6 October 2008
column
Johannesburg — THE joke going around last week was that you should be careful when making out a cheque because your bank might bounce. It goes without saying that this past week has been one of the most remarkable in financial circles in living memory.
Just keeping track of the speed of events, never mind understanding them, has been mind-boggling.
What we are seeing is nothing short of the unravelling of the global system of finance.
It's not by accident that the vortex of this crisis is in New York, the largest and most pivotal part of this system.
Once you accept this essential point, the failure of Lehman Brothers, the sale of Merrill Lynch and Wachovia, the rescue of AIG, Fannie Mae and Freddie Mac, and the stock market declines simply become symptoms of the root cause.
Wall Street is essentially no more, and this is signified by Morgan Stanley and Goldman Sachs choosing to become regulated bank holding companies.
The power of this collapse is being felt all over the world, notably Europe and particularly the UK, where bank failures are now cropping up with increasing frequency.
In the middle of this cataclysmic implosion, the US Congress decided against a record $700bn rescue package, before correcting itself later in the week when the scale of the crisis finally hit home.
This was not a perfect package; but how could they be so stupid? Even iconic investor Warren Buffett took a bath since his $5bn investment in Goldman Sachs was premised on Congress passing Tarp, the Troubled Assets Relief Programme.
This is all very mesmerising, but what we need to know is how it is going to affect us here on the southern tip.
The first thing to note is that SA's relative disconnectedness from international financial markets has suddenly begun to look like an extremely good idea. SA's foreign debt is small, the government's overall debt is small, and our financial institutions are profitable and stable -- partly a consequence of our own crises a few years ago.
The word on the lips of the financial sector is : "thank God for exchange controls".
Short-sighted of course, but its truth reflects just how much everything has been turned on its head. Yet precisely because of SA's isolation, there is also a dangerous complacency. On the basis of a journalist's pessimistic instinct rather than specialised knowledge, I have to say I suspect this crisis will embrace us much more than we think now. In order to make a judgment , we have to understand the problem, and that is no easy task. The commentator with the gift of the grip is the Financial Times' Martin Wolf (I can't understand why they don't make Wolf global finance czar for the duration of the crisis) who describes the problem this way:"We are watching the disintegration of the financial system. Finance is the web of intermediation binding economic agents to one another, across both space and time. Without it, no modern economy can survive. Yet that is now threatened, with the ongoing collapse in trust and flight to safety."
He cites one particularly shocking graph, which shows the difference between three-month Libor (the London interbank offered rate) and three-month overnight index swaps, which jumped from 75 basis point to 200 basis points almost overnight earlier this month in the US and dramatically in Europe and the UK too.
The graph demonstrates an awful thing: banks no longer want to lend to each other.
This means what started as a problem in a corner of the financial world in the US housing market has snowballed in to a genuine, international banking crisis.
Consequently, Wolf argues, the $700bn Tarp is misconceived since it is designed to solve a problem of illiquidity in what seems certain to be a growing crisis of insolvency, particularly as house prices fall and the economy continues to weaken. Yet he strongly believes it should be passed by the Congress, which it now has been, and that it should be used as a basis for improvement.
US legislators were averse to the plan because it appeared to be a bail-out of Wall Street without sufficient support for Main Street.
Yet after the plan was initially rejected, the S&P 500 also fell by 8,8% on Monday, its worst day since October 19 1987. He writes, "Nothing can better demonstrate how absurd it is to believe one can punish Wall Street without hurting Main Street. The two streets meet. That is what streets do."
For all its distance and isolation, SA is also a street in the world financial system and we need to start thinking harder about how and where the shockwaves will be felt.
Some areas are obvious; the rand is vulnerable and stock markets all over the world will be weak.
But it runs further. Corporate executives now need to re-examine the strength of their balance sheets.
This will be unpopular, but they might also have to rethink their dividend policies.
The focus now must be on stress management, and executives should think about possibilities and alternatives to recapitalisation if that becomes necessary.
In doing so they will need to recognise that this is a buyer's market. People with cash are king.
The second thing is that for all but distress purchases, it's probably a good time to drop the M&A plans into the bottom drawer. A series of deals have already failed, notably Xstrata's bid for Lonmin, and things are only likely to get worse.
From the government's point of view, perhaps they too need to be proactive in examining their options, which might have to include support for bank depositors, as the Irish government has already done.
And for the JSE, despite its inclinations otherwise, temporary bans on short-selling banks should be examined.
At the very least, the Industrial Development Corporation and other big fund managers should be more careful about lending out stock.
There is also some interesting work to be done on mark-to-market accounting.
None of this might be necessary but if there is one big lesson to be learnt from the past few months, it is this: don't be caught flat-footed.
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