謝國忠-美國經濟市場雪崩

The following was just printed in South China Morning Post.

Market meltdown

The credit crisis is only the first phase of a greater unravelling of the financial system

Andy Xie

Mar 12, 2008


When you see a cockroach, assume that there are hundreds of others behind it. This redneck wisdom seems to work best in finance: the recent bankruptcies of several funds administered by hedge funds and private equity firms may be followed by an avalanche. Hedge funds and private equity firms have over US$3 trillion under management; their debts may be twice as high. Their investment activities are primarily concerned with borrowing cheaply to buy higher-return assets. "Higher return", of late, has come to mean "faster appreciating", not "higher yielding". As debt costs rise and asset prices fall, thousands of funds may already be under water. When their banks make margin calls, they have to liquidate.


This liquidation bounces back on lenders. Most large financial institutions have been mimicking hedge funds and private equity firms by acquiring assets with debts, warehousing them for appreciation, and booking the appreciation as earnings. As hedge funds and private equity firms liquidate, they have to mark-to-market their assets - that is, value their assets and liabilities on their balance sheet using the assets\' current market values. Global financial institutions may have to write down three times the US$160 billion that they have announced.


As the financial market melts down, many investors may want to withdraw from good-performing funds, usually small hedge funds, to preserve their wealth. They may be surprised to learn that these funds were not so good after all; they have been supporting the share prices of small companies. When these funds liquidate, there are no takers. Their real performance may be even worse than the bad ones.


What is occurring is the meltdown of the biggest pyramid game in human history. Since the burst of the Nasdaq bubble in March 2000, hedge funds, private equity funds and proprietary trading at banks have come to dominate money making. The new business model depends on asset prices rising. As so many rushed to the same side at the same time, their demand pushed up asset prices; thus, this model was self-fulfilling.


So much demand for debt should have pushed up their costs and invalidated the model. Luckily for our heroes, the then Federal Reserve chairman Alan Greenspan kept the liquidity spigot flowing to meet all the debt demand. Our heroes prospered by raising capital from other people and borrowing from financial institutions, which borrowed from other people. This new model created very young heroes.


When the tide goes out, you discover who is not wearing a bathing costume, as they say. This time, it turns out, nobody is. Now, our naked young heroes are being fired left and right. Their grey-haired bosses blame them for the big losses that their firms are suffering; never mind that they paid themselves tens of millions of dollars on their erstwhile heroes\' false profits.


In the Nasdaq bust, chief executives of the collapsing firms also blamed others at first, claiming ignorance of the financial shenanigans at their own companies. As the wheels of justice turned, they went to jail one after another. I suspect we are witnessing a repeat of this eternal drama - and that some Wall Street executives will go to jail this time, too.


We are through only the first wave of this credit bubble bursting. The bankruptcies of hedge funds and private equity firms will lead to capital losses for their investors and their financing banks. Around the corner, the second wave of writedowns will come from marking-to-market mortgage-backed securities, corporate credits and leveraged loans. As the financial turmoil brings down the economy, consumer credit will deteriorate in quality. The third wave of writedowns will occur amid surging unemployment late this year or early next.


So far, the decline of asset prices has been mostly normalisation; they were exaggerated by excessive leverage. Declining asset prices do temporarily crimp consumption and investment, which causes economic weakness and inspires fear in the financial market. Declining capital stock in the global financial system, however, is a bigger factor. The right course of action is for the US government to establish a Resolution Trust Corporation to take over failing financial institutions, including hedge funds and private equity firms, and leave the Fed to tackle inflation. But a Republican administration could not go to a Democratic Congress for money to capitalise such a corporation. It could not justify spending US$1 trillion to bail out those who deceived investors around the world and destroyed the finest financial institutions in America for their own gains. Instead, the Fed will be called on to save the financial system, boost the economy and suppress inflation at the same time.


Fed chairman Ben Bernanke will go down in history as a tragic figure. He has focused on stabilising the financial system first and foremost. His cutting of interest rates has opened up a big gap between short- and long-term rates. Financial institutions could profit from the gap by borrowing short-term funds for investing in long-term bonds. But this trick is not working well now, as financial institutions lack the capital. Instead, they are looking to make a fast buck in commodity markets, which is increasing inflationary pressure. Wall Street is burning the man who is trying to save it. History will inevitably compare Dr Bernanke with Arthur Burns, the Fed chairman who presided over stagflation in the 1970s.


When the financial system stabilises, inflation will force Dr Bernanke to raise interest rates quickly and to a very high level, causing a gut-wrenching recession, as Paul Volker did to cure Burns\' stagflation. Dr Bernanke could become Burns and Mr Volker in one term.


Andy Xie is an independent economist