http://financial.seekingalpha.com/article/25527 Instability in Global Financial Markets May Trigger Repricing of Assets Posted on Jan 30th, 2007 Michael Panzner submits: In "Prepare for Asset Repricing, Warns Trichet," the Financial Times' Gillian Tett describes what seems to be a quickening sense of alarm among some policymakers. Current conditions in global financial markets look potentially "unstable", suggesting that investors need to prepare themselves for a significant "repricing" of some assets, Jean-Claude Trichet, president of the European Central Bank, warned at the weekend in Davos. The recent explosion of structured financial products and derivatives had made it more difficult for regulators and investors to judge the current risks in the financial system, Mr Trichet said. "We are currently seeing elements in global financial markets which are not necessarily stable," he said, pointing to the "low level of rates, spreads and risk premiums" as factors that could trigger a repricing. "There is now such creativity of new and very sophisticated financial instruments . . . that we don't know fully where the risks are located," he added. "We are trying to understand what is going on - but it is a big, big challenge."... Malcolm Knight, managing director of the Bank for International Settlements, said: "Financial innovation has produced vehicles for leverage which are very hard to measure . . . liquidity is increasing very rapidly and this is affecting asset prices." Central banks were scrambling to address the problem by intensifying their joint discussions via forums linked to the BIS, he said, but he warned that international co-operation and data gathering efforts "need to be deepened". A few have even started voicing once unthinkable concerns about who will clean up the mess if and when policymakers' worst fears are realized. Stanley Fisher, governor of Israel's central bank, pointed out that it remained unclear "who takes responsibility for the [financial] system" at a time of crisis, particularly given that the "hegemony of the US is diminishing". Given all the warnings coming out of Davos recently, some might be wondering how things had gotten to this point to begin with. While there have been a number of interconnecting factors involved, yesterday's Wall Street Journal addressed at least one key driver: "The Greed-Fear Imbalance." The smart money knows today's liquidity-inflated financial markets are full of risk. That was clear from the chatter at last week's World Economic Forum in Davos, Switzerland. Yet private-equity firms, hedge funds and investment banks are acting as if the good times will continue. Skewed incentives, which pump up greed and damp fear, explain the discrepancy. Fortunes will be made if the good times roll on; but the insiders won't lose much if there is a crash because they are mostly playing with other people's money.... The main way to get seriously rich quickly these days is to play the hedge-fund or private-equity game. The incentive system -- the notorious "2 and 20" under which managers get some 2% of funds under management as an annual fee and 20% of the profits -- favors those who can scoop up the biggest pots of other people's money. The primary aim has become to gather assets rather than to deploy them effectively. That's not to say the smart money likes to make bad investments. But when things go pear-shaped -- as with Amaranth Advisors -- the managers don't share in the losses or give back past takings. In a well-functioning market, greed and fear are appropriately balanced. The "heads-I-win, tails-you-lose" structures rife today have distorted the balance.... The smart operators are aware the party can't go on forever. But the longer it continues, the more money they will make. What's more, there is no obvious reason why it has to end now. There may be kindling on the forest floor, but where is the spark that is going to ignite it? The snag, of course, is that as time passes, more brushwood accumulates. When the conflagration comes, it could be dramatic. An understatement, perhaps?
My colleague got a "cold call" from a private equity guy this morning asking "if he had any deals that needed financing" Hedge funds and Private Equity are to the 2000`s As Stockbrokers were to the 1990`s Easy money.
Minyanville Staff Jan 30, 2007 8:45 am When money supply grows you can by definition be sure that debt is growing commensurately. I have been thinking a lot lately about the state of economics and markets. From an intellectual point of view it is fascinating; from an emotional point of view it is scary. Oh donât worry about me. I am parked over here in Japan, long the yen that everyone else in the world is short. I am happy to lend these yen back out at basically zero to speculators since I believe that one day they will be forced to buy them back from me at much higher prices. This will occur when the Bank of Japan will finally be forced by the market to raise interest rates from their ridiculous âfreeâ money levels. When will this be? Well, I think we saw the first strains of rebellion by Thailand a few months ago when it raised margin requirements. Speculation is rampant and they seem the only ones out here with any common sense. Just because they were âcajoledâ by their trading partners to reverse course doesnât mean those strains are still not there. I am willing to forgo the 5% interest I can earn on other currencies for the expected value of doubling my âmoneyâ in a few years or sooner. The Bank of Japan is a laughing stock. They are inflationists that would make any central banker proud; a country naively being used by others, especially the U.S., to dump liquidity into markets. Yes folks, there is rampant inflation in asset prices. Not only do central bankers of all stripes understate the cost of living, but asset prices like stocks and houses are now in hyper-inflationary territory. Being long assets that are in such a state is like taking a picture of an egg at the height of its toss: it looks fine unless one ponders the inevitable state of it being splattered on the sidewalk. The egg has been going up and up and up and it may go up further, but gravity is doing its work and it will not fail. In normal times a good deal of market liquidity comes from income and thus savings. Economic production produces excess in certain societies and that excess is saved and invested. A little debt thrown in makes some of those investments happen a little sooner and with a little more return. But that debt is used prudently by those with the brains to have accumulated the necessary capital. Money is precious to them. But these are not normal times. With GDP growing at 2-3% (I believe this to be overstated) and M3 (broad money) growing at an astounding 13% for the worldâs largest economy, we have our first clue that things are not normal. Money is free to any who want to take the risk. When money supply grows you can by definition be sure that debt is growing commensurately. Debt is not used prudently because it is created easily for anyone and everyone out of thin air by central banks. Almost all of the current liquidity is coming from debt creation. This is the definition of inflation. We now have an amount of debt in the system that would scare a hedge-hog. The only place left of moderate leverage is in some corporate balance sheets (as long as we ignore contingent liabilities like pension obligations and health care benefits). Corporations rapidly de-levered after 2001 (causing asset prices to deflate) due to perceived high risk and now they are rapidly levering again due to perceived low risk. Of course these two things, leverage and risk, are tied at the hip so once this latest and last form of levering is complete the forces of deflation, created themselves by massive inflation, will most likely advance. Total global debt issuance jumped 14.1 percent from 2005 to a record $US 6.948 TRILLION in 2006. Leading the way once again was the U.S. with total debt issuance in 2006 increasing by 10.1 percent to $US 4.085 TRILLION. With the US economy at about 20% of the global GDP, it has issued debt almost three times its own relative global economic size. The U.S. now has total debt of 3.7 times GDP, a level never seen before. At some point debt becomes deflationary because there is too much of it and the debt has been used to create even more overcapacity. We are starting to see in the U.S. signs, like sub-prime lending losses and higher home foreclosures, that income cannot support the amount of debt. Has anyone lately driven by a new commercial complex that is half empty while they are building a brand new one right next to it? As a result, new debt begins to have less and less effect on creating growth: in 1980 it took $1 of new debt to create $1 of GDP; in 2000 it took $4 and today it makes $7. We seem to be pushing on a string. So when people say âthere is so much money out thereâ it is the same thing as saying âthere is so much debt out thereâ. Debt issuance is fueling speculation as this âmoneyâ is searching for return, any return, regardless of risk. All rates of return are being driven lower and lower in the search. So why even look for return? As everyone else searches harder and harder for return and taking greater and greater risk to do it, perhaps the best thing to do is search for lower risk. It looks to me like Sam Zell agrees. This is very hard to do and perhaps that is why only some of the worldâs greatest investors like Sam Zell have the patience to do it. So what can you do about it? This does not mean short stocks, for that takes timing and I care not to âspeculateâ on the timing of deflation. Central banks are adamant, but they are wrong, and eventually their methodology of creating new debt to fight the forces of old debt will not work. Instead of getting in the way, I suggest just getting out of the way. First, be prudent. Look carefully at your risks. Deflation hates stocks so be careful there. It also hates debt, so pay it back if you can. Sincerely, Mr. Practical