Monday, November 17, 2008

The Looming Recession

Last weekend, exiting President George W Bush, hosted the leaders of the G20 nations at a summit here to discuss a coordinated response to the global economic crisis.

While the world leaders, including our own, rushed into the Capitol, we drove out of it in search of America’s equivalent of the Rosetta Stone to help illustrate the meaning of this sprawling economic mess.

Washington DC is not the place to find it. It is virtually recession-proof, given the high numbers around here who work for Government or are involved in lobbying it. I witnessed this a few weekends ago when we had dinner at the uber-expensive Palm steakhouse (where the rudeness of the waiters is matched only by the number of Washingtonians who clamour for a table here). The bill for a meal for four, without dessert, amounted to around R4000. Fortunately my visiting, and wealthier brother picked up the tab.

But Greenwich, Connecticut seemed to be a better place to take the weakening pulse of the wealth creators (and laterally destroyers) of the American and world financial markets. One of the wealthiest enclaves in the United States, it headquarters the major hedge fund companies and financial service corporations, and is home to some of America’s richest people.

Last Saturday, we approached this gleaming citadel of American capitalism via the neighbouring town of Stamford. My friend, Laurence Kaplan, pointed out two of the imposing and shiny structures which house UBS’s American trading operations – which boasts the largest trading floor in the world - and the Royal Bank of Scotland. Both stand today as monuments to the subprime crisis which has caused them to write down, and write off, tens of billions of dollars of dodgy mortgages and credit default swaps. RBS has landed up as a state-owned asset of Gordon Brown, and UBS’s fate is even worse: last week a US Federal Grand Jury indicted its head of global wealth management on a slew of charges relating to tax evasion and other breaches of American regulatory law.

Our walk along the main street of Greenwich was even more instructive of what Paul Krugman, winner of this year’s Nobel Prize for Economics, recently termed “the long feared capitulation of American consumers”. Indeed, on this crisp autumnal morning, there were hardly any shoppers around. In the chic boutiques and splendid luxury store fronts of this immaculately maintained town (where appropriately, perhaps, the “Stepford Wives” was filmed here four years ago). We were the only visitors at a tony luggage store. The shop assistant advised us, that the dearth of customers was “soul-destroying”. Greenwich might be the high-end of the American retail. But the desertion of its shops and stores is now reflected across the board. Real consumer spending is plummeting and fell at an annual rate of 3.1% in the third quarter while spending on durable goods (cars and TVs, etc.) fell at an annual rate of 14%. As Krugman points out this is a real change in consumer behaviour which could not have come at a worse time. Because while excess household debt got a lot of Americans into their current problems, and trimming debt and boosting savings is always a virtue, a freeze on spending by consumers right now will slide America, and much of the world, into a recession. (The so-called “paradox of thrift”).

Laurence Summers, the once and possibly future US Treasury Secretary, tartly summed up the central cause of the financial markets’ crisis as a case of “too much greed, not enough fear”. But the fear which now keeps shoppers out of the stores presents its own set of headaches. It is further driven by the new fear of banks and lending institutions proving as unwilling as ever – despite the $700 billion rescue package – to lend to consumers and to each other. General Motors, now titters on bankruptcy just two months after celebrating its 100 birthday, it says it may not survive to see another year unless it is rescued by a Federal bailout. Starbucks, the corner-store icon of globalisation, posted a net income drop of 97%.

The current desertion of main street Greenwich is also explained by looming job losses in the financial industry as banks attempt to slash costs, to cushion the blow of further market turbulence anticipated for 2009. The Financial Times reported last week that up to 70 000 jobs could be lost in US banks and financial institutions over the next few months. Across all sectors of the American labour market some 1.2 million jobs have already been lost in 2008 and 3.8 million homes are under foreclosure. Clearly, a fiscal stimulus of some sort is required. But will it work in unfreezing the credit markets? In any event, the new administration is hedged in by the thicket of the national debt, which currently stands at around $10 trillion, and rising.

All this bad news has led to a schadenefreude by the pundits all-round. The most prescient of the lot is Michael Lewis who lifted the veil on the excesses of Wall Street in “Liars’ Poker” way back in 1985. He retuned to splendid form in a recent article posted on Tina Brown’s marvellous new blog “The Daily Beast”. In it he profiles Steve Eisman, a hedge fund manager who was among the first to detect the weakness of the subprime mortgage market, and who made a fortune from shorting it and everyone with a hand in it: first, the lenders; then the rating agencies; finally, the big banks. As he explains, the subprime market was actually too small to feed investors greed and so they created a market of side bets. This is where derivatives and other esoteric, and ultimately toxic, assets created a market which at its height was worth trillions of dollars worldwide.

Lewis also quotes the analyst who apparently first saw the basic lack of real value underlying these assets. Meredith Whitney of Oppenheimers, back in last October, was the first to blow the whistle on this financial house of cards. As she put it “if you want to know what those Wall Street firms are really worth, take a hard look at the crappy assets they bought with huge sums of borrowed money, and imagine what they’d fetch in a fire sale.” Lewis’s own interpretation is priceless: “this woman wasn’t saying Wall Street bankers were corrupt (if mere scandal could have destroyed big Wall Street investment banks, they would have vanished long time ago), this woman was saying, they were stupid.” And this was much more seditious and calamitous.

The marvel of the American economy is that 60% of its citizens own shares today, literally from Warren Buffet to the legendary Joe Six-Pack. But it is now demonstrating the defects of this quality: like its wealth the misery is now spread about, but by no means equally.

*Written for the Weekender, to be published 21 Nov.

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