Shooting Star

New Star fading fast

One of the UK's leading asset managers seems to be the latest victim of the financial turmoil. The funds have been hit by massive redemptions and forced the asset manager to negotiate a debt-for-equity swap that would leave its lenders with a majority stake. Mr. Duffield's New Star is a very high profile firm in the UK market, and would definitely make headlines if it would fall: the advertising campaigns won awards when the company floated in 2005 as its all-star fund operators were spread across billboards - New Star had some of the best minds in the business and was determined to make a killing in the market. For a few good years, they indeed did.

The credit crunch has taken its toll on New Star: only this year, the company has seen its share price sink by 95%. Underperformance by high profile managers, a Mr. Whittaker and Mr. Evershed, could not have come at a aworse time. The whole confidence in the market has been shattered, so investors seeing their trusted high-return investments dipping quickly in value is the perfect reason for them to fulfill redemptions asap. The added debt burden of New Star, taken on already in 2007, is what is breaking the camel's back. As the credit markets have frozen over, the asset manager is struggling to refinance its loans - a hefty £300 million.

As if this wouldn't be troublesome enough for one company, it was forced to suspend trading in its flagship international property fund due alarming redemption rates. John Duffield, founder and chairman of New Star, told the Financial Times: “This is a crisis of confidence. There is nothing to be lacking in confidence about, and we’re determined to get through it.” Mr. Duffield did seem to be lacking confidence in his investors as he requested the Financial Services Authority to suspend trading in its shares today. The request was denied, and New Star shares saw a further drop of 50% in their value in early trading - a crisis of confidence if we ever saw one. It remains to be seen whether talks with its lenders will resolve the debt burden or if New Star will become yet another victim of the credit crunch.

The spook of deflation

The deflated inflationary fears are ruffling feathers

During the summer, inflation seemed to be one of the largest problems on the economical agenda. Trying to balance slowing growth and rising inflation was one of the largest dilemmas policy-makers were facing. Now it seems the trend has reversed: slowing growth is still a worry, while inflation management has become deflation management. According to Kazumasa Iwata, former deputy governor of the Bank of Japan, "the U.S. Federal Reserve has shifted its monetary policy toward flooding the economy with cash and away from targeting interest-rate levels". Japan might be useful as a successful precedent of advanced economies combating deflation as the BoJ kept interest rates close to zero from 2001-2006 and supplied ample cash into the economy in order to keep deflation under control. In Japan, this strategy worked well as it eased liquidity and restored confidence in the market.

The Fed cut rates by 150 basis points (1.5%) on October 29th to 1.00% and the ECB followed suit by cutting rates by 50 bps to 3.25% on November 6th. On the same day, the BoE responded with a clean 150 bps cut to 3.0%. The Fed is now largely expected to cut its rates a further 50 bps at its next meeting on December the 16th. The record fall in US consumer prices in October triggered the vast programme of fighting deflation. Don Kohn, the Fed vice chairman, assured that the US will take every step necessary to ensure the US does not fall prey to deflation.

In the past months, the Fed has already widened the discount window and aggressively cut interest rates. There are still several tools in its arsenal in order to stave off inflation, such as providing fiscal stimulus, lending through government agencies such as Fannie Mae/Freddie Mac, committing to lower overnight rates for a considerable period, purchase of longer term bonds to lower long-term rates and purchase of risky assets. The $800 billion stimulus package to ease lending and offering a market to asset-backed securities already shows some of these tools in use. The threat of deflation is even worse off with the risk of debt deflation: the collateral which secures a debt falls in value, leading to a forced devaluation of the debt, which in turn causes further falls in collateral value. For example, a mortgage in which the market value of the property falls below the price of the loan. Some might argue this is already taking place with US subprime-backed assets - the eagle of the American economy is in for a rough flight.

A Darling way to retaliate

UK twists the banks' arms to open up lending facilities

The day after the Fed published its plans of an $800 billion programme to boost lending, the UK Treasury has announced a similar push to facilitate lending. However, the UK Chancellor Alistair Darling is slightly less diplomatic about his efforts: he is threatening banks with full nationalization if they fail to give credit to companies in need. Mervyn King, the Bank of England's governor, stated he understand why some banks are on the defensive. In stead of extending more credit, they are using last month's £50 billion recapitalisation package to boost their balance sheets. However, in the long term this will only extend the severity of the current recession.

By forcing banks to revive their lending practices, the government is hoping to minimize the impact of the recession - but aren't rampant lending practices what caused this situation in the first place? If the UK is looking to lend its way out of the recession, banks need to feel so strongly recapitalized that they are able to take on the credit risks of SMEs and faltering consumers. As things stand, they don't seem confident enough to do so - even with Darling threatening them with nationalization.

Fed hoarding credit risk

Stocks rally as Fed boosts lending


The Fed has committed up to $800 billion in an attempt to unfreeze credit markets for homebuyers, small businesses and consumers. The increasing threat of deflation is calling for some unusual measure to be put in place, including buying up $600 billion in debt issued or backed by government-chartered housing-finance companies and establish a $200 billion support programme for consumers and small businesses. The Fed said in its statement that "This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally".

Economists have responded with criticisms, as the lending programme is devised to ease lending practices for consumers who are not sure if they want to take on more debt. The ever-sinking property market combined with low stock values isn't enticing consumers to spend. In spite of this, the Fed is pressuring banks to increase lending - even though they fear the loans will not be paid back. The Fed, on the other hand, is taking on increasing amounts of debt - and piling on the credit risk. Much lies on the ratings of asset-backed securities which the Fed is taking on with the taxpayers money: it is becoming increasingly difficult to assess where the underlying assets' value will be in a few years time. Even though Hank Paulson seems convinced that they are “a great investment for the taxpayer", many taxpayers might feel more sceptical banking on assets that got them into this mess in the first place.

Saviour of the Citi

Citibank deemed to big to fall

As the US government agrees to bail out Citigroup by guaranteeing $306bn of toxic assets and injecting $20bn into the bank, stock markets welcomed the news: Citi's stock price surged over 50% today after sinking 60% last week. According to some analysts, this is a demonstration of how investors are still not feeling confident - the days of capital injections are still not over.

Citi was deemed to be too significant to fail, which has raised questions of which banks qualify for this description. According to Mr. Crittenden, Citi's CFO, the package provided by the Fed would not be exclusive to Citi, but could be tailored for other large institutions. Lehman was seen as an expendable bank, but the comments from Mr. Crittenden were seen as an indicator of further possible rescues from the US government.

Another interesting development on the Citi deal was the lack of management purging, unlike the bail-out of AIG where executives heads rolled. As the US government declined to comment the lack of heads on a plate, more questions were raised on how different the conditions of the bail-out seem to be. Even though the capital injection may not be enough, the TARP programme is seeming more and more like a burden to the US taxpayer.

Mr. Obama to the rescue

What will Barack's Wall Street look like?

Most people would not want to be in Barack Obama's shoes at the moment. He is arguably facing one of the most challenging beginning-of-term scenarios an American president has ever had to deal with. On top of a phenomenal foreign policy crisis and an increasingly indebted economy, he is now in the battle ring with a fnancial meltdown. The economy is top priority at the moment, but what does Obama plan to do with it?

The US government seems to be subprime and the budget balance is reaching record low levels, exports are stalling and the housing market continues its decline. With his promises of investing in education and healthcare, Obama seems to be setting himself up for quite a challenge. The era of the famous "light touch" regulation seems to be ending - time will only tell what this will mean for Wall Street.

Hank Paulson will leave his post as Treasury Secretary to either Lawrence Summers or Timothy Greithner. Paul Volcker, the former Fed chairman, has also been mentioned. Summers already did the job for Clinton, while Greithner has gained experience as Chairman of the New York Fed. As Summers writes in his column for the FT: "we need to reform tax incentives that encourage financial risk taking, regulate leverage and prevent government policies that give rise to a toxic combination of privatised gains and socialised losses". Volcker and Greithner seem to be following the same general guidelines. The time of record bonuses might truely be over.

What is happening to the EMs?

The devil of deleveraging

Still this September, many emerging markets looked poised to survive the crisis - few had direct exposures to the toxic assets troubling advanced economies. Several EMs were struggling with high inflation and overheated economies during the summer. So isn't slowing external demand and falling commodity prices just what the doctor ordered?

Unfortunately, the downside risks to an EM seizure have greatly increased: since September, growth in industrialized economies has slowed down rapidly, while the deleveraging cycle has taken a turn for the worse. Western investors are increasingly worried about the strength of emerging markets in the current precarious scenario. As banks are desperately trying to take leverage off their balance sheets, asset prices are bound to sink - making the risky EM markets less enticing for investors.

Even sovereigns are not exempt from the increasing distaste for EMs. Moody's recently set Latvia, Bulgaria, Ukraine and Pakistan on a particular black list of vulnerable economies due to their reliance on foreign debt - as western lenders keep deleveraging, the sourcing of this debt is increasingly doubtful. Depending on how much longer the debt markets remain paralyzed, the more EM victims this crisis will take.

The last injections for the UK?

The big black hole

Banks globally seem to have become black holes for cash injections. The latest wave in the cascade of cash injections is England's plan to inject £39 billion into select financial institutions. RBS, HBOS and Lloyds TSB all stand to receive their share of this cash and guarantee their liquidity; in addition the UK government stands to end up with a lion's share of RBS shares.

This plan is nothing compared to the US $700 billion plus bail-out, but still adds on to the ever-growing list of cash injections into the financial system. The Fed and European Central Bank have been continuously supplying funds to the system, but somehow increasing amounts seem to be required on a continuous basis. Where are all these floods of money going?

As the liquidity of the financial system has frozen over, banks are constantly in dire need of recapitalizing to meet their liabilities. As their business models are built to rely on ample availability of cheap credit, these banks are now struggling to find alternative sources of capital. Credit has become so expensive or hard to obtain that the lenders of ultimate resource, central banks and governments, are being forced to keep the system afloat. How long this frenzy of lending of ultimate resort can be sustained is a different matter altogether.

When the turmoil reached Siberia and beyond

The small country of Iceland has become headline news on a global scale. Nationalizing Glitnir, Landsbanki and Kaupthing shows what a struggle the tiny island is going through. Simultaneously, there seems to be much ado about wether Iceland nationalizing a bank provides the same security as England doing the same. The prime minister has even threatened the press with national bankruptcy.

The British investors have understandably got cold feet, and would be performing a bank run if the Icelandic culprits would be any closer. Now they have been subjected to complaining on BBC News and on the Q&A of the Financial Times about their frozen accounts. With the currency sinking faster than its cod fishing industry, the 15% interest rates don't seem so appealing any longer. How did investors not realize that such a phenomenal interest rate is bound to carry risk?

Today, the Iceland has resorted to suspending trading citing "unusual market conditions" - indeed true when the country is being threatened by a law suit from England over British savings. Wether or not the British where foolish to expect such high interest rates without risk is now irrelevant; the icy grip of excessive leverage is now not only choking the financial sector of the tiny economy, but threatening its very existence. Back to cod-fishing by the looks of things.

The White Knight

Doesn’t look like we reached the next bull market yet. Paulson’s ambitious plan to perform a (roughly estimated) $700 billion bail-out of toxic assets from banks was hailed as the end of the financial crisis. Using taxpayer’s money, the US government would take on the trash and sell it back into the market over a period of several years. Last week saw phenomenal 8% gains in stock markets worldwide as markets were reassured by Prince Charming Paulson’s plan.

The key word, however, remains plan. After the violent rallies, markets have been riding a rollercoaster on doubts whether the plan will become a reality. The US Congress is quite understandably upset about shoving in taxpayers’ hard-earned cash to bail out an industry that has been known to give out billion dollar bonuses. This uncertainty has further deteriorated markets: interbank lending rates have reached record levels and even the sassy hedge funds have directed their cash to money market fund safe havens. Even Buffett’s plan to inject $5 billion into Goldman Sachs doesn’t seem to be enough to smooth this ride.

This political juggle might be the death of this white knight. Once president Bush starts citing a global financial meltdown if the plan doesn’t go through and the Congress still puts up a fight, it’s not surprising alarm bells start going off in the markets. Mr. Paulson better get the Congress on a leash before Bush’s prophecies become self-fulfilling.

What will the world look like before the next Bull Run?

Can you pay my bills, can you pay my telephone bills...

A global meltdown of the financial sector is well on its way if one is to believe the headlines. The credit crunch has claimed some notorious victories against some of the biggest names on Wall Street, with Merrill and Lehman being the latest ones to be found on their knees. If in the spring of 2007 anyone would have claimed Lehman would lose 94% of its market value in 2008 and then go bankrupt, they would have been deemed insane. Yet Lehman is only one of the victims of the liquidity crisis since the crunch began, and judging by the unravelling HBOS story it will certainly not be the last.

It is easy to get caught up in the daily or even weekly noise of the markets; an even more interesting picture lies in the long term. Looking at the wave of acquisitions and financial institutions with a “For Sale” sign hanging around their neck, one has to wonder where it all will end. Once this crisis is over, which it eventually will be, what will the world of finance look like? Will the customers of financial institutions end up scrambling for offers, where as before the crunch they could rely on shopping around for the best deals?

The talks about a merger of Lloyds and HBOS mentioned how the regulators might turn a blind eye to the 30% of mortgage market share the combo will end up with, and in stead try and speed up the deal to ensure the survival of HBOS. The question is whether consumers will suffer. Under any normal circumstance, pushing through such a merger would have taken months to be approved. Currently, it seems regulators are much more concerned about ensuring swift deals than ensuring competitive fairness.

So who will be the winners of the consolidated industry? On the other side of the pond, Goldman Sachs and Morgan Stanley are the last independent investment banks standing on Wall Street. David Viniar, Goldman’s chief financial officer, stated “When there’s less competition, that’s better for us.. We have pricing power and it gives us an even better competitive advantage”. Certainly, that seems in line with the rules of supply and demand. If demand for the services of the financial sector finally picks up at the end of the crunch, the few suppliers who have weathered this storm will be handsomely rewarded. The question is who will be paying the price?