It has taken a period of stock market turmoil for some investors to realise that we are living through historic times for the global financial system. Put like that, it sounds apocalyptic, and indeed it may well be; but we are also facing an opportunity for financial authorities around the world to continue demonstrating their responsibility, competence and ability to view the global economic landscape from a global perspective.- The stock market volatility of recent days is nothing more than the visible manifestation of the underlying turbulence caused by the US mortgage crisis.
- Mortgage abuse, falling house prices and rising interest rates have led to a high proportion (14%) of mortgages going into default in the US. It is worth noting that a similar scenario could easily apply to Spain and parts of the EU.
- This default has led to a fall in the value of funds and assets based on this type of debt, as many of these non-performing loans had subtitled and recklessly leveraged. A Bear Stearns two of his funds were written off: High-Grade Structured Credit Strategies Enhanced Leverage Fund y High-Grade Structured Credit Strategies Fund (the latter having some residual value given its lower leverage). Other major banks such as BNP are also facing their own problems.
- The public outcry This also makes investors reluctant to buy corporate debt. This jeopardises corporate transactions that have nothing to do with an American failing to pay their mortgage, but it hinders global business growth whilst increasing risk aversion among investors.
- These problems are amplify due to various factors, including: a) Securitisation or securitisation of these mortgage debts of doubtful recoverability by packaging them as assets attached to more secure mortgage debts. This apparently dilutes the risk to make them more marketable, but in reality it is creating a route of transmission from the crisis to products that should not be affected by defaults. b) The leverage that financial institutions generate in order to capitalise more fully on the substantial returns from these products. The debt incurred through these funds will become another route of transmission for the rest of the economy.
- The timing of the contagion It is unfolding gradually: the securitisation of subprime mortgages, corporate debt, a reluctance to engage in frivolous interbank lending, and nervousness in the equity markets, although the latter is of little consequence given the gravity of the underlying problem.
- A coordinated, sustained and long-standing effort by the world’s major central banks to prevent dry the cash flow of the system.
- Outlook: Unpredictable, although we do not believe the situation will be catastrophic for a number of reasons, which we will explain below.
People today tend to react to problems in a narrow-minded way, whether for the sake of the nation, a corporation, a race, a religion, and so on… But when faced with exceptional problems, humanity must—we must—be capable of responding on a global scale. Why? Quite simply, because the stakes are too high: the financial system – in other words, everything. One example of which we should be proud is the intervention widespread, concerted and proactive by central banks to breathe new life into our economic system. The EU, the US, Japan, Australia, Canada, Switzerland and Norway have already done far more than just make a symbolic gesture for the financial well-being of us all. South Korea and Indonesia, amongst others, have also committed themselves, and this is only the beginning. I am fully convinced that the response, based on solidarity, will be historic, even from China and some Islamic countries. We are all in the same boat. If our economic system fails, it fails all our mode Vivendi, and our planet would be set back by many generations. Such global solidarity can only arise in the face of catastrophes that we have only ever seen in science-fiction films, or in situations such as the current one, where the stakes are even higher than climate change or a bird flu pandemic.
For all these reasons, it seems logical to me to think that this event, which brings us closer than ever to the 1929 crash, will serve to strengthen our financial system and make it more resilient in the future. I believe, and I want to believe, that the measures we will see taken by all The world’s economic authorities over the coming months will feature in future economics textbooks. We are probably laying the theoretical foundations for the protocols global which must be implemented by all countries worldwide in the event of future crises and major financial instability.
Having said all that, I want to make it absolutely clear that my personal view is an optimistic and positive one. And that the success or failure of our financial system depends largely on our collective willingness to keep a cool head and our investments active. As I say in the title of this post, if we can turn this scenario into a historic opportunity instead of a hysterical breakdown, we’ll come out on top, with the system even stronger than before. But if that doesn’t happen, we’ll all end up doing ourselves a great deal of harm.
Faced with this scenario—whether one of normality or collapse, which we ourselves will bring about—the question we must ask ourselves is: Where are we going to put our money if we no longer lend it through the financial system to keep things running smoothly? Do we really think that creating a macro-corralito Will a global approach spare us any harm in terms of the risk of continuing to rely on the system? Common sense will save us, whereas panic would be the greatest act of self-destruction in history.
Tomorrow, Monday, we will see how the world reacts to this unprecedented situation. Nervousness and volatility are guaranteed, but above all, we must have confidence in ourselves. We may see sharp corrections in the credit spread, stock market volatility with ‘Black Fridays’, ‘Black Mondays’ and ‘Black Days’ on any day of the week, sharp adjustments and corrections in macroeconomic figures, etc. We might even, why not, see a certain normality from now on and tiptoe past all the dangers mentioned as if it had all been nothing more than a nightmare. In any case, it will be a positive step. The one option we cannot afford is a global economic collapse. As far as we are concerned, it is very clear what we are going to do and what advice we will give our clients: we will continue to have faith in the system and try to make the most of the opportunities that arise in any crisis. What else can we do that won’t lead to our own downfall?
Keep a close eye on developments over the coming days and weeks. Are we as clever as we think we are?