Hot Topic – which crisis is the leading crisis ?

This week I start with the “Hot Topic” again, as depending on what you regard as the primary driver behind the crisis it will determine how your mid term risk assessment should be.

Many media reports and politicians speak about the financial crisis as being the reason for a slowdown in global growth. No doubt that a crisis among financial institutions has a negative impact on economies in general. But I argue that the financial crisis is caused by a global slowdown that started in USA for more than 2½ years ago, and by a busting global real estate bubble.

For 2 ½ years ago some smelled that the US housing market was turning sour, and as we all were full aware of at that time, it meant that the US consumers’ cash machine was turned off. Since then the demand slowdown has spread across the globe. Many seem to have forgotten how private consumption very suddenly dropped in UK and Japan last year. What we observe now is a global move towards recession, and a recession always takes casualties among banks.

The serious issue in this downturn, is the leveraged economic world we lived in. The decade of much too cheap money from Fed and Bank of Japan made it too easy to invest with less and less own equity. In both US and Europe houses and real estate projects was sold with a debt ratio above 100% and many other investments was done with minimal equity. When demand in the world stops, then assets corrects lower, but this time we had stretched demand driven growth to extremes, partly due to cheap funding.

The forceful global asset price collapse worries all of us, but we come from extreme situations. A couple of times I have given examples on how leveraged the European banks had become (more than most US banks). In US, even during autumn last year Dow Jones continued to climb and making new highs above 14.000. This, despite it was clear for (almost) everybody that the US economy was pointing downwards. If Dow Jones had topped out around 12.000 at year start 2007 it would had make sense, and given a possibility for a correction down to 10.000. It would also have been unpleasant, but easier to survive, and maybe without coming into a bear market territory.

In my world fundamentals (dropping demand followed by slower growth) took over and caused assets to be less worth. The powerful pace of prices on assets falling almost every day is caused by the much too high leverage. In my view the bearish fundamentals factors are still working and spreading, i.e. the original economic slowdown is now to become a recession – globally.

A few official institutions have been very realistic about the upcoming problems. IMF is particular in the lead, though Bundesbank and Bank of England have been ok as well, where Fed is good in taking action. If you choose to listen to IMF, then they are forecasting more negative news to come. I agree and do not expect any recovery just around the corner. Despite this bear view, there might still be interesting opportunities out there, but more about that in the comments below.

The speed in the global slowdown is accelerated by so many banks in more than serious problems. I agree 100% in what is done from the different governments, as these solutions are the necessary steps to save the financial system. We are talking about making sure, that basics within the banking sector function and surely not re-establishing the banking system we had for just 1 year ago. More losses are not to avoid for the banks as the Ice Age is coming right against us.

If you are more upbeat on the world than I am, and in particular, if you believe that the global crisis is caused by the crisis in the financial sector, then it’s time to buy assets now. The global banking rescue of historical dimensions will stabilise the sector, so with this rescue a very negative factor for the markets is gone. It’s not my opinion that it will save growth in the world, but I surely respect the view.

I need to mention it. One of the features in the different government bailout plans, is….guess what, yes I know you have seen it, but very ironic, even lower rates and more liquidity – the key element in the “Big Experiment” that send asset prices towards the moon, and now causes a global meltdown.

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