The housing situation is deteriorating. Credit markets are snarled. Bank earnings have been clobbered by mortgage and consumer credit card defaults and late payments.
Layoffs in the construction industry are picking up speed. Consumer confidence is down, partly because oil prices are so high as to be sucking purchasing power out of the economy; retailers fear that the Grinch has stolen Christmas. The dollar is sinking, forcing cancellation of that European trip.
For about 15 years, credit has been somewhere between cheap and virtually free. Result: lots of borrowing to buy houses, credit cards worn to the nub by hyperactive consumers, and deals by private equity firms based on cheap loans. Now, it turns out that too much of the collateral for too many mortgages and too many loans is not quite as good as it was thought to be.
So much for a summary of the news. A popular broadcaster attractedmillions of listeners with promises of “the story behind the story.” Let me try to repeat his success.
Banks are indeed less able and less willing to lend. But banks are not the only game in town any more. There is reason to believe that their woes are less relevant to the long-run performance of the economy than they have been in the past.
Start with the commercial property market. Banks are imposing tougher terms on property developers. As a result, the issuance of securities backed by commercial mortgages dropped from about $30 billion per month to $6 billion.
But the absence of traditional banks has called into the game new players, including non-U.S. banks, insurance companies and what the Wall Street Journal describes as “smaller real-estate shops.” So property developers are paying more, but they can get financing for sound deals.
Then there is the deals business. Small buyouts, under $200 million, are having little trouble getting the debt needed to complement the equity being put up by buyers. Funding for transactions in the $500 million range remains available.
And not all big deals are being called off. Dealogic reports that companies and private-equity firms pulled off $435 billion of acquisitions in the first three weeks of last month, a 23 percent increase over the same period last year. So the deal business is hardly at a standstill.
Most important of all is the rise of sovereign wealth funds — massive aggregations of capital in the hands of the world’s oil producers and major exporters such as China.
China’s $200 billion pile of money looking for a home pales in comparison to Abu Dhabi’s, variously estimated at $650 billion to $1,000 billion (these funds are less than transparent, so estimates of their size varies).
It isn’t much of an exaggeration to say that the managing director of Abu Dhabi’s sovereign wealth fund, Sheik Ahmed bin Zaqyed al-Nahyan, had only to dip into his petty cash drawer to come up with the $7.5 billion needed to make his country the largest shareholder in Citigroup.
If estimates that the Abu Dhabi fund earns a return of about 10 percent annually are correct, the Citigroup investment represents approximately a mere one year’s earnings.
The high 11 percent interest rate that Citigroup will pay, in addition to giving Abu Dhabi convertible stock — the so-called equity kicker — shows how desperate the bank is to get its hands on new capital, and to avoid cutting its dividend.
But Citigroup was having problems long before market conditions deteriorated, and the banking sector as a whole is going through a long-term change that is merely compounded by current credit-market tightness.
The world has changed. Wealth has moved into new hands. Morgan Stanley estimates that the world’s sovereign wealth funds hold some $2,500 billion in assets, more than the global hedge fund industry.
And they are adding about $500 billion to their assets every year. One Goldman Sachs banker told me that until recently he had never been to the Middle East; now he makes several trips each month.
Traditional banks, licking their wounds and trying to restore their balance sheets, are reluctantly selling off pieces of themselves to these funds, to the tune of $37 billion so far. Look for more such deals. And for these funds to take equity positions in nonfinancial companies.
Equity capital from these sovereign wealth funds is replacing the debt capital that in the past 15 years greased the wheels of commerce. The result will be a healthy deleveraging of the world’s business: less debt, more equity. Not a bad thing.
Examiner columnist Irwin Stelzer is a senior fellow and director of The Hudson’s Institute’s Center for Economic Policy.
