Will China Save The US Economy?

It is not easy for journalsts covering the sub-prime mortgage crisis in the US to tell it like it is, as the truth is so bad that, if it is clearly spelled out, it only causes the panic to get worse. You have to read between the lines. I blogged before HERE stating that official estimates of the size of the sub-prime losses look to be on the cautious side. They mention figures such as $400 billion, but already the assumptions those gestimates were based on, are well out of date. The write-downs are accelerating, not stabilising.

The knock-on effects are now being felt by the likes of Hedge Funds, who borrow heavily to get more leverage to increase the profits on their market bets. Now they are all being forced to become unwilling sellers scrambling in an undignified race to get cash. Shares are tumbling round the globe, not because the economies and companies are any worse than they were before, but because the holders of shares have to raise cash any way they can, because they’re in a mess.

The problem is not that the kind of assets they hold, have reduced in price. They have, of course. But it’s worse than that. For many assets there is now literally no market and no buyers. In Britain for example, mortgage providers are pulling out of the market as cash dries up, and the interbank rate rises to 6%. In the US and elsewhere large financial organisations are finding that they are effectively and to all intents and purposes illiquid or in conventional language – BUST. There are no buyers for their riskier assets at all, and they cannot borrow to cover their short-term financing needs so that they cannot hang on until markets recover.

If Bear Stearns is bust, you can be sure they are not the only ones. Nor in the UK, is the Northern Rock the only institution which is in serious trouble. The financial faecal matter is impacting on the fan, you might say.

The problem now is who or what is going to bring an end to the spiralling losses and collapsing markets?

There has to be a financier of last resort. The US government has released stimulus packages and cut interest rates to help the situation, but it cannot enter the markets themselves and start buying up shares and other riskier assets. The US Government does not have a Sovereign Investment Fund.

From the FT today (with my comments added),

“This is not a crisis of liquidity, it is a crisis of confidence,” says a US banker.

I think that unfortunately he’ll find that it’s a crisis of both.

Indeed, the crisis is stoking tensions between Wall Street and policymakers. Treasury and Federal Reserve officials increasingly feel that the ball is now in Wall Street’s court and that financial institutions should raise capital and cut their dividends.

If that would sort the situation, I’m sure Wall Street would do it. But it won’t.

No one knows how long the situation will last: one top Wall Street banker likens it to the Great Flood, with the rain worsening every day. There is nevertheless a hardening view among senior bankers that the credit assets at the heart of the crisis are too cheap. If investors start to buy them, the situation could snap back quickly.

There is certainly a case to be made for valuing assets at a fair price, not market price during a market collapse – and for banks to take a lenient view of values. But lenders are fearful that the situation might get worse and so they start asking for their umbrellas back now the rain’s really belting down.

But bankers say the crisis is hampered by the requirement to use mark to market accounting even when the markets in question are illiquid and characterised by a yawning gap between bid and offer prices.

This means no one dares buy these assets because they fear that the forced selling by hedge funds could push down asset prices further. Only investors with abundant cash, who who do not rely on leverage, can afford to take the risk of seeing their investment fall another 15 per cent in the short term.

As if the penny’s finally dropped, the FT article finishes by saying there is in effect only one way the markets can be stabilised – in one rather pathetic sentence, as follows –

Sovereign wealth funds are one potential source of such funds.

I would say they are the only potential source of such funds.

So that’s the $65 million question. Will the Chinese and other governments be willing to bail out world markets? I imagine they will, as it is very much in their own interests to do so – but probably on condition that they acquire ownership or part ownership in the process. Prepare for the new era therefore – Chinese bosses who own the place.

I guess they’ll invest longer term, and not blow their wealth chasing short term risks, American style. It will be an Asian business culture that starts to dominate the world next, not an American one. It may be no bad thing.

UPDATE – The willingness of sovereign funds to buy Wall Street casualties is over.

Or is it? See HERE. Arabs still want to buy into the US.

And they are getting political support from the OECD HERE

The Tap Blog is a collective of like-minded researchers and writers who’ve joined forces to distribute information and voice opinions avoided by the world’s media.

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