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2012-07-11 10:59:26
By Mike Dolan
LONDON (Reuters) - If it feels as though efforts to revive the world economy
are continually running into the mire, that's partly because policymakers are
still trying to map the extent of the credit swamp.
Five years to the month since the credit bubble popped, one of the striking
aspects of the recurrent gloom invading households, businesses and investors is
how the horizon for sustainable recovery is being pushed years into the
distance.
Bank of England governor Mervyn King, who last month said the world was barely
half way through this crisis, now speaks with almost biblical foreboding of the
big "black cloud" of uncertainty hanging over the world.
And King's is not the darkest voice out there. Hedge fund manager Jamil Baz
from GLG Partners claims the western world's deleveraging, or debt reduction,
process could take another 15 to 20 years if the ratio of economy-wide debts to
gross domestic product (GDP) in the United States and Europe is to be cut to
anything like sustainable levels.
True or not, this is fast becoming mainstream for many crisis-weary companies
and money managers.
For many investors, the timeline may be somewhere in between King and Baz but
they are already shaping up for years in which investment opportunities will
either be brief, on the back of periodic lifelines from policymakers, or
one-off corporate successes such as Apple, or long hard slog in search of
relative safety in top-rated bonds or high-dividend blue chips.
"The overriding way we look at the world is it's in a multi-year deleveraging
environment and it's really only just begun," said Alex Godwin, head of asset
allocation at Citi Private Bank.
"If you look at the private sector debt to GDP ratio in the United States,
we've seen a little bit of a reduction but this has got a long, long way to
go," he added. "If you take a simple extrapolation of what's been happening so
far, then we're probably looking at a five, maybe 10-year process."
SHIFTING HORIZON
This stifling deleveraging has already driven a sharp reduction of lending by
banks since 2007 peaks, catalyzed by interbank mistrust, falling credit quality
and new regulation aimed at stabilizing previously bloated bank balance sheets.
As the credit shortfall drains money needed to lubricate the underlying
economy, central banks have printed more. The big four central banks in the
United States, euro zone, Japan and Britain have created more than $6 trillion
since 2008 but are barely filling the hole - as spluttering economies attest.
The question on many minds is why it's been so difficult to calibrate the size
of the problem and gauge a recovery horizon.
There are myriad answers to the latter -- from the political minefield in
Europe preventing a lasting solution to the euro crisis to divisive U.S. and
British debates on government debt sustainability and central bank independence
in printing money.
But the scale and nature of the original credit bubble too is only now really
becoming apparent and, with that, just how broken the private-sector credit
generator remains.
A study currently grabbing the attention of economists focuses on the scale of
pre-crisis money creation between banks and investment funds -- the largely
unregulated "shadow banking system" that supercharged credit independently of
central banks.
The paper, by International Monetary Fund economist Manmohan Singh and
consultant Peter Stella, detail how multiple repledging of collateral between
institutions unlocked vast stores of "new" cash and how subsequent interbank
mistrust and a shrinkage of what's acceptable as collateral drained the pool.
The complex process with an appropriately impenetrable name, "rehypothecation",
describes how a hedge fund in Asia or mutual fund in Boston borrows cash from a
bank by posting a bond as collateral and then how that bank subsequently
repledges that same bond as collateral for its own purposes.
At 2007 peaks, the paper estimates the re-use rate of primary collateral from
funds and custodians by the largest banks was about 3 times -- creating a total
web of intricate collateral chains in excess of $10 trillion. That compares
with a U.S. M2 money supply back then of some $7 trillion.
But by 2011, this re-use rate was already down to 2.4, involving almost a
halving of the total collateral pool.
"The loss in collateral flow is estimated at $4-5 trillion, stemming from both
shorter collateral chains and increased idle' collateral due to institutional
ring-fencing; the knock-on impact is higher credit costs for the economy,"
Singh and Stella wrote.
New central bank money via bond buying doesn't solve this problem because
"quantitative easing" to date just gives new cash to banks and removes ever
more high-quality collateral from the system. And nervous banks are still
hoarding much of the new cash bank at central banks anyway.
Yet refilling reusable collateral pools may require even more, not less,
government debt in the short run. This goes to the heart of the political
debate about sovereign debt in the United States or even joint government debt
in the euro zone.
And if that's too politically thorny, the question is whether a return to 2007
is even desirable and whether the credit system needs to be taken down a peg
for the sake of long-term financial stability.
If going back is deemed unwise, then it's easier to understand those resigned
to a hard slog for years to come.
(Additional reporting by Laurence Fletcher; Editing by Ruth Pitchford)