Zombies prowl the basement of recovery

Many of the factors that led to the global financial meltdown are still lurking to haunt the recovery. Photo / Herald on Sunday

The journey to global recovery from credit crisis looks well under way.

Economies from Hong Kong to Germany to the United States have popped out of recession. Consumers everywhere seem a bit more confident. Central banks are starting to hint at ways to unhook the financial community from the life support of liquidity and quantitative easing.

All that remains, dear investor, is to get through the shopping mall. Unfortunately, the basement is still crawling with zombies, and the chances are that they will find their way out in 2010 while you are trying to navigate your way to the fields of prosperity. Here are some of the risks you'll be running next year:

Bond Vigilantes Neutered, Rating Companies Search for a Spine: Government bailouts mean risk has flowed to public finances from private banks. Increased risk typically means lower ratings and higher borrowing costs - except debt markets are distorted. Central banks are buying their own Governments' securities and commercial banks are repairing their balance sheets, to the point where even the most watchful bond vigilante will struggle to punish miscreant borrowers.

If the bond market can't send a message, the rating companies should. Greece got downgraded this month; Standard & Poor's revised the outlook on Spain's debt to negative. Bigger, higher-rated countries might be next.

Investors may learn the hard way that it isn't just collateralised debt obligations and structured finance products that can have top AAA credit ratings one day and something lower the next. Last week's statement by Moody's Investors Service that deteriorating finances in the US and Britain may "test the AAA boundaries" should be a reminder that lending to the US Government for 10 years at 3.4 per cent interest and to Britain for 3.7 per cent might not be your smartest trade.

All Quasi, No Sovereign: The word "quasi" means "kind of; resembling or simulating, but not really the same as", says the Oxford English Dictionary. So in many cases - perhaps all - using the designation "quasi-sovereign" to describe borrowers perceived to be a smidgeon more risky than a country is about as helpful for assessing creditworthiness as a chocolate teapot is for brewing a hot beverage.

That's the lesson from the Dubai debacle, where lenders are learning that just because a company is state-owned doesn't mean its bondholders can access the state's coffers when it's time for debts to be repaid. "Queasy Non-Sovereigns" might prove a better classification for some of that higher-yielding debt you were tempted to buy.

The New Normal May Prove Neither New Nor Normal: The phrase coined by Pacific Investment Management to describe the post credit-crunch economy is catching on; even Bank of America Merrill Lynch adopted "The New Normal" as part of the title for its 2010 outlook report.

Conditions, though, are still far from normal, especially with central banks in the US, Europe and elsewhere keeping interest rates at record lows in an effort to stimulate borrowing and stoke their economies. The new normal might turn out to be the old business-as-usual: boom-bust economies, bubbles everywhere and a reawakening of the inflation monster.

You Can't Stand Under My Umbrella: Anyone hanging on to Greek Government debt in the belief that the euro region would not let a member state get into trouble on its debt payments doesn't understand the Bundesbank.

Buy Greece because you think its bonds are cheap, or its stockmarket has fallen too far, too fast, or because you trust the Government to get its finances in order. Do not, though, depend on the euro umbrella to protect your investments; there is no joint and several guarantee among the common currency members.

Securitisation's Snake-Oil Salesmen are Back: The financial authorities appear to have missed a golden opportunity to force transparency on the securitisation market, where different kinds of debt are bundled together in packages that can be sliced, diced and resold.

Central banks have been the only buyers of such debt for months, after the subprime crisis revealed the toxicity of what lay beneath the misguided AAA ratings slapped on many asset- backed securities. As lenders of last resort, the Federal Reserve, the European Central Bank and the Bank of England could have forced the banks they funded to start giving granular detail on every individual loan being securitised.

Such strictures would have bathed the market in the antiseptic of sunlight. Instead, yield-hungry investors are again willing to buy bonds without proper access to details about the underlying assets. It's not too late. Central bankers, though, will have to move swiftly if they want to change the securitisation game before it's too late.

Bad Losers: The banking fraternity needs to stop moaning about how unfair it is that it can't award gargantuan bonuses now that the taxpayer has underwritten the global financial system.

Bankers need to shut up and take their medicine, otherwise the nurse is likely to spank them even harder - witness the announcement that Britain will impose a one-time 50 per cent tax on bonuses over above about $56,000. Calling such measures populist doesn't change the basic truth that Governments are itching for revenge and banks are soft targets.

- BLOOMBERG