Fred Destin

Over the last few weeks I have been wondering whether I was drinking too much from the Black Swan fountain and being overly pessimistic.  After all, when everyone turns negative has go to be a time to be buying, right ?  But just as I am getting tired of myself of as angel of doom, I come across this little column on the back of the Financial Times on my way to London (View from the Markets, December 1).

Chris Flanagan is head of asset-backed research at JP Morgan.  You may be less immediately in awe of JPM than a Goldman Sachs, but when it comes to complex derivatives and asset backed innovation these guys are at the top of the league tables.  Here are a few snippets from Mr Flanagan (loose editing applies):

• Q: it seems that virtually every mortage-backed security could be classified as toxic or distressed ? A: that is correct
• You have losses […] up the triple A part of the capital structure.  Prices on Triple A are down to 30, 40, 50 cents on the dollar.
• A large, large portion of the asset-backed investor base, anywhere from 65 to 75 percent, is gone.   It’s going to be gone for a very long time.
• Q: Should people buy asset-backed right now A: I think the sectors people invest in really will be very dependent on […] the affiliation or the linkage to government support, such as student loans or credit cards issued by government-backed banks.  Mortgage-backed securities are still much more of an open question.

Let’s just recap: mainstream triple AAA securities are trading at 30-50 cents on the dollar and the head of asset-backed is recommending investing only in non-mortage related, government-backed programs ???  Wow.  Of course the guy is probably chastised from pushing in the other direction for the last 5 years, but still…

So here is my contribution to shaping your view on the world economy:

• Post crisis we saw a strong $ rush as investors literally did not know where to put their money, but the US is on an unsustainable borrowing path (and has been for a while) which means its paper will need to yield more at some point — except that interest rates essentially cannot go down further –>  The US dollar is likely to take a deep dive in the next 12 months
• It is also clear from the above that fundamental economic programs (such as student lending) are on government life support already, leaving the US government little additional room for maneuver in boosting the real economy, and that the all-important stabilisation of the mortgage market will be very, very costly to achieve –> Any drop in confidence in the US economy will leave the government stranded with high borrowing costs and a “snowball” effect on repayments.

The countries that have suffered snowball effects on their national debt, such as Belgium or Japan, took a long time to recover, marked by sustained fiscal austerity.  As much as I am astonished by Merkel’s decision to go hawkish, I am increasingly concerned about the likelihood of a dollar fall and what that is likely to do to the world economy.  Even aggressive Keynesian economics may not be enough to save the day for us. 

This explains the rumoured $700bn package; it will need to be communicated with extraordinary and strength to have a chance of being successful.  The goal: nothing less than convincing the world’s investors that US government paper is still the best place to park their money.  A daunting task for the new US economic staff, no doubt.

<— Once it was JP Morgan who bailed out the US Treasury