Bradley in DC
08-22-2007, 08:11 AM
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/08/21/ccbanks121.xml
Capitalism not to blame for debacle
Last Updated: 12:12am BST 22/08/2007
Ambrose Evans-Pritchard points the finger at the central banks that created the credit bubble
The witch hunt has begun. French president Nicolas Sarkozy has vowed to hunt down the "speculators". Germany's Angela Merkel is eyeing laws to curtail hedge funds.Brussels has launched a probe of the rating agencies, suspected of sticking "AAA" and "AA" grades on sub-prime debt for venal motives. The US Congress is orchestrating a show trial of "predatory lenders".
The blame-game was ever thus. Wall Street bankers were hounded after the 1929 crash: some went to prison. But if you track down the root cause of this credit bubble - now popped - the "blame" lies with Asian, European and Anglo Saxon central banks.
They created this mess, if that is what we now face. It was they - in effect governments - who intervened in countless complex ways to push down the price of global credit to levels that warped behaviour, as the Bank for International Settlements (BIS) has repeatedly noted. By setting the price of money too low, they encouraged debt and punished savings.
The markets have merely responded with their usual exuberance to this distorted signal. Private equity was tempted to launch a takeover blitz at a debt-to-cashflow ratio of 5.4 because debt was made so cheap. The US savings rate turned negative because interest rates were held below inflation.
Untangling the varied causes of this credit debacle is not easy but the central banks of Asia and the developing world have surely played a key role by hoarding reserves. Their motive is either to hold down currencies or to ensure that they need never again suffer bitter medicine from the IMF.
The sums are staggering: China $1,330bn (£670bn), Japan $924bn, Russia $414bn, South Korea $251bn, Taiwan $266bn, India $229bn, Brazil $147bn, Singapore $144bn, Malaysia $98bn, Thailand $73bn. Compare this to US insouciance, $67bn.
These reserves have risen from $3,000bn in 2003 to $6,700bn today. The vast bulk has been invested in G10 government bonds or agency debt - although some countries are switching to sovereign wealth funds able to invest in equities and property.
The effect has been to drive down global bond yields, with effects spilling into the M&A market, Latin American debt and, of course, US property. It is why the spreads on corporate bonds reached the lowest ever recorded in February this year. The iTraxx Crossover index of low-grade debt reached 162, while the spread on Brazil's bonds fell to 138 - a wafer-thin margin over "AAA" benchmarks. Pension funds and insurers are often compelled to buy "AAA" bonds, yet the yields on offer have not been enough to meet their long-term liabilities. So when the alchemists hawked tranches of "senior" US sub-prime debt - and car loans, etc - that had been packaged into securities (collateralized debt obligations, or CDOs) with an "AAA" or "AA" rating and a bumper yield, they could hardly resist. Some $470bn of CDOs and $524bn of "synthetic" CDOs were issued last year, BIS data shows.
So while the investment boutiques - Bear Stearns, Morgan Stanley, Deutsche Bank, Lehman Brothers - may have pushed a toxic product (a rash of lawsuits will decide), this occurred in a context where policy error had bent incentives.
In parallel, the Bank of Japan held interest rates at zero for six years until July 2006 to stave off deflation. Even now, rates are still just 0.5pc. It also injected some $12bn liquidity every month by printing money to buy bonds. The net effect has been a massive leakage of money into the global economy. Faced with a pitiful yield at home, Japan's funds and thrifty grannies shovelled savings abroad. Banks, hedge funds, and the proverbial Mrs Watanabe, were all able to borrow for near nothing in Tokyo to snap up assets across the globe. BNP Paribas estimates this "carry trade" to be $1,200bn.
Faced with an asset shock coming from Asia, the Federal Reserve and the European Central Bank could have taken counter-action. They did not do so. Nor did they tighten much to offset liquidity being "created" by the new-fangled credit instruments. The Fed held rates at 1pc until June 2004, when the economy was growing at 5pc. The ECB kept rates at 2pc until December 2005. It takes 18 months - or so - for monetary policy to exert its full effects. The bubble peaked in early 2007.
The central banks have said their task is to fight inflation, not to police asset prices. Critics retort that the US asset bubble in the 1920s and Japan's bubble in the 1980s both occurred at a time of low inflation. Belatedly the Bank of Japan, the ECB, the Swiss, the Scandies and the Bank of England are questioning the wisdom of ignoring asset prices, deeming it wise to "lean into the wind" to slow excesses. But it is very late in the day. The credit bubble is already with us.
Capitalism not to blame for debacle
Last Updated: 12:12am BST 22/08/2007
Ambrose Evans-Pritchard points the finger at the central banks that created the credit bubble
The witch hunt has begun. French president Nicolas Sarkozy has vowed to hunt down the "speculators". Germany's Angela Merkel is eyeing laws to curtail hedge funds.Brussels has launched a probe of the rating agencies, suspected of sticking "AAA" and "AA" grades on sub-prime debt for venal motives. The US Congress is orchestrating a show trial of "predatory lenders".
The blame-game was ever thus. Wall Street bankers were hounded after the 1929 crash: some went to prison. But if you track down the root cause of this credit bubble - now popped - the "blame" lies with Asian, European and Anglo Saxon central banks.
They created this mess, if that is what we now face. It was they - in effect governments - who intervened in countless complex ways to push down the price of global credit to levels that warped behaviour, as the Bank for International Settlements (BIS) has repeatedly noted. By setting the price of money too low, they encouraged debt and punished savings.
The markets have merely responded with their usual exuberance to this distorted signal. Private equity was tempted to launch a takeover blitz at a debt-to-cashflow ratio of 5.4 because debt was made so cheap. The US savings rate turned negative because interest rates were held below inflation.
Untangling the varied causes of this credit debacle is not easy but the central banks of Asia and the developing world have surely played a key role by hoarding reserves. Their motive is either to hold down currencies or to ensure that they need never again suffer bitter medicine from the IMF.
The sums are staggering: China $1,330bn (£670bn), Japan $924bn, Russia $414bn, South Korea $251bn, Taiwan $266bn, India $229bn, Brazil $147bn, Singapore $144bn, Malaysia $98bn, Thailand $73bn. Compare this to US insouciance, $67bn.
These reserves have risen from $3,000bn in 2003 to $6,700bn today. The vast bulk has been invested in G10 government bonds or agency debt - although some countries are switching to sovereign wealth funds able to invest in equities and property.
The effect has been to drive down global bond yields, with effects spilling into the M&A market, Latin American debt and, of course, US property. It is why the spreads on corporate bonds reached the lowest ever recorded in February this year. The iTraxx Crossover index of low-grade debt reached 162, while the spread on Brazil's bonds fell to 138 - a wafer-thin margin over "AAA" benchmarks. Pension funds and insurers are often compelled to buy "AAA" bonds, yet the yields on offer have not been enough to meet their long-term liabilities. So when the alchemists hawked tranches of "senior" US sub-prime debt - and car loans, etc - that had been packaged into securities (collateralized debt obligations, or CDOs) with an "AAA" or "AA" rating and a bumper yield, they could hardly resist. Some $470bn of CDOs and $524bn of "synthetic" CDOs were issued last year, BIS data shows.
So while the investment boutiques - Bear Stearns, Morgan Stanley, Deutsche Bank, Lehman Brothers - may have pushed a toxic product (a rash of lawsuits will decide), this occurred in a context where policy error had bent incentives.
In parallel, the Bank of Japan held interest rates at zero for six years until July 2006 to stave off deflation. Even now, rates are still just 0.5pc. It also injected some $12bn liquidity every month by printing money to buy bonds. The net effect has been a massive leakage of money into the global economy. Faced with a pitiful yield at home, Japan's funds and thrifty grannies shovelled savings abroad. Banks, hedge funds, and the proverbial Mrs Watanabe, were all able to borrow for near nothing in Tokyo to snap up assets across the globe. BNP Paribas estimates this "carry trade" to be $1,200bn.
Faced with an asset shock coming from Asia, the Federal Reserve and the European Central Bank could have taken counter-action. They did not do so. Nor did they tighten much to offset liquidity being "created" by the new-fangled credit instruments. The Fed held rates at 1pc until June 2004, when the economy was growing at 5pc. The ECB kept rates at 2pc until December 2005. It takes 18 months - or so - for monetary policy to exert its full effects. The bubble peaked in early 2007.
The central banks have said their task is to fight inflation, not to police asset prices. Critics retort that the US asset bubble in the 1920s and Japan's bubble in the 1980s both occurred at a time of low inflation. Belatedly the Bank of Japan, the ECB, the Swiss, the Scandies and the Bank of England are questioning the wisdom of ignoring asset prices, deeming it wise to "lean into the wind" to slow excesses. But it is very late in the day. The credit bubble is already with us.