Thursday, 18 March 2010

Niall Ferguson in Davos on Credit Crisis

Live-blogging transcript from a video I watched of Niall at Davos regarding the credit crunch and the future.

Crisis not due to simple "bankers are greedy", much more complex and nuanced than that!

The crisis had 6 dimensions:

1. Monetary System became compromised by the excessive leverage on company balance sheets.  Investment Banks were leverage 25 to 1 (debt to capital)

2. Contamination of Bond Market: fatally corrupted by series of financial inventions.  Synthetic credit and collateralised debt obligations: only 12 AAA rated institutions prior to credit crisis, yet 64,000 AAA investment vehicles.  Defaults in subprime exposed the fraudulence in credit derivative market.

3. Monetary Policy: Fed kept federal funds rate (short term) at below 1% while housing was increasing by 20% year-on-year.  Greenspan believed his own press.  "Fed doesn't need to worry about assets prices" argued leading economists.  Fed should focus on core consumer inflation is what they countered.  "Markets will regulate themselves".

4. Corruption of Insurance:  Explosion of Credit Default Swaps allowed companies like AIG an opportunity to build businesses in uncertainty, and not sticking to what they were good at - risk.  False sense of security occurred, thinking all synthetic credit was in same way hedged.

5. Over-hyped House Push: both parties liable for pushing this agenda.  Politicians to blame.  They regulated Freddie and Fannie

6.  Chimerica: relationship between China and America.  Chinese did saving, US spending; Chinese exporting, US importing; China all the investing, US all the consuming.  If it hadn't been Chinese accumulation of US debt $2tn, the bubble wouldn't have been so severe.

So why didn't this cause another "Great Depression"?

By some measures it was actually worse but it was prevented because of:
i) Monetary Policy - Fed doubled size of its balance sheet by buying toxic assets (Niall thinks this one is most important)
ii) Fiscal Policy - Treasury increasing deficit in true Keynesian fashion

Krugman reckons its deficits that saved the world, Niall thinks it might sink the global economy.  Makes the argument that deficits of 90% of GDP could slow growth and increase risk of inflation.

Public debt run up is unprecedented in peace time.  CBO say debt will 90% of GDP in 2039 (optimisstic) and 2021 (pessimistic).


Key question: how will bond investors react to this explosion of debt?  China has put a floor on the price of treasuries in last 2 years (by buying them).  Will they continue to do this?  If bond market sentiment on US treasuries changes and yields rise, it will start crushing US recovery.

UK and Ireland at sever risk of this already.  Greek, Portuguese, Spain already "basket" case.  Thus, the Eurozone will likely keep bond traders from moving out of US debt any time soon.

Developing nations look well poised to benefit from this "Anglo" crisis.  It remains to be seen which developing nations these will be.


Future Risks: Excessive debt is a big worry, crisis in Eurozone because of this debt, slowdown in China and clash of civilisations between West and Islam nations is still very real, and could send a geopolitical shock greater than the financial crisis - smaller things have lead to wars!


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