August 27, 2007

Getting Our Dollars Back, One Way or the Other

LATE LAST WEEK I was talking with a colleague at work about the mess in the lending markets. We had just received word the Bank of China Ltd. was stuck with billions of dollars of debt backed by sub-prime mortgages, and I said something to the effect of, "We're getting our dollars back, one way or the other!"

Well, as it turns out, that's exactly what's happening -- and it's happening all over the world. Ambrose-Evans Pritchard -- yes, who else would it be -- blogged about it over at The Telegraph. Mr Evans-Pritchard writes:

In a warped sense, one has to admire the cool way that Americans – who save nothing, in aggregate – tapped into the vast savings pool of thrifty Germans to finance their speculative excesses, and then left the creditors holding a chunk of the subprime losses.

Was it sharp practice, in the same way that foreigners were recruited by Lloyds of London in 1986 and 1987 – before the impending asbestos losses were known – and placed like cannon fodder on “spiral syndicates” to absorb crippling losses? (Lloyds denies this occurred).

I am endebted to Randall W. Forsyth from Barron’s for this delicious quote from a hedge-fund operator, recounting with disgust what happened this time in a letter to clients:

" 'Real money' (U.S. insurance companies, pension funds, etc.) accounts had stopped purchasing mezzanine tranches of U.S. subprime debt in late 2003 and [Wall Street] needed a mechanism that could enable them to 'mark up' these loans, package them opaquely, and EXPORT THE NEWLY PACKAGED RISK TO UNWITTING BUYERS IN ASIA AND CENTRAL EUROPE!!!!

"These CDOs were the only way to get rid of the riskiest tranches of subprime debt. Interestingly enough, these buyers (mainland Chinese banks, the Chinese Government, Taiwanese banks, Korean banks, German banks, French banks, U.K. banks) possess the 'excess' pools of liquidity around the globe. These pools are basically derived from two sources: 1) massive trade surpluses with the U.S. in U.S. dollars, 2) petrodollar recyclers. These two pools of excess capital are U.S. dollar-denominated and have had a virtually insatiable demand for U.S. dollar-denominated debt . . . until now."

Mr Evans-Pritchard sums up his feelings in one word: "Shameless." And it was.

But then, what else would you expect from Wall Street, which has been doing that type of thing for years? It's like the bond-selling scenes from Liar's Poker on a grand scale. Plus, there's something to be said for caveat emptor here. While I'm sorry these folks are losing their shirts in this whole mess, I have to say I feel a bit like the counter-point guy in "Airplane!" -- "They bought the paper. They knew what they were getting into. I say, let 'em crash!"

Now, a benign view of all this might note these types of things seem to happen on a cyclical basis. Back in the Eighties, when everyone was in an uproar over the seeming Japanese domination of our economy, many Japanese came over with their dollars and bought trophy properties in the United States. They also managed to lose a bundle on these but at least they got to enjoy a bit of golf in the meantime. This time around, it's China's turn -- and they don't even get to golf. (Maximum suckage).

Mr Evans-Pritchard, however, does not find this benign. Apparently the Germans have been hit especially hard due to the subprime mess, with at least one German bank being sold in a fire sale as a result of its sub-prime issues. Another one had to be bailed out. Plus, the jump in interest rates has apparently put a real squeeze on corporate borrowing, and it seems there's a very real likelihood this whole mess will spill over into the larger economy. And that, Mr Evans-Pritchard writes, could mean recession.

I sure don't know what the future holds, but I do know this. The idea of a recession around the corner doesn't mean one should panic. It does, however, mean one should position oneself for the possibility, and be ready to strike when the iron is hot. To my way of thinking, that means building up cash reserves in the meantime, paying down or paying off debts, and being ready to invest when the time seems right. A recession, if it comes, would end eventually, and it seems to me one could do very well if one bought the right investments when things seem at their bleakest.

Posted by Benjamin Kepple at August 27, 2007 07:35 PM | TrackBack
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