Kaletsky still doesn't get it

At an early stage of this summer's financial crisis (30 July to be exact), I wrote about the confidence of the big beasts of economic punditry in the UK that the whole thing would blow over without any serious impact on the real economy. I suggested that it was much to soon to be sure about this, since banks always react to old loans going bad in the same way: they stop making new loans.

One of the big beasts I named at that time, Anatole Kaletsky, has continued to write about the crisis on a regular basis. He's been careful to abide by one of the main rules of punditry: express every possible opinion at least once, so you always have a helpful quote to fall back on. Without parodying his views too much, I'd say he's gone from "crisis, what crisis?" to "there wouldn't be a crisis if market participants were as smart as A. Kaletsky".

So when I opened the biz section of today's Times and found a Kaletsky piece called "Summer crisis will change things forever", I thought that his Damascene conversion was finally complete. I was wrong: after a few swipes at the Bank of England, Kaletsky gets to his main point -- which is that the hedge funds done it: "The question that nobody bothered to ask was how the managers of hedge funds and SIVs could provide this desirable combination of liquidity and safety, while still paying high returns and pocketing very handsome fees for themselves." Speak for yourself, Anatole. Quite a lot of people (including, no doubt, many within the hedge fund sector itself) were asking that question years ago, and managed to resist the temptation to invest there.

But hedge funds' fee structures, obscene as they may have been, are SO beside the point. The issue now is that these funds took on enormous amounts of structured product -- CLOs and CDOs and all that stuff, prime and non-prime. Their appetite for it was so huge that a lot of investment banks turned into sausage machines, churning the product out at ever-increasing rates.

As interest rates have risen, the credit quality of the sub-prime stuff has come into question, particularly in the US. Hedge fund investors are asking for their money back, so the managers are having to liquidate assets -- or to put it another way, they're selling the CLO and CDO product back to the banks that originated it. In fairness to Kaletsky, he recognises this, but stops short of drawing the important conclusion: the need to fund this tidal wave of product that is falling onto the balance sheet is putting a strain on the banks' own liquidity, so they're not making any new loans, least of all to each other. In today's highly credit-driven economy, this is all but certain to lead to big problems.

I wouldn't be surprised if hedge fund fees become a matter for a huge class action lawsuit once we get through the present crisis. But that will be a luxury we can enjoy in a quieter time. For now, the huge rollover of commercial paper in London this week and the possible unwinding of the Yen carry trade are much more pressing concerns.