How Manuel got it oh so wrong

2008-02-23 00:00

The image: Zapiro’s political cartoon on the morning of the Budget speech. A bemused Trevor Manuel at the podium. Behind him is a flipchart open to a pie chart that is 90% black with a thin sliver of white for the other 10%.

The chart’s title is “Budget 2008”.

The black represents “Eskom Bailout”.

The 10% sliver — “The rest”.

Every system, every philosophy, every plan has flaws. Those flaws are called people. Everybody wanted to know how the government was going to solve the energy crisis. Everybody.

Even the people who steal a measurable proportion of our power had a stake in Manuel’s Budget.

But as Manuel says, “we are all in this together”, so even the thieves must be worried that they are going to have to put an oar into the water as the storm clouds gather.

But those storm clouds are a real economic tsunami that will at the very first wave take out Tito Mboweni’s more than $36 billion.

Manuel was justifiably nervous ahead of a flawed Budget philosophy that partially rested on those billions of dollars in the Reserve Bank.

Nervous also because solely, in my opinion, the entire house had already vetted his Budget speech and was waiting patiently for it to be over so they could get back to whatever they do with your tax rands, disband the Scorpions and sing I Did it My Way.

Humour was the main component in keeping your eyes off the real economic ball.

His first, to me, “deception” — for we are at war — and war is the art of keeping the other guys’ eyes off the ball — was his lack of understanding of just how devastating the American sub-prime collapse is to this country and the rest of the world.

This précis from Nouriel Roubini of New York University’s Stern School of Business, founder of RGE monitor, sums up the situation that Mr “Weatherman” Manuel sees as simply “storm clouds gathering on the horizon”.

But the up-and-coming storm isn’t in a teacup. What’s coming up is no joke, sir.

Roubini sees 12 steps in the gathering storm called the “meltdown of the American economy”.

Step one is what every economist on the planet, including Manuel, is aware of: the worst housing recession in U.S. history. House prices will, Roubini says, fall by 20% to 30% from their peak, which would wipe out between $4 000 and $6 000 billion in household wealth. Ten million households will end up with negative equity and with a huge incentive to either burn down the house and claim insurance — which is happening — or just put the house keys in the post and depart for greener fields. Many more homebuilders will be bankrupted, he maintains.

Step two would be further losses, beyond the $250- to $300 billion now estimated, for sub-prime mortgages. About 60% of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Roubini.

Goldman Sachs estimates mortgage losses at $400 billion. But if home prices fell by more than 20%, losses would be bigger. That would further impair the banks’ ability to offer credit.

Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The crunch would then spread from mortgages to consumer credit.

Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150 billion write down of asset-backed securities would then ensue, and in fact are now ensuing.

Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.

Step seven would be big losses on reckless leveraged buy-outs, says Roubini. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.

Step eight would be a wave of corporate defaults. On average, U.S. companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250 billion. Some insurers might go bankrupt.

(What actually happens is the corporate defaults are split into “decent shape” companies and low-profit ones. The decent shape companies are sold off, leaving the rest in a credit default situation that actually has to end in bankruptcy.)

Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.

Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices. Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.

Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.

And Manuel finds his economy supported by this crashing American one?

Has he not noticed that the Euro is about to tear the dollar to shreds by taking over the 90-year-old oil/dollar parity?

Ben Shalom Bernanke (chairman of the Federal Reserve Bank) has dropped the American equivalent of the repo rate to just three percent to encourage spending. Wouldn’t you buy everything you could at three percent?

Now we get to the electricity problem, which seems to be “just one of those things”. (I would like to see some media attention on the amount the Eskom board awards itself in bonuses next month.)

Well, even at three percent you can’t win on a more than three percent increase in rates and we can’t go for generators because that would annoy the green people and “I want to thank the 240 people who sent in Tips For Trevor [I was one of them and this article contains the gist] and … er … um … we are going to look into it”.

Wow! With the Zapiro right-on-the-button cartoon comment, you have to admit that Manuel dropped a New Age light bulb somewhere, even though it was free.

He is right on about the trade deficit, too, but about 20 years behind Mr Clem Sunter’s Budget speech that said the bottom line is, “South Africa must become a manufacturing nation”.

And then, after telling us to avoid certain energy taxes, nudge, nudge, he told us who will be paying for the energy crisis — us “sinners” of course!

But the best was the tip of the hat to "ANC chairman, Mr Jacob Zuma", to an almost standing ovation.

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