Credit is a single question — and the world spent ten years not answering it

What happens if you do not pay? Everything in credit exists to answer that question before it is asked; 2008 is what happens when the answer is an acronym.

The world's interbank market has frozen. Banks will not lend to banks, not even overnight, not even at a premium. National treasuries pour in trillions and the money does not circulate. The hurried reader concludes that the money ran out.

The money did not run out. What is left over is fear.

Everyone is hunting for culprits: subprime, the agencies, greed, the acronyms. Culprits are a consolation; mechanisms are an education. I prefer the mechanism, because it is simple enough to fit in one sentence and old enough to have no owner.

Credit, reduced to its essence, is a single question: what happens if you do not pay?

Everything humanity has invented in the matter of debt is a way of answering that question before it is asked. Collateral answers it. The covenant answers it. The tenor matched to the cash flow answers it. The pledge, the mortgage, the lien, the guarantor — each institution is a piece of the answer, written and registered while the parties are still shaking hands.

The world spent ten years answering with an acronym.

The American mortgage was packaged, sliced, repackaged, and stamped by an agency paid by the issuer itself. At the end of the conveyor belt, nobody knew what was inside the package anymore — only the stamp was known. When someone finally asked the original question, what happens if the borrower in Cleveland does not pay?, it turned out the answer had been outsourced, and the outsourcer had no answer. It had an opinion.

A rating is a rented opinion. Collateral is a registered fact.

The current panic is the difference between those two things being priced all at once, after a decade of grace period. Trust died worldwide in six weeks. Notice, however, what did not die: the collateral. The house in Cleveland is worth less, but it is worth something, and whoever holds the registration forecloses. Whoever holds the acronym waits in line, behind the lawyers, to find out what exactly he owns.

In every credit crisis in history, the same selection: promise turns to dust, fact turns to price. Whoever lent against opinion lost sleep. Whoever lent against real assets, with a margin, lost only the vanity of having earned less during the euphoria.

Brazil, which was watching from the box seats, has just discovered it was in the audience all along.

Sadia and Aracruz — admirable operating companies, exporters, with decades of industrial competence — announced billions in losses on currency derivatives. They were selling a structure that yielded a small premium while the dollar fell and charged an unlimited bill if the dollar rose. The dollar rose. The treasury desk became a casino and the board found out about the game through a material fact notice.

It is the same American mistake, in the mirror. Nobody at the table could answer the question what happens if the dollar rises? — and they signed anyway. A structure the management cannot explain in one sentence is not a hedge. It is a liability in revenue's costume.

Meanwhile, commercial credit dries up. Export credit lines have vanished, the Central Bank releases reserve requirements by the tens of billions, and the small entrepreneur — who has never seen a CDO in his life — pays for the panic of the big ones in the price of his working capital. Brazilian credit, which was already expensive by habit, became expensive by terror.

What would I do this October?

I would hold liquidity the way one holds ammunition, not the way one holds fear. In a panic, liquidity is the only ideology. Crises of this scale transfer wealth from those who need to sell to those who can wait, and the line of those who need to sell is only beginning to form.

And I would lend — yes, lend. This is the moment when whoever has capital and knows how to ask the right question does the deal of the decade. Lending against real assets, with a panic discount on the appraisal and the answer registered at the notary, has never been as well paid as in the weeks when nobody lends anything. The premium on other people's fear is the most honest of revenues: one charges dearly for having done the homework the whole world postponed.

I would not buy the promise that this will never happen again. They will regulate acronym by acronym, committee by committee, and the next excess will change its name, because excess always changes its name. The question will not. The question has been the same since Mesopotamia.

Credit will come back. Credit always comes back; civilization does not run without it.

But notice how it will come back: asking for collateral, reading the flow, matching the tenor, registering the answer. The credit that is reborn from a crisis is always reborn more structured than the credit that died in it.

Whoever learns this now, with other people's money, will not need to learn it later, with his own.

Leo Bentier