There is an article by Gilian Tett in today's Financial Times ("Fearful banks make liquidity grab") that discusses the sudden recent drying up of liquidity that occurred in the midst of what seemed like a world of endless liquidity:
When a panic hits a population – say, bird flu or flooding – they are apt to hoard baked beans or bottles of water. So too, in the supposedly sophisticated arena of high finance. For as the markets have embarked on their recent roller-coaster ride, one reason for the swing is that investment funds have suffered painful losses that are forcing asset sales.
But another crucial factor – indeed the key issue now – is a massive, old-fashioned grab for liquidity. For just as households might stockpile baked beans, banks are currently trying to stockpile funds, either because they have to meet repayment demands from investment vehicles or, most perniciously, because they fear these demands are looming soon...
...And, just as a frenetic stockpiling of baked beans tends to fuel panic, the very fact that banks are grabbing for cash is making investors even more nervous, particularly in the dollar market where many investment vehicles have raised funding in recent years, even if they are based in Europe (ironically, because the dollar market was supposed to be ultra-liquid.)
Why would I refer to an article about how suddenly and unexpectedly liquidity can collapse in a blog dedicated to China, where we have so much liquidity that the insolvency of the banking system can be largely ignored? No reason. I'm just being perverse.
But I have to say that references to sudden panics like "say, bird flu or flooding" hit a little close to home. Could a health, weather, or environmental panic ever lead to a financial panic in China by, say, undermining credibility in the authorities? After all the only thing holding up the banking system is generally confidence that the goverment wouldn't let anything bad ever happen.
As an aside, on August 9 David Barboza of the New York Times did have an unsettling little article ("Virus spreading alarm and pig disease in China") on the spread of this new disease. He says:
A highly infectious swine virus is sweeping China’s pig population, driving up pork prices and creating fears of a global pandemic among domesticated pigs. Animal virus experts say Chinese authorities are playing down the gravity and spread of the disease.
So far, the mysterious virus — believed to cause an unusually deadly form of an infection known as blue-ear pig disease — has spread to 25 of this country’s 33 provinces and regions, prompting a pork shortage and the strongest inflation in China in a decade. More than that, China’s past lack of transparency — particularly over what became the SARS epidemic — has created global concern.
One instant thought is the international liqudities issue might not affect China in a direct way but in the longer term China will not hold on to the re-rating party the way it did before... Chiese capital mkt gonna get hit if retreating of "hot foreign money" appears first in both ppt mkt and equity mkt. Although the QFII part of A share liquidity source is not significant at the current stage and can be easily absorbed by the crazy domestic individuals. However the ppt mkt is more of a concern in spite of the so called " greatest demand on housings ever" story told by all of the developer's boss.... Chinese are blding their own leverage even with the absence of similar sub-prime way of financing. As indicated by the top developers' chairman last week in HK, he actually saw this shift of real estate buying pattern in the last 12m, saying more and more Chinese are using mortgage now, which is very opposite the culture of this nation... cos most of these buyers are marginal buyers that might be on one hand speculating on housing px appreciation with the least possible capital investment and quickest asset turnover , on another hand to use as much spare cash as possible to buy stocks..... Local Chinese have no investment philosphy and no respect of valuations, incl most of the fund managers, esp those who joined the industry after 04... My point is, when this whole party unwind, China will see internal liquidities meltdown with or without foreign hot money to act as the last little mouse who drag the big carrot.... The question is when this is to happen and by what triggers.
Brokers arguing Asian econs esp China enjoying a lot less leverages in this cycle than last, so the hurt wouldn't be as direct and great as the last. While the global re-pricing of risk already started, I would not take it for granted that western happy famlies gonna hold their faith to the leading insurance company in China which are facing mostly downside from the fundamental side, and only upside from the financial valuation assumption adjustment side ( say, 1% less in discount rate assumption will enhance theoretical value to a significant megnitude..), and after all, at 3 digits multiples.... The de-rating of risks premium will simply make those "dilutions free" mode of financing totally vanished and the rest of the growth related financing needs would go back to traditonal debt side.... What making things worse is the lately high multiple financed money actually would be used to do the M&As with strikingly similar level of over valued px ... The leverage would catch up quicker than you might have thought and as long as the projects and assets don't deliver, de-rating would kill corp's valuations and stock mkt fall and leveraged-stock-financing unwind, and mortgage mkt might get hit and ... what's more, I didn't mention the operation leverage side of Chinese econ in this cycle at all... where could offer more downside
By Bruce Yang - 8/17/2007 5:26 PM
I think you are right to focus on all the leverage, hidden or not so hidden, that exists especially in the housing and real estate markets. Nearly every experienced banker I speak to who is deeply involved in real estate warns (sometimes only after many drinks) about all the hidden and unrecorded stuff going on.
It is hard to get real numbers on leverage and the amount of speculative activity, but I suspect if we knew what was really going on in the real estate markets we would all be very uncomfortable with the risks, especially the risk to the banking system, which is apparently far more exposed to real estate than the nominal numbers suggest. One question that hasn't been resolved as far as I know: in case of payment difficulties how easy will it be for banks to seize and liquidate the collateral?
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (2) for "Illiquid liquidity"
December, 2007
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