Paulson’s predicament

  • Robert Peston
  • 16 Aug 07, 09:45 AM

hank_paulson.jpgWhen gales are blowing through global financial markets, as they are, in some ways it helps to have a former Goldman Sachs boss as US Treasury Secretary. Certainly Hank Paulson’s interview in today’s Wall Street Journal shows a grasp of market technicalities well beyond the knowledge and vocabulary of most of the world’s finance ministers.

His message can be boiled down as follows:

1) The gyrations of debt and equity markets will continue for some time
2) There will be a negative impact on economic growth from the market mayhem
3) But US and global growth is so strong currently that we won’t be tipped into recession
4) Some financial institutions will go out of business
5) A more robust system for lending to US homebuyers with poor credit histories has to be put in place.

As for the implications for the structure of financial markets, there he was a little less confident. He talked in fairly general terms of the need for the agencies that rate debt – and which underpin the way that markets price that debt – to show “a better understanding about the risk”.

You can say that again. The credit rating agencies are belatedly reviewing the quality of CDOs, CLOs and other specially manufactured debt securities, weeks after many financial institutions wouldn’t touch much of this stuff with a fifty-foot barge pole.

Paulson also paid lip service to the need to gather better information from banks and hedge funds about where financial risk actually sits in the global system.

But it’s not just locating the risk that is tricky to do. If you talk to three different regulators, as I have, about something as basic as how much leverage is in hedge funds – how much they’ve borrowed – you get three different answers. That’s not reassuring.

My favourite Paulson quote however came in response to the question whether what’s happening in markets is welcome. He said:

“I’m going to say it’s inevitable. When you have periods of benign markets, particularly in situations where parts of markets and the economy are growing at levels that are unsustainable, market participants aren’t going to be as vigilant as they should. You’re always going to have these events from time to time. When they come…it’s difficult to predict what might happen…what might be the precipitating cause. But as long as you have capital markets, there will be events like this…”

At the moment, it looks like it’s worth paying the price of “events like these” for the faster global growth that globalised financial markets have delivered over the past decade.

Paulson and his former Goldman colleagues will be hoping beyond hope that a fully-fledged recession does not set in, because that would create significant political pressure to increase regulation of these markets, and do something not very nice to their golden goose.

UPDATE 19:27 Well, the markets are convinced that global growth is set to slow sharply, which may imply that Mr Paulson and other politicians are whistling in the wind.

There were sharp falls in the price of oil and base metals. Copper and zinc are down around 8 per cent, lead and nickel are 6 per cent lower.

Some of that was a consequence of forced sales prompted by margin calls on leveraged investors. But much of it reflects the view that US consumer spending will slow, and that will feed through to lower demand for Chinese exports, and hence to lower demand for natural resources.

It is also worth noting that the mining-heavy London stock market has been led down by the international mining stocks: Anglo American, Lonmin and Antofagasta all fell more than 9 per cent; Rio Tinto, BHP and Xstrata were all about 7 per cent down.

Standard Chartered was the worst performing bank, because of its dependence on Asian growth. Man was the worst performing financial stock – because it rode the hedge-fund phenomenon up and up, and now is riding it in the other direction.

The stock to watch, however, is Northern Rock. As one of the most aggressive lenders in the UK housing market, and heavily dependent on funding from the bond market, its shares have fallen almost 50 per cent from their peak of the past 12 months: a pretty soft rock.

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