"Young girl with her Thanksgiving dinner"
Ilargi: Long day today, driving to Oxford to attend a Robert Prechter lecture, thinking Max Keiser would post a Stoneleigh interview, working on the Stoneleigh DVD-Rom that should be available within a handful of days barring divine intervention, and all that with only intermittent web access.
Funny to see that nobody talks about California or Illinois for a while, as Angela Merkel has grabbed the international media headlines with her solid bid to bring down the euro vs the USD through a series of carefully planned rumors and the stand and/or deliver execution of Ireland. It doesn't look like what happens in Ireland could have been avoided, the place looks more like Iceland every day, but you still feel to feel for the Irish people. Word is that the total bailout costs are moving towards the €200 billion level (their budget cuts are €15 billion), and that's for a country of 4.5 million souls.
Well, at least they won’t be alone in that predicament much longer. As in when California and Illinois will be in the spotlight again. Or Spain, which some have apparently suddenly figured out is also still as doomed as it always was. It’s not a bad thing to follow the news and fads of the day, but it's still not very wise to lose track of the underlying theme: no matter what bailouts and stimuli are concocted by those wishing to hang on to their seats and fat wallets, more debt doesn’t solve debt problems.
Debt always has to be paid down, restructured or solved through some combination of the two. For now, the negatives of both options are laid squarely on the shoulders of the people of the various afflicted nations, instead of on those of the folks who incurred the debt. It seems unlikely that this will continue much longer. Surely, there must be one nation where enough voices can come together to say: no mas?! So far, little action. Protests in Britain, Ireland, Portugal, but nothing anywhere near massive. Nothing that even seriously disrupts an economy or society.
I saw some footage early this morning on BBC that sort of says it all. The news presenters compared the student protest marches outside yesterday with those inside, some sort of sit-down. The latter were praised for being peaceful, the former derided for being violent. Which they weren’t really, there were just the odd few token people who threw stuff, a few among many thousands who just marched. And those few could easily have been paid to throw that stuff by the government. The message being that both the BBC and the government had rather see you sit in a room than march on a street. Much easier to control.
As long as we don’t escape that sort of controlled environment, nothing will happen. It’s all about the difference between a financial crisis, which most people continue to believe this is, and a political one, which it actually is. This crisis is entirely political because, for instance, politicians don’t protect their electorate from predatory institutions and practices. Because those predators are the ones who have the real political power (re: campaign finance). Because, see Ireland, banks and their stockholders are still being made whole on their losses, without restructuring, without haircuts, at the cost of the people. Who still have no clue what is going on. It would be a good thing if that would change. A very good thing. For you. For your children.
Where do you think the €100 billion or so -or more- involved in the Irish bailout ends up? This money is used to pay off the gambling debt of Irish bankers to global banks, to Deutsche, Société Générale, and eventually to the same Goldman Sachs and JPMorgan that are in the center of all these miserable stories all over the globe. That is what has to stop. And until that happens, it makes no difference who you vote for in your elections, no matter where you are.
And if anyone tells you it’ll all be alright, you just ask them what they suggest we do with the debt. Shoveling more and more into your own kids' graves doesn’t sound like a great idea, so why do you do it?. You’re not going to change this one with a sit-down protest.
Ireland unveils 'staggeringly austere' budget to appease EU
Ireland's government has set out a harsh and ambitious four-year plan to make €15bn in spending cuts and tax increase to bring down its record deficit, although financial markets remained sceptical. The Irish people will begin to feel the pain next year when 40pc - or €6bn - of the €10bn in spending cuts and €5bn in tax increases will happen.
The effect of the measures - required as the precondition for an EU-IMF bailout - will mean the average Irish household will have to pay up £3,000 in extra taxes. Brian Lenihan, the Finance Minister, said the tough measures were taking place against the backdrop of a slow economic recovery, with the Government forecasting the economy will grow by an average of 2.75pc in the years from 2011 to 2014.
However, financial markets had doubts about the plan with yields on 10-year Irish Government bonds widening. "It doesn't seem all that realistic to me," said Stephen Lewis, chief economist at Monument Securities. "It seems they're planning very stringent fiscal measures and yet they expect the economy to grow against that background. That seems highly unlikely."
James Nixon, chief European economist at Societe Generale, said: "It's a staggeringly austere budget, the cuts are deep and it will hurt. The main thing that stands out is that they still expect the economy to grow by 2.7pc over the next 4 years but it's hard to see how that can be true." All Irish households face a new £257 property tax from 2012. The plan outlined 24,750 public sector job cuts, a $2.8bn reduction in social welfare spending, and plans to raise an additional €1.9bn from income tax.
The minimum wage will be cut by €1 cut to €7.65 an hour, and VAT will be raised from 21pc-23pc in 2013, with a further increase to 24pc in 2014. Unemployment is expected to fall from 13.5pc to below 10pc over the four years. The government is continuing to talk to the EU and IMF about a bail-out package, expected to be worth around €85bn.
The EU wanted the Irish government to find savings worth £5bn next year. EU and IMF officials will police the plan and Ireland has been warned that if targets are not met then eurozone loans, totalling £72bn over three years, will be withheld until tax increases and spending cuts are ratcheted up. There was more bad news for Ireland this morning after Standard & Poor cuts its debt rating two points as contagion threatens to spread through the rest of the euro region.
Middle class Irish families face the loss of tax credits and low paid workers, totalling 50 per cent of the labour force, will start to pay taxes for the first time. The current entrance level for income tax is £15,506 for a single person and £27,071 for a married couple with children, thresholds that will rise over the next four years. ”It appears that the day of reckoning has arrived,” said David Begg, head of the Irish Congress of Trade Unions. “The Barbarians are at the gates.”
Irish children 'to be hit by IMF plans'
by Press Association
Thousands of children will be hungry and cold if the Government rolls out cost-cutting plans signed off by the International Monetary Fund (IMF), it has been claimed. A leading children's rights campaigner warned any cuts in social welfare payments or the minimum wage will directly affect underprivileged youngsters across the country. Fergus Finlay, Barnardos chief executive, called on politicians not to agree to any plan that will plunge households further below the breadline.
He said: "There are thousands of families in Ireland who live at or below the poverty line. That means there are thousands of children below the poverty line. Those children are hungry, cold and at risk of ill health because they live in damp unheated houses. I can't think of a single good reason to make things worse for those children." On Monday, the IMF issued an academic paper, signed off by lead negotiator in Dublin Ajai Chopra, that minimum wage and dole payments should be cut.
Meanwhile, embattled Taoiseach Brian Cowen and his Government are finalising a 15 billion euro four-year savings plan to be published on Wednesday. Social justice campaigner, Fr Sean Healy, claimed the IMF's approach intended to save banks and big businesses while targeting the weak, poor, sick, unemployed and marginalised. He said: "These proposals are tailor-made to make sure the working poor group will be in deeper poverty."
Fr Healy maintained proposals to cut social welfare payments to make people go back to work were nonsense and added: "What jobs are they going to take up? There are 450,000 people unemployed. The jobs are not out there." The Society of St Vincent de Paul maintained people on social welfare and low wages should not have to pay the price for Ireland's economic woes.
'Ireland was just one big pyramid scheme'
by Emma Rowley - Telegraph
"A sticking plaster over the open wound in the eurozone", was the judgment from Ireland's finance workers as their Government revealed a €15bn (£12.7bn) package of cuts. Much of the four-year plan – or the "IMF/EU directive, they signed it off", in the words of one Dublin trader – had been leaked ahead of Wednesday's announcement. As expected, the income tax base was widened, the minimum wage was cut €1 to €7.65 and Ireland's much-vaunted corporation tax rate stayed at 12.5pc.
Dealers in Dublin were combing through the 140-page plan for nuances that could affect their positions, but saw no major surprises – or cause for cheer. No one views the redoubled efforts to cut Ireland's deficit, which stands at about 12pc of GDP even without factoring in the costs of propping up the banks, as drawing a line under the eurozone's debt crisis. "I think the markets have moved on," said Alan McQuaid, economist at Dublin stockbroker Bloxham. "From Ireland's point of view, the plan is ambitious but not impossible. But a lot of it is out of our control, so we've got to wait and see what will happen."
A canvas of views in Dublin's financial district revealed similar concerns. Cafes and restaurants around the International Financial Services Centre – think a scaled-down Canary Wharf – emptied as the government's 2pm announcement approached. Firms were, not surprisingly, less than keen to welcome in a curious journalist to record how their traders and brokers reacted to the deep fiscal retrenchment. (Perhaps justifiably – "I'd like to see social welfare cut 25pc," opined one trader.)
But as staff were lured from their offices by the call of nicotine, the verdicts rolled in. "It's a step," conceded a chief executive, who would not give his name. "The next will have to be to make sure Portugal and Spain are alright."
That was among the more positive views. "I don't think the market really cares about the package," said one trader. "The issue is the solvency of the Irish state. Can Ireland pay the bill for the [international] bail-out?" he asked, predicting that servicing the support will cost billions each year.
A fellow trader was equally unconvinced about the plan's ability to stabilise sentiment. "I don't believe this is going to calm the markets," he said. "We can save money, tax people more, but the sums are so enormous, the total amount of bail-out is so large, that market participants are definitely looking to the eurozone as a whole."
Worryingly for European politicians, the talk from the pair, who trade across equities, bonds, commodities and currencies, was not idle chat. Trader One said he was carefully reviewing the wording of his futures contracts to see how they will be affected if the euro collapses. "I'll be looking for [the package] to have a negative effect on the eurozone markets – maybe not initially – but the measures are too small for the scale of the problem, and it's not just Ireland that's the issue," he said, referring to other debt-laden eurozone nations.
There has been speculation struggling periphery countries such as Portugal and Spain could be allowed to devalue as a survival strategy, but he was deeply sceptical. "I don't see the point of the euro continuing if we have a two-speed euro." That said, there was agreement over the need for Ireland to make cuts, and the International Monetary Fund's (IMF) involvement was welcomed. "It's a good thing that external people are looking in. We've a government that isn't qualified to take on this mess," said one female banker, again speaking anonymously.
There was definitely room for savings to be made, people believed, with concern over the current basic dole rate – estimated at €5 an hour – and relatively high minimum wage. But many worried the general public has yet to grasp that there is no alternative to the severe and lasting cuts and feared civil unrest. The anger at the government is certainly ever-present. "That was edited by Granta," quipped the host of a TV arts show, reviewing a collection of Irish short stories on the eve of the package. "Volume two is to be edited by the IMF."
However, many voters fail to realise Ireland no longer has control of its own economy and believe that if a new government comes in it can delay the cuts, financial workers said. "The reality is that the government is not running the economy," said one trader. "The budget will go through irrespective of what party is in power." But while the austerity package may have held few unknowns for Dublin's financiers, one question is still puzzling them: Where did all the money go?
"We don't know where the money went," added the trader, half in jest, but half in earnest. "We've been debating it all morning. Cars, flat-screen TVs, Bulgarian properties? Everyone round here used to have a Mercedes. The whole country was a pyramid scheme."
There Is No Silver Bullet Solution To The Irish Crisis
by Bill Black - Benzinga
This column is the second in a series of discussions of the developing EU crisis that was the subject of the recent Kilkenomics Festival in Kilkenny, Ireland. This installment addresses four recurrent myths that are the enemy of effective financial regulation.
- Assets aren't bad, only misunderstood
- There are silver bullet solutions that will resolve bad assets at minimal cost
- Control fraud by financial institutions can be ignored
- Bank examiners and bank underwriting add little value and can largely be displaced by software
Thorough bank examinations and a sophisticated understanding of fraud schemes are prerequisites for reducing the frequency and severity of financial crises. The recurrent efforts to substitute software for underwriting and bank examination have allowed hundreds of billions of dollars in losses. This two-part column discusses these myths in the context of the Irish crisis. Next week's column warns of a disastrous desupervisory development by the Bank of England (BOE). The foil for both columns is Richard Field. Mr. Field has offered the latest silver bullet solution to the Irish crisis – and cheered the BOE's desupervision as implementing “21st Century Oversight.”
Field's basic idea is unassailable: transparency is desirable. The problems are that he ignores the limitations of his proprietary software and overpromises what it could accomplish. The Irish crisis and the BOE's desupervision illustrate the dangers of the resultant complacency and analytical errors that come from silver bullet “solutions.”
The Irish crisis has nothing to do with structured financial products, which is Mr. Field's field. This is important because securitization has been blamed for the current U.S. banking crisis. Epidemics of accounting control fraud drove the financial crises in Ireland, Iceland, the former Soviet states (“tunneling”), the Enron era scandals, and the S&L debacle. Securitization did not play a primary role in any of these crises. Securitization (and Fannie and Freddie) are not necessary conditions for banking or economic crises. That does not mean that securitization cannot exacerbate a crisis, but it does mean that it does not explain why we suffer recurrent, intensifying financial crises.
The Irish crisis shows that several other aspects sometimes asserted by Americans to be essential to a financial crisis are not. For example, some claim that the fact that some U.S. states do not allow deficiency judgments against homeowners (i.e., the loans are non-recourse) played a decisive role in the crisis. Ireland, however, allows deficiency judgments. Ireland's crisis, like the S&L debacle in the Southwest, was driven by a hyper-inflated bubble in commercial real estate (CRE). The U.S. does not protect commercial developers from deficiency judgments. It is revealing that it is very unusual for creditors to require U.S. CRE developers to provide meaningful personal guarantees. Non-recourse CRE loans are the norm. If recourse is a vital protection to creditors, why do they not consistently require it on far larger projects (CRE) for which the developers often have substantial personal wealth?
Ireland's CRE bubble was the worst in the developed world in terms of relative magnitude. The CRE bubble helped drive a bubble in residential housing by causing land prices to rise. Ireland's record bubble produced epic destructions of wealth. Control frauds increase their lending into the teeth of the bubble. This misallocates assets to unproductive purposes (carpeting Ireland with “ghost” shopping centers). The result was catastrophic losses to the banks, developers, and homeowners. The losses drove a severe recession. The recession drove a wave of migration.
The Irish government then turned the banking crisis into a budgetary and sovereign debt crisis by guaranteeing virtually all of the banks' liabilities. The government bought a pig in a poke because it ignored all the warning signs of massive fraud and monumental losses in the assets. The Irish guarantee led to (1) huge debts for every citizen (roughly $15,000 per capita), (2) a budgetary crisis because Ireland's adoption of the Euro means that it no longer has a currency under sovereign control and is subject to the EU treaty limits on deficits, (3) a deeper recession because Ireland adopted austerity in the teeth of a severe recession, (4) substantial migration, which made the recession and the collapse of the bubble more harmful.
The banks' losses were so large relative to the shrinking Irish economy that the bailout of the banks was smoke and mirrors. The bailout relied on promissory notes from the Irish government. The notes did not guarantee any cash payments (of interest or the repayment of principal) to the banks prior to maturity. The Irish government had guaranteed bank losses that were over 25% of its falling GDP.
Mr. Field has never been a regulator or (he worked relatively briefly for the Federal Reserve as a research assistant and for a bank as an AVP). He argues, however, that his software provides the ultimate in silver bullet solutions. The title of his article says it all: “Ireland's Choice: Inexpensive Cure or Expensive Bailout.” We lived for 20 years in Silicon Valley, so I admit to skepticism about software claims. Here's how Field explains his Irish cure:
“The Irish government faces a choice in how to handle its financial crisis. It can implement an inexpensive cure and resolve the cause of the crisis, or it can implement an expensive bailout and treat the symptoms of the crisis. At its core, the cause of the Irish financial crisis is the same as the 2007/2008 global credit crisis. The root cause of the crisis is the inability of investors and other market participants to independently analyze and value commercial and residential real-estate loans.”
The premise is that investors and creditors could not determine the value of the assets that would determine whether their investments or loans would be sensible. Neo-classical economics (and the efficient markets and contracts hypotheses) claims that this is impossible. Lenders and investors would suffer such severe losses in such an inefficient market that they would not lend. If one assumes inefficient markets (lemons markets) and applies Akerlof's findings then investors would only purchase at very large statistical discounts from the original lenders' book values (in reality, they often purchased them at a premium) and lenders would only loan if they could charge extreme yield premia (in reality, spreads between nonprime and prime loans fell in the U.S.).
Note that if multi trillion dollar securities and debt markets are lemons markets, then all of the models used to price securities and debt instruments will dramatically overvalue the securities and debt instruments. Criminologists and regulators (and traders) have long known that markets and contracts are frequently inefficient, so I am not troubled by Field's recognition that markets are inefficient. My difficulty is with his assumption that his software will make markets and contracts efficient.
Field's assertions rely on three inaccurate premises. First, Ireland and the U.S. did not suffer severe, real losses due to bad assets or bubbles. Both crises had ready “inexpensive” resolutions available through his software. Second, his software allows nearly real time valuations by outside investors of the true asset values of bank loans. Third, his software allows investors to reach a reliable asset valuation that “reflects the reality of the situation and not fear of how bad the situation could be.”
With regard to the Irish crisis, Field argues:
“Like the sub-prime mortgage backed securities, the devaluation cycle on the Irish 'bad' assets appears to have no logical stopping point other than zero. As a result, investors are questioning the solvency of Ireland. Naturally, if Ireland accepts a bailout from the EU and the IMF to close the difference in interest rates, it faces both the stigma associated with applying for aid and restrictions on the government and its fiscal policies. This is a very high price to pay for treating the symptoms of the problem like high interest rate differentials. There is an inexpensive alternative available to the Irish government which treats and cures the cause of the devaluation cycle of the Irish 'bad' assets.”
Field does not understand that Ireland already faces crippling “restrictions on the government and its fiscal policies” because it is a member of the EU and adopted the Euro. It cannot devalue. It cannot run the type of deficits it should employ to reduce the severity of its recession. It also faces constraints because of bank guarantee and the size of the bank losses relative to Ireland's GDP. It cannot borrow except at very high interest rates because of these facts and its deepening recession. Field does not propose any change in the guarantee. He says his solution is premised on the currently projected Irish bank losses, and there being no future losses. “This success of this alternative is based on the Irish government having identified all the 'bad' assets and properly discounted them.”
He also states that he is assuming that the Irish “good bank” has only good assets. The reality is that the Irish government has stated that it will need to create another good bank/bad bank division (out of the supposed good bank) to resolve Anglo Irish Bank. His first premise means that his “cure” isn't a cure and isn't “inexpensive.” Remember, the Irish government has not paid to resolve its banks' bad assets. It has, primarily, given promissory notes with no assurance of cash payments of interest or principal until the notes mature in 10 years. The bank losses that Field assumes for purposes of his proposal, given the (insane) Irish guarantee, are crippling, not “inexpensive.” His software will not make the bank losses or the guarantee disappear. The losses are so large that the guarantee creates a fiscal crisis and in conjunction with austerity imperil the Irish recovery from the recession.
Mr. Field's second premise is that his software would allow investors to independently determine accurate market values for Irish bank assets. He promises that his software would provide sufficient information to investors to allow them to determine the true economic value of Irish bank assets. “The proposed solution of providing observable event based reporting puts the loans into the equivalent of a clear plastic bag. With observable event based reporting, all the changes, like payments or defaults, to the loans are reported on the day that the changes occur. Investors can see what they are buying and can value the securities or the good or bad banks the loans support. If investors can value the loans, they can also determine that Ireland is solvent without a bailout.”
The quotation requires us to return briefly to the problems with Field's first premise. It is unclear what Field means by “solvent” when he refers to Ireland. A nation with a sovereign currency never needs to default on sovereign debt, but Ireland has adopted the Euro. Irish bank losses are so large that, given the guarantee, Ireland either has to push its economy deeper into recession through increased austerity or face promptly greatly increased interest rates.
Of course, they can face both simultaneously because the combination of the deepening recession, emigration, budgetary crisis, austerity, and increasing interest rate expenses can create a self-reinforcing downward spiral. Ireland also faces the danger that another nation will trigger a “flight to quality” and cause a dramatic increase in spreads on Irish debt at some future date. Absent a bailout, leaving the Euro, or terminating the guarantee of bank losses, Ireland faces a crisis.
Turning now to Field's second premise, “observable event based reporting” cannot deliver the information necessary to determine correct asset valuations. Instead, it is likely to worsen one of the worst features of existing models. There is a famous saying that captures the problem: It's not the things you don't know that cause disaster; it's the things you do know – but aren't true. The financial models were absurd primarily because the controlling officers created perverse incentives to create models that inflated asset values. The alleged sophistication and precision of the models made them particularly dangerous to those that did not know the models were bent.
Field's model is fatally flawed by its claim that “observable” events are sufficient to value assets. The Irish and U.S. crises show how severe this flaw is. Nonprime loans, particularly liar's loans, were endemically fraudulent. Sophisticated frauds are designed not be readily “observable.” The only way to detect them in time to minimize losses is to look for fraud “markers” in the individual loan applications files as part of a prudent underwriting process.
Where the lender is an accounting control fraud the lender will not conduct reliable underwriting, it will not keep accurate records, and it will not make accurate reports. Only vigorous banking examiners, reviewing adequate samples of loan files are likely to have the independence and expertise necessary to detect accounting control frauds prior to catastrophic losses. Field is naïve if he really believes his metaphor – that his software will turn banking into a “clear plastic bag” – perfectly transparent.
Reporting on loan payments and loan terms (the two key deliverables that Field's software is supposed to provide) is inadequate to identify accounting control frauds until they are near collapse. Fraud occurs at multiple levels in a fraudulent bank. U.S. nonprime lenders and Irish banks provided false information about the borrowers' creditworthiness and the value of the collateral.
Epidemics of accounting control fraud cause bubbles to hyper-inflate and make it simple to hide losses for years on massive portfolios, but even individual accounting control frauds can hide losses for year by refinancing bad loans. The loan delinquencies and defaults will eventually occur in profusion, but that is far too late for investors or regulators to act to prevent massive losses or bubbles. Epidemics of accounting control fraud, particularly when they hyper-inflate a bubble, can cause catastrophic losses (Anglo's bad assets have experienced losses of over 70 percent). A software system that misses fraud losses will grossly overestimate asset values in a situation like Ireland.
Field also assumes that if investors had more information on loans they would impose effective private market discipline. There was no effective private market discipline even when nonprime specialty lenders and the worst Irish banks publicly informed investors that the banks had provided grossly inadequate loss reserves and it was public that there was an epidemic of mortgage fraud.
Field also makes the common mistake of assuming that knowing current loan delinquency frequencies is adequate to determine the risk of future losses. “Based on their own analysis, investors can then set a differential between Irish and German government bonds that reflects the reality of the situation and not fear of how bad the situation could be.”
Field thinks the “reality of situation” (current information on loan payments) should remove investors' “fear of how bad the situation could be.” An accurate snapshot of loan performance inherently cannot tell an investor “how bad the situation could be.” (I have explained why his software will not provide an accurate snapshot in the situations where it is most important to have accuracy.) For example, the fact that CRE loans are not currently delinquent may be an aspect of the “reality” of the “situation,” but the fact that the interest is being “paid” out of an interest reserve may be a far more important aspect of the “reality” and the fact that the appraised value of the shopping center being constructed was deliberately inflated by the lender is by far the most important aspect of the relevant “reality.”
When a hyper-inflated bubble collapses formerly good assets can also suffer serious losses. This is particularly true in CRE bubbles. Again, the “observable” events will come far too late to protect the investors. Note also that asset values change continuously as the bubble hyper-inflates and over the course of its collapses. Similarly, asset values change as a recession deepens or eases. Even if we could assume, contrary to reality, that Field's software delivered accurate snapshots of “reality” the software could never remove the investor's need to consider risk – a concept that includes the “fear” “how bad the situation could be[come].” Field does not understand risk or he is not being candid about the limitations of his software.
Irish Banks May Need Up to $40 Billion in Extra Capital
by John Glover - Bloomberg
Irish banks may need as much as 30 billion euros ($40 billion) of new capital before investors will be persuaded to fund them, according to CreditSights Inc. Allied Irish Banks Plc and Bank of Ireland, the nation’s biggest lenders, will probably have to boost their so-called core Tier 1 ratio to 15 percent from 8 percent, analyst Simon Adamson wrote in a note today. Allied Irish needs 9.1 billion euros and Bank of Ireland needs 4.5 billion euros, based on CreditSights’ analysis of the banks’ latest financial reports.
“If you really want to put the banks in a position where people are comfortable, a 15 percent core Tier 1 ratio is probably the level you’re going to need,” London-based Adamson said in an interview. “The alternative would be to have a pot of money available if needed, but at that point you might as well just put it in.”
Ireland is in talks with the European Union and the International Monetary Fund on an 85 billion-euro aid package as the authorities seek to avoid the nation’s financial crisis spreading to Portugal and Spain. Ireland’s financial system imploded after banks racked up losses when a decade-long real- estate boom ended. Anglo Irish Bank Plc, which was nationalized last year, is slated to receive 11.4 billion euros of new capital, though its final needs will depend on what the government decides to do with the lender, Adamson wrote.
The country is likely to resist taking full ownership of Allied Irish and Bank of Ireland. The recapitalization of Allied Irish will bring the government’s stake to “close to 100 percent,” while its 36 percent share in Bank of Ireland is likely to rise to “a significant majority,” Adamson wrote. The banks’ subordinated debt holders may face losses, according to Adamson. “It would be no surprise if the European Commission and the IMF tried to impose losses on holders of subordinated debt in the Irish banks,” he said. The government may copy the template used with Anglo Irish subordinated bonds, where investors exchanged existing notes at a minimum 80 percent discount for government-guaranteed senior debt, according to Adamson’s note.
“There are few hard facts and predicting the outcome for the Irish banks is mainly speculative,” he wrote. Among the more likely outcomes is that “subordinated debt holders could suffer substantial losses in a similarly structured deal to that used for Anglo Irish.” The government is unlikely to impose losses on senior bondholders, partly because it wants the banks to return to the markets soon, Adamson wrote.
Germany Rejects Plan to Boost EU Bailout Fund
by Marcus Walker and Matthew Karnitschnig - Wall Street Journal
The European Commission floated a proposal Wednesday to double the size of Europe's €440 billion ($588 billion) bailout fund for indebted euro-zone countries, but the idea was quickly dismissed by Germany, according to people familiar with the situation.
The apparent disagreement between Brussels and Berlin comes amid uncertainty among financial-market participants over whether the funds that Europe has set aside for rescuing stricken euro-zone members would be enough to cope with a possible financial meltdown in Spain. Support from Germany, Europe's largest economy and biggest contributor to the bailout fund, would be essential to push through any increase in the fund.
Following Greece's bailout in May, the European Union set up a €750 billion rescue program together with the International Monetary Fund. The centerpiece of that effort is the European Financial Stability Facility, which euro-zone members agreed to support with up to €440 billion in financing. The remaining contributions would come from the IMF and the Brussels-based commission. European officials said the commission's position was that Portugal and Spain could get by without a bailout. A spokesman for the EU Commission said it is "absolutely not true" that it is proposing a doubling or an expansion of the bailout fund.
But other European people familiar with the matter say that the commission did float a plan to increase the capacity of the fund and that it was quickly dismissed by Berlin. Bundesbank President Axel Weber hinted at the discussions going on behind the scenes when he said on Wednesday that euro-zone governments would expand the EFSF if necessary. The German government views Mr. Weber's comments as badly timed and has told the commission that the EFSF has plenty of funds at its disposal already, according to a person familiar with the matter. Referring to the EFSF in a speech on Thursday, German Chancellor Angela Merkel said: "Everything will remain as it has been agreed to."
Concerns over Spain and neighboring Portugal continued to weigh on European markets on Thursday. The bond markets of Europe's weaker economies showed further signs of stress, keeping these countries' borrowing costs elevated—even as traders speculated that the European Central Bank was buying bonds as part of its emergency program to support the market. The euro edged higher to $1.3378 after reassurance from Mr. Weber about Europe's commitment to its currency.
Spain accounts for about 10% of all economic activity in the 16-nation euro area, making it potentially far more expensive to rescue than Portugal, Ireland or Greece, the other euro-zone countries struggling most acutely with their debts. Unlike Ireland and Greece, Spain hasn't lost access to bond markets, but its borrowing costs have risen sharply because of investors' loss of confidence in the euro zone's indebted periphery. The EFSF has plenty of funds at its disposal already, according to a person familiar with the matter.
The effective lending capacity of the combined EU and IMF arrangements could be reduced to around €530 billion if Portugal and Spain join Ireland in needing a bailout. The EFSF is a Luxembourg-registered company that can issue bonds backed by credit guarantees from Germany and other solvent euro-zone countries. Doubling the EFSF's capacity to €880 billion would remove any doubt about whether the facility has enough firepower to prop up Spain if the country's government can't fund itself on bond markets.
Such an expansion would require a bigger financial commitment from Germany, where many lawmakers and voters are skeptical about bailouts for euro-zone countries, which many Germans believe caused their own problems through excessive borrowing. Ireland became the first country to apply for help from the EFSF last week and is negotiating a bailout package from Europe and the IMF that is expected to total roughly €85 billion. Greece received a €110 billion rescue package from the EU and the IMF in May, before the creation of the EFSF.
In a political understanding reached in May between the EU and the Washington-based IMF, the latter would lend roughly half as much money to crisis-hit euro members as the EU. Germany and other euro-zone members have made IMF involvement a condition of disbursing funds from the EFSF.
How much of a bailout will we need? – “You can work it out yourselves” says Minister for Finance, Brian Lenihan. Here are my workings (€200 billion?!)
by NAMA Wine lake
I must admit to being frustrated yesterday by our Minister for Finance’s clumsy handling of the key question of the quantum of any bailout. Plainly some unknowns remain and negotiations need to be concluded but the Minister could surely have done better than denying that it would be a “three-figure sum”, by which he meant €100bn (surely that’s a 12-figure sum – €100,000,000,000) and then saying during the same RTE interview with Richard Crowley that it wasn’t going to be “€60-70bn”. Sources in Europe seem to have been more forthright and last night David Buick of BGC Partners in an interview on BBC News 24 said at one point that he thought it would be in the region of €80bn and a few moments later stated with what seemed like confidence that it would be €85bn. Just a few moments later in Dublin, the two Brians commenced their press conference during which Brian Lenihan was asked how much would be required and his response was that “we could work it out” and he repeated that the funding requirements of the State were €19bn per annum. This entry tries to produce some workings.
(1) NAMA – €5bn. NAMA appears to have been frozen out debt markets and although it has been putting in place programmes to access State-guaranteed debt of up to €5bn as allowed by the NAMA Act, it has not executed the programmes. The betting must be that NAMA’s €5bn will be provided by the bailout.
(2) Deficit funding for 2011-2014 will be €43.25bn, being €16bn in 2011, €12bn in 2012, €9.75bn in 2013 and €5.5bn in 2014. This is from the NTMA in November 2010 after the Department of Finance announced the €15bn fiscal adjustment upto 2014 and the €6bn adjustment in 2011.
(3) Promissory Note funding for the banks. Although the Department of Finance claimed this would be €3.1bn per annum from 2011 onwards, the truth is that it may be frontloaded. €31bn may be needed immediately.
(4) Repayment of national debt debt (bonds, treasury bills). The workings of the NTMA above don’t appear accurate and in particular seem to exclude the repayment of treasury bills. Elsewhere on the NTMA website they show a graph of redemptions which indicate the following up to and including 2014 (total of €38bn)
(a) €12bn in 2011
(b) €6bn in 2012
(c) €7bn in 2013
(d) €13bn in 2014
(5) Replacement of ECB emergency liquidity assistance. The ECB has already signalled that it intends to cease its emergency assistance programme. As we know at the end of October 2010, the six State guaranteed banks had borrowed €90-100bn from the ECB. This may have increased in the past three weeks. But if the ECB is withdrawing the assistance and no-one else is lending then presumably the State will need pony up this funding. So that would be €90bn ++
So by working it out myself like Brian Lenihan suggested, I come to €207bn approximately for the period up to the end of 2014 (perhaps I should be looking at a shorter period?). Of course we have some €10bn of funding already (the “fully funded to the middle of next year” funds) and we have €14bn or so available from the National Pension Reserve Fund (€25bn less commitments to AIB/BoI). The promissory notes may not need immediate upfront funding. On the other hand we will have substantial interest payments on borrowings not previously accounted for. And of course there may be further nasties lurking in the banks and it seems that the substitute ECB funding will be considerably more than €90bn. But regardless I can’t see how the bailout can be less than a 12-figure sum and likely to be in the €200bn zone. So Brian, are my workings wrong?
UPDATE: 22nd November, 2010. Video of the press conference last night in which Minister Lenihan said we could work it out ourselves is now available – in the clip below the relevant question and answer is from 5.25 and the transcript is “You asked another question, a breakdown of the two I can’t give you that [a ratio breakdown - how much of the bailout is for the banks and how much is for the country] but you can work it out for yourselves because you know what the gap in terms of public expenditure is at present – it’s €19bn this year for example. So clearly as with the banks, so with the State itself the arrangement will be designed to show the firepower available to Ireland”
UPDATE: 23rd November, 2010. Minister of State at the Department of Health and Children (one of 15 ministers outside the cabinet which itself has 14 ministers plus the Taoiseach) John Moloney was on the under-rated Vincent Browne show last night when the following exchange took place (from about the 37th minute)
From 37:00 minutes on –
MINISTER JOHN MOLONEY: Let’s take the worst scenario that it might transpire, of course it’s a huge concern a huge worry as we go forward .The clear implication of all of this is that unless we secure support from the ECB, the alternative is worse
VINCENT BROWNE: Do you ever think in your head, in your mind “how could we have screwed it up so badly that we have forfeited the future of this society for years and years and years to come” You ‘re going to leave a debt of the order of €150-160bn?
JM: I wouldn’t make light of that at all, nor would I play politics with it, of course it’s down to poor regulation-
VB: Sorry it’s going to be €200bn
JM: In fact it will even be in excess of that, if it’s drawn down of course but I’m thinking of the worst possible scenario. Of course there’s huge implications. The reality has been and we’ve acknowledged this.
Our national debt today is €90bn according to the NTMA. If the bailout is say, €90bn, then how do we get to a national debt of “in excess of ” €200bn? I think the answer must be that part of the bailout will be earmarked and certain whilst the rest will be contingent. Contingent on what? The ECB not withdrawing emergency liquidity assistance totally as planned in January 2011, the ability of Ireland to return to the debt markets over the course of the next three years, the promissory notes that the State is using to capitalise the banks not being called in in the short term. But there you have it, a Minister of State conceding that the national debt may be in excess of €200bn and given the likely exit from power of this present government by the end of January 2010, I think the betting would have to be that the bailout now in prospect is €100bn+ at least.
Unions bring Portugal to a grinding halt as Irish-style bailout looms
by Giles Tremlett - Guardian
Trades unions brought parts of Portugal to a grinding halt as a general strike shut down most public transport in protest at cuts being introduced to stave off an Irish-style debt crisis. Most flights in and out of Portugal were cancelled, ferries across the River Tagus remained at their berths, metro stations were closed and only a handful of trams ran as Lisbonites sought other ways to get to work. Angry British tourists were among those left stranded at airports.
"It is like a Sunday here," said newspaper salesman Francisco Amaral outside Lisbon's Cais do Sodré transport interchange, where the metro and ferry stations were closed and only a handful of overland trains ran. Trade unions claimed 80% of workers stayed at home, while the government put the figure at around 20%. "This may not change the budget plans, but they know now how the workers feel about taking the biggest part of the cuts," said local Lisbon union organiser Libério Domingues.
Portugal's parliament is expected to approve a budget on Friday that will include pay cuts for civil servants as the government tries to reduce next year's deficit to 4.6%. It was by no means clear, however, that the budget would prevent Portugal following Ireland and Greece by seeking bailout money to help pay debts. Yields on Portugal's 10-year bonds rose above 7% – a level that many analysts consider unsustainable.
"In some ways this is now a problem that is beyond Portugal's control. It is not a problem that can be solved with one year's budget," said one economist. "And if risk aversion in the market increases, there is not much you can do about it." The chances of Portugal eventually asking for help are now "above 50%", argued Phyllis Reed, of Kleinwort Benson.
Fears of Domino Effect Pervade Europe
by Tom Lauricella,Stephen Fidler and Mark Gongloff - Wall Street Journal
Contagion once again emerged in Europe as investors turned from Ireland's debt crisis and set their sights on Portugal and Spain. Both Spanish and Portuguese bond prices fell sharply Tuesday, and the yields above German bunds rose to records. The euro slid below $1.34 for the first time in two months, though part of the weakness came as investors turned to the safe-haven status of the U.S. dollar after North Korean artillery attacks on South Korea. "People that are betting on contagion are probably making the right bet here," said David Gilmore, a strategist at Foreign Exchange Analytics. "There's not really anything to stop the markets from pushing the next domino over."
The unease over Europe, combined with the events in Korea, spread to U.S. markets as well. The Dow Jones Industrial Average slumped 142.21 points, or 1.3%, to 11036.37. Asian markets were down in early Wednesday trading, with Japan's Nikkei Stock Average down 1.5%, South Korea's Kospi down 2%, New Zealand's NZSX-50 down 0.3% and Australia's S&P/ASX 200 down 0.6%. Prices of Treasurys, typically seen as a haven investment, jumped. Highlighting the concerns about European financial markets, German Chancellor Angela Merkel called Ireland's crisis "very worrying" for the region.
The sudden turn in Europe has caught many traders off guard. The focus in recent weeks has been on the impact of the Federal Reserve's easing measures. And at the tail end of last week, many investors had assumed the Irish situation was on its way to being resolved. But with the unraveling of Ireland's coalition government Monday, contagion is back on the minds of investors. Ireland's request for a bailout from the European Union and the International Monetary Fund followed government capital injections to prop up banks that suffered big loan losses. This has turned the spotlight to banks in Spain and Portugal.
Meanwhile, Portugal reported on Monday that its 10-month budget deficit widened from a year ago. Tuesday, Spain issued short-term debt at a significantly higher cost than a month ago. "I think that's the market's realization; that these are systemic problems that are going to need a systemic solution," said Brian Yelvington, fixed-income strategist at Knight Capital. "This is not a one-off problem with an individual country." Rising spreads have hit one country after the other, moving from Greece to Ireland and now to Portugal and Spain. The worry is that those rising borrowing costs eventually may prove prohibitive, forcing countries to seek some sort of bailout.
Contagion, broadly defined as when a loss of market confidence in one economy transmits to others, can occur through trade connections, economic similarities or financial linkages. An economic downturn in one country can hit its trading partner's exports or reduce tourism revenue. A collapse in value of financial assets in one country can hit confidence about banks in another if those banks hold a lot of those assets. A second source of contagion is where investors look across from a troubled economy and see similar problems elsewhere.
While Portugal doesn't have banking problems of the scale of Ireland's or a budget deficit as big as Greece's, it does have a combination of budget deficits, high government debt and low growth that worries some investors. A third transmission mechanism for contagion is through investor portfolios, in which price declines in one asset class cause investors to sell other assets.
Particularly noteworthy is the focus on Spain. Tuesday, the gap between German and Spanish bonds rose 0.30 percentage point overnight, to 2.36 percentage points, the highest since the euro was introduced in 1999, well above the previous record of 2.21 percentage points set in May, according to RBC Capital Markets. That selloff is notable because while Greece, Portugal and Ireland are facing significant fiscal and economic woes, those economies are relatively small. Bailouts of all three are seen as manageable.
But should Spain fall into a death spiral, where its interest payments rise so much that the country can't afford to borrow, a bailout is seen by many in the markets as impractical and more likely to require a restructuring of debt that would inflict losses on bondholders, many of whom happen to be European banks. Traders said those banks likely were among those selling either Spanish, Portuguese and even Italian bonds Tuesday, as well as buying insurance against default by those countries as a hedge. For hedge funds and other money managers, figuring out how best to trade in the turmoil has been complicated by several factors.
Some they are hesitant to make big speculative bets through the market for credit-default swaps, because trading in Portuguese and Spanish swaps is relatively infrequent. That makes buying and selling much more difficult. Credit-default swaps act like insurance, protecting bondholders in the event of a default. There also is a concern among hedge funds that there could be government bailouts, which could affect how CDS trade.
Instead, some managers are looking to trade the debt of financial companies in countries such as Ireland and Portugal by betting that some of that debt will fall in price. It also is harder to place bets against the euro, now that the Federal Reserve is pumping the financial system with money. In fact, rather than betting on a decline in the euro, many traders had been leaning the opposite direction leading up to the recent turmoil, holding short positions in the dollar and owning euros.
'Crash JP Morgan' Goes Viral!
Trading Inquiry Widens to Big Firms
by Jenny Strasburg, Michael Rothfeld and Steve Eder - Wall Street Journal
Federal authorities, intensifying an insider-trading investigation, are demanding trading and other information from some of the nation's most powerful investment firms. Hedge-fund giants SAC Capital Advisors and Citadel LLC, big mutual-fund company Janus Capital Group Inc. and Wellington Management Co., one of the nation's biggest institutional-investment firms, have received subpoenas from the Manhattan U.S. Attorney's office seeking trading, communications and other data as part of a broad criminal investigation, according to people familiar with the matter.
The Federal Bureau of Investigation also recently questioned an account manager at Primary Global Research LLC, a California company that provides "expert-network" services to hedge funds and mutual funds, people familiar with the matter say. Such expert-network firms set up meetings and arrange calls between traders seeking an investing edge and current and former managers from hundreds of companies. The FBI is seeking information about a Primary Global consultant and his hedge-fund clients, these people say.
Executives of Primary Global, based in Mountain View, Calif., didn't respond to requests for comment. Representatives of Wellington, Citadel and SAC, which is run by Steve Cohen, declined to comment. In a letter to investors, SAC said it received an "extraordinarily broad" subpoena, that it will cooperate with investigators, and that the request doesn't suggest that "anyone at SAC has engaged in wrongdoing." Janus said in a filing that it "intends to cooperate fully with that inquiry," which sought "general information." Janus shares fell 2.8% in Tuesday trading. Subpoenas are requests for information and don't necessarily mean the recipients are suspected of wrongdoing.
The latest disclosures show that authorities are pursuing numerous strands in their three-year investigation. One focus is whether expert-network firms leaked inside information to hedge funds and others, according to people familiar with the matter. Another is whether independent consultants provided nonpublic information to investors, these people say.
SAC, Wellington, Janus and Citadel were among the clients of John Kinnucan, an analyst who recently was questioned by two FBI agents. The agents visited Mr. Kinnucan last month and accused him and his clients of trading on inside information, according to an email Mr. Kinnucan sent to about 20 clients. The FBI asked him to tape his calls with SAC, according to a person close to the situation. In his email, Mr. Kinnucan said he refused to tape any calls.
Still another strand of the probe is examining whether Goldman Sachs Group Inc. bankers leaked information about transactions, including health-care mergers, in ways that benefited certain investors, the people say. Goldman declined to comment. On Oct. 26, the day after the FBI visited Mr. Kinnucan, agents visited the Primary Global account manager at his home, people familiar with the matter say. FBI agent B.J. Kang, who was involved in last year's Galleon Group insider-trading case, asked most of the questions, which focused on an expert in the semiconductor industry who consulted for clients of Primary Global and several other expert-network firms, these people say.
The manager was asked about the firm's work with the expert, his pay and Primary Global guidelines regarding sharing proprietary, nonpublic information with clients, these people say. Mr. Kang declined to comment. Primary Global's compliance policies, posted on its website, say experts "are required to keep in confidence proprietary information acquired by them," and must not "breach any agreement with their employers" by working as consultants or sharing prohibited information.
One challenge for expert-network firms is policing their consultants. Such firms hire current or former company employees, as well as doctors and other specialists, to share information with investment funds.
The consultants typically earn several hundred dollars an hour for their services, which can include meetings or phone calls with traders to discuss developments in their company or industry. The expert-network companies say internal policies bar their consultants from disclosing confidential information. But because there are so many calls and meetings with investment funds, not all are monitored, according to executives at expert-network companies.
It isn't the first time authorities have examined whether individuals working for expert-network firms have passed along inside information. The SEC and the New York Attorney General's office examined the activities of Gerson Lehrman Group, the largest expert-network firm, following a Wall Street Journal article on the company in late 2006. Both probes were dropped with no charges brought. Those probes prompted a number of expert-network firms to beef up compliance rules, such as requiring experts to sign agreements saying they have their employers' permission to act as consultants, and saying they won't share material, nonpublic information with clients.
Executives of expert-network firms and others say such rules can't stop consultants from sharing prohibited information on private phone calls, either purposely or accidentally, when a client pressures them.
Attempts to get consent from consultants and clients to record phone calls, which some say would be a strong deterrent to problematic behavior, have fallen flat, people in the industry say.
"Clients have generally said they didn't want that," says Stuart Lewtan, who runs Zintro Inc, a small Waltham, Mass., expert-network firm. "These are people who generally operate in a pretty secretive way. Even if they're complying with SEC regulations, they generally just don't like to be recorded." The current investigation has caused some hedge funds to cancel calls with experts, while others are going ahead with calls after reviewing compliance procedures with the analysts involved, lawyers and others say.
"In the short term, clients are going to be very nervous about using expert-network firms," said Michael Mayhew, head of Integrity Research Associates, a New York firm that tracks the industry and collects fees for helping investors select expert-network firms. After news of the investigation broke on the Journal website on Friday night, some hedge funds reached out to clients to reassure them that they didn't rely on expert networks. Vijai Mohan, founder of hedge fund Hyphen Partners LP in San Francisco, sent a letter to his investors over the weekend saying: "Hyphen purposely uses no 'expert networks,' and relies on publicly available information to draw its conclusions."
Meredith Whitney to rival Moody’s and S&P with own rating agency
by Aline van Duyn - Financial Times
Meredith Whitney, a Wall Street analyst who shot to prominence with bearish calls on banks before the financial crisis, plans to set up a credit-rating agency to go head to head with Moody’s Investors Service and Standard & Poor’s. Ms Whitney said in an interview with the Financial Times that her new agency would use the same business model as established agencies, in which issuers of debt pay for ratings. She maintainted that she would be able to manage potential conflicts of interest, saying: “If you run a good business and you have compliance in place, there should not be problems.”
Ms Whitney left her job as an analyst at Oppenheimer and set up her own research company, Meredith Whitney Advisory Group, last year. She has decided to seek rating agency status for the company after creating ratings for the $2,800bn US municipal finance market, information that she sells to investors and other clients. She will seek approval from the Securities and Exchange Commission to become a “nationally recognised statistical rating organisation”, a status that is needed to charge debt issuers for ratings and for investors to be able to use them.
“We’re in the process of applying for an NRSRO licence with the intention of being a formal competitor to S&P and Moody’s,” Ms Whitney said. She plans to rate global structured products and corporate bonds and US municipal bonds.
Rating agencies have been in the spotlight in the past three years after top triple A ratings on hundreds of billions of securities backed by risky US mortgages proved to be inaccurate as the financial crisis unfolded. Many triple A bonds were downgraded and proved worthless. Ratings on corporate and sovereign debt have been more reliable than those for securitised bonds such as mortgage debt.
The ratings market is still dominated by Moody’s and S&P, which is owned by McGraw-Hill. Fitch Ratings is the third- biggest agency. There are a handful of smaller groups, including Egan Jones and DBRS. Since the crisis, agencies have faced rules aimed at managing conflicts of interest that come from rating the entity that also pays for those ratings. Ms Whitney, who was trained as a credit analyst and foresaw problems at Citigroup in 2007, said issuer-pay models are the only way for an agency to achieve scale.
Shadow over Asia
by David Galland - The Casey Report
An interview with Vitaliy Katsenelson
TCR: What our readers are looking for is a better sense of China and Japan, both of which are very important in the context of the global economy. As we have to start somewhere, let’s start with China.
Today the conventional wisdom is that somehow the Chinese economy is better managed than its competitors, very similar to how people viewed Japan in the 1970s and 1980s. Back then people were absolutely convinced that Japan was the superior country with superior policies and that its economy was unstoppable. We all know how that ended.
So, let’s start there. Is China's system better than everyone else's? Is it really possible the Chinese economy can keep steamrolling along?
VK: A few months ago, I watched a movie about Ayn Rand and it talked about how Americans in the 1930s looked at the Soviet Union’s flavor of managed economy as being superior to the American version of capitalism. At the time America was just coming out of the Great Depression, so that view made a lot of sense. So in the short run, and especially after the ugly side of creative destruction has paid us a visit, the grass of managed economy may look greener.
So when we look at China, the conventional wisdom says that the government is very, very smart, and therefore they can do a very good job in steering the economy in the right way. Chinese government may have the best intentions, its leaders may have IQs of 250 each on a bad day, but it is impossible to centrally manage an economy of China’s size.
I am a big believer that in the boxing match between a visible and an invisible hand, though the invisible hand may lose a few rounds, it will win the match every time. Last century we had the most amazing economic experiment take place when after World War II, Germany was split into two countries with different economic and political systems. But they were the same people, with the same language and culture, separated by a wall. We know how that story ended.
Of course, for a time, having government control over the levers of the economy can have advantages. For example, by taking prompt action, the Chinese government was able to pull the economy out of the recession remarkably fast, basically by fire-housing the stimulus package that was equivalent to 12% GDP. That's the advantage. The only problem is that these kinds of short-term advantages come with long-term, painful consequences.
For example, when you have a huge government presence in the economy, you also have a huge bureaucracy, and bureaucracy brings corruption. This is one of the reasons why China is rated so poorly on Transparency International’s annual corruption rating. Corruption breeds misallocation of capital, because the capital flows not to the best use, but it basically flows to whatever the political connection or whatever the bribe is directed to.
In addition, when you have a government-managed economy, it creates excesses. China has huge excesses in the industrial sector, as well as in commercial and residential real estate. We see plenty of evidence of these excesses, but they are likely to be much greater than we can measure today as they are covered up by robust economic growth. The true magnitude of these excesses will come to the surface once the economy slows down.
TCR: In essence, you’ve got a relatively small group of individuals who are making big decisions about China's economy and where production should be, in what sectors, etc. If history is any guide, that really can't last, yet many people seem to think it can. That said, China’s economy has certainly done remarkably well in the global economic crisis. In fact, according to their government, their GDP is almost back to where it was pre-crash. Why?
VK: Sure, the growth you see today in China is there, but it’s not a sustainable growth. It's not a growth that you'll see a few years from now. That is an important point for readers to understand.
TCR: Why is it not sustainable?
VK: Because the growth is being induced by government spending, by a misallocation of capital.
I'll give you an example. The vacancy rate on commercial real estate in China is fairly high, but they still keep on building new office buildings because they think they will always grow. So therefore as long as they keep building, that activity will be registered as growth, until they stop. And when they do stop, they’ll drown in overcapacity, and they won't be building new skyscrapers for a very long time.
TCR: We read that note you sent about the South China Mall, which is pretty stunning. It's the second largest mall in the world but is mostly empty.
VK: That's right. But as outrageous an example as the South China Mall is, there's an even more outrageous example – namely that the Chinese built an entire city, Ordos, in Inner Mongolia for 1.5 million residents and it is completely empty. These are classic examples of the sort of excesses going on in China.
TCR: The equivalent of building bridges to nowhere, but on a very large – Chinese – scale.
VK: Exactly. There are no shortcuts to greatness. As long as they keep building new bridges, the economic numbers will register that there is growth, but at some point the piper will have to be paid, and these projects have a negative return on capital.
TCR: It seems the Chinese are following the script Japan used to dig itself out of its postwar doldrums, deliberately keeping their currency low in order to build an economy on the back of low-cost manufacturing. But that game inevitably has to end – already we see more and more things being made in Indonesia, Pakistan, India, and so forth. If China loses the manufacturing core of their economy, won’t they be in big trouble?
VK: Well, once you move manufacturing to other countries, it’s very difficult to get it back. So you could probably argue that China will maintain its manufacturing advantage for a while.
The problem with China is pretty much the same as with any bubble. Though it may have had a solid foundation under it, it is simply a good thing taken too far. If you look at the railroad bubble in the United States, the country did need railroads, but we built too many.
The same thing happened with the technology bubble in 1998. The Internet was transformative to our economy, no question about it. But, again, it was taken too far.
There are some other countries that are lower-cost producers than China, but they probably can’t do it on the same scale that China can. But my point is that China is just a good thing taken too far, and if you add government involvement and corruption into the mix, you will get a bubble that is taken a lot further than you would normally expect.
One way of thinking about it is that the actions taken by the Chinese government, especially after the recent global recession, have basically supersized the bubble that was already forming.
TCR: Their government is sort of a holdover from a largely bygone era when many nations were communists, so isn’t it true that they need to maintain some fairly strong forward momentum, otherwise they could run into some political problems? Is that why they were so quick to unleash the massive stimulus or encourage their banks to lend an amazing amount of money? You have a chart showing those loans amounted to 29% of GDP in 2009. What kind of quality of lending can that be?
VK: Let's try to understand why the Chinese government did the things they did. As everyone knows, the Chinese economy grew at a very high rate for a long period of time. When the global economy slowed down, their economy slowed down as well (though official numbers did not show it). The Chinese government is extremely concerned about the economy slowing down because that is likely to lead to political unrest. A lot of that potential friction comes because a lot of people moved from villages to the cities. China has an almost nonexistent social safety net system. So people who lose jobs don’t complain, they riot.
So, yes, the Chinese government is afraid of political unrest, and therefore they quickly released a tremendous amount of stimulus into the economy, then followed it up with encouraging bank loans equal to 29% of GDP in 2009, a huge increase. When you infuse this much debt into an economy, it's impossible to have good capital allocation decisions. While the economy is growing, the bad debt won’t be so apparent, but it certainly will be when the economic growth slows.
A good analogy might be that when you analyze a credit card company that is growing very, very fast, and that has opened new accounts, you don’t see the bad debt because that debt is covered up by new loans. The true nature of the past lending decisions only becomes obvious when the company’s growth falls off.
One way to think about the Chinese economy is by comparing it to the bus in the movie Speed with Keanu Reeves and Dennis Hopper. In the movie, a bus was wired with explosives that would blow up if the bus’s speed dropped below 50 miles an hour.
Since China is manufacturer to the world, that manufacturing business comes with a lot of fixed costs. Factories, equipment need financing, and they are mainly financed by debt – another fixed cost. The high level of fixed costs doesn’t afford China an economic slowdown, but when it happens, the consequences will be dire. High fixed costs are great when revenues are rising as income grows at a faster rate than sales. But they are devastating to profitability when sales decline: costs decline at a slower rate than sales and you start losing money, fast.
TCR: Interestingly, there's clearly a slowdown in the U.S. and Europe, China's two biggest markets, so you would assume that China’s export industries would have suffered a fairly sharp decline since the go-go days before the crash. That has to be putting pressure on their growth. How important to the Chinese is it that the U.S. and the European economies recover and Western consumers get back into the game?
VK: I think a return of U.S. and European consumers is extremely important to the health of the Chinese economy. Some analysts think China’s internal demands can overcome the demand decline from U.S. and European consumers, and I think it is possible in the long run. But in the short run, I don’t think that's possible. Let me explain the reasons for that.
Chinese consumers represent one-third of a 5-trillion-dollar economy. If you look at the size of the U.S. and European Union together, they are equal to a 30-trillion-dollar economy, and the consumers there constitute about two-thirds of those economies.
So on the one hand, you have U.S. and European consumers representing 20 trillion dollars in purchases, versus Chinese consumers at about 2 trillion dollars. In other words, U.S. and European consumers are 10 times the size of the Chinese consumers. As a result, a very small change in consumption in the U.S. and Europe has to be overcompensated by a huge increase in consumption in China, and that is going to be very difficult to do, especially considering that the Chinese currency is kept at artificially low levels. That, of course, diminishes the purchasing power of the Chinese consumer. Over time the Chinese consumer will play a larger role in the economy, but it’s going to take a decade, not months – not even a few years.
TCR: You're pretty bearish on the outlook for China; do you have a theory about what might trip them up? What's the thing that readers should be watching for that would suggest things are starting to unravel?
VK: It’s very difficult to know exactly what's going to be the straw that breaks the camel’s back. It could be a slowdown in the Japanese economy, or a double-dip in the U.S., or some other factors that are not apparent to us today. It could be just the simple fact that the Chinese government is trying to put the brakes on the economy and mistakenly does too much.
I don’t trust government-reported statistics, thus I’d watch numbers that the Chinese government is less likely to fudge: electricity consumption, which was down during the global recession, same-store sales of American fast food restaurants in China, tonnage of goods shipped through railroads, and, though they may lag, sales by American and European companies in China.
TCR: If you look at inputs like copper imports and even copper stocks in Shanghai, by all appearances China is at least pretending that it’s business as usual. In fact, I think in August they imported 22% more refined copper than they did the year before. But if this is just to build bridges to nowhere, then it supports the idea that this is not going to be sustainable.
VK: That’s right. That is the problem with looking at this kind of data, because a lot of it is going to building things that have a negative return on capital. Therefore, you look at the data and the data does not really tell you that much – until it does. Because, basically, it’s the government's involvement that is driving a lot of the demand.
You can make the same argument that the U.S. economy was doing great in 2004, 2005, 2006, despite the obvious problems in real estate and its financial system. Likewise, a lot of people said great things about what was going on in Japan in the late ‘80s. Of course, the U.S., and Japan before it, were experiencing huge real estate bubbles that few saw as being a problem, until they were.
There was a recent article in the Wall Street Journal talking about a Chinese state-owned enterprise that operated salt mines, but now it's building office parks. Those are kind of the signs you start seeing in an economy in the late stages of a bubble, where a state-owned enterprise starts building real estate projects because it's almost like you can't lose money doing this. But one thing that makes predicting the end of this bubble very difficult is the amount of firepower the Chinese government has. The government can drive this bubble further than a rational observer would expect.
TCR: Because they’ve got so much in the way of reserves?
VK: Because they have a significant influence over the economy. Chinese government can force banks to lend and can force companies to borrow and spend (or build).
TCR: On the topic of real estate, I was speaking to a very well-off Chinese friend recently who had bought a very expensive apartment in Beijing. When I asked him about buying at bubble prices, he commented that it really didn’t matter. The money was almost irrelevant, given the status that came from having an apartment in that particular part of town. He said it was very good for his business and that he didn’t really plan on using it very much. It was an interesting perspective, how he saw real estate.
VK: In the same way that everyone in the United States decided they “must” own a house, this belief was reinforced by continuously rising house prices. You can see how big a problem this became in big cities such as Beijing and Shanghai where the affordability ratio is horrible, so the property-value-to-income ratio in Beijing is pushing 15. In Shanghai it is over 12. If you look at the national average, it is over eight times.
TCR: Can you explain that ratio to our readers?
VK: You get the ratio by taking the property value and dividing it by annual disposable income.
Basically, if you spent all your money, after you paid your taxes, just to pay off the mortgage, it would take you 14 years – which means you didn’t pay for food, electricity, etc.
This ratio is important because it helps put the scale of the Chinese real estate bubble in its proper context. In Tokyo, at the peak of the massive Japanese bubble, the ratio stood at nine times. In Beijing it's already 14 times. In Shanghai it's over 12 times. The national average for China is pushing 8.2 times right now. So housing affordability is very, very low, and the housing prices are extremely high.
Here is another interesting piece of data: property investment in China in 2009 was 10% of GDP, up from 8% in 2007. In Japan, at the peak of its bubble, it did not exceed 9%; in the U.S. it never exceeded 6%.
A recent study found that 64.5 million apartments basically don’t use electricity because they are empty. Chinese people buy those condos, and they don’t rent them. Similar to new cars in the U.S. when taken off the lot, in China an apartment is worth less once rented out. So they just keep them unoccupied with the hope to flip them, and you know how that story ends.
TCR: Yes, after Japan’s real estate bubble collapsed, prices in the major cities fell by about two-thirds and have rebounded only very little from the post-crash lows.
If a lot of Chinese lost a lot of money in real estate, one has to assume they’re going to be very unhappy. I recall a conversation with another Chinese man who lives in the States half a year and in Beijing half the year. When I asked him about the real estate bubble in China, his comment was, "Well, the government would never let it fall," and he said the same thing was true of their stock market. To put it mildly, he had an inordinate amount of faith in the Chinese government's ability to prop up bubbles.
VK: As you can tell from my accent, I was born in Russia and spent half of my life in Soviet Russia. From my direct experience, the Russian propaganda machine was very, very powerful, and so many people believed how smart the leaders were and that they could do nothing wrong.
China is not that much different from Russia in that respect. Due to the government’s control of the media, the average citizen has been brainwashed into thinking of the government with respect. They has led to an unconditional belief that the Chinese government walks on water, that the laws of economics are somehow suspended when they touch things (except they also did a fine job convincing not just their own citizens but the West as well). Sure, they have a greater control of the economy, but at the long-term cost we talked about earlier. That’s point number one.
Point number two can be understood by asking why people are buying those apartments, why are they buying this real estate? In part it is because if they put money in the bank – where the government basically sets the rates on savings accounts and the checking deposits – they are getting very little interest on their savings. Therefore they look at real estate as basically a form of savings.
Some analysts will argue that it can’t be a bubble because of the lack of leverage, given that in China you have to put 30%-40% down when you buy an apartment. It is a large down payment. But think about how much wealth will be destroyed when real estate prices decline – and that in itself could trigger a serious crisis in China because it would destroy a lot of wealth, and that could lead to political unrest. So that would be very important psychologically and for the political stability of the Chinese economy.
TCR: What would typically trigger the end of this real estate bubble?
VK: To some degree, a real estate bubble is like a Ponzi scheme. As long as there is an incremental buyer, prices keep going up, but at some point everybody who wants to buy a house has bought a house, so when an incremental buyer is not there, the prices start declining and then it becomes self-feeding. It's very difficult to time the end, but there is always an end.
TCR: What about commercial real estate?
VK: If you look at commercial real estate, it's often one subsidiary that is borrowing money from another subsidiary to put a down payment to build or buy a building. And a lot of times land is used as collateral. As land prices decline, so the loan-to-value ratio can jump through the roof very quickly when real estate prices collapse.
TCR: Talk a little about the renminbi. The Chinese government has been making noises about possibly allowing it to rise against the dollar, but from a practical standpoint, can they actually afford to let that happen?
VK: They could let it rise on a very gradual basis, but they absolutely cannot allow it to rise very rapidly because that would quickly diminish the value of the foreign reserves. But there is a conundrum. When the Chinese economy bursts, there is a very good chance the renminbi will actually depreciate, because you are going to have a flight of capital leaving China. So right now you may argue that China’s currency is too cheap, but during the crisis it's probably going to get cheaper.
TCR: What's your general sense about how much longer they can keep the game going before they collapse? And is collapse the right word?
VK: I really don’t know. In the case of Japan, their government basically ran out of chips. I think the Chinese government still has enough chips to keep the bubble going awhile longer. These bubbles usually last longer than the reputation of the person who predicts their demise.
TCR: Do you think it will occur within a decade?
VK: I think so, yes. GMO became famous for predicting the Japanese bubble collapse, but they started predicting it in 1986, so they were “wrong” for a while because it actually burst in 1989-1990. The point being, these bubbles typically last longer than you would expect, but it's going to burst.
TCR: Let’s talk for a minute about some of the potential implications of a bursting Chinese bubble. There are some fairly obvious ones, like Chinese real estate, but there are a lot of somewhat less obvious consequences, for example the hit this would cause to the Australian economy because its export sector depends heavily on China.
VK: China has been responsible for a very large portion, if not all, of incremental demand for commodities in recent years. If you're talking about copper, about oil, or pretty much all the industrial commodities, China was responsible for a very large portion of the demand. When the economy slows down and the bubble bursts, then the demand for those commodities will decline dramatically.
It's going to impact economies that benefitted tremendously from China’s ascent, so Australia will be impacted, Russia will be impacted because oil prices will decline and Russia is basically a commodity-driven nation. Brazil will be impacted. Any economy you can think of that benefitted from China's ascent will get hurt from its descent as well.
Let me clarify this. I'm not saying that China will cease to exist or that it's going back to the stone-age – I'm saying there is a bubble and it’s going to burst. It's going to go through readjustments.
TCR: But it will be a serious crisis.
VK: The bubble burst will have significant consequences.
TCR: So you'd be cautious on sort of base commodities.
VK: Yes. But also think about industrial goods. Getting commodities out of the ground, building empty shopping malls, ghost towns, and bridges to nowhere requires a lot of equipment. Industrial goods companies benefitted tremendously from Chinese demand. In the past, those were very cyclical companies, and it seems like this time they almost didn’t have a normal cycle. They declined but then came back very fast because the demand came back very fast, and a lot of that demand came from China.
TCR: And what would you invest in, are there any opportunities you see?
VK: Unless you short stocks, it's very difficult to see an opportunity in a Chinese downturn. As a portfolio manager, I look at it as a risk, and I say, all right, what can I do to immunize my portfolio from that risk. I have very little exposure to commodities and industrial stocks, and very little exposure to countries that will get hurt from China's bursting bubble – the countries we mentioned, like Australia, Brazil, Russia, etc.
TCR: Canada would have to be on that list.
VK: Yes, very true.
TCR: Let's talk briefly about Japan. Bud Conrad, our chief economist, has done a lot of looking at Japan and concludes that it's basically past the point of no return. What are your general thoughts on the implications of that country tipping back into a serious crisis? After all, it’s a very big economy, and so that would have to have a big impact on the world.
VK: Japan's story is very simple. The economy slowed down in the 1990s. To keep the economy growing, the government lowered taxes and increased government spending, sending budget deficits up. In order to finance those deficits, the amount of government debt has tripled.
The only reason they were able to finance that debt was because over 90% of the government debt was purchased internally; therefore, thanks to Japanese interest rates declining from 7.5% to 1.4%, the government was able to dramatically increase the amount of debt without the total borrowing costs going up.
Today, Japan is one of the most indebted nations in the developed world, and its population demographics are horrible because every fourth Japanese is over 65 years old. There’s no immigration into Japan, and the population is aging rapidly, and the savings rate went from the middle teens to quickly approaching zero.
TCR: So there is less demand for Japanese government bonds.
VK: Yes, exactly. With the demand for Japanese bonds declining, they are going to have to start shopping their debt outside of Japan, and the second they do, they’ll realize that no rational buyer would buy Japanese debt yielding 1.4% when they can buy U.S. debt or German debt with yields double that.
So the Japanese are going to have to start paying high interest rates, and they can't afford that, because one-quarter of the tax revenues already goes to servicing their debt. If their interest rates were to double to just 2.8%, it basically wipes out the funding for the country’s Departments of Defense and Education. So this is a situation where they go from deflation to hyperinflation, because they’re going to have to start printing money to be able to keep paying off their debt, so this is the case where they are going just from one extreme to another.
TCR: Their economy has been hugely helped by their trade surplus, but their trade surplus has been going down steadily, in no small part because China has been stealing market share.
VK: Exactly. A lot of manufacturing went to China from Japan, so that hurt the economy too.
So when you ask me about what could trigger Chinese problems, well, you know, Japan is still a big trading partner for China, so Japan's decline would impact China as well, and vice versa.
TCR: We have heard a lot about Japanese demographics. That seems to be an intractable problem.
VK: Recently I heard that the Japanese were considering trying to solve their demographic problems by allowing immigration from China to Japan. I almost fell off my chair when I heard that, because there is a lot of animosity between the two countries. They love each other as much as Armenians love Turks, so it's very difficult for me to see that happening just because of the cultural issues going on.
TCR: And it seems that the tensions are actually getting much worse.
VK: Too true. But the key point is that Japan is past the point of no return. It’s like the Titanic has already hit the iceberg and you know it’s going to sink, you just don’t know just how long it will take to go down. That's basically what is taking place in Japan.
TCR: Sticking with that metaphor, it seems like people need to begin donning life jackets and edging toward the nearest lifeboat.
So we've got some serious issues with Asia, which obviously will have some global implications. How does this tie back to the U.S.? Our take has been that – at least on a short-term basis – when things start to come unglued, it will benefit the U.S. as a purported “safe harbor,” but then people will begin to realize that if two out of three of the world’s biggest economies can fall, so can the U.S.
VK: In the short run, it may benefit the U.S. dollar because the value of currencies is relative, right? As my friend Barry Pasikov says – the U.S. dollar is valedictorian in summer school. So if people are afraid of Japan, afraid of China, they would be running towards the U.S. currency. By the way, the Japanese currency made a 15-year high recently suggesting what could be the trade of the decade.
I'm a value investor, so I generally don’t spend much time on currencies, but I think this is a case where shorting Japanese yen makes a lot of sense.
It may work against you for a while, but in the long run, I think it could turn out to be the trade of the decade.
Again, I think the U.S. dollar might benefit in the short run, but don’t overlook that China and Japan are the largest foreign holders of U.S. debt. If Japan becomes a net seller of U.S. debt and their debt starts competing with U.S. debt, then that's going to be negative for our economy because we are going to have high interest rates. If China also becomes a net seller of U.S. debt, again, it's negative for our economy.
The big question, once they start selling, is how fast will they sell their U.S. debt. If they sell it very fast, maybe because they have to, it's going to drive our interest rates higher. If it's something that develops over a long period of time, it may not drive our interest rates as much as you would think.
TCR: But ultimately, if they hit a real bump in the road, they’re going to have to start selling.
VK: Exactly. Plus, the Japanese government bonds will start competing with our bonds. In the past the Japanese people were able to consume the government debt internally, down the road the government is going to have to start selling its bonds to the same people who are buying our bonds, and instead of paying 1-2%, they’ll have to start paying 5, 6, 7%.
TCR: Which would be devastating for the Japanese economy, given the scale of their debt.
VK: Absolutely, At that point, they are going to have a very high inflation because they’ll be forced to print a lot of money.
Computerized trades in EU face tougher rules
by Huw Jones and Nick Vincour - Reuters
Britain and France flagged on Thursday a looming crackdown on ultra-fast share trading that featured in May's brief "flash crash" freefall on Wall Street, alarming regulators and investors globally. French Economy Minister Christine Lagarde said a form of computerized trading known as high-frequency trading (HFT) may need banning in some cases. "My natural tendency would be at least to regulate, to oversee it very strictly and after a cost-benefit analysis of these methods, maybe to forbid it," Lagarde told a parliamentary commission hearing on financial speculation. "Or at least give market authorities the power to forbid it in circumstances that are considered exceptional," she added.
Britain, Europe's biggest share trading center and where HFT accounts for about a third of trading on the London Stock Exchange, also signaled that tougher rules were needed but that they must be proportionate and targeted. HFT was simply the evolution of trading to a much faster pace due to advances in technology, said Alexander Justham, director of markets at the UK's Financial Services Authority. "We are not here to turn the clock back," he told a TradeTech 2010 markets industry conference.
Computerized trading and methods such as algorithmic trading and HFT transact a huge number of trades in microseconds. "If you drive so fast, the technology should be that you can brake as fast as well," Justham said. Justham said HFT has narrowed bid/offer spreads but the jury was out on whether it has led to more efficient trading and on whether it has created unfair advantages in trading. Justham said there were key differences between the U.S. and EU share markets such as controls on who can trade and availability of "circuit breakers" to slow sharp moves. "We are absolutely not complacent about the general risk of what all this means. Has the playing field been tilted?" Justham said.
Bank of France Governor Christian Noyer told the same French parliamentary panel on Wednesday evening that HFT was a real problem. "I would only see advantages if it was scrutinized as much as possible," Noyer said. Industry officials said HFT takes place on regulated markets. "The main issues are around credit derivatives and structured derivatives, all of which are happening in the dark. We're probably the most transparent part of the market," said Kee-Meng Tan, managing director at Knight Capital, a trading services provider.
Jim Farachi, director at Getco, a key player in HFT, said: "High frequency trading firms are market makers who utilize technology to provide liquidity to the market in a more efficient way than pit or phone trading." The U.S. Securities and Exchange Commission, the FSA's equivalent on Wall Street, said this month it will take further steps to make markets more stable after the flash crash by zeroing in on lightning-fast Computerized trading that could "go crazy.
Exchanges like the LSE and the Madrid bourse are taking steps to attract HFT firms as they face downward pressure on general volumes due to the weak economy. Tougher regulation is inevitable, however. European Union share trading rules, known as markets in financial instruments directive or MiFID, introduced in November 2007 have sparked competition in share trading, greater use of Computerized trading and fragmentation of markets. The EU's executive European Commission is due to present legislative amendments to MiFID by next summer with the European Parliament and EU governments having the final say.
Justham said that the review should look at tougher limits on "carve outs" for some firms from MiFID's transparency rules and look at forcing a wider spectrum of trading firms to report trades so that regulators have a full and speedy picture of the market when things go wrong. Trading firms may also need to "stress test" their Computerized trading models or algorithms before they go live. Justham later told Reuters that any policy changes for markets in Britain would come under the umbrella of the MiFID review but there could be changes in the way the FSA supervises the domestic market in the meantime.
The MiFID review will also crack down on dark pools or anonymous, off-exchange trading venues that have flourished. "The proliferation of dark pools was a tragic error and I would like us to come back to it," France's Noyer said, noting that it was up to market supervisors to address the matter. Britain's government announced earlier this week it was sponsoring a study by scientists into the impact of HFT on London as a financial center over the coming decade and this would help shape the MiFID review.
China, Russia quit dollar on bilateral trade
China and Russia have decided to renounce the US dollar and resort to using their own currencies for bilateral trade, Premier Wen Jiabao and his Russian counterpart Vladimir Putin announced late on Tuesday in St. Petersburg. Chinese experts said the move reflected closer relations between Beijing and Moscow and is not aimed at challenging the dollar, but to protect their domestic economies. "About trade settlement, we have decided to use our own currencies," Putin said at a joint news conference with Wen in St. Petersburg.
The two countries were accustomed to using other currencies, especially the dollar, for bilateral trade. Since the financial crisis, however, high-ranking officials on both sides began to explore other possibilities. The yuan has now started trading against the Russian rouble in the Chinese interbank market, while the renminbi will soon be allowed to trade against the rouble in Russia, Putin said. "That has forged an important step in bilateral trade and it is a result of the consolidated financial systems of world countries," he said.
Putin made his remarks after a meeting with Wen. They also officiated at a signing ceremony for 12 documents, including energy cooperation. The documents covered cooperation on aviation, railroad construction, customs, protecting intellectual property, culture and a joint communiqu. Details of the documents have yet to be released.
Putin said one of the pacts between the two countries is about the purchase of two nuclear reactors from Russia by China's Tianwan nuclear power plant, the most advanced nuclear power complex in China. Putin has called for boosting sales of natural resources - Russia's main export - to China, but price has proven to be a sticking point.
Russian Deputy Prime Minister Igor Sechin, who holds sway over Russia's energy sector, said following a meeting with Chinese representatives that Moscow and Beijing are unlikely to agree on the price of Russian gas supplies to China before the middle of next year.
Russia is looking for China to pay prices similar to those Russian gas giant Gazprom charges its European customers, but Beijing wants a discount. The two sides were about $100 per 1,000 cubic meters apart, according to Chinese officials last week.
Wen's trip follows Russian President Dmitry Medvedev's three-day visit to China in September, during which he and President Hu Jintao launched a cross-border pipeline linking the world's biggest energy producer with the largest energy consumer. Wen said at the press conference that the partnership between Beijing and Moscow has "reached an unprecedented level" and pledged the two countries will "never become each other's enemy".
Over the past year, "our strategic cooperative partnership endured strenuous tests and reached an unprecedented level," Wen said, adding the two nations are now more confident and determined to defend their mutual interests. "China will firmly follow the path of peaceful development and support the renaissance of Russia as a great power," he said. "The modernization of China will not affect other countries' interests, while a solid and strong Sino-Russian relationship is in line with the fundamental interests of both countries."
Wen said Beijing is willing to boost cooperation with Moscow in Northeast Asia, Central Asia and the Asia-Pacific region, as well as in major international organizations and on mechanisms in pursuit of a "fair and reasonable new order" in international politics and the economy.
Sun Zhuangzhi, a senior researcher in Central Asian studies at the Chinese Academy of Social Sciences, said the new mode of trade settlement between China and Russia follows a global trend after the financial crisis exposed the faults of a dollar-dominated world financial system. Pang Zhongying, who specializes in international politics at Renmin University of China, said the proposal is not challenging the dollar, but aimed at avoiding the risks the dollar represents.
Wen arrived in the northern Russian city on Monday evening for a regular meeting between Chinese and Russian heads of government. He left St. Petersburg for Moscow late on Tuesday and is set to meet with Russian President Dmitry Medvedev on Wednesday.
Default Swaps Soar on 'Sacrosanct' Senior Europe Bank Debt
by Abigail Moses - Bloomberg
The cost of protecting against defaults on senior notes of European banks is soaring on speculation bondholders will be forced to take losses as governments try to share the burden of taxpayer-funded bailouts. The Markit iTraxx Financial Index of credit-default swaps on senior debt rose 6.5 basis points, or 0.065 percentage point, to 157.5. basis points. Contracts on Portugal’s Banco Espirito Santo SA are at a record, and Spain’s Banco Santander SA are at the highest level in five months.
Europe’s debt crisis has spread to Ireland from Greece, and bond investors bet that Portugal and Spain will be next in line for a bailout from the European Union and International Monetary Fund. The EU estimates a rescue for Ireland, downgraded yesterday by Standard & Poor’s, may total 85 billion euros ($113 billion).
“Under a ‘bail-in’ regime, senior bondholders will most likely find themselves as potential burden-sharers, which is in stark contrast with the rules of engagement of the market hitherto,” Roberto Henriques, an analyst at JPMorgan Chase & Co. in London, said in a research report. “Even at the worst point of the current crisis, it was generally a given that senior debt was sacrosanct.”
Subordinated bonds have largely borne the brunt of losses because they stop paying before senior securities in case of a default or debt restructuring. Should banks be unable to pay senior bondholders, they may find it more difficult and expensive to raise money. Anglo Irish Bank Corp. investors were forced to take 20 cents on the euro for subordinated debt this week.
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar maturity government debt rose 3 basis points to 169 basis points, the highest since Oct. 20, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.61 percent.
Performance Food Group Co. withdrew a planned $550 million note sale citing “adverse market conditions.”
National Amusements Inc., the movie-theater chain and holding company controlled by billionaire Sumner Redstone, planned to issue $390 million of bonds. Loan prices fell yesterday and relative yields on emerging market debt soared. “There’s a risk-off trade right now because there’s a lot of fear in the marketplace,” said Kingman Penniman, chief executive officer of KDP Investment Advisors in Montpelier, Vermont. “With the combination of everything that’s happening in Europe and Asia and the aggressive amount of new issuance that’s come recently, we’re definitely seeing a correction.”
Performance Food, owned by Blackstone Group LP and Wellspring Capital Management LLC, pulled its offering even after sweetening terms for the debt on Nov. 22 in an effort to attract investors, said a person familiar with the transaction who declined to be identified because the marketing was private.
Bain Capital LLC’s Burlington Coat Factory Warehouse Corp. decided to cancel a $1.5 billion debt financing on Nov. 18. In Asia, Hongkong Electric Holdings Ltd., delayed its sale of as much as $500 million of 10-year dollar bonds due to tensions on the Korean peninsula, two people familiar with the matter said today. Yuzhou Properties Co., a developer in southern China, and Vietnam National Coal-Mineral Industries Group postponed dollar- denominated bond offerings as investor appetite for risk diminished, people with knowledge of the sales said yesterday.
In Europe, Vienna Insurance Group, the east of the region’s biggest insurer, postponed its 500 million-euro ($666 million) sale of 30-year subordinated bonds, according to a banker involved in the transaction. Caterpillar Inc., the world’s biggest maker of construction equipment, hired Goldman Sachs Group Inc. to help it sell yuan- denominated bonds in Hong Kong, according to a person familiar with the matter.
The Peoria, Illinois-based company plans to raise as much as 1 billion yuan ($150 million) from two-year bonds, said the person, who asked not to be identified as the matter is private. National Amusements may sell its seven-year senior secured notes as soon as next week, said a person familiar with the transaction. The notes will have a provision allowing up to 10 percent of the debt to be redeemed at 103 percent annually during the first three years, after which time all of it can be called, said the person, who declined to be identified because terms aren’t set.
In the asset-backed securities market, the Securities and Exchange Commission indefinitely extended the timeframe for bond issuers to omit credit ratings from marketing materials, effectively exempting companies from part of the U.S. Dodd-Frank financial reform act. Fears of burden sharing are also being seen in senior bank bonds. The 1 billion euros of senior unsecured floating-rate notes due 2012 issued by Banco Espirito Santo were at 90.8 cents, down from 93.4 on Nov. 4, according to Bloomberg composite prices. Its 500 million euros of senior notes due 2013 were at 83 cents, down from 88.38 on Nov. 4.
Banco Bilbao Vizcaya Argentaria SA’s 1.25 billion euros of 3.875 percent senior notes due 2015 were at 98.8 cents to yield 4.14 percent, down from 101.7 cents and a yield of 3.47 percent on Nov. 1, according to Bloomberg composite prices. While Irish Finance Minister Brian Lenihan has pledged only to impose losses on holders of subordinated bonds of nationalized lenders, investors are concerned his promise won’t be honored as EU and IMF officials gain authority in Dublin.
Outlook for Bondholders
“There will be private-sector burden-sharing,” said Willem Buiter, chief economist at Citigroup Inc. in London. “Ireland may be the first example, with haircutting of senior unsecured bank debt and possible sovereign debt restructuring as well in due course.” The Markit iTraxx SovX Western Europe Index of contracts on 15 governments reached a record high 181.5 basis points.
Credit-default swaps typically rise as investor confidence deteriorates and fall as it improves, paying the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt. Dublin-based Anglo Irish was taken over by the government in January 2009 as loan losses spiraled after a real-estate bubble burst. The government has also taken a 36 percent stake in Bank of Ireland, the country’s biggest lender, and is preparing to take a majority share of Allied Irish.
Credit-default swaps on Anglo Irish’s bonds may be triggered following a subordinated debt exchange, with investors asking the International Swaps & Derivatives Association whether the transaction constitutes a so-called restructuring credit event. If ISDA rules that Anglo Irish swaps can be triggered, buyers of insurance on the bank’s senior bonds should hold off demanding payment because they may recover more as the risk of holding the debt increases, according to Tim Brunne, a credit strategist at UniCredit SpA in Munich.
Forcing holders of senior bonds sold by some European banks to take losses may be necessary given the amount of debt involved, according to Brunne. “You don’t have the possibility to solve the situation without cutting the link between the financial sector and the sovereign, and that’s a problem you see everywhere,” he said.
The 750-billion-euro European Financial Stability Facility, created in May to support the region’s most indebted governments, won’t be big enough to rescue Spain, Citigroup’s Buiter said. A rise in Spanish bank risk could be the “tipping point” for the financial credit swaps gauge, according to JPMorgan.
Credit-default swaps on Lisbon-based Banco Espirito Santo have climbed to a record 722, according to CMA. Contracts on Banco Santander are at a five-month high of 236. German Chancellor Angela Merkel wants buyers of new euro- region bonds to accept liability clauses starting in 2011, two years before a revamped crisis-management system kicks in, according to a government document obtained by Bloomberg News.
“The problem areas are there for all to see -- haircuts for subordinated bank debt holders and fear that senior holders could get dragged in,” said Suki Mann, a credit strategist at Societe Generale SA in London. “The market has moved on from Greece, is beating up on Ireland and is looking closely at Portugal.”
Elizabeth Warren Helped Shoot Down Bill That Would Have Sped Foreclosures
by Shahien Nasiripour - Huffington Post.
Elizabeth Warren was the first senior Obama administration official to recognize the potentially incendiary impact of a bill that would have made it significantly easier for mortgage companies to foreclose on homes, and her subsequent warnings played a crucial role in persuading the President to veto the measure, according to freshly released documents and people familiar with the deliberations.
The disclosure that Warren was instrumental in halting a bill that would have streamlined the foreclosure process comes as she confronts fierce criticism from Republicans on Capitol Hill for the way she was appointed to construct a new consumer financial protection bureau, and characterizations that she is inclined to take an overly punitive tack with Wall Street.
A long-time advocate for greater regulation of the financial system and a prominent critic of predatory lending, Warren now finds herself at the center of an intensifying debate over the relationship between the Obama administration and the business world. For consumer advocates, who have long decried what they portray as Wall Street's outsized influence in Washington, Warren represents their greatest hope that big banks will be more tightly supervised following the worst financial crisis since the Great Depression. For a vocal group of business leaders and their Republican allies, Warren has become Exhibit A in their case that the Obama administration is anti-business.
The decisive way in which she labored behind the scenes to stymie a bill that would have eased requirements for documentation in the foreclosure process underscores how her arrival has altered the administration's relationship with major banks. The bill, which passed both houses of Congress and awaited President Obama's signature to become law, essentially would have compelled notaries to accept out-of-state notarizations, regardless of the rules in those states.
State officials across the country--who have been pursuing probes looking into wrongdoing within the foreclosure process-- feared that those jurisdictions with lax standards could have become hotbeds for foreclosure documentation fraud. Lenders and mortgage companies could have used those states as central clearing houses to produce bogus foreclosure paperwork, and then export those documents to other states with more stringent regulations--an expedient bypass around the strictures.
Obama ultimately declined to sign the law, and the House of Representatives failed to override the veto. Officials said Warren was among the first federal officials to recognize the significance of the notary bill, titled the Interstate Recognition of Notarizations Act of 2010. She met with authorities from several states and then relayed their concerns to influential administration officials.
During the morning of Oct. 6, Warren's team at the Treasury Department wrote the first memos on the bill, raising questions about the possible consequences if it became law, these people said. That evening, Warren met for 30 minutes with Peter Rouse, Obama's interim chief of staff, her calendar shows. She later spent an hour on the phone with Illinois Attorney General Lisa Madigan, who once sued Countrywide Financial and exacted an $8.4 billion multi-state settlement.
The next day, Warren participated in an afternoon meeting on the bill, her calendar shows. During that meeting one of Obama's top spokesmen, Dan Pfeiffer, posted an entry on the White House Blog explaining why Obama would not sign the bill. On Oct. 8, Obama declined to sign the bill into law, citing the need for "further deliberations about the possible unintended impact" of the bill on "consumer protections, including those for mortgages."
Documents released Wednesday show that Warren met or spoke with at least eight state officials leading a 50-state investigation into possibly-fraudulent mortgage documentation practices. The state attorneys general, secretaries of state and bank supervisors are probing the way in which major mortgage companies have pushed through thousands of foreclosure cases at a time, as if on a factory assembly line, by short-cutting the required documentation process.
Recent weeks have featured a host of unsavory disclosures about how mortgage companies employed so-called robo-signers-- people whose sole job was to sign foreclosure documents without reading them or confirming basic facts, as required by law. The volume of cases and shoddy handling of paperwork is reflective of the messy and indiscriminate lending practices that characterized the nation's housing boom, as Wall Street eagerly handed mortgages to seemingly anyone willing to sign off.
The states' investigation and a parallel multi-agency federal probe are now roiling the mortgage industry, heightening the possibility that major lenders could face potentially huge fresh losses as bad loans continue to emerge. With legal and regulatory uncertainty now enshrouding the industry and public outrage trained on foreclosures, the banks could have trouble limiting those losses by selling off the homes pledged against bad mortgages. The nation's biggest lender, Bank of America, has seen its share price drop 18 percent through yesterday's market close since the day before the states announced their joint inquiry.
Warren serves as an assistant to Obama and a special adviser to Treasury Secretary Timothy Geithner as she leads the effort to create the new Bureau of Consumer Financial Protection, a watchdog designed to protect borrowers from abusive lenders. Her calendar from Sept. 20 to Nov. 2 was released per a Freedom of Information Act request. The longtime Harvard Law School professor and consumer advocate met or spoke with the state attorneys general from Iowa, Illinois, Texas, North Carolina, Massachusetts and Ohio, her calendar shows. She also met with Ohio Secretary of State Jennifer Brunner, and spoke with New York's top banking regulator, Richard H. Neiman. They are among the leaders of the combined state probe.
Warren has long chided federal regulators for their lax oversight of the financial industry and slipshod protection of consumers. She's championed state regulators, however, who have often been ahead of their federal counterparts when it comes to consumer finance issues. Warren's calendar also shows numerous meetings with bankers and their representatives. Financial executives and lobbyists have noted that Warren was reaching out to them more than they initially expected. The calendar confirms her outreach.
On Sept. 20, the same day she took a photo for her Treasury Department badge, Warren spent an hour and a half meeting with bankers from Oklahoma, her calendar shows. She spent an hour having lunch with Geithner that day as well. Since then she's met with the chief executives of the nation's largest banks, including Vikram Pandit of Citigroup; Jamie Dimon of JPMorgan Chase; John Stumpf of Wells Fargo; James Gorman of Morgan Stanley; Richard Davis of U.S. Bancorp; W. Edmund Clark of TD Bank Financial Group; David Nelms of Discover Financial Services; Niall Booker of HSBC North America Holdings; and Kenneth Chenault of American Express.
The calendar entry for Chenault's one-hour meeting on Oct. 13 notes that "He's flying here for us." Warren also met with officials from Goldman Sachs and Deutsche Bank, Germany's biggest lender and one of the world's biggest financial institutions. Notably absent from Warren's calendar are officials from Bank of America, the biggest bank in the U.S. by assets and branches, including its chief executive, Brian Moynihan.
Warren's calendar includes meetings with investors and trade groups, like the Consumer Bankers Association, the Independent Community Bankers of America, the Financial Services Roundtable and the Securities Industry and Financial Markets Association. Though Warren is known for her vigorous advocacy on behalf of consumers, she's spent more time with bankers and their lobbyists than with consumer groups and advocates during her roughly two months on the job.
Warren's 2007 journal article calling for the creation of a dedicated consumer agency inspired policymakers to enact it into law. Big banks opposed it. Warren has also met with nearly two dozen members of Congress from both sides of the aisle, including the likely incoming chair of the House Financial Services Committee, Rep. Spencer Bachus, and the top Republican on the Senate Banking Committee, Richard Shelby. The Alabama Republicans have been particularly critical of Warren and her new agency.
Warren's calendar features numerous White House meetings, like a two-hour dinner on Sept. 23 with top Obama adviser David Axelrod and breakfasts and lunches with another top Obama counselor, Valerie Jarrett. She's also met with the heads of all the major federal financial regulatory agencies, including Federal Reserve Chairman Ben Bernanke.
Among Warren's early initiatives are efforts to make credit card disclosure forms shorter and easier to read, and simplifying mortgage documents. Her first major speech since joining the administration was a Sept. 29 address to the Financial Services Roundtable, a Washington trade group representing firms like JPMorgan Chase, BlackRock and State Farm. She asked the assembled executives to work with her to create a new system of consumer regulation focused on core principles rather than a mountain of specific rules.
Greenhouse Gas Concentration In Atmosphere Hits Record Levels
A report by the U.N. weather agency has found that greenhouse gas levels in the atmosphere reached record levels in 2009. The World Meteorological Organization says efforts to reduce emissions of carbon dioxide, methane and nitrous oxide haven't diminished the atmospheric concentration of these gases widely blamed for stoking global warming.
The Geneva-based agency says concentrations of carbon dioxide rose in 2009 by 1.6 parts per million, to 386.8 parts per million. The preindustrial carbon dioxide average was about 280 parts per million. The higher the concentration of greenhouse gases, the more heat is trapped in the atmosphere. WMO said Wednesday that the recent economic slowdown hadn't significantly affected emissions of greenhouse gases.