Financial Crisis Deepens

February 19, 2010

Today’s (FT) headlines are incredible:

“The UK now pays as much to borrow as Italy, considered one of the more vulnerable euro zone members and – at best – rated two notches below Britain.”

“In 1990 there was only one bank with total assets worth more than 50 per cent of home country gross domestic product. Today more than half the top 25 banks are in this position.”

These headlines speak to the reality that the global financial crisis is deepening, starting to spin out of control. More importantly our fate is in the hands of institutions that are bigger than most governments, and who have as much to gain from crisis as stability.

Conflicts of interest are extensive

Goldman Sacks, the world’s most respected and important investment bank stands accused of orchestrating the Greek debt crisis. Goldman’s were certainly neck deep in helping the Greek government finance their spending binge, and therefore overextend themselves in the first place. Apparently they then helped the Greek government disguise their true level of indebtedness through sophisticated credit derivatives, which they designed in their advisory role (a fact they neglected to mention to their customers, when selling the bonds). But more importantly Goldman’s now stands accused (by the French) of engineering, through closely associated hedge funds, the present attack on Greek sovereign debt and, by association, the euro and the stability of the European Union.  

Major investment banks have always been uniquely positioned to profit through their proprietary positioning in the global financial system. They play a variety of key roles, and often find themselves on both sides of major deals. For instance they both advise and participate in corporate finance deals, mergers and acquisitions (M&A), and IPO’s, as well as being financiers and advisors to governments and are (de facto) designers of financial systems: a positioning that lets them peer into the heart of major deals, providing them with valuable insights and information unavailable to others.

They have also, for decades, traded for their own profit, insider dealing leveraging their unique positioning to best advantage.

The Empire Strikes Back

So, what happens next, you ask? Well it’s clear that governments, defenders of virtue, the poor and weak, are set to act. The Establishment is starting to turn on big investment banks (Goldman Sacks in particular), as if they were Tiger Woods.

If you’re a certain age you may remember the name Paul Volcker – he was the Chairman of the United States Federal Reserve Bank in the early 1980’s. In wrestling inflation to the ground Mr. Volcker’s ‘tough love’ approach pushed interest rates into the stratosphere. Today, as advisor to President Obama, he is preparing to reverse policy on interest rates (yes, they’re going UP) and regulate the big investment banks, restricting (or removing), for example, their rights to ‘proprietary’ trading. These are new realities that – to say the least – would not be welcome by the investment banking industry. Mr. Volcker has been receiving some major encouragement from international players including the Basel committee – a factor that could lead to major reforms of the financial system.

All good, right? Well, yes, but only if you are debt free and financing your business out of outstanding cash flow.

It can’t be good that battle lines are being drawn at the heart of the global financial system. And, more critically, it is not clear at this point who will out dual whom. Governments will act, that’s a near certainty. But obtaining global agreement for strict banking controls is difficult enough, consistent enforcement around the world is almost impossible. The banking industry knows this, and is prepared to use its global reach, its virtual control over major financial markets and its political leverage to best advantage. It all spells trouble, with a capital T.

In addition its clear that the fiscal crisis facing governments will force them to retreat from their various stimulus packages. A similar logic applies to monetary policy. It will insure that the ‘quantitative’ easing (near zero interest rates) will end in the near future – probably with a bang. The result, demand in Western economies could fall at the very moment that the cost of credit starts to rise, and, with Paul Volcker back in the saddle, it could rise sharply.

Furthermore a shooting war at the heart of the capitalist system is not good for business. Mind you neither are predatory investment banks. So the stage is set for conflict and new layers of complication for corporate finance and just plain business.

Things to Think About

  1. At the moment the shooting has yet to start in earnest; it’s still the Phony War. So take the time available to strengthen your balance sheet, and rationalize your corporate finance (if you can).
  2.  Longer term, the era of cheap and easily available credit is ending. What will replace it are more stringent controls, higher rates and much greater uncertainty. For starters you’ll have to be a lot more discriminating in future about who you deal with, so be prepared to ask tough questions, and probe deeply into the business practices of your financial advisors and bankers.  
  3. Bottom line, you’ll probably have to get MUCH better acquainted with equity financing than you have in the past.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: