exposed as they are to short-term commercial paper and subprime CDOs). This did not occur after 9/11, or in the heat of the October 1987 crash. Nor did was there such a banking panic in October 1929. (it hit in August 1931). If you think this is of no importance, or that this will pass swiftly, you have a strong nerve.

Maybe that explains the Fed's Friday letter to Citigroup and Bank of America, allowing extraordinary repo terms... That news should put perspective on the Congressional rush to "fix" the problem with Freddie/Fannie funds.

...The belief that Europe would somehow be insulated has been tested over the last two weeks. Two German banks have required bail-outs on subprime bets – Sachsen LB for Eu 17.3bn, IKB for Eu 8.1bn.

Hence the continued actions of the European Central Bank, which has quietly injected 85bn euros in extra liquidity so far this week, almost as much as it did on the first day of emergency stimulus in early August.

So the question: who's to blame for this?

In a warped sense, one has to admire the cool way that Americans – who save nothing, in aggregate – tapped into the vast savings pool of thrifty Germans to finance their speculative excesses, and then left the creditors holding a chunk of the subprime losses.

Ambrose-Pritchard quotes an anonymous US hedge-fund operator:

'Real money' (U.S. insurance companies, pension funds, etc.) accounts had stopped purchasing mezzanine tranches of U.S. subprime debt in late 2003 and [Wall Street] needed a mechanism that could enable them to 'mark up' these loans, package them opaquely, and EXPORT THE NEWLY PACKAGED RISK TO UNWITTING BUYERS IN ASIA AND CENTRAL EUROPE!!!!

"These CDOs were the only way to get rid of the riskiest tranches of subprime debt.

Interestingly enough, these buyers (mainland Chinese banks, the Chinese Government, Taiwanese banks, Korean banks, German banks, French banks, U.K. banks) possess the 'excess' pools of liquidity around the globe. These pools are basically derived from two sources: 1) massive trade surpluses with the U.S. in U.S. dollars, 2) petrodollar recyclers. These two pools of excess capital are U.S. dollar-denominated and have had a virtually insatiable demand for U.S. dollar-denominated debt . . . until now.

So, you see, the US hoodwinked all them furriners into purchasing junk bonds.

Ambrose-Pritchard forgot to mention that it is "all Bush's fault." But not to worry; if things get nasty here in the US, the only question is 'Which Dem candidate gets to the microphone first'.

HT: Calculated Risk

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