Titanic
Shift in Global Capital Market Power
The worst financial crisis in US history is just now appearing in its real dimension. It spells the end of New York’s reign as the globally dominant financial power, the heart of the power of the American Century. It is a shift whose true significance has not yet been appreciated. It soon will be.
By F. William Engdahl, 22
January 2008
We’re in the midst of the most politically
significant shift in global capital flows since 1919, when New York emerged out
of the ashes of the Great War to replace the City of London as the dominant
global capital center. The significance of this shift, being dramatically
accelerated by the ongoing crises of US banks and financial institutions and
insurers as a consequence of the failed “securitization revolution,” is that it
portends a de facto end of the American Century dominance of global
geopolitics.
In its January 15th issue, the senior Financial Times financial journalist,
Gillian Tett noted, “The US looks poised to lose its mantle as the world’s
dominant financial market because of a rapid rise in the depth and maturity of
markets in Europe, a study suggests.”
Tett continues, “The change may have occurred
already, not least because US markets are beset by credit woes, according to
research by McKinsey Global Institute… ‘We think the differential growth rates
are so significant that it is quite likely Europe has overtaken the US,” said
Diana Farrell, author of the report. ‘They are now neck and neck, which means
exchange rates are very important. It is a real change.’”
The McKinsey assessment is actually downplaying the
depth of the global shift underway since the Enron and related accounting
crises and the punitive US corporate disclosure laws, especially the
Sarbanes-Oxley Act made New York unattractive for major international companies
to raise capital through stock listings. Until the July-August 2007 crisis in
the US sub-prime asset securitization markets revealed that major UK financial
institutions as well had huge exposures to the US problems, London was
overshadowing New York for the first time since before World War I as the place
companies turned to list their stocks. London had for years been the world’s
center for foreign exchange trading in terms of volume, far exceeding
Frankfurt, Tokyo or New York.
Twilight of American financial supremacy
The unfolding crisis in the US is developing with
such speed and intensity that a panicked President Bush was forced to announce
his proposal for a $140 billion spending stimulus and tax cut bill to try to
prevent a full-blown recession or worse by the November elections.
Historically, the party in power amid an economic
recession never wins. The Bush proposals, far too little and too late, like the
proposal of his Treasury Secretary Henry Paulson, the former Goldman Sachs
banker, to postpone the reset the adjustments on billions of dollars worth of
sub-prime and similar home mortgages for “five months,” i.e. just enough time
to slide past November but not more, are indicative of the deepening mood of
gloom around the Bush White House and Wall Street.
The problems with the declining role of the dollar
in world finance, of the power of US banks globally in leading capital market
trends is terminal. In the past several weeks, some of the largest US banks,
including Citigroup and Merrill Lynch have had to go hat-in-hand, literally
begging various Sovereign Wealth Funds in the Middle East and in Asia to inject
equity capital to prevent the banks from going bankrupt. The last time
Citigroup was in such dire straits was in 1989 when it was technically
insolvent and had to be bailed out by seriously wealthy Saudi investor, Prince
Waleed bin Talal. The Prince has announced he is back to throw more good money
after the bad Citigroup, but this may be too late.
Securitization Insurance the next crisis
The next wave in the deepening US asset
securitization crisis began on January 18 when Fitch Ratings announced it had
stripped the AAA rating of the second largest “monoline” insurance company, Ambac
Financial Group Inc., the second-largest US bond insurer. Without its AAA
rating Ambac may be unable to write the top-ranked bond insurance that makes up
74% of its revenue. The downgrade throws doubt on the ratings of $556 billion
in municipal and structured finance debt guaranteed by Ambac. One market
adviser, Matt Fabian of Municipal Market Advisors noted, “This makes Ambac
insurance toxic. The market has no tolerance for a ratings-deprived insurer.”
The Ambac downgrade is just the start of the next
wave of the unraveling in US finance. MBIA Inc.’s AAA insurance rating may be
cut by Moody’s. MBIA is the largest US monocline insurer. The ratings review
reflects potential losses from subprime mortgage securities including collateralized
debt obligations, Moody’s said. Moody’s should know. Their ratings created the
entire sub-prime fraud to begin with as we will detail in a later piece.
At the heart of the game of the past several years
in which Wall Street banks and financial giants made literally hundreds of
billions of dollars in fees and trading profits was their ability to
“securitize” low quality home mortgage loans, so-called Sub-prime and Alt-A
loans, and have them rated by Moodys, Fitch and Standard & Poors as AAA. The
AAA rating was essential in order that pension funds would buy the securitized
bonds issued by the likes of Merrill Lynch, Morgan Stanley, Goldman Sachs and
the other major Wall Street and City of London financial players.
The key to how Moody’s et al could rate such
dubious mortgages as AAA lay in the insurance guarantee given in event of
mortgage default by the new group of specialized Wall Street financial
insurers, hence the name “monoline”—they had one line of insurance. With the
rate of default on sub-prime and Alt-A mortgages exploding by the week across
America, the ability of the Monoline insurers such as Ambac and MBIA to be able
to meet insurance underwriting demands is now in question.
MBIA
Inc. and Ambac Financial Group Inc., the two biggest bond insurers, have a more
than 70% chance of going bankrupt, credit-default swaps show. Prices for
contracts that pay investors if MBIA can’t meet its debt obligations imply a
71% chance the company will default in the next five years, according to a J.P.
Morgan Chase & Co. valuation model. Contracts on Ambac imply 72% odds.
At
least $2.4 trillion worth of securities, that is $2,400 billion (€ 1.64
trillion) are at risk to the financial insurance monoline downgrades. This is
the early phase of the most severe financial crisis the United States has faced
in its entire history, vastly paling 1929. It is now inevitable that the US
Federal government will soon be forced to enter the “financial guarantee”
business, assuming the obligations of municipal bond from the “monolines” and
mortgage-backed securities insurance.
Fatally
flawed models and Greenspan
The
fatally-flawed models behind so many strategies that have come to permeate
“contemporary finance” have completely broken down. The strategies of thousands
of financial institutions - big and small - have turned infeasible.
Wall
Street Risk Intermediation, the Alan Greenspan “Securitization Revolution” has
essentially crashed and the risk markets essentially seized up. Across the
board, the major risk operators are moving aggressively to rein in risk-taking.
Hundreds
of US financial players – from small hedge funds to the major money center banks
– with complex books of derivative trades, now have a very serious problem.
Their “hedged books” contain supposedly offsetting risk exposures that were to
have created a reasonable portfolio risk profile. The breakdown in Wall Street
finance has transformed these highly leveraged “books” into essentially
unmanageable “toxic waste” and financial land mines. The heart of the
securitization process has been to make financial exposure less and less
transparent. In good times, few cared. Now everyone cares. Banks dare not to
trade with other banks fearing unknown risks.
New
centers to emerge
What
is most likely to emerge from the ashes of the US securitization crisis? At
this point, thanks to the colossally inept policies of an American Century establishment,
grouped around the Bush-Cheney regime, trying to deny reality on the world
stage through exercise of brute force politics, we will likely see the
emergence of several distinct centers
of global financial power, rather than one dominant center as had been the case
first with the City of London after the Napoleonic wars, then with Wall Street
after 1919.
One
center will emerge around the growing size and depth of Euro capital markets.
Here Britain’s decision to keep Britain out of the Eurozone since the Pound
Sterling crisis in 1992 puts the City of London at a distinct disadvantage,
though huge volumes of Euro bonds and stocks are traded by London banks. The
problem with the Eurozone center is that it is geopolitically inadequate to
replace the US superpower. It desperately needs raw materials and for that
Russia, the Middle East and Africa are essential. China is becoming essential
for trade outlets to replace the US market. Eurozone leaders have but dimly
perceived their new geopolitical reality. They soon will.
The
second center that will emerge will be based around the huge capital
accumulations of dollar surplus countries especially since 2001 and the record
high oil prices. These include the so-called Sovereign Wealth Funds,
state-owned investment funds similar to the Norwegian Petroleum Fund, that have
billions of dollars (and increasingly Euros) in capital that is looking to
invest around the globe. The largest to date is that of the Emirates, including
Dubai. They are believed to hold more than $800 billion in assets today. Saudi
Arabia is planning to launch a similar wealth fund. China announced its $200
billion SWF last summer, and Russia, which now holds well over $400 billion in
dollar reserves, is another major capital source.
The sharp declines in global stock markets on
Monday, January 21 is a tiny hint of what will unfold. The driver is the US
creature called financial securitization. It was valued in the trillions of
dollars, nurtured and fully backed by a coalition of interests that included
Alan Greenspan’s Federal Reserve, the US Treasury, the rating agencies, the
Wall Street monoline insurers, hedge funds and the banks behind them. I will
detail in further installments on this site, The Financial Tsunami (see parts I
and soon II), the history and the scope of what is only now becoming obvious to
many as the greatest financial crisis at least since 1929-31 and in my
estimation, ever.