It is rare to hear CLSA’s Christopher Wood (the man described by the Wall Street Journal in relation to the subprime mortgage crisis as “the man who saw it coming” ) admit he “feels like a schmuck”. But, he adds hastily, Bank of England governor Mervyn King should also feel like schmuck (concerning the Bank’s rescue of UK mortgage lender Northern Rock ).
In a special Sunday edition of his weekly newsletter Greed & Fear, Wood fumes that a day after he praised the central banker in Thursday’s newsletter for his tough public stance on the role to be played by the lender of last resort (we thought Wood was joking), “King appears to have blinked at the first sign of real political pressure”.
The fact that the exact terms of the seeming bailout of Northern Rock have not been published “invites more suspicion than trust,” he says.
Wood, like some of the FT’s commentators, believes King has undermined not only his own credibility but also the Bank’s:
The reality is that the Bank of England is lending taxpayer money against dodgy mortgage collateral, a lot of which is very likely to turn bad. The British central bank governor has, therefore, massively accentuated moral hazard; which is precisely what King claimed on Wednesday he was determined not to do for fear of encouraging a future financial crisis.
Wood is certainly not suggesting there is a systemic issue at hand with Northern Rock – after all, he notes, the building society only has 76 branches. “But this business was run in such an aggressive manner that it was always likely to be the first prominent casualty of any real downturn in Britain’s long ludicrously inflated housing market”.
This is clear from a cursory glance at its balance sheet. The facts, he notes, “would not disgrace a Thai finance company prior to the Asian Crisis”:
Northern Rock has £80bn in mortgages outstanding supported by just £2bn of shareholders’ equity and £78bn of mostly short-term debt. And the company has set aside only 0.04% for bad debts. On an average mortgage lent of around £180,000, this amounts to a miniscule £67.
It is amazing that the Bank of England has felt it necessary to come to the rescue of an institution that had been run in such a reckless fashion. Securitised wholesale money markets account for about 40% of Northern Rock’s funding while its net residential property lending has risen by a shocking 55% YoY in the first eight months of this year.
It is also an amazing fact that Northern Rock, as a result of its imprudent dependence on wholesale funding, has managed to reach such a financially disastrous point - even before the British housing market has started turning down. But a real downturn in Britain’s mass-housing market is now surely inevitable, as suggested by the market action in British mortgage lenders and homebuilders.
Why is all of the above important for investors not involved in Britain?, asks Wood. “It is important because what the central banks do, or do not do, will influence near-term market action”.
By “every law of fundamental logic”, it makes sense to be tactically cautious in the short term over the direction of stock markets, with all the risk to US and global growth on the downside, he notes.
But if leading western central banks universally abandon all pretence at maintaining strict collateral standards and bail out all and sundry at the first hint of real pain then the shorts, or
the defensively-positioned, risk being badly squeezed.
On this point, Wood notes an “extraordinary reluctance in the west” to admit that one part of the necessary macro-economic adjustment is a reduction in credit excesses - that is because such a decline in credit extension inevitably means slower economic growth, he says.
The self-serving humbug and hypocrisy in this official attitude, when contrasted with the patronising advice handed out to Asia 10 years ago, is deeply nauseating and invites a complete loss of respect.
For Wood, then, the long term conclusion from both an equity and currency perspective is crystal clear. Remain massively overweight Asia. And Wood is not joking on this one.
