The New York Times-20080125-Insiders- Insights Are Glum
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Insiders' Insights Are Glum
The closer you are to financial markets, the glummer you are.
This has not been an unreservedly negative year at the World Economic Forum, the annual gathering of business and economic leaders at this ski resort, even if Klaus Schwab, the major-domo of the event, did feel called upon to try to cheer up attendees at the forum's formal opening.
I know the mood is different from last year, he said, but we do not want to fall into gloom and doom.
Many have not done so. There has been optimism from some American business executives, who say they have yet to see weakness in their sales. Richard N. Cooper, an economist from Harvard, said his best guess was that while the American economy was slowing, it would not fall into recession. He said he doubted that consumer spending would really contract so sharply that it would bring down the economy.
Others forecast that the rest of the world will keep growing even if the American economy tanks.
This is the first time that the world is looking at a possible American recession with two engines of growth: China and India, said Kamal Nath, India's minister of commerce and industry.
The momentum of growth is increasing year by year, he added. It will take a great recession to stop this momentum.
But the pessimism is much greater among those closest to the financial system. While some take a functioning financial system for granted, in the same way they view highways or indoor plumbing, others see a system in crisis.
We're entering a perfect storm, a period of financial turbulence and very limited capital, said one executive, whose company needs to borrow money to grow.
What's driving everyone crazy, another executive said, is, you don't know who you can trust. Both are well-known executives who did not want to call attention to themselves.
The new lack of trust has virtually closed down the securitization system that financed many companies and many mortgages. It has shaken other markets, where traders worry that counterparties -- the people they trade with -- will not be able to perform on contracts that may require large payments years later.
It's like walking blind in a minefield, said Nouriel Roubini, a New York University economics professor who warned of an impending credit crisis at this conference a year ago. You have no idea if your counterparty has a lot of toxic waste, or not much.
Established financial markets dealt with that issue generations ago by using exchanges and standardized contracts. The exchange monitored the health of its members and guaranteed the trades. If you put in an order to sell 100 shares of I.B.M., it doesn't matter to you if the buyer defaults. You will get your money anyway.
But in the over-the-counter market for financial derivatives, each trade depends on the counterparty. Many deal only with established banks, and the banks are expected to monitor the standing of the people they trade with.
Until this summer, it was easy to trust the banks. The Basel II capital guidelines for banks, now being phased in around the world, even relied on the banks' own credit evaluations to decide how much capital they needed to back a given loan.
But what appeared to be a well-capitalized financial system has turned out to be the opposite, as big bank after big bank has had to seek huge capital infusions. Securities that banks had been able to keep off balance sheets -- Mr. Roubini says regulators should never have allowed such things -- have come back just in time to provide large losses.
We did not, an executive of one financial institution said, fully understand the extent of the risks in some securities. For obvious reasons, he did not want to be identified.
The newest big loss shows the problem is spreading.
On Thursday, Societe Generale, the big French bank, reported that it had to write down 2 billion euros because of the same kind of problems that have besieged American banks. That was bad enough, but it also said it lost 4.9 billion euros from trading in European stock index futures. Societe Generale said a trader had exceeded his trading limits.
The lack of trust has intensified because some banks offset big risks by purchasing insurance against defaults, and now the insurance seems dicey. The so-called monoline insurers, like MBIA, are in danger of losing their AAA ratings, and some have already done so.
Even worse, at least potentially, are the risks from credit default swaps, which have become a $45 trillion business. George Soros, the legendary hedge fund manager, called in reporters here to warn that some of those swaps had been sold by hedge funds that might be unable to pay if there were a wave of defaults by corporate borrowers.
His proposed method of dealing with that seemed unlikely to win approval, but it was interesting because of the extent of fear it showed.
He wants bank regulators to go in and audit the big financial institutions, and then either close them down or give them clean bills of health, with explicit guarantees of their positions. Then traders would know some counterparties were safe.
That such an idea could cost the Treasury billions, or give big financial advantages to the favored banks, or even amount to practical nationalization, did not seem to bother Mr. Soros. He is worried about the possibility of systemic collapse.
The fear at this forum is among the financiers.
