Oh dear – things seem to have taken a turn for the worse over at the Morgan Stanley Global Economic Forum.
Richard Berner there has been arguing, in contrast to the bank’s resident bear Stephen Roach, that the problems in subprime lending in the US are “idiosyncratic” and will not spillover into a systemic crunch. Worries about a wider crunch are “dramatically overblown” he wrote earlier this month.
He has not changed that view, he says. But some, such as Nouriel Roubini at RGE Monitor, think they detect a shift in Mr Berner’s stance on the matter, as the bank’s chief US economist ponders a number of risks that could trigger a more generalised crunch.
In his latest post, Mr Berner writes: “There’s no evidence yet of a broader deterioration in consumer credit quality or of spreading lender restraint,” before adding, “nonetheless, the tails of the credit quality distribution are getting fatter, and consumer delinquencies and chargeoffs are rising.”
“In these circumstances, investors should not confuse the resilience of consumers or businesses with ongoing stable credit quality. For years, I’ve argued that rising debt levels and credit risks would not trigger consumer retrenchment, but that the causality wouldn’t necessarily run in the other direction,” he goes on.
“Likewise, there is an important dichotomy between the risks to markets and those to the economy from a deterioration in credit quality. Financial innovation such as the structured credit and ABS markets have dispersed risk more broadly, thus increasing the resilience of the financial system and increasing the apparent resilience of markets to shocks. The risk is that if liquidity ebbs, that apparent market resilience will also dwindle. So while the subprime meltdown is likely to remain idiosyncratic, it should remind investors to carefully reassess lender credit quality and monitor risk-free spreads closely for any signs of distress selling or inability to roll over maturing paper, as well as the tone of rating-agency commentary that may affect ability to finance.”
Meanwhile, poor Mr Roach seems to have descended into new depths of despair.
“A new level of complacency has set in. It’s not just a financial-market thing — extremely tight spreads on risky assets and sharply reduced volatility in major equity and bond markets. It’s also an outgrowth of the increasingly cavalier attitude of policy makers. That’s true not only of central banks but also — and this is a major concern of mine — by the global authorities charged with managing the world financial architecture. Meanwhile, by flirting with the perils of protectionism, politicians are ignoring some of the most painfully important lessons from history. After four fat years, convictions are deep that nothing can derail a Teflon-like global economy. That’s the time to worry the most.”
His conclusion: “Enough is enough — from where I sit, it no longer makes sense to maintain an optimistic prognosis of the world. This is more of a structural call than a cyclical view. I remain agnostic on the near-term outlook, and certainly concede that the Goldilocks-type mindset currently prevailing could put more froth into the markets. But complacency is building to dangerous levels — always one of the greatest pitfalls for financial markets. And yet that’s precisely the risk today, as investors, policymakers, and politicians all seem to have dropped their guard at the same point in time. The odds have shifted back toward a more bearish endgame. I have a gnawing feeling we’ll look back on the current period with great regret.”
The bulls are reining themselves in, the bears are close to tears and European markets are rattled. Time to worry…