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Bailout doesn't adequately aid solvency issue: Jim Walker

Published on Fri, Oct 03, 2008 at 11:01 | Source : CNBC-TV18

Updated at Tue, Oct 21, 2008 at 15:50

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Jim Walker , Managing Director , Asianomics

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Stock futures have fallen after the bailout passage. Asian markets have also slipped marginally post the US Senate passage of the bill.

Jim Walker , Managing Director of Asianomics , said that there is a possibility of negative US GDP numbers starting this month and that there may be much weaker economic growth in 2009. Also, the interest rates will fall sharply in Europe and the US, he said. Walker further said that the balance sheets in the whole financial system in the West need to shrink.

Here is a verbatim transcript of the exclusive interview with Jim Walker on CNBC-TV18. Also watch the accompanying video.

Q: What do you make of all this excitement around the bailout package? How much or how little would it matter finally?

A: It is a question of about USD 64,000, and unfortunately, this is almost like a game of Poker that takes us hold on where the Treasury and the Federal Reserve have put everything into the pot. If they don't win on this one, then there is nothing left in the armoury that is going to calm fears or change the course of this horrible recession.

Personally, I am not that hopeful for the rescue package, because there are far too many questions unanswered about how the banking system will cope with the giving the assets that are bad to the new agency resolution trust. There are going to be far too many write downs for the banks to cope with, and their balance sheets are just going to shrink anyway. Warren Buffet, probably, said that nothing is going to stop us from a recession, and in fact, it is probably going to be a significant one, a lot worse than that.

Q: Does it do anything to address the most immediate concerns of a credit freeze in the system and this intense deleveraging that we have seen through last month?

A: The problem with the package is that it really does not solve the solvency problems of some of the players in the banking system, whether it is in the US or in Europe or indeed maybe elsewhere.

Hence, there is a complete freezing of activity in the money markets and the debt markets. Nobody wants to deal with anybody else. Certainly, the players--be it Bernanke or Paulson--haven't explained the Congress that it will take months to set this thing up and then it will take months to negotiate the prices of the assets. In the meantime, the systems has frozen and there is nothing really that they can do about it. They are beginning to trying pump some new money into the markets via the Fed facilities.

To be honest, nobody is dealing with anybody else, the trust in the system has completely broken down and what will really happen, I am sorry to say this, is the only way that people have to go bust, banks and financial companies have to go under in the US. The money that is with those bad institutions, ones that can't survive, has to go to those remaining which will make them much more solid and trustworthy. Subsequently, people will start dealing with each other again. It is this uncertainty about who is going to fail next that is the real problem and by not allowing anybody to fail they won't get rid of the uncertainty.

Q: The other fear is the way this has started spreading. This week the big concern was how the same story was cropping up in many parts of Europe as well?

A: It is a surprise that it has taken so long to get to Europe. The European banking system has been financing itself on an average to a much greater extent than the American banking system.

When one looks at some of the numbers of shareholder equity to assets, one finds that some of the European banks have 40-50-60 times assets to capital; whereas, that of the American and some of the ones going bust have been 20-30 times. So, there is no surprise that Europe is now beginning to shudder to hold in terms of its banking system and lending between the banks. It is going to have a bigger shake and a bigger consolidation process to go through than the Americans. The real problem there, of course, is that one is dealing with different national banks or may be an European Central Bank that runs monetary policy in Europe. But the regulators of each of the national banking system are still the national banks--the one's who are left, who got left as regulators of those systems.

A number of decisions are going to be made in Europe that is going to upset the apple carts. The one that people are talking about at present is Ireland where they have guaranteed all deposits in the system, and of course, there is money flocking from the rest of the Europe into Ireland now. These people don't know what they are doing, but it is causing more and more problem within the European banking system and there is a long way to go there.

Q: What do you expect the regulators to do once this bailout package comes through? Do you think they will have to throw more to bolster sentiment such as cutting rates across the board by the Fed and the European Central Bank (ECB)? Do you think that is next and what difference would it make, if that came through?

A: Next the interest rates will fall, probably, quite sharply. Obviously, the US has less to play with as compared to Europe. But, I would certainly expect Europe to be cutting interest rates in the next two to three months, probably each month. The US forecast has been of 1.5 per cent by the end of this year and may be 1.5 per cent by the end of this month. The reason for that is to make the yield curve steeper.

The yield curve gives the banking system the ability to borrow at the short end for very little money and very low interest rates and lend to the government, the treasury bills, treasury securities at the long end. That is the only thing they can do. It is a long process of recapitalization and the earnings going up from that pure yield curve play. Indian banks know this very well. The State Banks in the past had used yield curve in India to try and get themselves out of the trouble, and it has taken them several years to do that.

Now, the US banking system and the European banking system have to go through the same process. Unfortunately, there is not a very steep yield curve, and that is whey they will cut at the short end and that's the good news from cutting interest rates. It doesn't help the economy, it just helps the banking system.

Q: While this bailout drama plays out, the macro numbers continue to be fairly weak in the US, though the last couple of quarterly GDP (gross domestic product) numbers have been positive from there. By when do you think we start hitting negative numbers and how long do you see that phase lasting, of the reported recession?

A: The macro monthly numbers have turned in pretty sharply in the last couple of months. So I would expect that the first negative GDP number will probably come in this month in the US when they will release the Q3 data. Then again we will have a Q4 negative number as well.

There is a stark contrast between the GDP numbers and the national income data in the US. National income includes profits and if one looks at the profit figures in the US, he will find that for the last three quarters the US economy has been doing badly. All I would expect now is that the GDP numbers begin to confirm what has come through in terms of corporate profitability.

Certainly, I would expect the next two negative quarters to continue through most of 2009 and we will be looking at much weaker economic growth in 2008 and 2009.

The yield curve is actually signalling, at the moment, a weak recovery in 2010 which is a positive aspect. However, 2009 will be a horrible year.

Q: How long do you think the entire financial mess will take to clear up. At one point when there was news coming on Fannie Mae and Freddie Mac, WaMu (Washington Mutual) and Merrill Lynch, it almost seemed like it was a purgatory phase and things might be getting on the mend, you do not agree with that, do you?

A: No, the balance sheets in the entire financial system in the West basically need to shrink. That takes a long time. We have seen it in Asia, not so much in India because it was a very different economy in 1997-98 from the rest of East Asia.

East Asia has gone through a process of deleveraging over the course of the last ten years. Japan has done that over the last twenty years; hopefully, it does not take us as long as Japan but if East Asia has anything to go by then we are really in, at least, five-seven year process in the US and Europe.

That does not imply that the economic growth will stay negative for five-seven years. It just means that it is probably going to be significantly less than what we experienced in the last ten years, certainly below trend and that will be painful for everybody. However, the deleveraging process really takes a long time, it is not done overnight.