This month, Sergei Polonsky, one of Russia’s largest and most indebted property developers, is trying to prevent powerful western banks from calling in their loans.
But as his company, Mirax, battles on, he admits he is in a cognitive fog. “Frankly, everything is uncertain right now,” he told a gathering of bankers, business leaders and policymakers that I attended in Moscow this week. “We don’t know whether to cut any contracts in roubles or dollars, or something else. We don’t know what prices for anything will be, what demand will be, what our market will look like.”
It is a comment that reveals much about the way that finance is developing right now. In the past few weeks, policymakers and investors have scurried to make sense of the sharp decline in global economic activity.
In part, this can be blamed on a contraction in credit as banks get tough with their creditors. But the sheer speed of this slump and the fact it is occurring with surprising global synchronicity suggest that psychology is also to blame. It is not simply the fact that people are feeling gloomy; the really pernicious issue is extreme uncertainty – on almost every front.
The type of cognitive fog besetting Polonsky is quietly shared to a greater or lesser degree by millions of other enterprises round the world. And while the Russians are apt to joke that “we have had plenty of practice in our history with uncertainty” the sense of disorientation is a bitter psychological blow to western bankers and businessmen. After all, most of the west has spent the past decade cocooned in a climate so calm it was dubbed the “Great Moderation”.
In the financial sector, this cognitive fog is manifesting itself in two specific ways. First, the collapse of Lehman Brothers has created an extreme terror about counterparty risk. As fresh writeoffs keep mounting, financiers of almost any stripe are nervous about committing to long-term transactions.
Second – and equally crucially – financiers are finding it increasingly hard to engage in the market “hedging” strategies they used to employ to mitigate risk. Most notably, in the wake of the Lehman collapse, the pattern of deleveraging and forced sales has been so intense that traditional price relationships have completely broken down, sending trading models haywire. “You just cannot devise any trading strategy now on a concept of a reversion to the mean, and you cannot really hedge,” confesses the head of one large investment bank.
As the banking sector pulls in its horns, businesses are being tipped into a gruelling hand-to-mouth existence. In truth, plenty of banks are still extending loans and plenty of businesses are still placing orders with each other. But time horizons have collapsed. “Nobody wants to make decisions on anything,” one Swedish businessman told me this week.
Western governments appear to be fuelling, not removing, this sense of uncertainty. The Lehman collapse has sown a sense of terror about creditors losing money on any bank bonds they hold. The only way truly to remove that terror would be for the government to persuade investors that banks are so healthy they cannot collapse – or promise to protect creditors if they do.
But while the latter route was employed – to great success – by the Swedish government 17 years ago, it has not been endorsed by Washington yet. Instead, the US (and many European countries) are rolling out piecemeal solutions. Meanwhile, efforts to persuade voters that banks are healthy are failing to convince – mainly because there is still so much uncertainty about asset values.
So that leaves Mr Polonsky holding his breath. He says a few weeks ago Credit Suisse agreed to restructure part of his company’s debt, and that gets him off the hook. But the ratings agencies remain unsure and two have since downgraded Mirax. What happens next remains anybody’s guess, for Mirax, for Russia – and for the world more widely. No wonder markets are in such turmoil – right now that seems the only rational response to a once-in-a-generation cognitive fog.
