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September 29, 2008

Let’s Do Crunch

By Spear's

Until now the credit crunch has been confined to the City and Wall Street banks who were selling each other toxic packages of sub-prime junk US mortgages on an unimaginable scale, so as to generate, as we all now know, false profits and bonuses.

The toxicity in this attempt to defy economic gravity arose from very poor judgement of the risks, from plain dumb deals where the ability to repay just was not there, and from fraud: fraudulent valuations, fraudulent self-certified statements of income, fraudulent non-existent borrowers and fraud based on non-existent properties in many instances. And what is the likelihood that many of these so-called ‘securities’ weren’t diced and spliced and sold by the Speedo-kids on the Street more than once?

The crunch began in August 2008 when such was the uncertainty that the banks would no longer lend to each other. The Anglosphere banking system was in its gravest crisis ever. Citigroup led the way with a costly bail-out deal with the Arabian ADIA for $4.7 billion. at the turn of the year. It wasn’t enough to stem the cash losses, however, and pay for the needed downsizing, redundancies and de-leveraging. Such banks could not take the write-downs on their dubious assets as priced to markets that no longer existed, just as the new FAB 157 rules required that they should do exactly that. If they had, they would have been bust, whereas they had to tell the world they were still alive, if not exactly kicking, in order to attract the new capital they so desperately needed.

In early May, in a day of strange symmetry, Citigroup announced it had now raised $47 billion just as UBS announced total write-offs of the same amount; but UBS also announced that it had lost $5.5 billion in the first quarter of 2008, but would make 5,500 employees redundant: the price of assuaging shareholder anger is now set at $1million of losses equals one employee bin-linered out. This new capital raised, however, is not for new profitable growth and expansion, but to pay for the sins and excesses of the past, and for the redundancies to come. The banks have so far written off $450 billion, so they could be only half-way through their crisis. If this tale of false profits sounds biblical, well that’s exactly how it now looks.

No economy can exist without a liquid banking system, that’s for certain. So the central Banks in the US, the UK and the EU had no option, as they saw it, but to proceed to flood the money markets with billions in the way of credit instruments to encourage the inter-bank lending market back to life, but based on government-backed T-Bills and gilts being exchanged by the central banks for the same questionable securities held by the private banks that had caused the crisis in the first place.

Actually, these initiatives merely spread the risk of toxicity to the central banks, which ultimately means to the taxpayer – so everyone pays. Was there an alternative? Could the central banks have let the bust banks go to the wall? Unfortunately not, it seems, as all the banks have entered into so many derivative contracts with each other, worth hundreds of trillions of dollars, but all on the assumption that the counter-party bank would never go bust, so that if one bank were to go bust, the whole lot could go in a domino collapse. This was the unpriced risk, and unforeseen calamity, in this particular money-go-round.

Until the banks begin lending to each other again on their own terms there will be no real revival of the inter-bank lending market. This could take a year or more, until the last bad debt is out of the system, but as has just been pointed out the banks themselves are not yet in a position to admit their losses in full. In the meantime, the credit crunch will inexorably move to the High Street, as the bankers restrict their credit availability, raise their criteria and the costs of borrowing, and penalise existing borrowers, while the central bankers have had their attentions directed from inflation, which is now palpably on the rise at an unacceptable rate: oil at $200 a barrel, and gold consequently at $2,000 per ounce are in propect.

The consumer is set to be hit from all sides: the rate of house repossessions is already doubling as the feelgood factor reduces to fear and house prices in the range upto £500,000-£1 million will decline, from froth to dip, by one-fifth to one-third at least.Those bankers and politicians calling the end of the crisis are engaging in premature exclamations. This is not the beginning of the end. Indeed, it is hardly the end of the beginning. The recession is now poised to hit the wider economy and to hit it hard. It will be a two- to three-year-long haul and the prospect of stagflation at the end hangs like a cloud over all.

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And finally, how will the future be affected by the Credit Crunch of 2008, the moral issue? What is crystal-clear is that a generation of computer jockeys, who could harness a new global technology to create markets so as to enrich themselves – while they practically bankrupted the entire system, as they took out outrageous bonuses, leaving the losses to be paid for by the taxpayer and the customers – must be brought to a swift stop. How? By simply linking staff pay-outs to the lifetime cashflow generated by each deal rather than by instanteous pay-outs as the deal is struck. Thus bonuses are out and incentivised trail fees are in.

If management won’t do this, then shareholders should sack the weak managers, and if this fails both will be losers as the regulators move onto the high moral ground. The greed that overtook the last decade became the cancer in the capitalist system that must be excised, preferably by the practitioners themselves, on the well-proven principle that it’s better for the lunatics to run the asylum rather than the government.

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