George M. Mangion | Wednesday, 25 February 2009

Gloom mongering must stop

February has triggered off a number of financial scandals and saw more banks going under. Yet not every thing is doom and gloom. Certainly, whether one is speaking of the economic condition or the response to it, we are experiencing unprecedented events that do not necessarily warrant the full blown pessimism that is rocking the western media. There are silver linings. Currency movements were complimentary as we see that Sterling bounced off two-week lows against the dollar this month after consumer price inflation fell less than expected in January. The dollar received a boost as well. The pound strengthened against the euro after Moody’s ratings agency said recession in eastern Europe would affect Austrian, Italian, French, German, Belgian and Swedish banks due to their exposure to the region. Media editors tend to over emphasise the doom factor in order to sensitise readers for the worst to come but this has been overplayed by the ego crazy media and taken to extremes. Thus we notice how amid the gloom and doom it is easy to overlook the good news which inevitably it is harder to notice, but it exists. Sceptics may have voiced loud their lack of confidence in the ability of government to fix accumulated financial problems but we must take courage and thank heavens for little mercies such as the massive drop in oil prices linked with a plunging cut in interest rates and low inflation. With oil price being dirt cheap at below $40, this is acting as a compelling stimulus to consumers and oil importing countries alike. Short-term dollar interest rates at zero massively helps mortgage owners and as can be expected in America many homeowners are rushing to refinance their homes at lower rates.
So the capitalist system seems to be endowed with self-healing qualities, albeit on a slow mode. Certainly, giving an overdose to the patient by resorting to accelerated nationalisation is dangerous. The slide underway in worldwide economies is being closely monitored by assertive governments and an effective therapy is being administered on both sides of the Atlantic. All this points to an improved possibility that markets will stabilise within the next 24 months. Lowered volatility may be seen as a visible sign of the cure for higher equity prices, but given how shaken investors were last year, a period of relative calm would certainly be helpful in drawing back interest in the market. Certainly, it will help reduce the perception of lower risk alertness which should lead to higher valuations in the next two years.
The current crisis is nowhere near the magnitude of some of the previous crises the world faced in the Great Depression. Thankfully, economies in the past recovered from such downfall despite ill conceived prescriptions by governments of dubious cures and assorted ill–timed financial solutions. Well-wishers retort that what stands out about the current difficulties is not its unique nature but how much it distinguishes itself from past recessions. The common characteristics of almost all past crises are fairly easy to identify. Thus we meet over lending by banks for untold speculative activities although mortgages is the most common way to burn dollars on unbridled speculation. The easy credit was generally a result of some type of monetary inflation. By sheer comparison, the Great Depression stands out a mile away from the present crisis and was noted for its length and the depth of political interference in the market processes. This is no consolation for us since the pain is with us and recessions always seem like the end of the world, and editors enriched with doomsday theories make them even scarier.
Some analysts think the stock market appears close to bottoming out since they contend that it is getting pulled down by uncertainty more than anything and fundamentals are being restored in the US by TARP rescue scheme and other impressive stimulus packages including tax cuts. Certainly, the quicker the uncertainty is removed the faster it will start to recover. President Obama is dead certain that the bailout package aimed to weed out toxic debts and restore jobs is giving a respectful start to normalise matters. Early economic indicators this year are showing a pulse, if not a robust recovery. So can we dare term this a softer depression? Can we conceptualise a return to a bull market when all around us we hear of scandals such as the Satyam in India, the Madoff billion dollar scam in New York and recently the failed Stanford bank in Texas? With all the fraud that is going on, how and when will it all end? In the current economic endgame, optimists clamour for a strategy for a renewed bull market.
Obviously, the persistent media blockage exacerbates the gloom and doom particularly where markets are concerned.
Despite the determined efforts of politicians to prevent the inevitable, the global economy is unhurriedly undergoing a much needed reallocation of resources. The process will be undoubtedly painful while the medicine takes effect since the excesses of the past decade cannot be remedied in a few days.
It all started with the excessive profits garnered by US bankers out of dubious sub-prime vehicles which they traded all over the world thus creating a massive bubble of shaky and toxic debts. The credit default swap and derivative traders of AIG and other financial institutions siphoned millions of dollars in executive bonuses. Some abused the financial system and knowingly created unprecedented amounts of unparallel risk. American taxpayers who yielded their earnings to bail out toxic debts are indirectly justifying the multi-million dollar lifestyles of rogue traders and bankers. Nobody doubts that we have probably seen the most reckless expansion of credit in the worlds’ history. As a result, we are now going through accelerated deflation with massive devaluation of assets and securities but one hopes that the upturn will be closer than the doom mongers predict.
Yes 2008 was a catastrophic year - we witnessed the downfall of Lehmann Brothers followed by the bailing out of Fannie Mae and Freddie Mac - both heavily in debt over shaky mortgage lending. The verdict on Citigroup and Bank of America in US and several other financial institutions in Europe like Northern Rock, Fortis, HBOS, RBS, HSBC has been fully publicised in the media. Obviously tabloids sell more copies if the headlines run something like…. ‘we are seeing the biggest credit bubble in the history of mankind’. Pessimists who see a long drawn recession ending in five years time base their argument that our fate is similar to that of the 1929 recession.
Last year saw suffering resulting from the severe drop in real estate prices and consequently builders registered deep cut in output. The effect of this shake-up has seen giant construction companies trimming workforce and start being reduced to a more manageable size. So the purge is ongoing and the financial sector, which had grown to gigantic proportions since the liberalisation of markets and in particular due to lax controls in the US, has been sent to a health consultant to initiate a forced diet. Slimming down to more approachable proportion will do it a lot of good and make it manageable for regulators to keep a beady eye. The cure is simple: higher savings is exactly what we need to repair the damage done to the global economy by excess consumption fueled by easy credit. Obviously, we are still in recession and there is more pain to come, but the persistent gloomy mood that surrounds the markets is either manufactured for some political purpose or completely unwarranted. Sometimes you have to turn off foreign media channels and the sinister websites and observe how the grass shoots are slowly but surely growing as the medication kicks in.

George Mangion
Partner at PKF – an audit and business advisory firm



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25 February 2009

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