Archive for July 16th, 2009

Tsunami of refinancing!

16 July 2009

Gyrations of stock markets would be a funny spectacle had it not been for their sacred bellwether status in determining which way the economy is moving. Stocks are supposed to be danger or opportunity detectors, not unlike AWACs albeit for financial markets & in turn for economy at large, that are ‘intelligently‘ factoring in data emerging from different countries & sectors to act like beacons for what future holds. What gives stock markets such sophistication? Sophistication of individual investors with expertise spread over vast segments of economy, acting singly or in cohort, seemingly aggregates into an informed action that moves stock market indices in ways that bestows on them their oracular majesty. Received wisdom tells markets know what’s best & stock markets know what is best of the bests. But this is all in theory. Investors are not all alike. Some are humongous hedge, pension or sovereign funds with unimaginable resources & clout. Coordinated & concerted action of few key players often deprives markets the opportunity of aggregating unalloyed wisdom of each player playing independently. Information asymmetry is a norm rather than deviation from the assumed theoretical construct. Numerous such distortions skew the markets behaviour from the idealized situation & grossly undermine its acclaimed predictive power. While market players seem to differ so widely in their size, tastes, motives, etc.; they surprisingly have a common quality. They are all chicken hearted & they get seduced by the lucre all too quickly. They Jump on or jump off the wagon at a fleeting sign of making a kill or at a slightest hint of panic.

Present wild swings in the markets are signs of uncertainty in global economy. Yet I was taken aback by senselessness of a story on CNBC TV-18 website (moneycontrol). See the opening gambit.

Even as the recent few days have been negative for global and Indian stock markets, Monday saw a sudden respite as Wall Street rallied about 2.5% led by stocks of the financial sectors, which rose by more than 6%. The reason: famous analyst Meredith Whitney who turned bullish on Goldman Sachs and initiated a buy rating on the financial institution. Whitney’s buy call sparked off a relief rally in financial stocks that then spread across Wall Street, and in turn provided some upside to Asian and Indian markets on Tuesday.

What did she have to say that turned the sagging markets northward for now? Goldman had turned in profits of over $ 3 billion (Were this firm not tottering into bankruptcy a year ago but for the US tax payer support?) for the last quarter. She commented on it thus :

Whitney said Goldman Sachs would benefit from ‘a tsunami of debt issuance‘ and on the back of re-emergence of lending. “It is clear that when the denominator shrinks and consumers have less averrable liquidity — and mind you there is a lot of refinancing, but not a lot of net new lending — the consumer suffers and will suffer for a long period of time. This is all, if you look at the first quarter, all of the government buying agency paper, it was all a way to put money in the back door of these financials,” she said.

Whitney, however, continued to remain bearish on the US economy and other US financials.

I don’t see what magic is there in these sobering words to make the markets swing the other way. If I read what she says carefully, this is what I seem to get. There is a tsunami of debt issuance (huge tidal wave of IOUs being issued). The denominator is shrinking means there are very few players left in ‘high risk taking’ merchant / investment banking domain. What with Bear & Stern, Lehman Brothers turning turtle & behemoths like Citi Group, BOFA, getting severely mauled. Doesn’t it mean no or less competition? Also have the banks returned to new lending providing that vital grease to lubricate the creaking wheels of commerce & industry? No! There is a lot of refinancing but no new lending (In India, there is a term called rolling over debt. RBI had tightened bad or non-performing assets criteria in the wake of Basel-I & II convention. It has stipulated that failure to pay three instalments of loans as an automatic trigger to classify debt as bad. What banks do in these circumstances was simply issue [refinance] fresh loan to cover old loan plus outstanding interest to set it off & buy time worth three more instalments. Neat, isn’t it?) I am not sure what refinancing in USA means, but it seems strikingly similar to rolling over debt in India. If true, signs are hardly promising. Who is buying agency paper (i.e. giving money against IOU to a bank with promise of some decent ROI)? US administration again comes to rescue with public money, as no private investors are out there to do the job they were supposed to be enticed into doing through the stimulus package. Rescue is for putting money in the hands of financial institutions to lend ahead. Interesting it is to see what is going on in fact. What is Goldman doing with the unexpected bonanza of earning huge commissions, unheard of in boom years, on agency business? There is a self congratulatory mood at Goldman. It has set aside S 11.4 billion for year to date compensation & benefits for its highflyers. Do I hear USA is in recession? Tell me another.

Returning to Moneycontrol story, the last statement is for cherry picking. Look at that ‘however’, dangling so deliciously, trying hard to counterpoise the euphoric optimism bubbling through earlier paragraphs. Whoooosh! I seem to be moving in a maze or like Alice in wonderland getting a gratuitous advice to run at double my current speed, which keeps me here, to get somewhere.

Looks like I am blind to good tidings that markets portend.

PS: Economists has a more, well, economical view here that I read after pouring out my musings.