作者：謝國忠 评论(0) 标签:谢国忠, 美国, 救市, 金融海啸
29 Sept 2008
I wrote this ten days ago. Seems the plan is still the same as before the McCain interruption. Its main impact in the short term is to bring confidence to the financial market and may support a bounce. But, the bounce won't last very long. The economic crisis is coming soon. The US economy may contract by 2-5% in 2009. As the economy contracts, highly leveraged businesses in the real economy will get into trouble. Their debts will be in trouble also. It may lead to a PE industry crisis. Cheers. Andy
Plan B is no silver bullet
The US government has rushed out a barrage of measures, the so-called Plan B, to save its financial system. The measures include (1) establishing a government entity to take over $700 billion bad assets off the balance sheets of financial institutions (the figure excludes nearly $300 billion for bailing out AIG, Fannie Mae and Freddie Mac), (2) guaranteeing $3.4 trillion deposits in money market funds, and (3) banning short selling of nearly 800 financial stocks temporarily. The measures have revived markets. But, the euphoria may be short-lived. Plan B won't stop a gut wrenching recession-2% or more contraction for the US economy in 2009. In the longer term, the US still has to figure out how to pay for the losses, decrease leverage in the real and financial economy, and find a non debt-driven growth model. This is not just a crisis of confidence. The fundamentals are deteriorating fast. Plan B can't halt that trend.
The bankruptcy of Lehman Brothers triggered the financial tsunami that has forced the government's hand to rush out Plan B. It has struggled to hold the system together since the crisis began one year ago. It has dealt with the crisis piecemeal. When Bear Stearns collapsed, it persuaded JP Morgan to 'buy' it with $30 billion from the Fed as incentive. When Fannie Mae and Freddie Mac collapsed, it took them over. It tried for the longest time to persuade Lehman Brothers and Merrill Lynch to save themselves. The failing financial institutions took time to find the best deals for themselves, usually about keeping their bosses in elevated positions. Out of frustration over the slow pace of their self-rescue efforts, the government decided to 'kill a chicken and show it to the monkeys' and let Lehman fail. But, it didn't let AIG fail and took it over, i.e., putting government credit behind its bad assets, because AIG was viewed as a monkey.
But, the Lehman bankruptcy deeply scarred the financial market already in a fragile mental state. Institutional investors like pension funds or mutual funds became deeply concerned who they should be doing businesses with. They were ready to move their funds out of any Wall Street firm that was rumored to be failing. The withdrawal of their funds would bleed the highly levered Wall Street firms to death. This is why short sellers attacked Goldman Sachs and Morgan Stanley soon after the Lehman failure. The sinking share prices of the two giants sent everyone scurrying for cover. It felt like the end of the Wall Street. Indeed, if the government had not taken actions, the US's financial system would have collapsed.
Ironically, the Wall Street gave birth to the short sellers, or hedge funds, after the tech burst in 2000 to juice up their businesses. These hedge funds have grown enormously and now manage about $2 trillion. They have become big enough to take on the Wall Street. Like a modern day Oedipus play, they have come to slay their parents and take their kingdom. While the government measures have held them off for now. This drama is far from over. The Wall Street firms are staffed with corporate warriors who succeed by sucking up to their bosses, while hedge funds have attracted the brightest and the most ruthless. The battle is unevenly matched. Without government help, the Wall Street is doomed. Like Teutonic Warriors perched on hills overlooking Rome, they can't wait to sack the opulent and corrupt establishment.
Pundits and government officials have heaped praises on Hank Paulson and Ben Bernanke for their handling of the crisis. I disagree. They have failed to understand the nature of the crisis. This is the collapsing of Greenspan's debt empire. The financial system is a house of cards on an unprecedented scale. The establishment cannot be saved. The aristocrats on Wall Street have been making billions every year by mixing debts with debts. They call them derivatives. The government cannot prop them up. There was nothing but air inside. The financial system that comes out of the crisis has to be very different. They should have seized all the failing financial institutions (i.e., most non banks and hundreds of banks), wiped out equity holders and debt holders, send debt peddlers to jail, bring down the leverage quickly, and attract foreign capital to recapitalize a much smaller but viable financial system. Instead, they hoped the people who made the bubble to solve the problems for them.
Let me launch a broadside on the Wall Street big wigs. Most of them have already been fired but walked away with millions as golden handshakes. Hopefully, justice will eventually catch up with them, and those who have destroyed so much would end up in maximum prison. The survivors still don't believe that their successes were a bubble phenomenon and psychologically biased towards preserving their empires. In a bubble, people who succeed are daring but not necessarily smart. But, successes make them believe otherwise. That is what brings them to a tragic ending. They are not capable of understanding the mess they have created. This is why the government's attempt for these people to rescue themselves would never work.
The delaying tactic by the government was due to the political considerations on the ongoing presidential election. A government bailout would expose the economic mismanagement of the past, which would diminish the chances of the Republican Candidate, John McCain, in November. Now the market has forced the government's hand. The rescue probably has killed McCain's chance to be the next president.
How would Plan B play out? I think it merely brings temporary relief. As investors imagine that the government takes over bad assets, they think they can forget about it and everyone can resume 'normal' life. This naïve view won't last. Who would pay for the losses? Wouldn't the government go after shareholders and creditors? Could taxpayers who are losing their homes have the money to cover the losses? Could the government whose debts stand at $10 trillion borrow more to pay the bill?
After covering the losses embedded in the bad assets, the US economy is still over levered. It takes an enormous amount of money to recapitalize the US economy. The US's non-financial sector debt rose to 226% of GDP in 2007 from183% ten years before, and the financial sector debt surged to 114% of GDP from 64% during the same period. The real economy may need 40% of GDP in extra equity or $5.5 trillion, equivalent to one third of the US's stock market capitalization. Even if Americans tighten belts and raise savings to boost their equity capital, the process would be too long for financial markets to feel comfortable today. The US may need foreign capital at least for half of the needed amount.
The US's financial sector may have to decrease leverage by $5-8 trillion. A significant portion of that are bad assets. The total reported losses have already amounted over $400 billion. New losses would far exceed that amount. As the total losses could be similar to the total amount of capital in the US's financial system before the crisis began, the US may have to let foreigners be majority owners of its big financial institutions. In the fund raising of the past year, the US's financial institutions sold minority stakes to sovereign wealth funds around the world. Without any control over these institutions, they of course are resentful of the terrible losses that they have suffered. In future fund raisings, the US's financial institutions may have to sell controlling stakes to foreigners.
The solution to America's crisis must involve the countries that own $10 trillion in foreign exchange reserves. The US economy is undercapitalized. An internal solution is usually one form of debt replaced with another. The current proposals fall into this category. When the shell game runs out of options, printing money is the only way out. That will eventually lead to dollar collapsing and hyperinflation in the US economy. The world should come together to prevent such a tragic ending. Countries with big foreign exchange reserves like China, Japan, Kuwait, Saudi Arabia, UAE, etc., should sit down with the US government to find a way to recapitalize its economy. They should swap their dollar assets in debt instruments like treasuries for equity assets like stocks.
The world has a vested interest in ensuring an orderly resolution to the US's crisis. If the US prints money to solve its problems, it will lead to the destruction of everyone's wealth in dollar assets and a global depression of unimaginable proportion. Rising leverage in the US has driven the demand growth in the global economy in the past decade. It has led to large US trade deficits and surging foreign exchange reserves among its trading partners. The foreign exchange reserves have been recycled back into the US's debt instruments, reinforcing its leverage-driven demand growth. Hence, the high foreign exchange reserves of its trading partners and the excessive leverage of the US economy are two sides of the same coin. It is hard to imagine that the solution wouldn't require both sides to participate.
The US needs to change its policy towards foreign investments. Its xenophobia over investments from non-western countries is a major barrier to the solution. Remember CNOOC's attempted takeover of Unocal and the forced sale of the US ports by Dubai Ports World. If the US can successfully make a debt-equity swap for its economy, the equity providers have to be Asian countries or oil exporters who Americans are not used to as owners. But, there are no other solutions. The US needs to become more like the UK in treating foreign ownership.
While the above proposal is a win-win for the world, the odds for its implementation are quite low. The United States still has an unrealistic view of itself. Its domestic politics is insular and xenophobic. Even tough the US is the largest debtor in the world it behaves like the largest creditor. Americans may need much more hardship to change their attitude.
The US's unwillingness to accept capital from non-western countries may push it down the path of printing money. The Fed can purchase whatever papers the Federal government issues to cover the losses in the bad asset disposal. It will lead to high inflation. When foreigners dump their dollar assets, the dollar would crash, the US may experience hyperinflation and economic chaos.
To protect themselves against such a scenario, foreign governments should switch their treasury holdings into stocks that preserve value better during inflation. Despite their sharp decline in recent months, the US's stocks are fairly valued, not dirt cheap. They may well decline in the coming months in a recessionary environment. But, they are better value than treasuries now. Central banks should put wealth preservation ahead of all other considerations.
Ironically, if foreigners switch from treasuries into stocks, it will ease the equity capital shortage in the US economy and discourage money printing by the Fed by pushing up treasury yields. Maybe, foreigners can save America even if it doesn't want to.
While the financial crisis is still far from over, the economic crisis is already around the corner. Rising leverage has supported the US's consumption led growth for the past decade. A significant portion of the US's aggregate demand is kept afloat by the bubble. As the bubble bursts, that part of the demand would vanish. The coming recession could be the most severe in fifty years. The US's economy could contract by 2% or more in 2009.
Many would be skeptical of this view. When the crisis happened one year ago, everyone worried about the worst. But, the US economy has not contracted. Many attribute it to the US's good export performance on 30% dollar devaluation. But, that is not the most important factor. The US economy has not decreased its leverage. The US's non-financial sector debt rose to $32.4 trillion by mid-2008 from 30.4 one year ago, and the financial sector debt to $16.5 trillion from 15.0 during the same period. The calm in the economy and financial system was sustained by increasing debts to cover up the bad debt problem.
The market has forced the issue now. Like Asian economies in 1998, the US has to deleverage . It means no loans for sustaining a big chunk of the existing consumption. It means acceleration in property price decline. These two factors would cause significant economic contraction. The knock-on effect will work through rising employment. The unemployment could rise above 8% in 2009, which would amplify the economic contraction. Asian financial markets collapsed in 1997, and their economies followed in 1998. The US is repeating the experience.
Beyond the economic collapse next year, the recovery beyond would be quite anemic. Asian economies recovered quickly in 1999 from export boom as they devalued their currencies and the global economy was good. The same would not happen to the US. Europe and Japan have weak domestic demand due to their aging problem. Emerging markets are not big enough to support the US recovery. The odds are that the US would stay flattish for years to come.
Governments around the world are implementing measures to boost financial markets. Their effects won't last for long. The world has experienced enormous prosperity since the fall of the Berlin Wall that discredited one form of economic management. The globalization since has boosted productivity by increasing division of labor across the world. But, a significant part of the prosperity was due to the debt bubble. Indeed, during the bubble, the Davos crowd-the globalization establishment heaped praises on financial capitalism led by Wall Street. That model is now discredited. We are moving towards a different world. It may not be as glitzy as the past one but could be better for average working men and woman. The transition, however, would be painful.