Downunder Daily : Pulling TARP
First, if it wasn't already obvious, it should be now that the deflating of the global credit bubble is a global problem. Even before the TARP no-vote, risk assets were sharply falling as financial stress snowballed. The previous 36 hours had seen the bail-out of Fortis, the nationalization of Bradford & Bingley, the rescue of Hypo Real Estate, the government takeover of Glitnir Bank (Iceland's third largest), and the sale of Wachovia. It is not just that the financial sector is the most interconnected industry in the world; it's that the global credit bubble created indigenous excess in many economies. Financial institutions are under stress not only because of exposure to falling American asset values, but also because of falling asset values in their home markets.
Second, it's likewise becoming clear that the only white knight with deep enough pockets is the public sector. Bloomberg's estimate of worldwide capital losses now stands at US$591.5 billion (compared with capital raising of $435bn). Those losses are certain to increase as the global cycle deteriorates.
Against that backdrop of large (and rising) losses, the early providers of capital either have been hurt (sovereign wealth funds, private equity) or have limited resources. The TARP vote underscored (if any of us were in doubt) that 'bailing out Wall Street' is politically unpalatable, yet there now seems little alternative. It has also become clear that the bail-out will require government involvement outside the US.
Third, it's noteworthy that growth-related assets were falling sharply even before the TARP no-vote. The CRB index fell 21 points in overnight trade; but it was already down 17 points prior to the TARP announcement. In short, investors are now moving to price in a global slowdown, and were doing so even before the no vote.
The relative sector-level performance of the S&P overnight was a text-book shift into low-beta sectors: staples, utilities, and health-care were the best three performing sectors, while energy, materials, and technology were, finance aside, the worst. This, broadly speaking, reflects the sector-level stance of our strategy teams. As I noted last week, I have been surprised over the past few months by how quickly the financial system has unraveled, and how resilient the real economy has been. The next few quarters will likely see the real economy catch up with the financial stress, to the relative detriment of economically sensitive sectors.
The prospective real economy downturn will almost certainly lead to further credit losses. Arguably, the losses to date have largely reflected the excesses of the bubble, but a recession causes loss even amongst 'good' credits. It is now probably too late to stop this second tranche of pain. But it reinforces my point that the there will have to be a call on the public purse.
Finally, policy makers will respond, and presumably respond quickly, to these events. The Federal Reserve announced overnight (again, prior to the TARP vote) that it was increasing its swap facilities with non-US central banks by $300bn to $620bn. The Term Auction Facility (TAF) has also been expanded by $300bn to $450bn. Expect other central banks to flood the system with liquidity.
With the macro outlook now clearly deteriorating, I assume it's only a matter of time before central banks ease their policy rates. Inflation is no longer the main game. Likewise, the Administration in the US will probably submit a modified plan to Congress.
After the largest one-day fall since 1987, there may be a sense that markets are close to capitulation. Moreover, the likely flood of liquidity and fresh policy initiatives may provide some relief. But these are historic times, and it seems to me that capital preservation will remain an over-riding strategy for some time.
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