Chris Sanders: Stock market follies


Richard Moore

Stock market follies

By Chris Sanders

Comical may seem a strange word to apply to world 
stock markets given the ferocious sell off that 
began a week ago, but it is the right one. 
Consider, the proximate cause of all this 
pandemonium is the damage done to the US 
financial sector that is meant to cause a 
recession in the US leading to an unwinding of 
the excesses of the last twenty years. At least, 
that appears to be the bear case.

It may turn out that way for all we know, but we 
are focused not so much on what has happened over 
the last twenty years as we are on what is 
happening right now as the shareholders of 
Citibank, Merrill Lynch, Morgan Stanley and other 
august financial institutions get their pockets 
picked. Don't get me wrong, they deserve it. 
Anybody stupid enough to buy their paper given 
the obvious debacle unfolding in the US housing 
market over the last three years needn't ask for 
special consideration. But the rest of us may 
legitimately ask what is going on when those same 
institutions offer such generous terms to their 
best international clients in order to sell them 
major chunks of their equity.

Taking the two Citibank deals as an industry 
bellwether, the first offers the Abu Dhabi 
Investment Company 11% per annum for five years 
during which time it will be forced to convert in 
stages to Citi common. The second offers the 
buyers (Korea Investment Co., Saudi Arabia's 
Olayan Group and Waleed bin Talal, Singapore's 
GIC, the Kuwait Investment Authority, etcŠ) a 
perpetual convertible preference share paying 7%.

The initial reaction of many observers to all 
this is that the banks have had to go cap in hand 
to those with the money and that this explains 
the generous terms. Maybe, but then again, maybe 
not. Our take is that the sub-prime debacle and 
its knock-on problems in bond insurance and so on 
are real enough, but manageable given time, and 
that eventual realised losses will be much 
smaller than the huge numbers feared by the 
markets. The American S&L industry's collapse in 
the late 80s was, in our estimation, bigger than 
the sub prime problem. The Resolution Trust 
Corporation assumed some $394 billion of S&L 
assets, and recovered 90% of them by 1996. Before 
the RTC was created in 1989, FSLIC had already 
wound up about $125 billion in S&L assets. To put 
the numbers in perspective this equates to more 
than $2 trillion in today's dollars. This 
approaches the top end of loss estimates for the 
sub prime mess. It's true enough that the 
situation is complex, that there is massive fraud 
but viewed in its historical context, it does not 
portend the end of life as we know it or even the 
end of the western financial system. To the cynic 
it simply represents the way that system really 

Does anyone really think that Charles Prince, 
John Mack or anyone else in charge did not know 
about the risks associated with lending money to 
borrowers who did not have the means to service 
their debt? Does anyone really believe that this 
is a surprise? The US housing bubble and the 
embedded sub-prime debacle has to have been the 
most widely anticipated financial problems in 
history. The bubble itself peaked toward the end 
of 2005. By spring the following year Goldman 
Sachs's Henry Paulson had been put in charge of 
Treasury, where his principle job (in our opinion 
at least) has been to make sure that a 
sufficiently large pool of foreign investment 
capital would be made available to plug the gaps 
in the US banking balance sheet brought about by 
the disconnect between bonuses and salaries on 
the one hand and the mortgage losses to come on 
the other. It takes time to negotiate deals this 
large; the idea that this all happened after 
August last year seems unlikely.

That all this portends global recession is an 
analytic arrow wide of the mark. GE's earnings 
announced last week say it all. Earnings are up 
on global infrastructure spending and the outlook 
is for much more where that came from. Money 
supply growth world wide is surging, led by the 
US, where broad money growth is well over 12% per 
annum. The idea that the real estate problem in 
the US has "wiped out" capital is simply absurd. 
Carpet bombing industrial assets wipes out 
capital. Mortgage defaults and market volatility 
entail a transfer of money from one pocket to 
another, not its disappearance. Investors need to 
ask themselves, with inflation surging along with 
money supply, what does one do with one's money? 
Do you park it in government bonds yielding less 
than nothing in real terms, do you leave in cash 
yielding even less or do you buy real assets and 
real companies doing real things?

When the dust settles, the smart money will be 
doing the latter, and in the meantime, it is 
buying some very attractive bank stocks. It will 
no doubt focus closely on the large amounts of 
urban real estate coming on the market in the 
wake of the wave of sub-rime defaults. Real 
estate that is ripe for gentrification when those 
with money decide to trade their expensive 
commutes for an urban lifestyle as petrol prices 
go up.

All that has really happened is that the capital 
"R" has been put back into risk. Until the next 
time, that is.

newslog archives:

Escaping the Matrix:

The Phoenix Project:

rkm blog: "How We the People can change the world":

The Post-Bush Regime: A Prognosis

Community Democracy Framework:

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