The End of the (Financial) World is Nigh

Wow – where do I start with this financial crisis/mess/shambles.

  • The Aussie Dollar is being savaged – down a third from its peak in July
  • The RBA has slashed interest rates by 1% followed by similar action from other banks
  • Oil prices have tumbled 40%
  • Share prices are crashing – and then crashing again today to its worst result since 1987

So what’s happening. A quick scan of the main media analyses shows that due to the subprime fiasco in the US and the onselling of this debt as packages throughout the financial sector, we are suffering a meltdown as banks refuse to lend to each other as they are uncertain whether these loans could be repaid. And with the globalisation of financial markets, nowhere is safe from the tentacles of bad debt with the flow on effects of fear in the stockmarkets, cutbacks in investments and looming recession.

And so what’s causing it? Was it the subprime mortgages in the USA? As I was mentioning to some foresight colleagues in Australia the other day, people will try and find a single root cause, but of course, as we know from complexity principles, it is the combination of a variety of “causes”, the positive feedback loops and the lack of inhibiting forces (such as satisfactory regulation) where we will find the real reasons.
While times are good, everything is rosy. Regulation (just like lawyers) is required for the worst case scenarios. It is when the speculators run rampant and greed takes hold overwhelming productive investment (funding things that actually produce something) that we start to get a frenzy like this which always ends in a market collapse.

From a recent article I read, comes this quote:

The cruelest irony is that none of this needed to happen. Many of these structural flaws were self-evident. But neither the risk managers on Wall Street nor their overseers in Washington wanted to face reality…. To preclude a sequel to this calamity, the Congress and the next administration will need to address the root causes of our current predicament. Wall Street could not handle the risk itself. Regrettably others will now have to do so.

And this one too:

It is clear however that the present mess has been predicated on one large falsehood. That is, that the broader you spread the risk and the more people you have participating in the risk, the lower the risk. This was the rationale for CDOs, ABS, CLOs and CDS too. Look how much these derivative cocktails are fetching now on the open market.

And so an industry predicated on its knowledge of savvy risk taking has spectacularly failed to handle this risk. Leveraging against mortgage asset values by major global financial institutions allowed them to borrow money and pocket the spread between the cost of this funding and they yield on their mortgage-backed securities. To protect against the risk of a downturn in the value of their assets, they took out insurance to protect them which could not make good on their obligations once defaults started to happen. It’s not just to do with subprime as other cheap financing was provided for companies although not to the same scale.

What a mess!! And so the hard part, what is to be done to clean up the mess (if anything!). Markets always overshoot. Fear is a very nasty emotion and we have a way to go to work out who is solvent and who is not. Nevertheless, as all this is happening so quickly, we have a way to fall yet as the doom and gloom will take time to dissipate. That is really scary. It will also take some time to play out as the debt instruments that have been created continually come up for refinancing.

There will continue to be the need for government intervention to reduce the slowdown and then systemic reform so that it does not happen again. Also, there are opportunities now for counter-traditional strategic plays in different markets and many organisations are taking advantage of this crisis to buy cheap investments. For Australia, the dollar devaluation is a double whammy as repayments need to be made in US dollars and with talk of commodities exports being affected, the $A is heading south.

In the end, all us consumerists and innocent bystanders can do is watch this space. I am not an economist but I do see tough times ahead. There is still no real impact here in Dubai with lots of job and investment opportunities. And today, I am off to the best place in Dubai for a Friday brunch. Party while Rome burns? Another cognac while the Titanic sinks? Quite possibly.

And Tracey, another glass of Moet please!!

Here are some good references that I have found .

http://business.theage.com.au/business/in-hock-to-the-world-20081007-4v8c.html

http://www.theage.com.au/national/education/economics-101–what-the-global-meltdown-means-20081006-4urk.html?page=-1

http://www.theage.com.au/opinion/a-shattering-moment-in-americas-fall-from-power-20081005-4udh.html?page=-1

http://www.tnr.com/politics/story.html?id=86401650-e151-401b-990a-63f589621b7e

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4 Responses to The End of the (Financial) World is Nigh

  1. kim sbarcea says:

    Luke, dark days ahead indeed. Everything is interconnected but I’m hoping there will be no “witch hunt” pinning it on some CEO of a bank and then believing no more questions need to be asked. As you point out, it’s a series of cascading reasons. I was reading the other day a very interesting aspect to all this – the day traders, hedge funds dudes and so on are young and relatively inexperienced, if we compare to say early 90s or 1987. And so they haven’t experienced this sort of meltdown before, they don’t know how to navigate their way through it, there’s a lack of expertise.
    Also, I think another major question will be – the US bailout package – largely lies in the hands of one man, Henry Paulson. Who is regulating him? I don’t think he gave satisfactory answers to Congress on why $700 billion, how it will be distributed and so on. Possibly this is Bush’s last slap to the American people – rip off the taxpayers!!

  2. […] End of the (Rest of the) World is Nigh! Following on from my last negative article on the mess of our financial system, I thought I would continue the theme with the mess of our […]

  3. […] out to the Burj Al Arab.  It’s an expensive lunch (450 dirhams) but well worth it.  The collapse in the financial markets the day before had not affected the turn-out at all.  It was booked out.  Perhaps this is a bit […]

  4. […] the current financial quagmire is more due to the inappropriate risk instruments than overt greed as such, it does call into […]

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