Global Financial Crisis Endgame: G-20 Meeting, Shared Losses?
Friday, November 14, 2008
In the middle of 2008, total mortgage debt (actual amount of cash given to people to buy a home) amounted to about $11.4 trillion. No model, mark-to-market, or sophisticated math is required to calculate this number. We now have one boundary condition in solving this problem; losses cannot exceed $11.4 trillion. This would happen if the price of every single house with a mortgage was zero...rather an extrememe case.
The total o/s US mortgage debt is comprised of 85% prime and 15% sub-prime loans. (These are broad figures..but will suffice). Let us assume that home prices decline 50% in the United States...what happens:
($ trillions) Total Prime Sub-PrimeWe get estimated losses of $3.75 trillion. These losses are not contained within the United States and that is problematic. Through the use of securitization, derivatives, credit enhancement techniques and other esoteric financial instruments the risks were syndicated far and wide. For example, China owns about $360 billion of securities that financed home buyers in the United States.
Total O/S $11.4 $9.7 $1.7
Loss % 50% 50%
Recovery % 20% 0%
Total Losses $3.75 $2.90 $.85
In the reach for yield, many institutions took on default risk of others to get a higher interest rate on the piece of security they bought.
In the fight for who funds the $3.75 trillion or so in losses the broad economy suffers. It should be the investor but the size of losses has meant the end of many institutions and others have been bailed out by governments using tax payer monies. Some countries are so important as investors that ...well you get the picture.
So my estimate has been to add another 30% to this bill which brings me to my round figure of $5 trillion of losses.
The 2007 Global GDP on a PPP basis was $65.5 trillion ....so we have blown roughly 7.6% of this amount...Which brings us back just above the 2006 Global GDP level of $58.6 trillion. ( All figures from World Bank).
So how does this help us: The markets went up and up and up...now they have crashed. Since global GDP after these losses is around the 2006 levels how do the equity markets compare?
From Jan 2006 to today: China is up 55%, US is down 40%, UK is down 40%, India is flat. This is decoupling....the vast majority of these losses will be for the account of USA affecting current value and future investment. UK and Europe fall into the same camp. China is up because they have conserved their reserves for this rainy day and will bear less of the losses. India will bear few losses but is critically dependent on foreign capital for growth so the market has been written down to 2006 levels.
Of course, the key issue is China growth...if the US goes into a deep recession who will buy from China. Realising the trap the Chinese have spent their reserves before they could be asked to bear some of the $5 trillion loss.
Regardless of how the G-20 discussions turn out, the dollar amount of losses will not change. It will have to be borne by the world economy; that has always meant a write-down to 2006 levels for global equity markets. If the disagreements turn nasty and we get protectionism and tariffs then all bets are off.
I am betting that sense will prevail.
3 Post Comments:
Great Blog Lee, well written and interesting. I will be visiting often.
I don't think it is fair to look at the Chinese equity market and suggest anything, it is a very warped equity market to begin with, dominated by dusty state owned enterprises with lots of cross holdings and closed to Foreign Institutions. It is just short of a bucket shop and there is heavy government intervention to prop up those markets when they fall.
The Hang Seng H-Share index or China Enterprises index is probably a better barometer, it issues are HK$ denominated, so fully convertible and are proxy US$ issues since those currencies are pegged, and more importantly there is full institutional participation, and because of that there is far better corporate governance amongst listed companies on that exchange,
http://finance.yahoo.com/echarts?s=^HSCE#symbol=^HSCE;range=2y
Using that diversified index of their largest Chinese companies, they are not much better of than the rest of us either in the time frame you mention.
The initial point you make quantifying mortgage losses, is very very interesting, I have never seen it estimated so clearly. It is a big number.
Gains or losses in equity markets, in my opinion would not be enough evidence of decoupling, largely because movements in equity markets for the last three months anyway have been driven by excessive mania and paranoia. Some fear and greed is good, but you have to question valuations when people start getting used to the idea of 20% falls and gains in a week.
People ask who will buy Chinese goods in America if it goes into recession. On the contrary I would asl who will not. Recession is a large opportunity for some of theirs and Asia's biggest and largest companies and brands to pick up more US market share, as consumers become even more price sensitive then they were a year ago. Haier Keelon all have opportunities now, if this is a protracted recession to do what the Japanese and the Koreans did decades before and establish credibility and build market share. A larger share of even a smaller American pie is going to affect their profits immensely.
Will it be enough to maintain growth. I doubt it. There are a lot of marginal Chinese manufacturers who employ lots of people and can only survive with high prices, that will disappear and have done so already, and they are not small companies either. Some argue that it has built capacity in other industries which can pick up the slack. I find that hard to believe, and stimulus as large as it is, can only provide so much relief.
If coastal China was not filled with marginal producers that depend on high prices and US demand for business I would be more sanguine. There is some room for optimism. I lived in Hong Kong for 30 years (as an Investment banker myself as it goes on the S&T side). The Chinese know how to adapt to changing conditions better than any other race I have come accross, speaking non scientifically and from experience, they have two things, they have labour and capital, they will figure out how to adapt to the new environment more quickly than any of us can imagine and will emerge stronger for it.
India. I am much more sanguine about, we are less dependant on the US, and the industries that do depend on that country, IT and outsourcing. well for a start companies in the current environment are all going to be looking to increase cost savings further, that goes without saying, and they are going to consider India much more seriously than they did 3 months ago and a cheap Rs. is a very nice incentive for them.
I don't know if I will ever subscribe fully to decoupling, It seems a little counter intuitive to globalisation, but I think there are lots of mitigating circumstances that can limit the negative effects of interdependence.
Thank you for your comments..with respect to indices I have gone back to Jan 2006 in line with my GDP estimates...^HSCE and Shanghai are both up near 50% while Sensex is flat and S&P is down 40%.
It will fascinating to watch the decisions of India and China to naviagate these times...both have become very entrepreneurial so I expect some bold and innovative policy making.
Sorry Lee which chart were you looking at, Shanghai, I am not particularly interested in, but by my reckoning (which I apologise in advance if the data I use is incorrect or different to yours) but the HSCE has not done 50% over two years, even if you back date to January which I did not do initially, its more its more like 30%. If you take a 3 year view its closer to 40%
http://main.hsi.com.hk/hsicom/statistics/hscei_fs_e.pdf
Friday's close was 7021
January 3rd 2006 5412.
Even still, the larger point you make I would have to agree with, a 29% rise in an index value in the that time frame given the correction we have had is nothing short of outstanding compared to the S&P or either of our own indexes.
I apologise for sounding like some twat who doubts everything you say. That is really not what I am about, nor have I any intention of doing that. I spent 30 + years in Hong Kong and just like you in investment banking as a market maker, if you quote performance of one of those indexes and the way you see it differs substantially from the way I see it, then I am going to want a clarification. I don't mind being wrong myself and it is not my intention in the slightest to cause offence or disrespect.
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