The US financial crisis may further escalate.
Article source: Song Hongbing's blog date: July 2, 20081day 14:36.
Editor's note:
After a few days of rebound, the US stock market plunged again on Thursday (24th). The sharp fluctuations in the stock market and commodity market in the past week have brought many investors a lot of confusion about the evolution of the US subprime mortgage crisis.
Mr. Song Hongbing, the author of Currency War, was the first person to warn the American subprime mortgage crisis in China. From the end of 2006 to the beginning of 2007, Song predicted the subprime mortgage crisis on his blog and gave a timetable for the evolution of the crisis. Later, the development of things was roughly consistent with his description.
The horror of subprime mortgage crisis lies in the scale of billions of financial derivatives based on subprime mortgage. Once these derivatives bubbles burst, it would be tantamount to detonating an economic atomic bomb. According to Song Hongbing, February last year to May this year was only a liquidity crisis stage, and the Federal Reserve temporarily passed this stage by drastically cutting interest rates and providing emergency loans to inject liquidity into the market. However, since June this year, the subprime mortgage crisis has entered the stage of credit default crisis. Can this only be solved by injecting liquidity into the market?
From a deeper perspective, the root of the subprime mortgage crisis lies in the unsustainable development model of "debt consumption" in the United States, and changing this model will not happen overnight. Besides, do Americans really have the courage to give up this model? Starting from next month, the American election will enter the sprint stage. With the development of the election, it will undoubtedly add many variables to the evolution of the subprime mortgage crisis. In any case, there is no reason to be overly optimistic now.
The Fed is fully aware of the seriousness of the problem. A huge financial tsunami is inevitable, which occurred from June 2008 to the summer of 2009, but so far, the Federal Reserve has not issued any warning to global investors. Without vigilance and prevention, investors all over the world will inevitably suffer heavy losses.
If a financial storm sweeping the world is inevitable, then the four stages of the crisis can be used as an image metaphor: the first stage of the subprime mortgage crisis is like a major earthquake in the global capital market; The second stage of the credit default crisis is the international financial tsunami; The third stage of the interest rate market panic is equivalent to the volcanic eruption of the dollar crisis; The fourth stage of the global financial crisis is the ice age of economic recession. Now, the second stage is coming!
Tsunami landing
On June 6th, 2008, the American stock market experienced the biggest decline since 15 months, and the new york stock market plunged by 394 points, even exceeding the peak of the subprime mortgage crisis in August, 2007. Obviously, the subprime mortgage crisis did not end, but escalated sharply. Without warning, the tsunami-level financial storm in the world financial market quietly landed, and this time the protagonist is the little-known CreditDefa ultSwap (CDS).
Credit default swap is a financial derivative product initiated by JPMorgan Chase in 1995, which can be regarded as a kind of default insurance for financial assets. For a long time, institutions holding financial assets have been facing a potential danger, that is, debtors may not pay the interest on their debts on time for various reasons, so institutions holding creditor's rights will find that the price of their financial assets has depreciated. How to "peel off" and "transfer" this default risk has always been a major challenge for the American financial community.
The emergence of credit default swaps has met this market demand. As a highly standardized contract, credit default swap enables institutions holding financial assets to find guarantors who are willing to bear the default risk for these assets. Among them, the party who buys credit default insurance is called the buyer, and the party who bears the risk is called the seller. Both parties agree that if the financial assets are not in default, the buyer will pay the "insurance premium" to the seller on a regular basis, and the seller will bear the losses of the buyer's assets in case of default. There are generally two ways to bear the loss. One is "physical delivery". In the event of default, the insurance seller promises to purchase the default financial assets of the buyer in full at face value. The second way is "cash delivery". In case of breach of contract, the insurance seller will make up the buyer's asset loss with cash. Credit default events are events recognized by both parties in advance, including: the debtor of financial assets went bankrupt and paid off, the debtor failed to pay interest on time, the creditor requested to recall the debt principal, demanded early repayment and debt restructuring caused by the debtor's default. Generally speaking, insurance is mainly purchased by banks or other financial institutions with large financial assets, while credit default insurance is sold by insurance companies, hedge funds, commercial banks and investment banks. Both parties are free to assign this insurance contract.
On the surface, credit default swap, a credit derivative product, satisfies the concerns of financial asset holders about default risk, and also provides a new source of profit for insurance companies or hedge funds willing and able to bear such risks. In fact, once the credit default swap came out, it was enthusiastically sought after in the international financial market, and its scale soared from 1 trillion dollars in 2000 to 62 trillion dollars in March 2008. Among them, this figure only includes the data reported by commercial banks to the Federal Reserve, but does not include the data of investment banks and hedge funds. According to statistics, only hedge funds have issued 3 1% credit default swap contracts, and Bear Stearns, a famous investment bank recently acquired by JPMorgan Chase, is the risk counterpart of 13 trillion USD credit default swap. If Bear Stearns really goes bankrupt, it will trigger an avalanche in the global credit default swap market, and the world financial market in 2007 may have been in ruins.
Fatal flaw
The problem is that there are major institutional defects in the credit default swap market, and the scale of 62 trillion US dollars makes the whole world financial market face unprecedented and incalculable systemic risks. Among them, the biggest risk is that credit default swaps are completely over-the-counter transactions without any government supervision. Greenspan praised credit default swap for many times as a major financial innovation, which dispersed the credit risk in the United States on a global scale and increased the flexibility of the entire financial system. He believes that banks have more motivation and ability to supervise the risk of credit default swaps than the government, thus resolutely opposing the government's supervision of the financial derivatives market. However, the fact is that credit default swap has developed into a ticking "financial nuclear bomb", threatening the security of financial markets all over the world at any time.
Another huge risk of credit default swaps is that there is no central clearing system, no centralized trading quotation system, no reserve guarantee requirements, and no risk monitoring and tracking. Everything operates in an opaque circle in the form of asymmetric information, with the aim of obtaining the highest income for traders.
At the same time, credit default swap is no longer a conservative category for financial asset holders to buy default risk insurance, but has actually alienated into a game behavior between buyers and sellers of credit insurance contracts. In fact, both parties can do nothing about financial assets that need credit insurance. They are betting on whether a credit default event will happen. This gambling behavior and scale have far exceeded the original intention of credit default swap design.
At present, people are not aware of the risk of credit default swaps, because the default rate of junk bonds and other bonds in the United States is at the lowest level in history, but dangerous dark clouds are rapidly gathering. The default rate of junk bonds in the United States rose rapidly from 1.5% in April 2007 to 2. 1% in April 2008. According to Moody's model, the default rate of junk bonds will soar by nearly 300% to 6. 1% in the coming year. However, judging from the past economic recession in the United States, Moody's model may have a serious deviation similar to CDO valuation this time. Historically, once the American economy enters recession, such as1991-192, 200 1 and 2002, the default rate of junk bonds will jump from 3%-4% to 10% or higher. Considering that the severity of this crisis in the United States is far greater than that of the last two recessions, once the American economy enters the recession stage in the second half of the year, the default rate of junk bonds in 2008 -2009 is likely to exceed 10%.
Different from the last two recessions, 199 1992 did not have credit default swaps in the United States. In 200 1- 2002, the scale of credit default swaps was only 1 trillion dollars, and junk bonds accounted for only 8%. But this time, the proportion of junk bonds has reached 40% in 2 007, and the scale of credit default swaps has expanded to an astonishing $62 trillion. If the average proportion of junk bonds since 2002 is about 30%, if the recovery rate of bond losses is 50%, the losses caused by credit default swaps will be about 500 billion US dollars according to Moody's model, which exceeds the estimated default rate of 10% based on historical experience data. This huge loss was the peak of the subprime mortgage crisis in 2007.
Four steps to defeat America
In fact, the persistent subprime mortgage crisis in the United States is only the initiator of the overall debt crisis in the United States, and the structural contradiction of high debt in the United States will inevitably lead to the outbreak of the global financial crisis. The process of crisis development will go through four stages:
The first stage is the liquidity crisis. The crisis occurred from February 2007 to May 2008. The main feature is the payment crisis in the American real estate subprime mortgage market. All securities based on subprime mortgage (such as subprime MBS bonds) and new financial products derived from these securities (such as CDO) in the financial market have experienced serious depreciation. With these financial assets as collateral, various funds that lend to banks with leverage of 1.5-30 times are forced to sell their assets to ease the pressure of bank debt collection. At this time, a large number of simultaneous and panic asset selling led to the rapid solidification of financial market liquidity. At this point, the payment crisis finally evolved into a liquidity crisis, which led to a further plunge in the value of financial assets and a large number of bad debts in banks. With the large-scale joint injection of liquidity by the Federal Reserve, the European Central Bank and the Bank of Japan, the crisis at this stage has eased. But the decline of American real estate market will last until 20 1 1 or 20 12. During this period, it is difficult for the American economy to really recover.
The second stage is the credit default crisis. Since June 2008, the United States has officially entered the second stage of the financial crisis. Its main sign is that the financial derivatives market such as credit default swaps (CDS) is about to face a full-scale crisis. The relief of the liquidity crisis in the first stage does not mean that the possibility and harmfulness of credit default have been effectively controlled. With the subprime mortgage crisis in the coming months, credit default swaps (CDS) may become a household name. In the American capital market, JunkBond, asset-backed bonds (ABS, including credit cards, auto loans, student loans, consumer loans, etc. ), mortgage-backed bonds (MBS), leveraged loans and other debt instruments will have a chain crisis of credit default. In particular, the default rate of junk bonds will soar by 300% to 500% in the coming year. From 2008 to 2009, the credit default swap of financial derivatives based on these bond credit gambling will cause huge losses as high as 1 trillion dollars, and its impact on the international financial market will be several times that of the subprime mortgage crisis in 2007. Credit default crisis is an inevitable financial disaster. Some world-renowned large financial institutions are likely to close down or be acquired.
The third stage, the interest rate market crisis. Under the violent impact of the large-scale credit default crisis, the American interbank market and money market will once again have a liquidity depletion crisis, and the reason behind it will be the sharp increase in worries about solvency. Fannie Mae and Freddie Mac, the two largest mortgage financial institutions indirectly guaranteed by the government in the United States, are likely to have a major crisis because of their ultra-thin self-owned capital. They issue bonds with a credit rating close to US Treasury bonds, which may lead to a dangerous situation of a sharp rise in yields. This crisis will infect the confidence of US Treasury bonds, which have been recognized as the safest financial assets in the world for 60 years, thus triggering a larger global financial market shock. The largest interest rate swap market in the financial derivatives market will face an unprecedented severe test.
The fourth stage, the dollar status crisis. The crisis of confidence in US Treasury bonds and bonds of Fannie Mae and Freddie Mac will lead to panic selling of US financial products on a global scale, as well as the uncontrolled plunge of the US dollar. Due to the status of the US dollar as the world reserve currency and the objective reality that 70% of global trade is settled in US dollars, the US dollar crisis will inevitably lead to the outbreak of the global financial crisis.
In essence, the American economic growth model has gradually evolved into an "asset expansion-dependent" economic development model. The subprime mortgage crisis in the United States is not accidental. The fundamental reason lies in the serious imbalance between American savings and investment and the huge debt problem caused by this imbalance. As we all know, a country's investment should be equal to its savings. The savings rate in the United States was 10.08% in 1984, and has been declining since then, reaching 4.6% in 1995, 0.8% in 2004, 0.4% in 2 005 and-/in 2006.
The troubled American economy
The wealth created by the United States itself is no longer enough to cover the growing expenditure. Globalization and various financial innovations in the American capital market enable the United States to absorb the savings of other countries to make up for its own savings. According to statistics, from 2000 to the first half of 2007, the total foreign savings absorbed by the United States through the capital market reached 5 trillion US dollars. The capital flowing into the United States through the purchase of US Treasury bonds and various financial products has greatly depressed the yield of long-term loans in the United States, and abundant and cheap foreign funds have stimulated the unprecedented activity of the US capital market. Under the super amplification of highly leveraged loans and financial derivatives, it directly gave birth to the inflation of asset prices in the United States.
On the other hand, all kinds of financial innovative products in the American capital market make it easy for Americans to cash out directly from the appreciation of assets, and the appreciation of assets such as real estate once became the "cash machine" for Americans to consume. A steady stream of foreign savings flows into the American capital market by purchasing American financial products, which lowers the cost of long-term loans and pushes up the price of American assets. Financial innovation will quickly convert the value-added part of assets into cash consumed by Americans. Encouraged by the appreciation of wealth, American consumers, enterprises and governments continue to spend boldly at the expense of increasing debt, thus stimulating GDP growth and sustained economic development, which is particularly prominent in the real estate industry in the United States.
Therefore, as long as American asset prices keep rising, foreign savings will keep pouring in, American economy will continue to grow, and the "asset expansion-dependent" economic development model can continue to be maintained.
However, using the savings of other countries to consume and stimulate economic growth will inevitably face a huge debt problem. In the case of limited real income growth of consumers, the continuous expansion of debt scale and the corresponding huge interest expenses will inevitably crush the driving force of asset price increase. Once asset prices stop rising, consumers will face the dilemma of "automatic teller machines" stopping working, the problem of long-term low savings and no savings will surface, and the payment crisis of huge debts will evolve into a credit crisis. When the credit crisis spreads to the whole capital market, a full-scale debt crisis is not far away.
Accurately speaking, the subprime mortgage crisis in the United States is just a detonator, and the total debt of $48 trillion and the fiscal deficit of $45 trillion behind it are the real giant powder magazines. At present, the massive injection of liquidity by the Federal Reserve and the European and Japanese central banks can only "save the emergency" but not "save the poor". Although these measures can delay the liquidity depletion crisis of financial institutions, they cannot fundamentally solve the huge debt problem of the United States itself. Moreover, with the rising inflationary pressure caused by issuing additional money, it will also restrict the scope of monetary policy of central banks in various countries.
According to the forecast of the interest rate reset peak and the default rate of junk bonds in the United States, it can be seen that June, July and August 2008, March 2009, September 20 10, and August 201year are likely to be dangerous periods for the subprime mortgage crisis to escalate in an all-round way. Among them, June, July and August of 2008 and August of 20 1 1 had the most severe impact on the world financial market.
Author: Song Hongbing