$2T monster shows its teeth(ZT)

Government-created monster shows its teeth		NEW 7/1/2007 10:14:37 PM
By Ambrose Evans- Pritchard Thenear collapse of two Bear Stearns hedge funds has lifted the rock onour 21st century mutant capitalism, exposing the bugs beneath to a rareshock of naked light. When creditors led by Merrill Lynch forced afire-sale of assets, they inadvertently revealed that up to $2 trillionof debt linked to the crumbling US sub-prime and "Alt A" propertymarket was falsely priced on books. Even A-rated securitiesfetched just 85pc of face value. B-grades fell off a cliff. The bankshalted the sale before "price discovery" set off a wider chain-reaction. "Itwas a cover-up," says Charles Dumas, global strategist at LombardStreet Research. He believes the banks alone have $750bn in exposure.They may have to call in loans. Not even the Bank for International Settlements (BIS) has a handle on the "opaque" instruments taking over world finance. "Who now holds these risks, and can they manage them adequately? The honest answer is that we do not know," it said. Marketshave been wobbly since the surge in yields on 10-year US Treasuries,the world's benchmark price of money. Yields have jumped 55 basispoints since early May on inflation scares, the steepest rise since1994. It infects everything; hence that ugly "double top" on WallStreet and Morgan Stanley's "triple sell signal" on equities. Wobblesare turning to fear. Just $3bn of the $20bn junk bonds planned forissue last week were actually sold. Lenders are refusing"covenant-lite" deals for leveraged buy-outs, especially those with"toggles" that allow debtors to pay bills with fresh bonds. Carlyle,Arcelor, MISC, and US Food Services are all shelving plans to raisemoney. This is how a credit crunch starts. "This is the big one: all investment portfolios will be shredded to ribbons," said Albert Edwards, from Dresdner Kleinwort. TheBIS had warned days earlier that markets were febrile: "morerisk-taking, more leverage, more funding, higher prices, morecollateral, and in turn, more risk-taking. The danger with suchendogenous market processes is that they can, indeed must, eventuallygo into reverse if the fundamentals have been over-priced. Such cycleshave been seen many times in the past," it said. The last fewmonths look like the final blow-off peak of an enormous credit balloon.Global M&A deals reached $2,278bn in the first half, up 50pc on ayear. Corporate debt jumped $1,450bn, up 32pc. Private equity buy-outsreached $568.7bn, up 23pc. Collateralised debt obligations (CDOs) rose$251bn in the first quarter, double last year's record rate. Leverageddeals are running at 5.4 debt/cash flow ratio, an all-time high. As theBIS warns, this debt will prove a killer when the cycle turns. "Thestrategy depends on the availability of cheap funding," it said. Whyhas such excess happened? Because global liquidity flooded the bondmarkets in 2005, 2006, and early 2007, compressing yields to wafer-thinlevels. It created an irresistible incentive to use debt. Whatis the source of this liquidity? Take your pick. Goldman Sachs says oilexporters armed with $1,250bn in annual revenues have been the silentforce, sinking wealth into bonds; China is recycling $1.3 trillion ofreserves into global credit, a by-product of its policy to cap theyuan; Japan's near-zero rates have spawned a "carry trade", injecting$500bn of Japanese money into Anglo-Saxon bonds, and such; the Swissfranc carry trade has juiced Europe, financing property booms in theex-Communist bloc. And, all the while, cheap Asian manufactures havedoused inflation, masking the monetary bubble. The deeper reasonis the ultra-loose policy of the world's central banks over a decade.They "fixed" the price of money too low in the 1990s, prevented aliquidation purge to clear the dotcom excesses, then kept rates too lowagain from 2003 to 2006. Belated tightening has yet to catch up. Don'tblame capitalism. This is a 100pc-proof government-created monster.Bureaucrats (yes, Alan Greenspan) have distorted market signals,leading to the warped behaviour we see all around us. As the BISnotes tartly in its warning on the nexus of excess, this blunder hasofficial fingerprints all over it. "Behind each set of concerns lurksthe common factor of highly accommodating financial conditions" it said. Rebukingthe Fed, it said Japan and Europe have turned sceptical of theorthodoxy that central banks can safely let asset booms run wild,merely stepping in afterwards to "clean-up". The strategy leadsto serial bubbles, creates an addiction to easy money, and transferswealth from savers to debtors, "sowing the seeds for more seriousproblems further ahead". If you think we are too clever now to let a full-blown slump occur, read the BIS report. "Virtuallynobody foresaw the Great Depression of the 1930s, or the crises whichaffected Japan and south-east Asia in the early and late 1990s. Infact, each downturn was preceded by a period of non-inflationary growthexuberant enough to lead many commentators to suggest that a 'new era'had arrived," it said. The subtext is that you bake slumps intothe pie when you let credit booms run wild. You can put off the day ofreckoning, as the Fed did in 2003, but not forever, and not withoutother costs. So the oldest and most venerable global watchdog isworried enough to evoke the dangers of depression. It will not happen.Fed chief Ben Bernanke made his name studying depressions. He willslash rates to zero if necessary, and then - in his own words - dropcash from helicopters. But his solution is somebody else's dollarcrisis. On it goes. Perhaps governments should simply stop trying to rig the price of money in the first place. The Telegraph (London)