19/12/2007
Perspectives - December 2007
2007 has been a worrying year for many investors, chief executives, central bankers and politicians, as they grapple with the complexities of the worst financial crisis in a decade. In my recent meetings with clients, a commonly asked question is ‘how soon will matters get better’? My response is simple: ‘patience is a virtue’.
Too many investors are looking for a quick fix, a panacea to current problems. Many have a mistaken belief that there is a quick external answer, that governments or central banks could solve the problems if only they would do a little more. Easy solutions are loudly proclaimed, such as the initial acclaim a few weeks ago for the ‘Super Fund’ to rescue Structured Investment Vehicles (SIVs) in difficulty. Sadly, the Fairy Godmother may appear in the Christmas pantomime, but come January investors will have to cope with some hard realities!
The clamour for central banks to do more partly reflects a number of leveraged investors and hedge funds in serious trouble. The reality is that unless inflation targets are completely torn up, not an outcome we would wish to see, then the ability of central banks to cut interest rates aggressively is limited in the near future. Headline inflation has reached a level which concerns the Federal Reserve, the ECB, the MPC, even the Peoples Bank of China! Ultimately our downbeat forecasts for economic growth in most of the major economies mean that easier policy will eventually be seen, but the process will take time.
Central banks are injecting moderate amounts of cash into the market place. If they stepped up very significantly there is a risk that longer term inflation targets would be undermined. It is no surprise therefore that bond investors have been rather wary about the latest co-ordinated moves by five of the world’s largest central banks to provide co-ordinated liquidity injections and currency swap facilities, in a bid to calm down money market tensions.
Against that background, what are the solutions? The twin answers are time and self help. The credit market problem can be seen as a balance sheet issue. A whole array of financial institutions do not have the balance sheet which they would prefer to have, and which investors would significantly reward them for! Too often there is a mismatch between assets and liabilities, whether in terms of value or maturity. A number of financial markets are paralysed, and models to determine value no longer work. Several hundred billion dollars worth of commercial paper and credit derivative instruments have been frozen, creating a considerable log jam.
The good news is that action is being taken to put this to rights. In the past few weeks, we have seen a range of banks accept previous large 'off-balance sheet commitments' back onto their balance sheets, and in return accept new capital, write down assets, or sell them at a significant discount. Examples would include sovereign wealth funds in Singapore and Dubai taking sizeable stakes in investment banks UBS and Citigroup, while private equity money has been invested in the bond insurer MBIA. This followed a variety of banks such as Citigroup, HSBC and Societe Generale avoiding the US Treasury’s proposed ‘super fund’ and instead taking SIVs worth over $100bn directly onto their own balance sheets.
The authorities have also been hard at work. In the US, Paulson finally proposed a complicated scheme to protect a number of sub-prime mortgage payers through limiting the future increase in their mortgage payments, while the rules are in the process of being relaxed to allow the Federal Housing Administration to support some home owners by raising the eligibility of more expensive loans. In practice, the market place is rather wary whether such schemes will do more than assist a few hundred thousand households – compared with over two million homes in trouble. Nevertheless, there is growing recognition that the credit crisis has important regulatory aspects. We expect these trends to become more noticeable during 2008: regulation of US mortgage brokers, German Landesbanks and UK commercial banks are all are obvious examples.
To emphasise the point once again, this will all take time. How long? We can look at one example, namely the changes taking place in the asset backed commercial paper market. At its height the US market was worth $1.2tn. As commercial paper programmes matured and were not rolled over, the market has shrunk it’s size to about $0.8tn. Assuming that this market will survive in some form, then perhaps the adjustment process is half way through, and stabilisation will be seen in the summer.
To quote Winston Churchill: "Now this is not the end, it is not even the beginning of the end, but it is, perhaps, the end of the beginning".
Andrew Milligan, Head of Global Strategy at Standard Life Investments
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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©2008 Standard Life Investments.
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