Credit Crisis Goes Globetrotting

Greed and misjudgment know no borders.
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This blog post originally appeared on RealMoney Silver on Sept. 14 at 7:57 a.m. EDT.

If risk continues to be underpriced, the next period of turmoil will be on an even bigger scale. The provision of such liquidity support undermines the efficient pricing of risk by providing ex post insurance for risky behavior and encourages excessive risk-taking and sows the seeds of a future financial crisis. If we had from the outset allowed two or three of the least-respected names to collapse in a flurry of publicity with losses to their depositors, it would have served them right and would have acted like a quick piece of surgery on the City, cutting out the canker and enabling the rest of us to continue the more easily with our normal business.--Bank of England Governor Mervyn Allister King (in written testimony to the British Parliament's Treasury Committee yesterday)

He is talking about the broadening universe of hedge funds, mortgage companies, investors/speculators in homes and financial intermediaries that, through a strategy of borrowing short and lending long, have abetted the boom in housing over the past decade. Many of those, in the process, have wangled a government bailout in order to continue expanding their business or for the purpose of staying solvent.

It seems that every day another poor-decision maker in the U.S. is getting short-term funding from the

Fed

or is being considered a beneficiary of legislation that will revive their financial well-being.

This is not only a domestic, U.S. phenomenon.

Greed and misjudgment knows no border.

Across the globe, disclosure of poor corporate stewardship is also being rewarded with assistance by government entities. Yesterday, Northern Rock, one of England's largest mortgage lenders,

received funding

(either through secured borrowings or repurchase facilities) by the Bank of England. (

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Surprisingly, this rescue came after the Bank of England Governor King denounced bailouts in a

paper

he published in preparation for a Sept. 20 Treasury Committee meeting.

From my perch, market participants and commentators overreacted to a slight reduction in the Libor rate and a slowing in the contraction of the commercial paper market, contributing to a view that the credit crisis would soon wane.

Yesterday's optimists will likely be proven wrong as the workout of the credit

unwind

will be a multiple-month process -- maybe longer.

The credit market unwind's most important impact in the quarters ahead will likely be felt in reduced hiring and delayed business investment.

This week's ISI Group surveys -- trucking and shipping (a new survey low), U.S. CFO Diffusion Index (Fuqua), U.S. Small Business Optimism Index, the North America Business Confidence Index, U.S. CFO Employment Expectations (Fuqua), U.S. CFO Capital Spending Expectations (Fuqua) and U.S. Small Business Trends (NFIB) Capex Plans -- all point to multiyear lows in confidence and are supportive of a marked slowdown in business spending.

Meanwhile, the same domestic trends are being seen in surveys in Europe and Japan. The latter is particularly discouraging as the Japan Consumer Confidence Index (ESRI) and Japan Business Confidence Index (ESRI) were the most negative in almost three years in light of "declining wages and financial market turmoil" and a "much weaker-than-expected second-quarter 2007," according to a report.

All these factors help to explain why I believe the future prospects for tech spending have been greatly exaggerated and why I have recently stepped up my technology shorts.

In summary, I expect the credit unwind to continue well into 2008, serving to have the effect of adjusting consumer and corporate spending downward. Not only does this portend a reduction in economic and corporate profit growth expectations, but the odds of a recession are rising daily.

While many are now just beginning to realize that a surplus of cash has led to a shortage of common sense in the credit markets, few seem to recognize how long the unwind of credit will take and how bad the collateral damage might be for the world's equity markets.

Finally, as the above deterioration in economic activity becomes increasingly clear, the issue of

moral hazard

will begin receiving a great deal of debate over the weeks ahead.

At time of publication, Kass and/or his funds were long QQQQ puts and short QQQQ calls, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.