C.M.O. 3.3.2010
Credit Market Overview
March 3, 2010
There is a famous Indian legend that depicts six blind men encountering an elephant. Each in turn walks up to a different part of the animal and as such comes away with a different impression of what the beast actually is. To give you an idea here is the second paragraph:
The First approach’d the Elephant / And happening to fall / Against his broad and sturdy side / At once began to bawl: “God bless me! but the Elephant / Is very like a wall!”
This story came to mind while hearing of some of the changes the International Monetary Fund (IMF) has been considering as possible policy objectives in the wake of the credit crisis and the effect it is having as it ripples through some of the less stable economies.
The credit crisis itself is a result, in part, of this kind of thinking but not by the IMF but by that other supra-national financial body the Bank for International Settlements (BIS). As a part of what is known as Basel II, the BIS decided to allow banks to base capital requirements on the volatility of the instruments they were reserving against. The lower the volatility the less capital needed. This was supposed to be a more enlightened form of risk management as it allowed banks to use more of there capital which, it was thought, would allow them to prosper during the “Great Moderation”. Needless to say when things became “un-moderated” there weren’t enough reserves and . . . well, you’re living through the rest of the story.
So now that we’ve come through what is hopefully the worst part of the storm everyone is running around trying to close all those gates that the horses left through. Not to be left out the IMF has a few proposals of its own.
One of the more interesting comes from the IMF’s top economist, Oliver Blanchard, who reasons that if the world’s developed economies were to target an inflation rate of 4% instead of the current 2% than the next time there is a credit tsunami there will be more room to lower rates, relieving the need for measures such as quantitative easing and TARP and TALP initiatives.
One of the other ideas being floated is that emerging economies should institute tax and regulatory regimes to moderate the vast inflows of capital they are experiencing as investors leave the hobbled west behind and seek markets where they expect stronger growth.
The IMF is also urging the leaders of the world’s western economies to coordinate regulation via multilateral agreements to remove the possibility of regulatory arbitrage. Dominique Strauss-Kahn, the IMF’s managing director said recently, “I am worried about the possibility of inconsistency of different countries proposals”.
The latest idea to be floated is one where the IMF would provide assistance to a group of countries vs. individual nations which is intended to remove the stigma associated with receiving aid from the world’s lender of last resort. While on a grander scale, this would seem to be somewhat similar to the U.S.’s Federal Reserve encouraging the use of the Discount Window during the depths of the crisis.
To discuss the pros and cons of each initiative would take many more pages than I have neither the time to write nor you, the time to read. The lesson here is similar to that of the blind men and the elephant and that is that perspective makes all the difference when making decisions.
With that said there are two encouraging things to report in the credit markets. The first is that sovereign protection for Greece closed at 320bps last night, down from its recent high of 428bps on 2/4 and the lowest close since that date. Whether the austerity plans or the unwillingness of its stronger Euro partners (Germany and France) to let Greece fail are the cause of this or even if it is the combination there of, the global financial system didn’t really need a sovereign default to deal with at the moment so averting that disaster has to be a good thing.
The other credit related news pertains to AIG whose CDS closed at 409bps last night. Given that in more normal circumstances 400bps would be nothing to brag about AIG has been through nothing that looks like normal circumstances. The last time AIG’s CDS traded lower than last night’s close was September 8th of 2008. Hopefully I don’t have to recount for you what happened right after that.
Enjoy the week.
Jim Delaney
