Global Leaders Address Greed: Fear May Abate

Global leaders have called for a complete revamp of banking rules and regulations, and in doing so have asked for an overhaul of a system that has been in place for sixty years, that founded the International Monetary Fund, and created the Gold Standard. Global leaders have “pledged to undertake effective and comprehensive reform of the international monetary and financial systems,'' stating ”we need even more financial regulation to ensure financial safety.''  The days of self-regulation may be coming to a close, and after financial institutions proved that they could not be trusted to preserve capital and limit leveraged losses, a new set of global rules may be getting drawn. The price of their freedom seems not to be worth their rewards, and a swath of changes look to be on the way that may instill a fresh confidence that things can be balanced in the global market place. The real test will be whether global leaders can find a consensus of opinion that leads to an easy answer, but the real benefit in the announcement is that something is being done to address what has become a global problem.

The moves will address the fact that financial institutions took advantage of leverage to buy and sell products without being adequately capitalized to do so, in other words the increasing value of the asset was the only thing that kept the house of cards from tumbling. Finally attention has been drawn to the rating agencies who allowed funds to trade in products that were not at fair value because of their inability to keep up with the changing market mechanics. The rating agencies marked up investment grading without really understanding what was being packaged, it seems, and in effect allowed institutions the right to buy and sell products that contained good, bad and ugly components without fear of regulatory questions.

The moment, in the summer of 2007, that the rating agencies announced a swath of cuts in the value of CDO and LDO mortgage backed securities was the moment that the credit crisis became public, and that was at least twelve months it seems from when serious questions were getting publicly asked, and three years from the warnings that came from the Davos meetings (the Swiss yearly meeting of global financiers and global leaders) that called for the un-leveraging of debt.

Pandora’s box has been opened and a consequence has been a global reduction in interest rates from virtually all major central banks. That however has not impacted mortgage rates, commercial lending, nor critically, inter-bank lending. The global economy now has low interest rates, but does not have a consumer that can access that reduction, nor companies that can tap into lower lending to help create growth. It will be those regions that are free of the weight of leveraged debt that are likely to show growth first, regions that include Australia and China. The U.S. will be at the opposite end of the equation as the region that is totally reliant on leveraged government debt, the U.S. is overdrawn to mind-boggling levels that make the talk of de-leveraging the markets seem ironic. The U.S. economy is the most highly leveraged of them all, it has no major economic peers in that regard, and is totally reliant upon overseas central banks and sovereign wealth funds to get it through each month. Turning on the printing press has a huge forward price to pay, and as soon as an answer to the credit crisis is found the USD may continue its decades long decline.

To put things into context, the dollar index recently bounced off the 71.50 area, and currently sits at a robust near-term looking 86.50. That however reveals the fact that $1 is now worth 86.5% of its value in 1973, the year that the dollar index was formed, and around the time that the U.S. scrapped the gold standard. In doing so the U.S. government leveraged the Federal Reserve by encouraging the fractional banking policy, something that allows only 10% of the value of notes printed to be held in reserve. Now that is the ultimate in leveraged debt.

The low global interest rate environment has created the first leg of a move to create growth and expansion, something that will be confirmed if regional banks can access reasonably priced credit, in consumers seeing a reduction in their borrowing costs, and the inter-bank lending rates dropping. That will signal confidence that a new foundation can be put in place that addresses the use of leverage, and the re-instatement of the basic rule of investing; capital preservation. The signal has been loud and clear from the financial sector in not wanting to build another house of cards, they are not moving in regard to expanding their lending portfolios until stability has been put in place, from the ground up. The news of a global revamping of the way that money and investments are protected may be the start of a move to build confidence in the inter-bank market.

A lot of damage has been done, and although it may be far from over, news like this may allow a relief move that at least stops the equity selling in the near-term. If the bottom of the market is actually still a long way off then this news may be one of those things that bounces confidence, and moves prices higher in the short term. From technically oversold conditions a bounce higher is overdue, how strong that could be all comes down to confidence, as well as a large dose of trust that the right thing is finally being put into place. The free market principles are still at work, but it has been proven that the amount of authority to self-regulate has to be adjusted so that capital preservation becomes the focus going forward, and leveraged debt becomes controlled. This could be seen as the silver lining on a very dark cloud for the global economy, and if it follows through could be the thing that addresses equity and USD valuations.

Comments

[Steven Hansen:]

australia is a commodity driven economy. it will be one of the first to recover but not because of debt. or because it is ladened with the costs of social programs,

china may not even fall to a point recovery is needed. it will be interesting to see how the economy in china plays out.

it is obvious you believe that simply curing the banks and setting them straight will make the sun come out so we can start to play. the asset destruction is so unbelievably great that the economies cannot restart on their own even if there was no debt. the debt issue is now a side show in this circus run by clowns, created by greed, and produced by the congress from hell.

i do not believe the market is oversold. if we are indeed in a recession, earnings fell 33 to over 60% in past recessions. this makes the market undersold.

and what is the 'leveraged debt' of the US government?

2008 Oct 27 05:12 AM