The Great Debate

Hans Christian Andersen’s fairy tale about the “The Emperor’s New Clothes” is a good explanation for the spectacular expansion and implosion of the bubble economy in the 2000s.

For a time, a collective suspension of disbelief allowed markets and investors to ignore risks produced by cheap credit, subprime mortgages, securitisation and the shadow banking system.

The system worked until someone impolitely shouted out the risk had not gone away, it was just hidden in plain sight, and many institutions were insolvent.

But how many people remember how the fairy tale ends?

“‘But he has nothing on at all,’ said a little child at last. ‘Good heavens! Listen to the voice of an innocent child,’ said the father, and one whispered to the other what the child had said. ‘But he has nothing on at all,’ cried at last the whole people.

“That made a deep impression upon the emperor, for it seemed to him that they were right; but he thought to himself ‘Now I must bear up to the end.’ And the chamberlains walked with still greater dignity, as if they carried the train which did not exist.”

- Steven Miller is managing director of Standard & Poor’s LCD, a unit not part of Standard & Poor’s ratings business. The opinions are his own and not those of S&P.-

As the worst credit crisis since the 1930s recedes, investors are starting to boil down the lessons of the past two and a half years.

With time, we’ll get smarter about how to interpret the recent upheaval but for now, it comes down to these: (1) financial covenants, which test the financial health of a borrower each quarter, can be used to reset loan spreads when times are tough, (2) collateral is indeed resilient, (3) bubbles work in both directions, (4) models are better at predicting the past than the future and (5) “black swans” –- those big unexpected events and their consequences — take many forms.

– Neil Unmack is a Reuters columnist. The opinions expressed are his own —

The masters of the universe seem to be losing control of their own destiny.

Jon Moulton, founder of private equity firm Alchemy Partners, has walked out acrimoniously amid a succession and strategic spat with his partners, and Dominique Megret, chairman at PAI, has been ousted. Both cases could trigger so-called “key-man” clauses in the groups’ funds, a nuclear option that allows investors to halt new investment, or in extreme cases even liquidate the fund.

Both Alchemy and PAI’s bust-ups are unique, but we’re likely to see more like them as the private equity model comes under pressure in the aftermath of a global credit crisis.

– Aron Cramer is president and CEO of BSR, a global business network and consultancy focused on sustainability. The opinions expressed are his own. –

The fall of Lehman Brothers last September triggered a collapse in financial markets, and then the real economy. It also signaled a further decline in the public’s trust in business. One year on, has anything changed?

At the start of 2009, only 36 percent of the U.S. public trusted business to “do what is right”—down dramatically from 59 percent one year before—according to surveys from the PR firm Edelman. But as of this July, trust levels in business had recovered somewhat, to 48 percent. Yet just as with the economic recovery overall, it is far too early to declare victory.

The U.S. Treasury Department on Tuesday unveiled a revamped financial rescue plan to cleanse up to $500 billion in spoiled assets from banks’ books and support $1 trillion in new lending through an expanded Federal Reserve program. But initial market reaction reflected investors’ doubts about the plan, with stocks falling around 3 percent after the announcement by Treasury Secretary Timothy Geithner.

“For all the rhetoric that this is a new plan, they’ve done nothing but rehash and expand the old procedures,” said Steven Ricchiuto, chief economist at Mizuho Securities USA.

Carl Lantz, U.S. interest rate strategist at Credit Suisse in New York, said details of a proposed public-private investment fund for mopping up toxic bank assets were “very vague”.

– John Kemp is a Reuters columnist.  The views expressed are his own –

The last eighteen months have witnessed a revolution in financial regulation — if by that we mean a fundamental reconstruction, total change or turn round from the previous orthodoxy occurring in a relatively compressed time.

In particular, the sheer scale of recent policy interventions in the banking system is throwing up very uncomfortable questions about the government’s role in the economy, centered on its function as the ultimate re-insurer of risk and its function via the central bank as “lender of last resort” (LOLR) to the banking system.

– John Kemp is a Reuters columnist. The opinions expressed are his own –

Most successful elected leaders must disappoint their most ardent supporters at some point, as the bright hopes of an election campaign give way to the complex realities and constraints of governing, and need to occupy and retain the political center-ground to win re-election.

The trick of really successful leaders is to let supporters down gently to avoid turning disappointment into frustration and anger, retaining allegiance and support even when the maximum agenda goes unfulfilled and compromises must be made. Political supporters have to be given enough policy gains to be kept loyal, even as some cherished objectives fall by the wayside.

– Preston Keat is director of research at Eurasia Group, a global political risk consultancy, and author of the forthcoming book “The Fat Tail: The Power of Political Knowledge for Strategic Investors” (with Ian Bremmer). Any views expressed are his own. For the related story, click here.

There are a number of macro risks that will continue to grab headlines in 2009, including the conflicts in Afghanistan and Iraq, cross-border tensions and state instability in Pakistan, and Iran’s 
ongoing quest to develop advanced nuclear technologies.

These risks are real, and will not be resolved easily or quickly. But there are two other general groups of political risks that could be defining both for investors and policy makers: first, the prospect of a number of interrelated market risks in developed and emerging Europe, and second, the challenges faced by the United States regarding multilateral leadership (particularly in the area of financial regulatory reform).

– John Kemp is a Reuters columnist. The views expressed are his own –

After six decades of uninterrupted credit creation and an unprecedented era of consumption and prosperity, the credit process has come to an abrupt halt. If credit has been the locomotive of the modern economy, the third quarter of 2008 marked the point when the engine stalled and the economy began to roll back down the hill.

For decades, financial activities have grown much faster than the real economy. Between 1952 and 2007, U.S. nominal GDP grew by a factor of 39 times, while total credit market debt outstanding surged 101 times.

– James Saft is a Reuters columnist. The opinions expressed are his own. –

Trade finance, a basic lubricant for the global economy, is becoming much more expensive and tougher to get, accelerating an already harrowing downturn.

Banks are reluctant to allocate scarce capital to trade finance, which funds cross-border buying and selling, and are very wary about being caught short by defaults by other banks which write letters of credit or by the importers and exporters themselves.