Tuesday, September 23, 2008

Who has their eye on the ball in New Zealand?

The Peters censure and the start of the election campaign make it difficult to focus on external events.

But it would be a pretty good bet that the consequences of the financial meltdown in the US will have some impact on the public consciousness in New Zealand before November 8.

It seems that the buy-up of bad mortgages in the US may go ahead in some form, despite being criticized on all sides. The US stockmarket's rush of blood to the head on Friday has faded, the dollar is down and oil prices are way back up.

According to Nouriel Roubini in the Financial Times, who has been right before, the next victims of the crisis will be the hedge funds and then private equity firms.

The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years.

Even private equity firms and their reckless, highly leveraged buy-outs will not be spared. The private equity bubble led to more than $1,000bn of LBOs that should never have occurred. The run on these LBOs is slowed by the existence of “convenant-lite” clauses, which do not include traditional default triggers, and “payment-in-kind toggles”, which allow borrowers to defer cash interest payments and accrue more debt, but these only delay the eventual refinancing crisis and will make uglier the bankruptcy that will follow. Even the largest LBOs, such as GMAC and Chrysler, are now at risk.

But we should all be thinking about the effects on the real economy in the US and elsewhere. Roubini again

The real economic side of this financial crisis will be a severe US recession. Financial contagion, the strong euro, falling US imports, the bursting of European housing bubbles, high oil prices and a hawkish European Central Bank will lead to a recession in the eurozone, the UK and most advanced economies.

European financial institutions are at risk of sharp losses because of the toxic US securitised products sold to them; the massive increase in leverage following aggressive risk-taking and domestic securitisation; a severe liquidity crunch exacerbated by a dollar shortage and a credit crunch; the bursting of domestic housing bubbles; household and corporate defaults in the recession; losses hidden by regulatory forbearance; the exposure of Swedish, Austrian and Italian banks to the Baltic states, Iceland and southern Europe where housing and credit bubbles financed in foreign currency are leading to hard landings.

Thus the financial crisis of the century will also envelop European financial institutions.

By the way, New Zealand did not ban short selling over the weekend, unlike the US, the UK and Australia among many others. We were told by several people on Morning Report Monday that this is because the practice is rather limited in New Zealand. I hope that either that is the case or that the people arguing that the short selling ban is a bad idea are right.

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