Deleveraging

This a follow-up on my last posting on deleveraging. Like many others(professionl or amateur investors), I've underestimated the potential problems of deleveraging. I thought the problem was not that big because we are talking only about US 1.5 trillion sub-prime problem. Ripple effects of this US $ 1.5 trillion is truly amazing as it already brought down many countries to its knees - Iceland for example. The so called decoupling economy where Hong Kong is tied to China can have bank runs, this is truly terrifying. You won't believe Malaysian and Singaporean governments have to step in to tell everybody their money is safe.

The world has been way over-leverage but now that the tides go the other way round - unwinding - is not something that we should take it lightly. That is the reason why I turned so bearish for the last few months.

An article by Bill Gross of PIMCO who understands leverage better than anyone is posted here.

Almost always – but not now because in a global financial marketplace in the process of delevering, assets that go up in price are rare diamonds as opposed to grains of sand. For the past several months our PIMCO Investment Committee blackboard has continued to display the following lesson plan:

What Happens During Delevering

1. Risk spreads, liquidity spreads, volatility, term premiums – they all go up.
2. Delevering slows/stops when assets have been liquidated and/or sufficient capital has been raised to produce an equilibrium.
3. The raising of sufficient capital now depends on the entrance of new balance sheets. Absent that, prices of almost all assets will go down.

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/Investment+Outlook+Bill+Gross+Sept+2008+Bull+Market.htm

When Warren Buffett steps in to buy companies like Goldman Sachs, he who understands a lot about institutional investors psychology would have weighed the possibility of deleveraging would create extremely profitable buying opportunities. By putting money where the mouth is - equities - he would have reached a conclusion of probability of bankers/governments put-off this fire is relatively high. Or will this be a Waterloo for Warren Buffett just like Napoleon who fought many great wars and battles ?