The credit crisis blew up eight years ago next month. The European Central Bank was forced to inject €94.8 billion of emergency funds into the money markets after several institutions admitted they had suffered significant losses on credit-related investments.
At the time, it was said to be the first financial crisis fought via BlackBerry from the beach. The electronic handsets had become the essential accessory to keep investors on their summer breaks in touch with the unfolding crisis.
Today, credit is the area where some predict the next crisis will originate, as money has poured into illiquid fixed-income assets in corporate and emerging market debt. In other words, there may be a repeat of 2007 when investors struggled to liquidate assets in markets where it is difficult to sell, except at fire-sale prices.
Morgan Stanley, the investment bank, and Oliver Wyman, the consultancy, wrote in a recent paper that the impact of less liquidity has been masked by benign, ultra-low interest rates. When they reverse, this could reveal the side effects of quantitative easing, which has pushed investors into less liquid securities.
This rate reversal is fast approaching. In last Wednesday’s testimony to Congress, Janet Yellen, chairman of the US Federal Reserve, suggested 2015 may be the year for rates to rise from zero, where they have been stuck for the past six years.
The Bank for International Settlements, known as the central bankers’ bank, said last month in its annual report that, given signs of the build-up of financial imbalances in several parts of the world, there is a troubling element of déjà vu.
It said the fundamental question is whether asset managers can take over the intermediation functions banks have shed. Financial institutions’ success in performing such functions depends on their capacity to take temporary losses in their stride.
But this capacity has declined in the asset management sector, where retail investors have been replacing institutional investors as ultimate risk bearers.
Yet, despite the warnings, some fund managers and pension schemes are sanguine. Institutions such as the CPPIB, Canada’s biggest pension fund, and asset management groups such as Schroders, M&G Investments and a number of specialist credit funds are happily investing in illiquid assets because they provide higher yields than liquid ones.
They say they are genuine long-term investors and, therefore, not overly worried about short-term squalls in the market.
If the credit markets crash this summer, they say they can hold on to a lot of their assets rather than sell, as many have either been locked up or are subject to dilution levies, which investors must pay if they want to liquidate.
Mark Wiseman, chief executive of CPPIB, says: “Our quarter is 25 years, not 100 days.”
M&G Investments considers areas such as direct lending and sale and leaseback real estate as businesses ripe for good returns. As long as the lending is not leveraged too highly, then they are also not that risky.
Since 2010, M&G and other asset managers have moved into the direct lending space, filling the hole left by banks, which have pulled out of these markets because of regulations and capital constraints.
Risks in these markets have also been more evenly spread across the system as fund managers, unlike banks, do not have the loans on their balance-sheets. Additionally, banks are still there as shock absorbers as they have increased credit lines to some fund managers to help them provide liquidity in the event of crisis.
This summer, therefore, some bankers and investors might be able to turn off their BlackBerrys, or rather iPhones, while they sun themselves on the beach.
Even if a credit crisis does erupt, they might not be under the same pressure to sell as they were in 2007.
— Financial Times
