more pain to come, page-8

And a panel of experts assembled by PM says the worst is yet to come.

Satyajit Das is a renowned risk analyst and author. More than a year ago, he predicted that massive investment in risky debt would cause a global credit crunch.

Warren Hogan is the head of market economics and strategy at ANZ, and highly regarded for his insights on the troubled debt markets.

Their pessimism differs in degree. But both believe the problems have only just begun. And they fear that efforts by the world's central banks to unlock the frozen credit markets could cause a dangerous outbreak of inflation.

They spoke to economics correspondent Stephen Long.

STEPHEN LONG: Gentleman, thanks very much for joining us.

This week alone we've seen the problems with Centro. Today, a $US9.5-billion write-down by Morgan Stanley, and that brings on my calculation, the total write-down on the books of the big investment banks to about $US90-billion. How concerned should we be?

We'll start with Satyajit Das.

SATYAJIT DAS: I think it's like the old Carpenters’ song, ‘it's only just begun’. I think the estimates keep going up, and I think we'll see more losses emerging early in the New Year.

STEPHEN LONG: You don't believe the reassurances of people who are saying, now that the big investment banks of the world have written-down so much, well it's pretty much all out there.

SATYAJIT DAS: I think there will be certain elements that have been written-down, which is sub-prime. But I think there will be other areas through to 2008, which as we've seen this week with Centro, which would be problematic, which is people who have short-term debt which needs to be refinanced, that will prove to be problematic in 2008.

STEPHEN LONG: Warren Hogan, what's you're view on that?

WARREN HOGAN: Well, $90-billion is only a part of the way there. Most of the estimates that I've seen have the number at around $400 to $500-billion, and it's not just sub-prime. Sub-prime may be a good proportion of that, but there's problem associated with the funding of SIVs, there's the problems related to CDOs (Collateralized Debt Obligation), there's the problem associated with the asset overhanging MNA. So, we've got a lot more bad news to come out of this system, and I agree, I think it's going to take sometime.

STEPHEN LONG: Those SIVs, Structured Investment Vehicles, off the balance sheets at the major banks, that seems to be one of the big worries. There's just so much debt and toxic stuff in those vehicles that the big investment banks set-up off their own books and are now having to take back on - to some extent - on to their books because they gave investors implicit or explicit guarantees that they'd back those funds.

WARREN HOGAN: Yeah, and the investment strategies, actually, are now turned around. It's no longer economic to be running these operations because they can't attract the capital at the same rate as they once did. And it's, the real problem here is not so much the sub-prime assets, the assets there, there is a credit quality…

STEPHEN LONG: The mortgages, yep.

WARREN HOGAN: Yeah, there's assets in there, that are of good credit quality, but that no-one wants to own them. And that gets to the heart of this matter is that we've had a debt boom, or some might say, a debt bubble. We've got more debt in the world than the world now currently wants to hold. And putting them back onto bank balance sheets isn't that easy because that puts bank capital under pressure.

STEPHEN LONG: Satyajit Das, what does the unwinding of that debt bubble imply?

SATYAJIT DAS: I think we've got to put that into perspective. Banks are basically moved a lot of assets off balance sheet over the last 15 years. They've also reduced their own capital basis in that process. That means they don't actually have to finance these assets, but also they don't hold shareholders funds against them.

By my estimate, between $1-trillion, that $1-trillion and $2-trillion of assets are in the process of returning onto bank balance sheets. Which means, number one, the banks have to find the cash to fund it.

Number two, they now have to hold regulatory capital against that. So, I think the world is going to be SIV positive, and there ain't too many retro-viral drugs around, that would cure this, at least in the short run. And I think people are being grossly irrational and assuming that this problem will be dealt with in a matter of months. It's a matter of years.

STEPHEN LONG: Those issues that we've discussed, imply that it's going to be very, very difficult for the world's big investment banks who really greased the wheels of capitalism by providing finance, to provide nearly as much finance as they have. But the central banks have been working on a cure, auctioning off hundreds of billions of dollars in cheap loans, to big investment banks, to try to free up the credit markets. Warren Hogan, do you think that that will work?

WARREN HOGAN: So far, it is working in the sense that we're seeing a liquidity squeeze in markets and not actually a credit crunch. And a credit crunch will imply a slowing in the flow of credit into the real economy, which will have very, very powerful repercussions for the broader economy, and of course, that's when people will start to recognise there's problem when that happens.

So, I think it's achieving its end of keeping the system ticking over. But there are a few issues around this. One is, can you keep doing this forever? Is it slowing the process of adjustment, ie: is it preventing the ultimate, sort of, reckoning and the ultimate adjustment that has to happen. And I think also from a monetary policy point of view is this about printing money. And of course the concerns around inflation at the moment suggest that's not an appropriate way to go about policy.

STEPHEN LONG: Indeed, we've got a risk of stagflation. Perhaps, you might call it, stagflation-light in the economy at the moment, haven't we, globally?

WARREN HOGAN: It's looking very much like that. Where a slower world economy is in the bag, it's a degree of slow-down that we're going to see, and I think it's going to take some time to ascertain when the worst of this hits the real economy.

But there will be a slowing in the rate of credit growth in the global economy, because we are unwinding a debt boom. And then there is inflation out there too. And the inflation, what we don't know, is whether the inflation, inflation problem will go away, if the economy slows. I suspect that's the case, but in the next six or nine months, it's going to look very much like stagflation.

STEPHEN LONG: Das, do you think that the intervention by central banks is going to work?

SATYAJIT DAS: I'm hugely amused to here that it's working because the same central banks, who are now doing this, the central banks who less than six months ago, was saying there was no problem, then the problem was contained. And since that time, they have launched a myriad of initiatives, none of which are going anywhere.

The fact of the matter is, just pump priming and pushing money into the banks is not going to help. It's like a giant tank. You're pouring water in one end, the problem is, the actual flow of money from one bank to the other and into the real economy, as we've seen with Centro this week, is essentially just about seized up.

But I think the central bank agenda is a different one to the one that's been discussed. The central bank agenda in my view is absolutely clear, they're going to basically print money, they're going to create inflation, because in an inflationary environment, the debt burden that the world has built up, becomes cheaper to actually service. And secondly, what they're trying to do, is essentially create inflation to bring asset prices down in real terms. That is the real implicit assumptions in the actions that they've taken.

STEPHEN LONG: You'd never hear any central banker in the world admit to that.

WARREN HOGAN: Well, I think the best comment I can say is Emperor Hirohito's comment upon the nuclear bomb exploding over Hiroshima. He's comment was that “the war situation had not developed necessarily to Japan's advantage”. And I think the central bankers are much in the same boat.

STEPHEN LONG: Warren Hogan, you agree?

WARREN HOGAN: I'm not quite sure that it's an implicit. I think there's risk. The central banks of the world are convincing themselves that this isn't printing money because the term on which they're providing liquidity have finite endpoint. They'll take that money back out, eventually, but the problem with the assumption that you can take it back out is, is that the system is adjusting and is improving, and of course, it's now six months after this emerged, and it's not.

STEPHEN LONG: It's patently not. So, how bad is it going to get next year?

WARREN HOGAN: I think the issue is all around bank balance sheet adjustment in the big global banks, and for the macro economy, for their broader system, it's all about whether or not we see a genuine credit crunch emerge. That is, the flow of credit into the real economy stops in a genuine way.

SATYAJIT DAS: I think there's going to be a series of knock-on effects. We've obviously been talking about sub-prime, we've been talking about some of the leverage finance, the private equity loans, the merger in acquisition loans, but nobody seems to be talking about other things which will happen and unfold over the first six months of next year.

Great Britain, Ireland, Spain, Australia, all have similar problems in real estate. And so those problem will come to light. So, I think we're going to be waiting for a whole lot of other shoes to drop, the problem here is, those shoes seem to be coming from the Imelda Marcos collection.

STEPHEN LONG: Hell in a handbasket by the sounds of it?

SATYAJIT DAS: Perhaps.

STEPHEN LONG: On that note, that gloomy note, perhaps I should wish you chaps eat, drink and be merry, have a good Christmas, because we may not be in position to next year?

SATYAJIT DAS: Let's party like it's 1929!

WARREN HOGAN: Thank you very much, Stephen.

BRENDAN TREMBATH: Warren Hogan of ANZ and the risk analyst Satyajit Das with our economics correspondent Stephen Long.