Debt Chairs on the Titanic

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2nd Oct 2008

Wednesday, 8 August 2007

Really, it could be worse, just manifest a positive reality. Anyone living in a major financial hub lately will have noticed a certain level of the jitters among bankers, hedge fund managers, private equity doods, real estate mavens and the media who write about them.

The slowly escalating "problem" in the subprime mortgage market based out of the United States seems to be slowly infecting wider and wider circles, creating a climate of fear not seen since 1997 - the year the Asian Financial Crisis dealt a massive blow to Asia's developing economies. Except this time the tables are turned, and it seems to be America and Europe in for the sucker punch.

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Risk % in the interdependence of the system?
Hub Culture is no expert on financial matters, and other sites like and Business Week have been covering the convergence of mortgages, private equity trubs, hedge fund failures, and the like. Look deeper into financial blogs and the scaremonger set, and one would be tempted to think the world is about to end as the totally interdependent global financial system seizes up right as everyone is on vacation in the south of France. The reality, as far as Hub Culture's recent conversations with members can tell, is not good, and not great either. It all depends on who you are.

Here are the contributing factors to a rapidly interlinking problem, which may or may not be creating a perfect storm, however brief. Several folks are essentially seeing a massive credit crunch and the evaporation of lending in the global financial system, at least temporarily, others laugh and see arbitrage opportunities ripe for the picking.

1. US subprime mortgages meltdown, which has hurt the US housing market and overall lending. The extent of bank exposure to these mortgages is not yet fully known.

2. Near collapse of the IKB - Germany's industrial credit bank, which resulted in a €8.1 billion bailout and some raised eyebrows in Germany. Then the European Central Bank injected over €130 billion to calm European credit fears, which only made investors more worried.

3. Hedge funds, highly leveraged on debt, going belly up because they can't refinance debt. Australia, the US, Germany, France, and the UK all look to be affected. In reality, hedge funds account for a very small portion of the overall system (less than $10 trillion, so their impact on the broad economy is not to be overstated) but the general figure we are hearing is 25% bloodbath.

4. Private equity firms who handled record buyouts are sitting on up to 40% debt for their acquisitions, which need to be serviced. As prices go up and credit liquidity evaporates, pricing and ability to pay is compromised, and they get squeezed. At the very least, this prevents new deals.

5. End of the yen carry trade - silent but deadly: cheap yen for the last 8 years made $500 billion available in easy lending capital to other markets like the US mortgage market and private equity. As the problems accelerated in the other markets, borrowers have tried to cash in their yen loans, resulting in an up-valuation of yen and the drying up of cheap yen - a wellspring of cheap liquidity.

6. Rising adjustable rate mortgages in the US. Even though they are "planned", the fact is that ARM and fixed mortgage rates are going up on properties in the US, adding hundreds of dollars a month to mortgages, which detracts from consumer spending power and will push bankruptcies up. Some predicting up to 10% in the US market on those who purchased ARMs with as little as 5% down. (Sound familiar... Scottsdale, Miami?).

7. Big banks are seeing merger and acquisition activity frozen, resulting in a full stoppage of deals that were in progress, which can't be good for bonuses. And we won't even mention that up to 20% of institutional pension funds are leveraged into hedge funds and other "complicated" financial instruments that have usually delivered above average returns.

Various bankers and financial types we've talked to lately have ranged from quietly worried to nearly hysterical to uncomfortably sarcastic.

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Well, it was good while it lasted...
"Work sux" says one hedgie by text.

"Its bigger than the Asian Financial Crisis in 1998" says one person at Merrill Lynch. "Some major hedge funds are going to not be here by next year."

"Run for the hills..." says another at Bear Sterns (which had two funds collapse at the end of July) - but in the next sentence says, "We were worried last week, but now it's like, whatever, the market is repricing it just fine. Some people will get slaughtered, but its not a meltdown.

" Head to Asia, and the view in Hong Kong is much more sanguine, nearly like schadenfreude. Says one strategist at JPMorgan: "Some people, especially hedge funds, are going to get hurt, but the reality is that as long as the US consumer keeps spending, exports from Asia will stay strong, and the system will be fine."

Sounds like global leadership... from Asia? "Saying what's happening could compare to the Asian Financial Crisis is laughable - especially because most large companies are cash rich right now and don't have a lot of debt. It will be fine."

But what if those rising mortgage rates crimp US consumer spending, that triggers a slow down in Asian exports, and the last safety valve - Chinese growth - sputters? Let's not go there.

Until then, unless you're in a hedge fund, leveraged buy-out firm, M&A team or private banking, you can head back to the beach: its a storm in a teacup, not a Titanic iceberg. But, um, wait a sec... these days, who isn't one of those?