The global credit bubble is bursting and there are many out there who “deserve what is coming to them,” writes Andy Xie, now an independent economist in Shanghai, in Tuesday’s FT.
In full finger-pointing stride, Xie, who resigned last year as Morgan Stanley’s chief Asia economist after some people took exception to his dim view of Singapore, says “this bubble is primarily leverage financing for owning risky assets”.
”The people who were responsible for what happened played with other people’s money, marketed arcane financial products with false promises of fat profits, but stuffed their own pockets with big bonuses. Neither these masters of the universe nor their greedy but naïve investors deserve to be bailed out”, he says.
The central banks bear equal responsibility in the current debacle, says Xie. After the 9/11 terrorist attacks on America, they slashed interest rates and “provided the cheap money for this leverage bubble”.
“They must not flood the world with liquidity again to sustain this bubble or create another,” warns Xie. Rather, they should focus on “price stability, not financial market stability, and should provide liquidity only to contain the multiplier effect of the bubble bursting on the economy”.
Nor should central banks stimulate to “avoid recession at any cost”, as that would only worsen the “excesses” in the global economy and make the inevitable correction more painful, he says. “Business cycles are not bad. Excesses must be followed with cleansing.”
Wall Street also comes in for its share of vitriole. In the past five years, says Xie, the collapsing agency business has pushed banks into betting their own money for profit and selling “high margin” structured products to their clients: “Their eagerness for selling new and poorly understood products, such as sub-prime mortgage derivatives, is a major factor in the current bubble”; and, like after the junk bond bubble of the 1980s, “lawsuits may hit Wall Street for years to come”.
Rating agencies, of course, “should share the guilt”, says Xie. “They give high ratings to sub-prime derivatives with high seniority in payment. Unfortunately, the repayment behaviour of the sub-prime borrowers depends on macro conditions… Like in the previous debt bubbles, rating agencies behave like momentum traders. The ratings are supposed to give guidance to investment risk during bad times, not to be downgraded when the situation turns sour.”
And let’s not forget the “ballooning” hedge fund industry. “As their funds have become big, they have focused on their 2 per cent management fees rather than the share in investment profit,” says Xie. “So they have focused on gathering assets by over-promising.” Some funds specialise in illiquid assets such as derivative products of sub-prime mortgages and can “report whatever pefromance they want” as long as they do not face redemption, he says. “As soon as redemptions happen, they cannot even sell their stuff and have to refuse withdrawals.”
If central banks try to bail out Wall Street, it would lead to high inflation for years, he warns. The inflationary effect of loose monetary policy of the past was offset by the deflationary effect of globalisation, he adds. “Now China and other developing countries are experiencing high and rising inflation. Loose money will go straight into inflation. The vicious cycle of the wage-price spiral of the 1970s has not occurred as both labour and capital still believe in the inflation-fighting credibility of the central banks. If they loosen up again to bail out Wall Street, this credibility may be squandered. The ensuing wage-price spiral could ruin the global economy for years to come.”
Xie’s conclusion is that central banks should now grab the opportunity to restore their credibility: “Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former Fed chairman, to flood the market with liquidity during financial instability is the genesis of this ‘central bank put’. As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan ‘put’ for good.”
Andy Xie also goes on to distribute blame:-
“In the past five years, Wall Street has changed dramatically and that may not be for the better. The collapsing agency business has pushed banks into betting their own money for profit and selling “high margin” structured products to their clients. Their eagerness for selling new and poorly understood products, such as sub-prime mortgage derivatives, is a major factor in the current bubble. Like after the junk bond bubble of the 1980s, lawsuits may hit Wall Street for years to come.
Rating agencies should share the guilt. They give high ratings to sub-prime derivatives with high seniority in payment. Unfortunately, the repayment behaviour of the sub-prime borrowers depends on macro conditions. As soon as property prices drop significantly, they tend to default at the same time and the seniority in repayment is not worth much. Like in the previous debt bubbles, rating agencies behave like momentum traders. The ratings are supposed to give guidance to investment risk during bad times, not to be downgraded when the situation turns sour.
The ballooning hedge fund industry is also culpable. As their funds have become big, they have focused on their 2 per cent management fees rather than the share in investment profit. So they have focused on gathering assets by over-promising. Some funds specialise in illiquid assets such as derivative products of sub-prime mortgages. As long as they do not face redemption, they can report whatever performance they want. As soon as redemptions happen, they cannot even sell their stuff and have to refuse withdrawals.”
Andy Xie finishes:-
“If central banks try to bail out Wall Street, it would lead to high inflation for years. The inflationary effect of loose monetary policy of the past was offset by the deflationary effect of globalisation. Now China and other developing countries are experiencing high and rising inflation. Loose money will go straight into inflation. The vicious cycle of the wage-price spiral of the 1970s has not occurred as both labour and capital still believe in the inflation-fighting credibility of the central banks. If they loosen up again to bail out Wall Street, this credibility may be squandered. The ensuing wage-price spiral could ruin the global economy for years to come.
What is occurring is an opportunity for central banks to restore their credibility. Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former US Federal Reserve chairman, to flood the market with liquidity during financial instability is the genesis of this “central bank put”. As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan “put” for good.”
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NOTE: Andy Xie’s article is the most over-the-top article on the FT , this will help you see the whole picture in term your investment.
We shall see US govt. jail Wall street greed one by one in the coming future as after the bubble have gonna.
"The greed of Wall street"
