The $300 bln reason why you should be careful

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It’s not a crisis, it’s a buying opportunity. At least, that’s what Goldman Sachs says. The investment banking giant pumped $2 billion into its Global Equity Opportunities fund after it slumped by more than 30% in just one week, with outside investors pumping in a further $1 billion.

To put that into perspective, the total bail-out package for Long-Term Capital Management was just $3.6 billion, although LTCM was much more highly leveraged. The fund was a victim of the recent market turmoil. CFO David Viniar assured the markets: “This is not a rescue… this is a good investment opportunity for us.” But as The Telegraph’s Damian Reece points out, this “sets a dangerous-looking precedent.” What will they do when the next “Goldman fund dives?” How many more investment banks will find themselves confronted with “good investment opportunities” - or disastrous fund wipe-outs - in the weeks and months ahead? And more to the point - how many can they buy into - or bail out - before the money runs out?

Goldman Sachs isn’t the only investment bank that sees buying opportunities at the moment. Morgan Stanley analysts - who did a pretty good job of calling the top of the market in mid-June - are now calling the bottom. Teun Draaisma, chief European equity strategist, tells The Telegraph: “This is still a bull market and we see no recession in sight… Sure there are risks, and we may be too early… We do not know who owns what financial vehicle and who sits on how big a loss. But one has to buy at the moment of maximum uncertainty, and in our judgement, now is close to such a moment.” It’s an interesting point - and there may well be some good buying opportunities out there, as we’ve pointed out in recent emails and in the current issue of MoneyWeek. But we’re not so sure on Morgan Stanley’s decision to buy into financial stocks - after all, these would be hit hardest by any more shock revelations, which seems all too likely.

Oddly enough, analysts at Goldman Sachs - even as their bosses are stumping up billions to prop up their own ailing funds - are also far less bullish than the MS team. “It would be a mistake to be complacent. Just as market participants in late 1997 and early 1998 were too quick to overlook problems in Asia, we are not inclined to be cavalier about the risks associated with the current episode of deleveraging.” They’re right to be cautious. There’s a lot of bad debt still to be uncovered – at least $300 billion in subprime debt has been identified, according to Philip Aldrick in The Telegraph, but no one knows exactly where it is.

Panmure Gordon analyst Sandy Chen reckons that UK banks could have quite heavy exposure to the market through yet another arcane set of initials – ABCP, or asset-backed commercial paper. To cut a long story short, he reckons – to take a couple of examples – that Barclays has £20-£25 ($40 –50 billion) billion of such exposure, while HBOS has £20 billion. Even a small write-down in such a large amount could represent a substantial hit for those banks. Bankers are trying to reassure people that the strength of the ‘real economy’ will mean that this is just a ‘blip’ and that the liquidity crisis will pass without severe consequences.

Robin Menzel of Augusta & Co tells Aldrick that “there is still a lot of liquidity out there and banks will still lend out because economies are booming.” But then, you have to wonder why economies have been booming. Certainly in a country like the UK, the economy has been growing because of cheap debt. Consumption accounts for a whopping 74% of British GDP. Easy lending has enabled surging house prices, which has also helped fuel a consumer spending and borrowing binge, which in turn boosts retailers’ profits. Cheap debt drives consumption; consumption drives the UK economy; ergo, a rise in the cost of debt will hammer the UK economy. We can already see this happening in the UK housing market, which is starting to look distinctly peaky. The latest report from the Royal Institution of Chartered Surveyors (Rics) found that the number of people looking for a home fell at the fastest rate in three years last month, while the number of unsold properties rose to its highest this year.

The Rics survey was one of the first to show evidence of a slowdown during the last big tremor in the housing market in 2004 - which was also accompanied by rising interest rates. And if you’re still skeptical about the idea that house prices in the UK can ever fall, just take a look across the Irish Sea. House prices in Ireland fell for the fourth month in a row in June, and were down 2.6% on an annual basis during the first half of the year. The falls are down to rising eurozone interest rates cutting into the amount that Irish homebuyers can borrow. (moneyweek.com)

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