Tuesday, September 23, 2008

One trillion dollars hanging on the wall....

The generous gift of something approaching one trillion dollars to the American financial system, (and I strongly suspect it will end up being much much more) was meant to provide surety where it had gone missing.

A certain amount of confusion surrounds what will be guaranteed and what will not, but it appears that not only will vast numbers of sour home mortgages be covered, but at the behest of banking lobbyists over the weekend, other debts will also be included. Credit card, student loans, and even margin lending gets a look in.

There are calls for a centralised piggy bank funded by US treasury to magically pop its cork and spill its pennies for anyone or anything profligate with their own or usually someone else's money. This is meant to ensure that a. no one panics and begins a run on a bank or institution and b. that liquidity does at its name suggests and is able to keep flowing through the economy.

If you are mortgage defaulter, you will still lose your home. But now your bank wont lose on the difference between the amount loaned to you and the now much lower value of the property. There have been indications that assistance will be available to keep people paying re-financed mortgages, but in an economy with rising unemployment, how generous will this largess be? Lehman Bros staff in the New York office will now receive their bonuses but will homeowners in Phoenix or Greater LA be living in their homes once they're unemployed and struggling on insurance?

There is another set of problems with this intervention. These will take perhaps some months to reveal themselves, and they are largely the unintended consequences of such large shifts of financial management. The most immediate issue is the impact that the deal will have on the US dollar. Opinion among pundits is divided but there is concern that it will lead to a devaluation of the currency against its major trading partners. This has been the case over the last 48 hours, which means little, but if it continues, it will undermine much of the supposed good impact of this wheeling and dealing.

If it declines sharply, it raises another danger that has been murmuring through the market for the last 30 months or so. Oil is bought and sold in US dollars, and is enormously important in supporting the market value of the currency. If the currency and its supporting economy appear unstable, and oil producing nations were to shift to say the Euro as an alternative, the impact would be severe to say the least.

The US economy is also funding itself by effectively borrowing - borrowing from its own future revenues. As the economy shrinks or stalls, tax revenues will also shrink. If unemployment rises, tax revenue will again fall. A very expensive war against terror has already made government deficits staggeringly large; public services have been experiencing budgetary pressure for some time (partly ideological) and the removal of upward of a trillion dollars from the public purse will have profound impacts upon government service provision over the coming years.

Market analysts began issuing advise to sell regional bank shares at the opening of trade in the US yesterday, as it appeared they being small and unrepresented at the weekend bailout meetings were not going to access any of the lovely money being thrown around. To make matters worse, the last two securities firms left standing are now morphing into holding banks, needing to access the security of deposited funds. And already looking to acquire the smaller and the vulnerable. Of which there are now a lot more than there were last Friday.

Regional banks probably will become ``lunch'' for larger institutions, JPMorgan Chase & Co. analyst Steven Alexopoulos told clients yesterday.

``We are seeing deals that are highly opportunistic and speedily arranged, where targets are distressed,'' said Marco Boschetti, co-head of global mergers and acquisitions at the Towers Perrin consulting firm in London.

What we will certainly see over the next few months is a rapid consolidation of banks and financial services. And as we Australians know, domination of the deposit market by four major banks is not the road to riches. Just ask anyone working in the farming finance area - the small are eaten, the vulnerable destroyed. And frankly, the bigger they are, the more difficult to govern and regulate. Recall the odd $330 million lost by "rogue traders" at NAB. The bank's own system of regulation failed and they were fined a pittance for reporting falsely to regulators as it unravelled. If governments fail to dramatically ramp up control and regulation, the next big market bubble will be beyond the scope of any one government to either control or ameliorate.

The market insists upon the logic of competition as the only mechanism able to impose the rational on the economy. With grossly increased consolidation, competition will decline. I suspect those fortunate enough to up at the pointy end of the economy wont be complaining.