The Crying Washinton

Regardless of who is taking the Oath of the Office in Capitol come this January 20, 2009, he (Cain or Obama) or she (Hillary) will be inheriting a messy economy with deep fundamental chasms. There will cheers and congratulatory speeches but only for a short 10 seconds, because for the next 3 years, 364 days, 23 hours, 59 minutes and 49 seconds, the 44th President of the United States of America will have to spend all of his or her effort to rally a fledging economy and to unite a disillusioned nation.

Just as the Revelation pointed to stark reminders of the end-days, the warning signs of a financial meltdown are everywhere. The temporary relief we had this year is perhaps the last breath that the economy will take before plunging back to the deep abyss.

I came across an article (Financial Times, Martin Wolf) in which the author pointed out 12 steps to a impending financial disaster, which has spiraled out of the recent subprime crisis. I will just point out what I have  read and my views. The steps are of Martin Wolf's views.

1. Due to the depressed property and the near collapse of confidence of the consumer, house prices will fall by an average of 25%, wiping out the household wealth of up to SG$ 84 trillion. Mind you, it is in trillions. This will represent an amount of money not diverted to productive use in terms of expanding the economy. This massive loss of the economic pie will take at least a decade to recover.

2. As confidence level dipped further, the subprime mortgages will drag more people and banks to the graves. An estimated SG$560 will be written off later this period.

3. With the above 2 major forces at work, a widespread credit defaults will rage like bush-fire.

4. Monoline insurers will have to be foreced to downgrade their ratings from AAA. 

5. The commerical property market is expected to face severe pressure. The author described it as a meltdown.

6. Banks will run and be bankrupted.

7. Big losses on reckless buyouts by the corporates. Hence, the raging bush-fire now spread from the property market to the banks and now to the rest of the corporate world.

8. It is expected that with the big losses, a wave of corporate defaults will join the already raging credit defaults.

9. Total meltdown of the "Shadow Financial System" is anticipated. This Shadow Financial System is named due to the dodgy and often -complex nature of hedge funds, derivatives and special investment vehicles. The pain is exacerbated by the fact that companies cannot borrow any more money at reasonable rates nor can they seek help from the central bank.

10. Collapse of the already weaken stock market. Total loss of confidence in the financial institutions.

11. Drying of liquidity, as people refused to invest in the financial market. Vicious cycle of lower liquidity, lower investment and lower income.

12. Onset of "Vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices."

Just as no one can raise his hand to stop an approaching tornado or beg an earthquake away, Chairman Bernanke and his team cannot stop the inevitable from happening. 

Firstly, the US monetary easing is constrained by risks to the greenback and inflation.

Secondly, aggressive easing of deals will only encourage illiquidity, not solvency.

Thirdly, the monoline insurers will lose their credit ratings with dire consequences. At this point, what is the big deal about monoline insurers? They represent the bond market. They guarantee the timely repayment of principal and the interest. Should their rating be downgraded, the implication is the corresponding downgrade of all the bonds they represent, in the process wiping out billions of dollars on the face value. Bonds are supposed to be the most secured form of investment instrument, with the downgrades of rating, it will drag the value down. This in turn represents the overall loss of confidence of the people in the financial market.

Fourthly, SWFs like GIC or from the Middle Eastern countries could not contain the fall out. GIC can't always buy into other banks as readily as it has for Citigroup.

Fifthly, internally, the US government has little maneuvering space to stablise anything.

Of course, the last resort that the US government can fall back on is the bear all of the losses, to allow for the precious tax income to be used to offset the losses, and for generations of Americans to shoulder the debt. Let's not forget about the pensioner pressure, the gapping national debt and the ever-burgeoning trade deficits.

Hence, in January 20, 2009, on top of Capitol Hill, may the next President of the United States of America add "God Bless America" to his or her Oath of the Office.