Global Trends by Martin Khor
Monday 17 March 2008
As Malaysians were engrossed
last week with our “political tsunami”, another tsunami was gathering
strength in the
In the past ten days or so Malaysia has been facing such a drastic change resulting from the general elections that media and the public have termed it a “political tsunami.”
In the same period, the global financial system has also been experiencing a tsunami of its own. We are living through tumultuous times, with one major problem following another.
It culminated last Friday
with the near-collapse of
Bear Stearns had to write
off billions of dollars of losses in mortgage-related
The news on Bear Stearns sent new shivers through the stock markets, with Dow Jones falling 195 points and the S&P 500 index closing 2.1% down on Friday. Bear Stearns’ own share price fell 47% that day, and it has lost over three-quarters of its value over the past year.
The last week has seen at least seven major developments indicating that the crisis is spiraling.
First, data was released
on 7 March showing that the
And not just a shallow, short-term
dip, but a deep recession that could be the most serious
"The situation is bad,
it's getting worse, and the risks are that the situation could be very
Second, the US dollar fell sharply to a record low on 13 March, going below Yen 100 to the dollar (Y99.77) for the first time since 1995, and to a record low of $1.56 to the euro on the same day. It is expected to fall even more.
Third, also on 13 March,
the spot price of gold for the first time broke through the US$1,000
level, and the price of oil (
Fourth, there is mounting evidence that the crisis has spread to hedge funds, which are facing pressures from their creditors and investors. Expect adverse repercussions as these funds “unwind” their positions in the markets in forced sales to meet these demands.
The banks that lend to the highly leveraged hedge funds are making margin calls. To meet these demands for more collateral, the funds have to sell their securities. Nervous investors are also redeeming their shares, thus adding to the pressures on the hedge funds to sell, and in a falling market. Their losses are thus climbing.
A dramatic sign of this was the collapse last week of Carlyle Capital Corporation (CCC), a hedge fund that is part of the Carlyle Group, one of the world’s largest equity fund groups.
CCC, which had unwisely invested in mortgage-backed securities. It revealed that up to 12 March it had defaulted on $16.6 billion of its indebtedness, and the remaining indebtedness is expected soon to go into default.
It added that its banks are likely to take possession of its remaining assets and liquidate them, after it ran out of cash to meet margin calls.
A front-page article in Financial Times (14 March) said the markets are “grappling with mounting signs of forced sales by hedge funds driven to reduce their portfolios by lenders trying to reduce their own risk exposures.”
Fifth, the cost of protection against credit default is also mounting, and this may soon trigger forced sales of structured credit instruments.
The cost of protection from
credit risk is measured by two indices – in the
On 10 March the CDX index jumped 15 basis points (bp) to a record 193 bp (a year ago the index was only 30-40 bp). The iTraxx index was trading on 10 March at a record 157 bp, up from 146 bp on 7 March.
According to Financial Times (11 March): “Structured trades based on the value of the CDX and the iTraxx are close to reaching a major inflection point. Many complex structures including so-called constant proportion debt obligations (CPDOs) have triggers that are released when spreads widen to a certain level. This could cause such complex vehicles to begin selling into the market and push credit spreads wider still.”
The CDX and iTraxx are very close to triggering a wave of such forced sales. Further ratings downgrades could also cause the sale of other structured credit instruments and weigh further on CDX and iTraxx, according to traders.
Sixth is the collapse of Bear Stearns. On 11 March, the Chairman of Bear’s executive committee Ace Greenberg dismissed speculation that the bank had liquidity problems as “totally ridiculous.” Just a few days later (14 March) it was revealed the bank had become insolvent and had to be bailed out.
And seventh is the news that
the two big companies, Fannie Mae and Freddie Mac, that hold or guarantee
most housing loans in the
They have already reported large losses in the fourth quarter of 2007 – US$ 2.5 billion for Freddie and $3.6 billion for Fannie.
These seven developments
(and other trends) are signs of the most serious crisis that causing
the crumbling of significant parts of the