G7 calls for major review of global financial system

The G7 communique from the current meeting makes for interesting reading. Their focus has been wide ranging and, for a change, not just on currencies though the headline statement does make a clear reference to recent moves.

What I took note of was their concerns around bank capital. This is really where the crunch point is located. They call for the Basel Committee to review liquidity risk management guidelines and a quick disclosure of write downs ands revaluations (or in reality devaluations).

The accounting for off balance sheet items was also raised, particularly the valuation of assets in a time of financial stress. That should cause palpitations amongst traders of credit default swaps. Quite frankly some of this stuff can only be valued when its traded. The idea that there is some kind of two way market is really a myth. That in itself should make regulators, as well as bank shareholders, sit up and think about some of the toxic trades sitting around on the books.

They also call for a speedy implementation of Basel II. I think they should tear up Basel II and move straight onto Basel III but more on that another time.

They realise the game is up and the time has come for a thorough overhaul of the system itself. It will be interesting to see how this plays out as more and more unwinding takes place. As far as currencies go, China was gently reminded to hurry up and revalue the Yuan and the market was reminded that G7 wasn’t happy about some of the moves we had in March.  Whether that helps the $ is anyone’s guess but they better have an intervention plan up their sleeves before the $ takes another big dump.

The markets had a nice rally but reality is never too far away in markets and the last couple of weeks may have just been a pause for thought.

Bollard pleads

Keep going guys, Alan Bollard pleads. He asks banks and businesses not to hibernate. What?!

Is he suddenly the Finance Minister? It’s really quite odd to see a central bank governor talking like this especially since the last few years he’s been going on about house prices and overborrowing without doing a great deal about it.

Now he’s saying don’t let credit constraints get in the way.

At the same time the Commerce Minister tells investors to get savvy or get “burned”. I love it especially from a Labour government where many ministers have invested in property themselves. Financial literacy? We’d certainly like some.

The facts are very simple. Too much leverage, much of it unseen, caused an asset bubble. That bubble is now deflating and there will be some major fallout. Add to that concerns over global food and energy prices and you have a perfect storm. So for banks now to put the shutters up whilst they count the cost is simply sound business practice.

Westpac has already adjusted its loan criteria. This just fuels the need for lower house prices and demonstrates the role that banks have played in the boom. Yes the interest rate is important but only at the margin. The real issue is how much will they lend: 100% or 65%.

It’s a big difference in what people can afford to pay.  Now landlords have the power as they can raise rents and people will just have to bear it. So along with an increase in mortgagee sales we will see an increase in rent arrears if rents increase beyond peoples’ means.

So it’s a bit late for the officials to weigh in with their comments. They have had plenty of time to look at banking regulation and have completely missed the boat.

Anderton lays into greedy banks

Jim Anderton, a senior member of cabinet and supporter of Helen Clark, has had a good crack at the NZ banks calling them “authors of their own misfortune”.

With lending up 14.3% in the last year he’s not wrong.

And with Lombard the 17th NZ finance company to hit the wall some serious questions must be asked about the health of the NZ financial system.

Deborah Hill Cone , the Hermione Granger of NZ journalism, has been banging on about this for many years now focusing mainly on the Hanover Group which surprisingly hasn’t gone under….yet.

Back in March 2004 she wrote a big piece on it for the NBR which prompted me to write to various MPs and the Finance Minister to express concern about the finance company sector as a whole. The only MP who took interest in it was John Key, the then shadow finance minister, whilst Michael Cullen, the current one, gave the standard response that the system was well regulated.

We also hear that Tower has closed a mortgage fund after a run on funds on a day that centre left leaders met in London to discuss urgent reform of global financial markets. Helen Clark was there and no doubt expressed her concern.

Perhaps her focus should be a little closer to home?

It’s All About Money, Cash Money, Cash Money, Who’s Making all the Money

This is in response to Dave’s post on a new wave of financial regulation. It’s a great 5 minute potted history of money to a stunning tune from Prince Charles and the City Beat Band. They rock!

Watch it here

Helicopter Ben readies for drastic action

After a chaotic few days the market has calmed as it awaits the next round of soothing medicine from the Fed. 100bps is expected now and anything less could see a major sell 0ff. So perhaps its time to recap on what’s happened:

- Global expansion of the money supply by the banking system abetted by loose regulation.

- Financial assets treated as investments.

- Trading on a leverage basis whether in the markets or in property.

- Reliance on capital gain to pay off debts.

- Creation of an asset bubble in property and stocks.

- New financial products promising spectacular gains.

A quick recap:

- Asset prices can go no higher as the mathematics of compound interest and cashflow catches up.

- The first domino falls as the sub-prime market starts to fall.

- Property finally turns and heads south in the US.

- Debts over run equity in houses.

- Spirals into derivative products causing a more widespread reaction.

- First reaction from Fed.

- Banks start to revalue (mark to market) loans.

- First run on a bank: Northern Rock fails.

- UK nationalises Northern Rock.

- General deleveraging starts as contagion spreads.

- Banks review lending and fringe financing companies fail.

- Rogue traders appear.

- Central banks provide copious amounts of liquidity.

- Fed cuts rates heavily and provides open lending to all.

- $ collapses and commodities explode as safe haven.

- Second run on an investment bank: Bear Stearns fails.

- Fed sort of nationalises Bear Stearns but gives it to JP Morgan under guarantee.

- Financial system on the verge of complete collapse.

So what now?

Well the Fed has studied the 1930s depression very carefully and realises that systemic bank failure is simply not an option. Yes shareholders will lose most of their money but that’s the risk with equity. The lines of credit and liquidity must be kept open and depositors must be kept afloat. If necessary banks in trouble will be taken over or have to merge.

It’s safe to say they will do whatever it takes, regardless of the cost. The clean up can come later but for now this is mainly about preserving confidence in the system.

How it pans out is impossible to predict but i wouldn’t want to own any banking stocks.

Man the Pumps: Central Banks run up the white flag

With rumours continuing to circle around main street financial institutions in trouble, the Fed along with other central banks piled in another $200bln worth of liquidity in a vain hope to stem the tide. It certainly worked sparking a massive rally in the US market which was looking very weak indeed.

I wrote 6 weeks ago that the Fed would have no option other than to underwrite the whole financial system. This is exactly what they are doing. The worrying aspect of this approach is that it leads the market to depend on continuing liquidity to provide confidence and prevent what would be happening without intervention, namely a full scale rout with several institutions going under.

This creates extreme moral hazard. Even though many financial institutions have clearly acted irresponsibly and in some cases in other ways, they will not be allowed to fail unless a “deal” is worked out where they will be “acquired” quietly for a nominal sum and so the system stays solidly in place and the illusion is maintained.

F.William Engdahl lays out his thoughts on the origins of this mess. It’s focus is the US over the last 100 years and is interesting to read though he makes some strong accusations about the actions of certain people.  The extent to which small cliques have organised and run the financial system is open to questions but there is no doubt that the US prevailed at Bretton Woods on the strength of pure self-interest.

So what now? Well I would say more of the same. But gravity is a powerful force and its hard to imagine these markets not falling further and more de-leveraging taking place in credit and carry trades. I’ll discuss shortly what a new global currency system might look like because the current one is about to explode.