Responsible for Treasury and Investment Banking
by Patrick Butler, Managing Board Member at Raiffeisen Zentralbank (RZB),
The last few months have seen a major reassessment of risk and the price it should command across all asset classes, but affecting, in particular, the sector where it first began and where the storm has been centred, the credit markets, with knock-on effects on anything and everything utilizing leverage.
In many respects this severe down-draught – some have even used the word ‘crisis’ – reflects others throughout history. A long bull market – fuelled by a confluence of benign factors, including a prolonged period of cheap and abundant liquidity, an absence of major credit events, a raw material price-inflation counterbalanced by a drop in production- and service-costs underpinned by new technologies plus global outsourcing and the emergence of the new workshop of the world, China – led to a complacent belief that things can only get better. The only way is up, the ‘Goldilocks’ economy and market, neither too hot nor too cold, were here to stay. Stability was a given and price improvement – spread compression – in the credit markets – was a long-term trend. In this environment the search for yield and a willingness to ‘suck it and see’ encouraged financial engineers to invent ever more complex devices to gear up on yield and risk – sometimes multiplying leverage by 20x and more.
Let’s face it, we are all influenced by our own experience, and, like the VaR and other models so favoured by our regulators these days, we tend to place more weight on recent history than the distant past.
Lenders – investors – got complacent. Bad news from one sector – the US sub-prime market – was largely dismissed at first in the wider market. Then nagging doubts nibbled away at confidence as the reality sank in that these risks had been so sliced and diced and redistributed and releveraged that God alone knew who was holding what. A slow march towards lower duration, less risky assets turned into a headlong flight to safety as mild concern metamorphosed into blind panic. Not much then, to distinguish this crisis from its predecessors. Of course there are many similarities – over confidence, over liquidity, over-leverage, over-paying for assets. But there are key differences.