Note: This series of writing and updates on the “US Financial Crisis” is dedicated and meant for those who would like to continue watching and trying to understand the on going financial crisis in the US (and the Global financial stability). One of my interest has been “the economy and financial markets”, and in this regard, I have researched extensively on the “economics and financial crisis”, in particular the Asian Economic and Financial Crisis of 1997/1998; the subject of which is covered in depth in my “yet to be published book” the “Future of Prosperity”.
The subject may be of “not much interest” to some readers, as he/she might think that these matters has none or little relations to his/her day-to-day life. Unfortunately, that is far from true, and that’s the reason why I always encourage everyone to keep a watchful eye on what’s going on; Given that there are so much “analysis” in the news as well as on the internet, I found that most of the media always exaggerate, miss the essential points, and tends to confuse people more than help them to understand. My attempt here is to keep it in simplest possible manner to get readers issues that they need to watch and understand.
With this note, here is the current update for today:
As suggested (and expected) the US lawmakers will finally approve the “bail-out” bill to allow the US Treasury to have necessary funds to plug the “sinking hole” as I have alluded to in my earlier article. With this, it is hoped that the impending hemorrhage will stop and keeps the financial system intact from systemic collapse. The Wall Street stock market initial rebounds probably is a vindication of such signal. For now, I think that is probably the case, because all in all, it was not about the amount of money, neither the method of the bail outs that matter – it was a matter of uplifting the “market loss of confidence” that was crippling the system. The verdict so far is clear – the banks are out of clear and present danger. So should everyone now rest easy?
Unfortunately that will not be the case, because there will be another wave of “bankruptcies” that is coming over the next few months. This time it will be the corporate sectors (i.e. non-banks). Why? the answer lies in the same problems as the banking crisis – liquidity. Since every banks has been battered, and now busy in solving their short and medium term liquidity, will have little to spare for “roll-over” of their short term loans to corporations. This funding is mainly in short term papers such as “Commercial Papers”, or “Short and Medium Term Notes”. Therefore, those companies that relies on such funding (especially the leveraged buy-out-firms) will surely be hit hard. The recent M&A frenzies, will have its day under the sun – they will be burned. The other players that will also be hit, off course, the hedge funds.
In this regards, I wish to defer with some analyst, saying that there will an explosion in the hedge fund markets, especially in the derivative contracts. Yes it is true that derivatives (and all its complex versions) will come under fire, but they will not be the main problem as these contracts are mainly “counter-party” risks which is already somewhat arrested in the banking crisis, as explained before (I also used the term “settlement risks” in earlier writings). Counter-party risks among the banks, when comes to derivatives, will be a zero-sum affair: one bank’s loss is another bank’s gain. Therefore, there won’t be any spillover effects, irregardless of the size of the whole derivative market. The real issue facing the hedge funds will be the “redemption factor” as many financial institutions and investors will call back their funds to face liquidity needs as well as the perceived increased in the risks premiums. Therefore, hedge funds are facing the same ailments as the others: liquidity crunch.
In conclusion: what are the effects that we may “feel” in these few months?
1. One thing that I am sure of, is the “Oil price” – it will come down by some major percentage points,as the hedge funds and banks that are active in the “oil plays” will have to unwind their positions. It is quite well known that these entities have been creating a “stock or inventory” of crude oil and petroleum products by way of financial products. Oil has been priced at a premium of US20 to 30 dollars above the base of which most long term contracts were written: US70. We may see these premiums to be significantly reduced. Therefore, expect prices of somewhere above US70 + small premium. GOOD NEWS.
2. Liquidity crunch: More and more banks, funds as well as companies from the US, Europe, and Japan will pull back their money; So expect that there will be some major size of outflow of funds from Malaysia (and Asia) over the next few months (anyway, it has been the case for the last couple of months). Hence the KLSE stock market will continue to be pressured downward , and demand of conversion of RM to USD will be higher, which might push RM lower against USD. NOT SO GOOD NEWS (depending on which position you are in).
Let us continue our watch.