This is the financial crisis that keeps on giving.
Right now I find myself asking many of the same questions about debt, risk, and collateral that investors were asking in the run up to the bankruptcy filing of Lehman Bros in September 2008.
The big question that I have at the moment is Where’s the collateral for all this debt—private, corporate, and governmental—that has been issued in efforts to prop up global growth? And what’s that collateral worth?
Like a brief survey of some recent high (or low) points? Please note that the examples are from pretty much everywhere.
On Thursday, July 19, the European Central Bank announced that it would accept lower rated assets—including asset-backed securities—as collateral from banks. The asset-backed securities would have to be simple, plain vanilla instruments, the bank said, and in exchange the EuroZone central bank would accept assets rated as low as A instead of the current AAA. Reminds me of the good old days when Wall Street added a thin dose of AAA credits to a bundle of risky subprime mortgages and called the whole thing an AAA credit.
Fitch Ratings and other credit analysts have warned that many of the wealth management products being sold to Chinese savers anxious to earn more on their deposits than the 3% that banks are allowed to pay are invested in loans backed by inadequate or shaky collateral. In the worst cases no one can identify exactly what collateral stands behind a loans.
Companies in Europe, Africa, and the Middle East with sub-investment grade credit- ratings—that is “junk” ratings—owe $114 billion that’s due in 2014. That’s up from $84 billion in 2013, according to Moody’s Investors Service. Half of that debt carries a negative outlook, up from 34% with negative ratings in 2012.
Credit outstanding to Brazilian consumers has climbed to 44% of disposable income from 18% over the last decade. The default rate on consumer borrowing did fall for the fourth straight month in April to the lowest level since November 2011—although I would note that at 7.5% the default rate in Brazil is still extraordinarily high. One explanation for the drop in default rates: Interest rates in Brazil fell to a historic low of 7.25% by April. Unfortunately, for Brazil’s consumers, the central bank raised rates in April in what looks like the beginning of a fight to reduce inflation that’s likely to last for the remainder of 2013.
The good news is that Japan’s budget for the fiscal year that started on April 1, 2013 will see the government raise a higher percentage of spending from tax revenue than in any time during the last four years. The bad news is that the government will still cover 46.3% of its spending from borrowing. The Organization for Economic Cooperation and Development estimates that Japan’s budget deficit for 2013 amounted to 10.3% of GDP. In comparison such countries as Spain and the United States that generate a fair amount of worry about the size of their deficits come in with estimated budget deficit to GDP ratios of “just” 6.9% and 5.4% for 2013. The CIA World Factbook estimated Japan’s accumulated government debt in 2012 at 214% of GDP, the highest ratio in the world.
Back in the U.S. of A, on May 20 Moody’s Investors Service warned of a rise in covenant-lite loans with fewer investor protections or covenants. The volume of these covenant-lite loans approached $80 billion in the first quarter of 2013. That’s close to the total for all of 2012, according to Thomson Reuters. Among new speculative grade corporate bonds rated B1 or below by Moody’s through April 2013, 35% received weak covenant quality ratings of 3.8 to 5.0 from Moody’s. In the same period a month ago, 29% of new issues had equivalently low scores.
I could go on and on. For example, there’s Russia’s recent decision to borrow money from its state pension funds to spend on expanding the Trans-Siberian Railroad, building an 800-kilometer high-speed rail line from Moscow to Kazan, and constructing a new ring road around Moscow. Or the EuroZone’s decision to leverage the credit ratings of member countries to sell debt to raise money for its bailout fund—a decision that showed its downside when Fitch Ratings simultaneously downgraded France to AA+ from AAA and dropped its rating on the European Financial Stability Facility to AA+ from AAA. Cutting the rating on the European rescue fund seemed only logical, Fitch said, because France is the second largest guarantor of the fund’s debt issues.
Why is all this important now? Read more
How near is the next bust? I asked about a month ago on May 14 http://jubakpicks.com/2013/05/14/how-near-is-the-next-bust/
Not very, I concluded then.
I haven’t completely changed my mind…
- I’m still convinced that a bust of the magnitude of the global financial crisis that followed the Lehman Bros. bankruptcy is very unlikely.
- I hear the growls from the bears that say we’re looking at a replay of the Asian currency crisis of 1997. I think a replay is very unlikely.
- But “something like” a smaller version of that crisis does seem to me to be more possible than it was a month ago. Emerging stock markets will bear the brunt of that smaller version—and I don’t think the decline in those markets is over yet.
- But the biggest danger of a global crisis remains the EuroZone banking system—and that danger is largely over-looked by the current market.
The Asian currency crisis of 1997 is a good place to start any examination of the risks in the current market. So let’s start there. Read more
It’s clear that the next stage in the global financial crisis/Great Recession/painfully slow recovery is a war between the young and old. In the United States, for example, sequester has left payments to the older generation under Social Security and Medicare largely untouched while leading to a wave of cuts to Head Start across the country. In Spain unemployment among the population as a whole was 27% in the first quarter. But for the youngest Spaniards who might be looking for work—16 to 24—the unemployment rate is above 50%.
It shouldn’t be any surprise that the next stage in this crisis—and I’d call everything from the U.S. mortgage meltdown to the current worsening recession in the EuroZone part of a single crisis—is about demographics.
Because I think the roots of the entire crisis lie in demographics. Debt and demographics fit together in really toxic ways, I’m afraid, that go a long way to explaining the current mess.
And I find that awfully depressing. If the cause of the global financial crisis, the Great Recession, the ongoing euro debt crisis, and the very slow economic recovery in the United States are all the result of an aging world, the global economy is likely to show both slow growth and destructive volatility for a long time. There’s very little we can do about the aging of the world’s population. And on the record so far we’re handling the transition to an aging world and its effects really, really badly.
This crisis is going to be even worse than it needs be, if our “solution” is to pit the old and the young against each other. Read more
Okay, I know that news that China’s economy grew at a slower than expected 7.7% rate in the first quarter—coupled with worries about a deepening recession in much of the EuroZone and that the U.S. economy might itself be slowing—knocked the stuffing out stocks on Monday, April 15. And that the China news looks like it has broken the momentum of the recent rally, at least for a while. Believe me, I’m not fond of drops of this magnitude.
In slightly longer-term I think this slowing in China’s growth rate is good news.
You see I think it’s intentional. (Which means that a return of fears about an unintentional hard landing aren’t justified.) China’s government is trying to slow its growth rate because its afraid of setting off another bout of real estate speculation, of increasing the flow of hot money into China’s economy, and of the rising tide of borrowing and debt in China especially at the local level.
Investors around the world who had decided that they could count on China revving up its economy again to 9% or 10% growth were indeed disappointed. They’d placed their bets, especially in the commodities sector, based on those expectations. And when those expectations weren’t met they sold and sold.
But the only way China could meet those expectations would be to go back to the old days of stimulus, stimulus, stimulus based on massive spending on infrastructure and other hard assets financed by loans that stood almost no chance of being repaid.
China faces a choice—a slowdown today or a crash tomorrow. And I think that China’s new leaders have picked “slowdown.”
Now like most medicine this one isn’t the tastiest thing to swallow. Read more
Last week, on Thursday July 5, three of the world’s central banks moved virtually simultaneously to stimulate the global economy. And financial markets shrugged. (See my post http://jubakpicks.com/2012/07/05/global-central-banks-move-to-stimulate-their-economies-and-financial-markets-yawn-at-best-heres-why/ )
I think that “shrug” marks an important new stage in the torturously slow recovery from the global financial crisis and the Great Recession. It indicates that financial markets now agree that although central bank intervention, especially by the U.S. Federal Reserve, stabilized the global financial system, central banks are now relatively powerless. The next stages of the recovery are about deleveraging to reduce the huge debt load distributed throughout the global economy and then demand creation.
And central banks are simply not very well suited to either of those tasks. It’s normally up to central governments and fiscal policy to make moves that might accelerate progress at this stage of the recovery. But very few governments are in a position to take forceful fiscal action and in even fewer countries is there a political consensus that such action is necessary.
If I’m right, we’re headed for more years of a recovery that at times is going to be so painfully slow that it won’t feel much different from recession.
In this post I’m going to lay out, briefly, my view of where we are, where we’re going, and what kind of investment strategies might work best in what is likely to be a very tough investing environment for years. Read more