By Andrew Barber, Director
Research Edge LLC
The year has seen the major Wall Street banks squander generations of work spent building the trust of investors globally. Now the contagion is spreading.
Yesterday I spoke with a friend of mine who is a successful wealth manager in Greenwich. This friend is a savvy investor who has built a successful practice. When I called him he told me that he had gone to the bank where he keeps his personal saving and checking accounts and withdrawn funds to spread around among other institutions because he was paranoid about having his liquid cash accounts frozen in case his bank failed. This is a rational and informed person that I am describing who is almost at the point where he would rather bury his savings in a jar in his backyard than keep it in a bank. This represents the total markdown of the greater US financials system’s largest intangible asset – trust. Reserve Primary, the oldest money market fund in the country, had to take a big markdown on that asset today when they broke the buck and sent more people like my friend scurrying to the bank to withdraw their life savings.
The US does not have a monopoly on trust. As we all know, doing Business in China is impossible unless you have a partnership with a local firm. We talked about the potential dangers of Chinese JVs repeatedly in the first half of this year as companies like Danone and Caterpillar wrestled with bad Chinese marriages. None of the problems they experienced compare with the complete betrayal that Fonterra is feeling today. Fonterra is a 43% owner of the Sanlu group –a company that used a dangerous chemical to make baby formula. The allegations are not that this is an accidental situation caused by a mistake at the factory –this is believed to have been a heinous, deliberate decision driven by greed that has caused at least 6,200 infants to suffer kidney damage and at least 3 to die. Imagine waking up to find out that your business partner was poisoning babies. By the way; some of the early reports that came out from the Chinese media (the government is now reportedly controlling coverage now to avoid panic) mentioned that some families of sick children were pursuing legal action. Welcome to the newest consumer trend in China: litigation. It’s global this time.
The commodity markets are not immune from this crisis of trust either. Today at 1 PM the EIA will release crude oil stock data. Everyone in that market, already on edge over the fighting in the Niger delta, will be watching closely to see how much Ike disrupted supply. The data that is reported today will be the first report drawn from surveys conducted after it was announced that the CFTC is investigating whether energy firms have been supplying false inventory data to manipulate the markets. We will have to wait until the regulators finish taking depositions from more traders to see if any charges are filed –but the shadow of doubt has already been cast. How can you trust the fundamentals if the data is corrupt?
AIG has shaken my trust in my own judgment of risk. I regarded AIG’s derivative trading subsidiary, AIG Financial Products, as one of the greatest firms to ever operate in the risk markets. I have personal friends and trusted business associates there -people who are, without doubt, some of the most intelligent and honorable people in our business, period. With a massive “double-triple A” balance sheet as a foundation and an awesome concentration of intellectual firepower, AIGFP was THE counterparty of choice for the largest institutions on earth as they sought to modify their market risk. They could do trades for bigger size, in more markets and for much, much longer duration than any other player in their markets. At some levels they WERE the market. From pensions and endowments executing index swaps to bulge bracket investment banks lying off equity volatility –the success of AIGFP’s derivatives team in winning trust hardwired them directly into the US financial system’s central nervous system. I implicitly trusted any derivative contract they guaranteed as being safe as, well, milk.
So that is the question I find myself asking today is: who is left to trust?