Evercore Pan Asset

I found responding to the huge bail out of Freddie Mac and Fannie Mae challenging. The scale of the guarantees offered to the markets through Conservatorship was large. Was this the decisive event that showed the US authorities are determined to make markets as liquid as we need to permit recovery? Or was this another admission that things are very bad, with the authorities still struggling to catch up with the magnitude of the losses in the banking sector? Did this mean that people would buy even more dollars because they became more optimistic about the US economy, or did it mean they started to sell dollars because it meant even looser fiscal policy, with so many risks on the government’s own balance sheet?

The first reaction of the markets was to drive equity prices sharply higher. No sooner had the US equity market leapt by 200 points than fears began to circulate about the condition of Lehmans. The second day after the bail out the markets retreated sharply.

We decided to do very little when in doubt and to learn from what the markets were doing. We did take profits on the short term dollar instruments we had bought for sterling clients, banking a very welcome 11% profit on the total value of the funds that had followed this advice. We felt more comfortable in sterling cash, as we clarified our thinking and listened to the markets.

A few days on, the markets are still arguing it out. The massive bail out does show us just how serious the financial problem had become. The US authorities yet again acted before the markets made the problem worse, but each time they act they have to put more taxpayer money at risk and take on an even bigger commitment to keeping markets open. The action limits the downside compared to the US authorities just watching the collapse of the two FMs. It brings eventual recovery a bit closer. It does not mean the problems are all over.

We still have bad news to come. There will be further property price falls, further bad profits reported, more banks in trouble, other types of lending that have gone wrong. No-one can yet be sure just how high the bad debts will turn out to be in mortgage lending or any other type of lending. The banks are still short of capital. They are having to cut back on lending to consumers, cutting demand for companies products. They are also cutting back on company advances, forcing stock reductions and less investment. We still have to see any of this in the output and income figures at the national level for the USA.

On the more positive side the news demonstrates that the US authorities are determined to do whatever it takes to avoid recession. They have sent a strong signal that they will prevent further market seizure, and will use the taxpayer to guarantee large parts of the failing system.

We said we were looking for two conditions to be met before buying equities. The first was falling commodity prices, which we forecast when oil hit more than $140 a barrel. This is happening rapidly, and means the inflationary pressures should also drop rapidly next year. The second was more liquidity on the back of low interest rates. This is beginning to happen in the US.

The UK remains in difficulties. We have been negative on UK assets other than deposits and short term sterling instruments all year. We remain so. The property decline has further to go, with the main commercial property agents becoming more bearish the more the market falls. Companies are experiencing much tougher trading conditions and beginning to report bad figures. Sterling has fallen a long way against both the Euro and the dollar. This will help exporters, but cuts disposable incomes more. The government has spent far more than budget, and still has to produce more accurate forecasts for 2008-9, let alone for the following year. The country has been living beyond its means for too long and is having to undertake a painful retrenchment. There will be better investment opportunities elsewhere.

In each of the western currency areas – dollar, Euro and sterling – the public authorities one way or another arte taking over poor quality paper from the banking system and giving them cash and better quality paper in exchange. There now needs to be an assessment of how much the public authorities are going to lose on all this, and how patient they are going to be. This is a deep Credit Crunch where we still do not know either how much has been lost in total, or who is going to pick up all of the bill. Clearly it is not just going to be bank shareholders, as the actions of the ECB and the UK and US governments have shown.