November 2009

Market risk is acceptable…  

While there is increasing evidence to support the view that the global economic slowdown is over, a sustainable recovery remains far from certain. A recovery requires growth; growth requires spending; spending requires employment; and employment is contingent upon investment, which is dependent to a large degree on the supply of credit. Since last year’s financial crisis, governments and central banks have been at pains to supply the liquidity necessary to stabilise the credit markets. But why has that liquidity barely impacted real demand? Some analysts argue that the rise in equity markets since their mid-March lows (and growing investor appetite for “risky” assets in general) is due more to the abundance of cheap liquidity than improved economic prospects. With interest rates around the globe at or around record lows, investors have preferred to find a home for a growing proportion of this liquidity not only in assets such as equities and corporate bonds, whose potential returns far exceed those available from relatively low-risk investments such as deposits and government bonds, but, more surprisingly (and perhaps worryingly), in emerging markets, commodities, precious metals, derivatives and even real estate. Companies have not been slow to react to the surge in demand for assets offering attractive returns. Globally, they have issued trillions of dollars worth of bonds this year, in addition to raising funds through rights issues (especially in Europe) and the occasional initial public offering. But many companies are not preparing to invest for the future and create muchneeded jobs. Instead, most of the funds raised have been used to reduce outstanding debt or otherwise prop up sagging balance sheets; only 10% of the 100 largest corporate bond deals world-wide so far in 2009 cited “expansion” as their primary purpose.

...but credit risk is not

One of the express reasons why the authorities have flooded the capital markets with liquidity in the last twelve months was to ensure the resumption of credit to small and medium-sized businesses. In many cases, however, the banks have not honoured this understanding and have shied away from lending to those who badly need it. Even where such loans are available, the costs imposed by the lenders are often too financially punitive for the borrower to accept. The situation is particularly galling in those jurisdictions where banks were bailed out by the very taxpayers who are now being denied funding. These banks are not prepared to play their part in securing future growth because of perceived credit risk, yet they are prepared to finance risky transactions. This conundrum threatens to weaken recovery efforts and, if unresolved, may possibly induce another crisis further down the road.