Posted by Sam Jones on Oct 23 14:46.
http://ftalphaville.ft.com/blog/2008/10/23/17365/the-cdo-unwind-waiting-to-happen/
Are the days of CDO carnage behind us?
Apparently not. Bloomberg reported on Wednesday:
Oct. 22 (Bloomberg) — Investors are taking losses of up to 90 percent in the $1.2 trillion market for collateralized debt obligations tied to corporate credit as the failures of Lehman Brothers Holdings Inc. and Icelandic banks send shockwaves through the global financial system.
The article is referring to synthetic CDOs: that is, CDOs which are not backed by tangible collateral (RMBS, CMBS, for example) but CDS contracts which reference some form of collateral.
In this case, CDS on corporations.
All of which may sound dreadfully esoteric. Until you ratchet up the numbers. On Friday last week, Barclays analyst Puneet Sharma put out a report on a possible synthetic CDO unwind, and what can be expected to happen to the market as we move through a recession in the coming months.
In graph form, here’s what would happen to the ratings on prime and high-grade tranches of the trillion dollar synthetic CDO market:
Huge, disastrous downgrades: exactly mirroring the structured finance downgrades from ABS CDOs which have brought the financial system to its knees already. Don’t forget, moreover, that these CDOs aren’t backed by dodgy subprime collateral, but are supposed to reference the investment grade corporate world. More proof that it’s not the collateral which is to blame, but the structuring. The medium is the message, and all that.
We guess the impact of this might make itself felt in three ways:
Firstly, there will likely be the mark-to-market losses on the CDO notes themselves. As the Bloomberg article noted, in some cases this is equivalent to a 90 per cent loss on capital. The question here then, is who is holding these notes? Hedge funds were certainly big buyers of synthetic CDOs. But guess what – banks are also holders too. And by and large, banks synthetic corporate CDO holdings haven’t been written down.
Secondly, trouble in the synthetic CDO market will – just as with ABS CDOs – have huge regulatory capital impacts for banks. Shama at Barclays produces another set of graphs to demonstrate:
Downgrades of synthetic CDOs, in other words, will have a devastating caustic effect on banks’ capital ratios – with the potential to completely offset government recapitalisation actions.
Thirdly – crisis for synthetic CDOs will suck money out of the banking system in other ways. Synthetics are “unfunded”. In a normal asset-backed CDO, the cash raised from selling bonds is used to buy assets, but in a synthetic CDO, the cash raised from selling bonds is not used up front: as a protection seller, the CDO collects premiums on CDS contracts which only cost it money in the event of a default (when the CDO must make good on its protection). Of course, depending on what is happening to the spread on the various CDS contracts a synthetic CDO might hold, the CDO might also need to make margin calls. Here is a quick diagram of the generic structure:
The point here is that the “collateral” account of synthetic CDOs usually takes one of two forms: a bank deposit, or a similar cash-equivalent holding: a money market deposit, for example. As spreads widen, and collateral posting (the red line in this diagram) comes into force, synthetic CDO SPVs will be drawing money out of banks and money market funds to meet their obligations. Given that there are quite a few synthetic CDOs out there, the effect shouldn’t be too insignificant.______
There’s one other point too: synthetic CDOs almost always have a super senior swap written on them. You can see it in the above diagram, technically sitting “outside” – above – the structure. The swap effectively offers the arranging bank protection against its position. The question is, who writes these swaps? LSS conduits, for one (another layer of SPV fun – backed by CP), insurers do (monolines and AIG, for example) and other banks do.
Complicated all the above might be. The long and the short of it is that the synthetic CDO market has used derivative technology to build a huge amount of leverage. With recession now biting, the whole house of cards is dangerously close to collapse.
The CDS markets should feel the impact when it does. One way synthetic CDO managers can offset losses- or rather, crystalise them at acceptable levels – would be to buy protection in the market to sterilise their portfolios.
2009年12月22日 星期二
S&P’s CDO rating methodology is unpatriotic, outrage du jour
Posted by Tracy Alloway on Oct 07 16:47.
Here’s a vitriolic demonstration of the current dilemma facing the ratings agencies.
Having been accused of ratings puffery — not being realistic or pessimistic enough when they first evaluated structured assets like collateralised debt obligations – the agencies are now being accused of being too bearish. To wit: the latest HCM Market Letter’s comments on Standard & Poor’s (H/T Sam Jones).
First, a bit of background:
On Sept. 17, S&P published a revised methodology for CDOs — the slice and dice securitisations backed by mortgages or other debt – after having flagged its revision proposal since at least March. The rating agency said the new methodology would affect nearly 5,000 deals, mostly based on corporate loans and worth about $578bn. Outstanding synthetic CDOs would likely get a downgrade of four notches, S&P said at the time. The upside was that CDOs which received triple-A ratings under the new criteria had to be able to withstand Depression era-esque default rates.
A fair trade-off? Not according to some commentators.
Here are the relevant excerpts from that HCM letter (emphasis ours):With this announcement, S&P accomplished several things. First, the revisions constitute an admission that its prior ratings were based on profoundly flawed intellectual assumptions and ratings models. Unfortunately, they have replaced their original mistakes with equally serious ones. Second — and most important from a systemic standpoint — the revisions effectively hammer the final nails into the coffin of the securitization of corporate debt. Third, with these revisions S&P unilaterally changed the rules governing hundreds of billions of dollars of Collateralized Loan Obligations that were issued over the past few years. It did so without giving investors in these transactions any right of appeal, or any recourse to recover their potential losses. Investments were made based on earlier ratings which arguably constituted an implied promise by the ratings agencies to maintain the original set of assumptions underlying their ratings. By unilaterally changing these assumptions to account for the first time for Black Swans, S&P has broken its compact with the entire financial world that came to rely on its ratings. This post hoc approach reflects extremely poorly on the intellectual abilities of the credit rating agency.
Err, ouch.
If that wasn’t enough, though, HCM are also accusing S&P of being ignorant of the current economic environment:Fifth, S&P is effectively raising the cost of capital for less than investment grade companies that are already suffering from a dearth of available capital sources. Moreover, it is doing so after credit conditions have improved. While the rating agency is a private sector entity, it has enjoyed the imprimatur of the Securities and Exchange Commission that requires so many areas of finance to rely on its ratings. Moves like this, which are dressed up in intellectual clothing but are little more than ex post facto attempts to correct its prior mistakes, have large systemic effects. The problem is that these systemic effects are being inflicted by an organization that has surrendered any claim to intellectual legitimacy by its prior errors. Moreover, it is compounding those errors by making changes to its ratings assumptions that fly in the face of current data that suggests that corporate credit conditions are improving, rendering its heightened default scenarios highly unlikely to occur and unsuitable for application to these structured credit products.
And what’s more, S&P’s actions pose wider problems for collateralised loan obligations — a type of CDO which securitises commercial loans:The tragedy is that S&P’s recent move suggests that they are being permitted to stick it to investors again. The rating agencies fail to understand that corporate loans are different from bonds or mortgages. Instead, they are applying the same standards they erroneously applied to Collateralized Mortgage Obligations and Collateralized Bond Obligations to Collateralized Loan Obligations. As a result, they are downgrading CLOs and limiting their ability to provide capital to less than investment grade companies in an already difficult financing environment. They are doing this without regard to the consequences of their actions, which is to render financing harder to come by for viable companies that need access to capital. Despite improved credit conditions, less-than-investment grade companies remain faced with the same situation that they have always faced, i.e., the rationing of credit. Banks long ago exited the lending business in favor of the originate-and-distribute model, and in the aftermath of the crisis have little desire to add assets to their balance sheets. As Chart 1 on the previous page illustrates so graphically, the banks are still in the process of exiting the lending business and nobody appears to be filling the gap. One of the last men standing to purchase less-than-investment grade securities in large volumes were CLOs, and an increasing number of these are being frozen out of the market by these downgrades just as market conditions are improving. This is directly contrary to the efforts the Obama Administration is making to encourage lending, and is another reason why credit agencies should be subject to far stricter regulation in view of the damage they have already done and continue to do.
Woah — downgrading CDOs/CLOs is now unpatriotic and against Obamanomics?
Evil ratings agencies. Perhaps we can have a McCarthy-style witch hunt to purge them of their new-found realism bearishness soon.
Or maybe just another ratings flip-flop.
Related links:Hedgie adventures in pop history; hyperbole. Redux – The Long RoomCDOs, a tendency to liquidate – FT Alphaville`Race to bottom’ at Moody’s, S&P secured subprime’s boom, bust – Bloomberg
Here’s a vitriolic demonstration of the current dilemma facing the ratings agencies.
Having been accused of ratings puffery — not being realistic or pessimistic enough when they first evaluated structured assets like collateralised debt obligations – the agencies are now being accused of being too bearish. To wit: the latest HCM Market Letter’s comments on Standard & Poor’s (H/T Sam Jones).
First, a bit of background:
On Sept. 17, S&P published a revised methodology for CDOs — the slice and dice securitisations backed by mortgages or other debt – after having flagged its revision proposal since at least March. The rating agency said the new methodology would affect nearly 5,000 deals, mostly based on corporate loans and worth about $578bn. Outstanding synthetic CDOs would likely get a downgrade of four notches, S&P said at the time. The upside was that CDOs which received triple-A ratings under the new criteria had to be able to withstand Depression era-esque default rates.
A fair trade-off? Not according to some commentators.
Here are the relevant excerpts from that HCM letter (emphasis ours):With this announcement, S&P accomplished several things. First, the revisions constitute an admission that its prior ratings were based on profoundly flawed intellectual assumptions and ratings models. Unfortunately, they have replaced their original mistakes with equally serious ones. Second — and most important from a systemic standpoint — the revisions effectively hammer the final nails into the coffin of the securitization of corporate debt. Third, with these revisions S&P unilaterally changed the rules governing hundreds of billions of dollars of Collateralized Loan Obligations that were issued over the past few years. It did so without giving investors in these transactions any right of appeal, or any recourse to recover their potential losses. Investments were made based on earlier ratings which arguably constituted an implied promise by the ratings agencies to maintain the original set of assumptions underlying their ratings. By unilaterally changing these assumptions to account for the first time for Black Swans, S&P has broken its compact with the entire financial world that came to rely on its ratings. This post hoc approach reflects extremely poorly on the intellectual abilities of the credit rating agency.
Err, ouch.
If that wasn’t enough, though, HCM are also accusing S&P of being ignorant of the current economic environment:Fifth, S&P is effectively raising the cost of capital for less than investment grade companies that are already suffering from a dearth of available capital sources. Moreover, it is doing so after credit conditions have improved. While the rating agency is a private sector entity, it has enjoyed the imprimatur of the Securities and Exchange Commission that requires so many areas of finance to rely on its ratings. Moves like this, which are dressed up in intellectual clothing but are little more than ex post facto attempts to correct its prior mistakes, have large systemic effects. The problem is that these systemic effects are being inflicted by an organization that has surrendered any claim to intellectual legitimacy by its prior errors. Moreover, it is compounding those errors by making changes to its ratings assumptions that fly in the face of current data that suggests that corporate credit conditions are improving, rendering its heightened default scenarios highly unlikely to occur and unsuitable for application to these structured credit products.
And what’s more, S&P’s actions pose wider problems for collateralised loan obligations — a type of CDO which securitises commercial loans:The tragedy is that S&P’s recent move suggests that they are being permitted to stick it to investors again. The rating agencies fail to understand that corporate loans are different from bonds or mortgages. Instead, they are applying the same standards they erroneously applied to Collateralized Mortgage Obligations and Collateralized Bond Obligations to Collateralized Loan Obligations. As a result, they are downgrading CLOs and limiting their ability to provide capital to less than investment grade companies in an already difficult financing environment. They are doing this without regard to the consequences of their actions, which is to render financing harder to come by for viable companies that need access to capital. Despite improved credit conditions, less-than-investment grade companies remain faced with the same situation that they have always faced, i.e., the rationing of credit. Banks long ago exited the lending business in favor of the originate-and-distribute model, and in the aftermath of the crisis have little desire to add assets to their balance sheets. As Chart 1 on the previous page illustrates so graphically, the banks are still in the process of exiting the lending business and nobody appears to be filling the gap. One of the last men standing to purchase less-than-investment grade securities in large volumes were CLOs, and an increasing number of these are being frozen out of the market by these downgrades just as market conditions are improving. This is directly contrary to the efforts the Obama Administration is making to encourage lending, and is another reason why credit agencies should be subject to far stricter regulation in view of the damage they have already done and continue to do.
Woah — downgrading CDOs/CLOs is now unpatriotic and against Obamanomics?
Evil ratings agencies. Perhaps we can have a McCarthy-style witch hunt to purge them of their new-found realism bearishness soon.
Or maybe just another ratings flip-flop.
Related links:Hedgie adventures in pop history; hyperbole. Redux – The Long RoomCDOs, a tendency to liquidate – FT Alphaville`Race to bottom’ at Moody’s, S&P secured subprime’s boom, bust – Bloomberg
As Currencies Collapse, What Do You Do?
By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens." - John Maynard Keynes
For the record, I believe John Maynard Keynes is one of the top-ten most evil human beings ever to have walked the earth, but I am thrilled to see that he at least admitted his theories amount to no more than legalized theft. And I know many of you will point out that I have used this quote several times in the last year. And it may trouble you to know I’ll probably continue to use it now and then, just to remind the Keynesians of the world that even the author of the theories they hold so dear considered them to be immoral. Of course, I’m presuming Keynes believed theft is immoral. I never spoke to him. So I can’t say for sure.
In the last several trading days, I've been watching the dollar strengthen, which, if you've been reading my articles, doesn't make a lot of sense -- at least not on the surface. The Fed (and every other major central bank) is creating currency and easing credit more than ever in history, and that, by definition, is inflationary. Remember what I’ve said so many times: inflation is not defined as rising prices; inflation is an increase in the amount of currency and credit available. Rising prices result from inflation. So if there are more dollars in the economy right now than ever before in history, shouldn't prices be rising? Further, as long-term Treasury yields increase -- as they have been over the last year -- doesn't this offer further evidence that rates are on an upward trend? And if they are going higher, as the cost of borrowing increases, won’t that cause hurdle rates to move higher, as well? (A hurdle rate is the rate at which managers and/or investors decide for or against an investment. If, for example, the hurdle rate is 12%, then any projected rate of return below 12% is rejected as an investment.)
But the dollar is stronger for now, and below is a video analysis of a chart that bears out yet more possible gains from the greenback – at least in the short term. The chart also serves as a good example of why I am not a technician, and why I don't use charts for anything but confirmation of trends.
It seems to me, however, as though there are two very strong long-term forces threatening to send rates and prices higher:
1. Unprecedented printing and easing of credit.
2. A diminishing appetite for U.S. debt.
Let me ask you this: would you loan money to any entity at less than 5%, knowing the entity’s credit was bumping against its ceiling, and that its earning-power had been severely crippled? I know I wouldn't. But somebody has been buying Treasuries, and I think those "somebodies" are starting to realize just exactly how stupid that sort of behavior is.
Consider these comments Friday, 12/18/09, from Zhu Min, deputy governor of the People's Bank of China:
“The United States cannot force foreign governments to increase their holdings of Treasuries," Zhu said, according to an audio recording of his remarks. "Double the holdings? It is definitely impossible.”
"The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world," he added. "The world does not have so much money to buy more US Treasuries."
What if sovereign nations are slowly beginning to curtail their purchases of U.S. Treasuries? Might that not account for the rise we’ve seen in yields over the last year? “Man-of-the-year” Bernanke says he’s going to hold down the long-end of the yield curve, but that hasn’t been working so well for him; it’s hard to keep rates down when the global economy no longer wants your debt.
But let’s take it a step further: what if, say China, suddenly noticed that the U.S. government really isn’t all that credit worthy anymore. And what if about a year ago, China recognized that long-end prices were at historical highs, and yields were at historical lows. What would China likely do? Right. They’d slowly start selling – or at least start minimizing purchases. And what would happen to bond prices? They’d fall. And how about those yields? Yep. They’d start creeping up.
I know what you’re going to say: foreign nations hold only a relatively small percentage of U.S. debt. So what? That certainly doesn’t mean foreign nations are the only investors in the world who recognize what is happening to United States credit. Treasuries are not the safe-haven they once were. More often than not these days, they move in tandem with the stock market! What kind of behavior is that for the so-called “risk free rate of return?”
Here’s the part most people don’t think about, however: if foreigners are slowly cashing in U.S. bonds, what happens? Effectively, they sell bonds, and they buy dollars. And until they convert those dollars to some other asset – whether a currency or some commodity – the dollar will strengthen. But how long with these foreigners hold on to greenbacks? My guess is not long, and I’m willing to bet the recent dollar rally is going to be very ephemeral.
Just as investors have started to realize that Treasury yields and prices are unsustainable at these levels, they will soon realize that the dollar is no longer the store of value it once was either. It cannot sustain its status as the world’s currency reserve. With the massive amounts of debt the U.S. has piled up, along with the unprecedented number of dollars now printed and floating in the system, public perception of the dollar is about to change. And there may be one more surprise coming that most people aren't anticipating: it is very likely that many of the world's largest oil-producing countries may soon begin transacting in some currency other than the dollar.
Where to Invest Now?
Stocks? I continue to say absolutely not.
For over a year, I've argued that stocks would recover, and then trade sideways to down for a very long time. I've also suggested that there is a possibility that stocks might even continue to climb, but not until inflationary price pressure begins to accelerate.
My argument is that no matter what stocks do, they will fail to outperform general price increases deriving from inflation.
So if you believe the dollar is heading south, where do you put your money? Should you short the dollar? Or perhaps you should go long the euro? I don't think either is a good investment; most currencies in the world are going to lose value as governments print their way out of this mess. Even the Swiss -- traditionally the most fiscally responsible government on earth -- are getting on board.
I think the Euro could be a moderately good short- to medium-term trade. One of the euro's strengths is that the European Union doesn't issue debt (at least for now), and so its monetary policy isn't heavily reliant on that component -- the way U.S. is. At least from the debt perspective, the euro isn’t as affected by the debt component, and so the world may well shift away from the dollar to the euro as its global currency reserve.
Or maybe the Chinese will get their wish, and SDRs will replace the dollar. Who knows? And who cares? Any fiat currency that replaces the dollar is going to have just as many problems. Remember the European Union's currency printing presses are in high gear too – along with everyone else’s. The only thing that’s going to stop the pattern of violent economic gyrations we’ve seen in the last century is the decriminalization of private competing currencies, backed by commodities – most likely precious metals.
So if all fiat currencies are going to fall simultaneously, what will they be falling in relation to?
The answer to that is simple: commodities. And that's where I’m putting my money. I still believe energy, agriculture, and metals are going to be sure winners; I’m especially bullish on silver right now, but when inflation really starts to hand us higher dollar-based prices, I think investor psychology will head toward gold because it is by far perceived as the most stable, long-term store of value in the world -- as it has been for thousands of years.
There are some people who believe gold and oil are going lower -- and by extension, that the dollar is going higher. I obviously disagree with that position -- as I said earlier -- before I expound, here are two bearish video counterarguments to my thoughts on gold and oil, respectively.
Both gold and oil -- and especially gold -- have ridden out economic historical crises extremely well. They don't just keep up with inflation-driven prices -- they outpace them. As such, since there's no question in my mind that the profligate global printing of currency and easing of credit are going to drive prices higher -- on an unimaginable scale. And while the above short-term outlooks may be useful in their capacities, my long-term outlook remains exceedingly bullish.
Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies
For the record, I believe John Maynard Keynes is one of the top-ten most evil human beings ever to have walked the earth, but I am thrilled to see that he at least admitted his theories amount to no more than legalized theft. And I know many of you will point out that I have used this quote several times in the last year. And it may trouble you to know I’ll probably continue to use it now and then, just to remind the Keynesians of the world that even the author of the theories they hold so dear considered them to be immoral. Of course, I’m presuming Keynes believed theft is immoral. I never spoke to him. So I can’t say for sure.
In the last several trading days, I've been watching the dollar strengthen, which, if you've been reading my articles, doesn't make a lot of sense -- at least not on the surface. The Fed (and every other major central bank) is creating currency and easing credit more than ever in history, and that, by definition, is inflationary. Remember what I’ve said so many times: inflation is not defined as rising prices; inflation is an increase in the amount of currency and credit available. Rising prices result from inflation. So if there are more dollars in the economy right now than ever before in history, shouldn't prices be rising? Further, as long-term Treasury yields increase -- as they have been over the last year -- doesn't this offer further evidence that rates are on an upward trend? And if they are going higher, as the cost of borrowing increases, won’t that cause hurdle rates to move higher, as well? (A hurdle rate is the rate at which managers and/or investors decide for or against an investment. If, for example, the hurdle rate is 12%, then any projected rate of return below 12% is rejected as an investment.)
But the dollar is stronger for now, and below is a video analysis of a chart that bears out yet more possible gains from the greenback – at least in the short term. The chart also serves as a good example of why I am not a technician, and why I don't use charts for anything but confirmation of trends.
It seems to me, however, as though there are two very strong long-term forces threatening to send rates and prices higher:
1. Unprecedented printing and easing of credit.
2. A diminishing appetite for U.S. debt.
Let me ask you this: would you loan money to any entity at less than 5%, knowing the entity’s credit was bumping against its ceiling, and that its earning-power had been severely crippled? I know I wouldn't. But somebody has been buying Treasuries, and I think those "somebodies" are starting to realize just exactly how stupid that sort of behavior is.
Consider these comments Friday, 12/18/09, from Zhu Min, deputy governor of the People's Bank of China:
“The United States cannot force foreign governments to increase their holdings of Treasuries," Zhu said, according to an audio recording of his remarks. "Double the holdings? It is definitely impossible.”
"The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world," he added. "The world does not have so much money to buy more US Treasuries."
What if sovereign nations are slowly beginning to curtail their purchases of U.S. Treasuries? Might that not account for the rise we’ve seen in yields over the last year? “Man-of-the-year” Bernanke says he’s going to hold down the long-end of the yield curve, but that hasn’t been working so well for him; it’s hard to keep rates down when the global economy no longer wants your debt.
But let’s take it a step further: what if, say China, suddenly noticed that the U.S. government really isn’t all that credit worthy anymore. And what if about a year ago, China recognized that long-end prices were at historical highs, and yields were at historical lows. What would China likely do? Right. They’d slowly start selling – or at least start minimizing purchases. And what would happen to bond prices? They’d fall. And how about those yields? Yep. They’d start creeping up.
I know what you’re going to say: foreign nations hold only a relatively small percentage of U.S. debt. So what? That certainly doesn’t mean foreign nations are the only investors in the world who recognize what is happening to United States credit. Treasuries are not the safe-haven they once were. More often than not these days, they move in tandem with the stock market! What kind of behavior is that for the so-called “risk free rate of return?”
Here’s the part most people don’t think about, however: if foreigners are slowly cashing in U.S. bonds, what happens? Effectively, they sell bonds, and they buy dollars. And until they convert those dollars to some other asset – whether a currency or some commodity – the dollar will strengthen. But how long with these foreigners hold on to greenbacks? My guess is not long, and I’m willing to bet the recent dollar rally is going to be very ephemeral.
Just as investors have started to realize that Treasury yields and prices are unsustainable at these levels, they will soon realize that the dollar is no longer the store of value it once was either. It cannot sustain its status as the world’s currency reserve. With the massive amounts of debt the U.S. has piled up, along with the unprecedented number of dollars now printed and floating in the system, public perception of the dollar is about to change. And there may be one more surprise coming that most people aren't anticipating: it is very likely that many of the world's largest oil-producing countries may soon begin transacting in some currency other than the dollar.
Where to Invest Now?
Stocks? I continue to say absolutely not.
For over a year, I've argued that stocks would recover, and then trade sideways to down for a very long time. I've also suggested that there is a possibility that stocks might even continue to climb, but not until inflationary price pressure begins to accelerate.
My argument is that no matter what stocks do, they will fail to outperform general price increases deriving from inflation.
So if you believe the dollar is heading south, where do you put your money? Should you short the dollar? Or perhaps you should go long the euro? I don't think either is a good investment; most currencies in the world are going to lose value as governments print their way out of this mess. Even the Swiss -- traditionally the most fiscally responsible government on earth -- are getting on board.
I think the Euro could be a moderately good short- to medium-term trade. One of the euro's strengths is that the European Union doesn't issue debt (at least for now), and so its monetary policy isn't heavily reliant on that component -- the way U.S. is. At least from the debt perspective, the euro isn’t as affected by the debt component, and so the world may well shift away from the dollar to the euro as its global currency reserve.
Or maybe the Chinese will get their wish, and SDRs will replace the dollar. Who knows? And who cares? Any fiat currency that replaces the dollar is going to have just as many problems. Remember the European Union's currency printing presses are in high gear too – along with everyone else’s. The only thing that’s going to stop the pattern of violent economic gyrations we’ve seen in the last century is the decriminalization of private competing currencies, backed by commodities – most likely precious metals.
So if all fiat currencies are going to fall simultaneously, what will they be falling in relation to?
The answer to that is simple: commodities. And that's where I’m putting my money. I still believe energy, agriculture, and metals are going to be sure winners; I’m especially bullish on silver right now, but when inflation really starts to hand us higher dollar-based prices, I think investor psychology will head toward gold because it is by far perceived as the most stable, long-term store of value in the world -- as it has been for thousands of years.
There are some people who believe gold and oil are going lower -- and by extension, that the dollar is going higher. I obviously disagree with that position -- as I said earlier -- before I expound, here are two bearish video counterarguments to my thoughts on gold and oil, respectively.
Both gold and oil -- and especially gold -- have ridden out economic historical crises extremely well. They don't just keep up with inflation-driven prices -- they outpace them. As such, since there's no question in my mind that the profligate global printing of currency and easing of credit are going to drive prices higher -- on an unimaginable scale. And while the above short-term outlooks may be useful in their capacities, my long-term outlook remains exceedingly bullish.
Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies
Basel was faulty
Published: December 17 2009 14:22 Last updated: December 17 2009 17:55
When push came to shove in the financial crisis, banks’ ordinary equity was too sparse and their prodigious amounts of quasi-equity could not take the losses. Now, the Basel Committee on Banking Supervision has proposed a comprehensive shake-up that aims to correct such faults. Although it gives few hard numbers, first impressions are of a punitive regime. Investors sold off bank shares around the world on Thursday on fears they may soon have to raise bucketloads of fresh capital.
Yet investors should welcome the Basel committee’s emphasis on beefing up permanent capital. Funny money hybrids will be phased out. The capital proposals are appropriately targeted: banks trading in derivatives, for example, will have to hold extra capital against counterparty risk. Furthermore, a leverage ratio – the preferred measure in the US – will be introduced as a supplementary dial on the regulatory dashboard. While many European banks already report such a ratio, it will be “harmonised internationally” to cater for differing accounting treatments around the world. In a nod to Spanish measures, the committee also wants to curb pro-cyclicality, requiring banks to bolster capital in good times. A minimum liquidity standard for internationally-active banks provides further protection.
Capturing the zeitgeist, there is a populist measure buried at the end of the proposal: a cap on bonus and dividend payments or share buybacks for banks if their capital drops nears a new, minimum level. This headline-grabbing recommendation is a reminder that regulation is a political game with many rival players, including the G20’s Financial Stability Board, each one jockeying for position. It is also just a framework, with actual ratios not set until late next year, with a view to adoption two years after that. Now the real lobbying by banks will begin.
When push came to shove in the financial crisis, banks’ ordinary equity was too sparse and their prodigious amounts of quasi-equity could not take the losses. Now, the Basel Committee on Banking Supervision has proposed a comprehensive shake-up that aims to correct such faults. Although it gives few hard numbers, first impressions are of a punitive regime. Investors sold off bank shares around the world on Thursday on fears they may soon have to raise bucketloads of fresh capital.
Yet investors should welcome the Basel committee’s emphasis on beefing up permanent capital. Funny money hybrids will be phased out. The capital proposals are appropriately targeted: banks trading in derivatives, for example, will have to hold extra capital against counterparty risk. Furthermore, a leverage ratio – the preferred measure in the US – will be introduced as a supplementary dial on the regulatory dashboard. While many European banks already report such a ratio, it will be “harmonised internationally” to cater for differing accounting treatments around the world. In a nod to Spanish measures, the committee also wants to curb pro-cyclicality, requiring banks to bolster capital in good times. A minimum liquidity standard for internationally-active banks provides further protection.
Capturing the zeitgeist, there is a populist measure buried at the end of the proposal: a cap on bonus and dividend payments or share buybacks for banks if their capital drops nears a new, minimum level. This headline-grabbing recommendation is a reminder that regulation is a political game with many rival players, including the G20’s Financial Stability Board, each one jockeying for position. It is also just a framework, with actual ratios not set until late next year, with a view to adoption two years after that. Now the real lobbying by banks will begin.
Greece and the euro - Athenian dances
Dec 17th 2009From The Economist print edition
Urgent measures must be taken by the most profligate euro-area member of all
IN GREECE ouzo and olives have given way to debt and downgrades. The country stands out among post-Dubai sovereign risks for its bloated and corrupt public sector, and a budget deficit and public debt of almost 13% and 125% of GDP, respectively. Spreads on Greek government bonds over German Bunds have widened to more than 2.5 percentage points. Nor were investors impressed by this week’s promises by George Papandreou, the prime minister, to cut the deficit to under 3% by 2013. They noted an absence of detail, a heavy reliance on hoped-for new revenues and talk of public-sector pay rises in 2010—and, warned by a credit downgrade by Standard & Poor’s, pushed spreads wider still (see article).
By Greek standards Mr Papandreou has been courageous, but he should have been braver still. Ireland set the pace on December 9th by producing a budget that sharply cut public-sector wages. Mr Papandreou and his finance minister, George Papaconstantinou, talk up the need to balance fairness and social peace with fiscal austerity. But the socialist Pasok party won a big majority in October’s election, making it Greece’s strongest government in a generation. The opposition has an untested new leader. Mr Papandreou wants to avoid direct confrontation with his trade union supporters, but the need to re-establish fiscal credibility ought to have come first.
document.write('');
To its credit, his government recognises that Greece’s ills go far beyond the public finances. Stuck in the euro, its economy has lost competitiveness. Too many Greeks are underemployed. Education, especially higher education, needs reform. Exacerbating these worries is the poor quality of Greece’s statistics. The previous government admitted that Greece had massaged its figures to qualify for the euro in 2001. The new one confessed that this year’s budget deficit had suddenly shot up from 6.7% to 12.7%. An independent statistics agency set up by Mr Papaconstantinou will help, but it will take years before the markets and Greece’s European Union partners trust its figures. That is one reason why Greece’s fellow euro-area members are so concerned. Their unspoken fear is that, unless the new government gets tougher and pushes through deep reforms, Greece could be on an inexorable path towards default.
Fearing Greeks bearing bonds
When the euro was born a decade ago, it came with central rules limiting budget deficits and banning bail-outs. Yet the rules, which theoretically included huge fines for excessive borrowing, were never likely to stick, and were soon emasculated by France and Germany. Worse, the financial markets came to assume that no euro-area country would ever be allowed to go bust: the EU and the European Central Bank would surely find some way to stand behind it.
It is true that, as Germany’s Angela Merkel has conceded, all euro-area countries have an interest in staving off a default. If Greece went under, the markets’ attention would quickly turn to other euro-area debtors like Spain, Ireland and Italy, and dent confidence in the euro itself. Yet no euro-area country wants to give its more profligate fellows the impression that their debts will be covered. The bond markets’ recent jumpiness suggests that investors, at least, are readier to believe that the strong might be willing to let the weak go under.
Good. The ban on bail-outs must remain credible, in the interests of all the euro members. Otherwise, the burden on the strong could become intolerable, and the weak would get feebler still. Investors are already nervous about Greece; if it finds an easier way out, its political leaders will never have the stomach for difficult choices. Hard times, unfortunately, demand harsh measures.
Urgent measures must be taken by the most profligate euro-area member of all
IN GREECE ouzo and olives have given way to debt and downgrades. The country stands out among post-Dubai sovereign risks for its bloated and corrupt public sector, and a budget deficit and public debt of almost 13% and 125% of GDP, respectively. Spreads on Greek government bonds over German Bunds have widened to more than 2.5 percentage points. Nor were investors impressed by this week’s promises by George Papandreou, the prime minister, to cut the deficit to under 3% by 2013. They noted an absence of detail, a heavy reliance on hoped-for new revenues and talk of public-sector pay rises in 2010—and, warned by a credit downgrade by Standard & Poor’s, pushed spreads wider still (see article).
By Greek standards Mr Papandreou has been courageous, but he should have been braver still. Ireland set the pace on December 9th by producing a budget that sharply cut public-sector wages. Mr Papandreou and his finance minister, George Papaconstantinou, talk up the need to balance fairness and social peace with fiscal austerity. But the socialist Pasok party won a big majority in October’s election, making it Greece’s strongest government in a generation. The opposition has an untested new leader. Mr Papandreou wants to avoid direct confrontation with his trade union supporters, but the need to re-establish fiscal credibility ought to have come first.
document.write('');
To its credit, his government recognises that Greece’s ills go far beyond the public finances. Stuck in the euro, its economy has lost competitiveness. Too many Greeks are underemployed. Education, especially higher education, needs reform. Exacerbating these worries is the poor quality of Greece’s statistics. The previous government admitted that Greece had massaged its figures to qualify for the euro in 2001. The new one confessed that this year’s budget deficit had suddenly shot up from 6.7% to 12.7%. An independent statistics agency set up by Mr Papaconstantinou will help, but it will take years before the markets and Greece’s European Union partners trust its figures. That is one reason why Greece’s fellow euro-area members are so concerned. Their unspoken fear is that, unless the new government gets tougher and pushes through deep reforms, Greece could be on an inexorable path towards default.
Fearing Greeks bearing bonds
When the euro was born a decade ago, it came with central rules limiting budget deficits and banning bail-outs. Yet the rules, which theoretically included huge fines for excessive borrowing, were never likely to stick, and were soon emasculated by France and Germany. Worse, the financial markets came to assume that no euro-area country would ever be allowed to go bust: the EU and the European Central Bank would surely find some way to stand behind it.
It is true that, as Germany’s Angela Merkel has conceded, all euro-area countries have an interest in staving off a default. If Greece went under, the markets’ attention would quickly turn to other euro-area debtors like Spain, Ireland and Italy, and dent confidence in the euro itself. Yet no euro-area country wants to give its more profligate fellows the impression that their debts will be covered. The bond markets’ recent jumpiness suggests that investors, at least, are readier to believe that the strong might be willing to let the weak go under.
Good. The ban on bail-outs must remain credible, in the interests of all the euro members. Otherwise, the burden on the strong could become intolerable, and the weak would get feebler still. Investors are already nervous about Greece; if it finds an easier way out, its political leaders will never have the stomach for difficult choices. Hard times, unfortunately, demand harsh measures.
Why market sentiment has no credibility
By Robert Skidelsky
Published: December 22 2009 20:30 Last updated: December 22 2009 20:30
It is not surprising that Britain’s largest economic downturn since the war should have seen the largest ever peacetime government budget deficit. By the end of this year Britain’s output will have fallen by about 5 per cent since the crisis started; in the same period the budget deficit will have risen by between 5 per cent and 8 per cent of output. Arithmetic so simple that even a child can understand it: smaller output, smaller revenues, larger deficit. And the corollary: larger output, larger revenues, smaller deficit.
The deficit for 2009-10 is projected to be £178bn (€200bn, $287bn), about 11 per cent of gross domestic product. There is some dispute as to how much of this is “structural” and how much “cyclical”. The “structural” deficit is the gap between government revenue and spending that will have to be closed by higher taxes or lower spending. The “cyclical” deficit is the gap that will automatically disappear when the economy has recovered. Those who say the downturn has added 8 per cent rather than 5 per cent to the deficit argue the recovered UK economy will be smaller than the pre-recession one, hence the recovery will leave a gap of £132bn rather than £100bn. Whatever the right number, no one doubts that there will remain a sizeable fiscal problem, even after the downturn has been reversed.
But why has the financial press been almost unanimous in condemning the modest pre-Budget measures announced by Alistair Darling, chancellor of the exchequer, to protect total spending in the face of a massive collapse of private demand? Why are the markets howling for “fiscal consolidation” now – ie cutting fiscal support to the economy immediately – when it has plainly not yet recovered?
To understand “market sentiment”, one has to go back to two ideas in the minds of most financial analysts which almost unconsciously shape their arguments. The first is the belief that economies are always at full employment. The second is the belief that even if they are not (obviously contradicting the first), they very soon would be if only governments would stop bailing them out.
The first is perhaps the most pervasive. It takes the form of denying that there is an output gap. That is, at all points in time output is no more or less than what the economy is able to produce. If this is so, government attempts to close an imaginary output gap by running a deficit will either take money better spent by the private sector or be inflationary. (Output-gap deniers always see the microbe of inflation in the air.) Either way deficits are bad, which is why “fiscal consolidation” needs to happen immediately. In the early days of the crisis this deep theoretical commitment to the existence of continuous full employment was temporarily overcome by common sense. But as the fear of apocalypse receded normal intellectual service was resumed.
The more cautious version of “output gap denial” is the view that the pre-crisis level of output was the result of bank-financed debt, and that much of it went for good with the credit crunch. Public finances cannot rely on a recovery of output to produce a stream of revenue to reduce the deficit because – wait for it – there is little or no output to be recovered.
Even the normally sober Martin Wolf has fallen for this line (FT, December 16 2009). The pre-crisis UK economy, he says, was a “bubble economy”. The bubble made UK output seem larger than it actually was! This is old-fashioned Puritanism: the boom was the illusion, the slump is the return of reality. However, experience of past recessions suggests that, once the corner is turned, output recovers vigorously from slump conditions (as do prices). Between 1933 and 1937 the UK economy expanded by 4 per cent a year, much higher than its “trend” rate of growth. Yet in 1931 orthodox economists were denying there was an output gap at the bottom of the greatest depression in history.
The second theoretical commitment of most financial analysts is that economies, if disturbed, revert quickly back to full employment if not further deranged by government actions. Thus contrary to the commonsense view that massive government intervention last autumn stopped the slide down to another Great Depression, the new conservative commentators (having got their breath and confidence back!) now argue that ill-conceived government measures have stopped, or are hindering, the natural recovery mechanisms.
For example, it is argued that massive government borrowing is keeping yields higher than they would otherwise be. Thus government efforts to stimulate spending have the effect only of retarding a natural fall in the rate of interest. If its borrowing is not rapidly reduced there will be a “gilt strike” – investors will demand higher and higher prices for holding government paper. Faced with the evidence that, despite increased government borrowing, gilt yields have been at a historic low, the critics say that this is only because the gilts are being bought by the Bank of England. Once the Bank stops buying government debt, interest rates will shoot up.
A parallel argument is that the expansion of the fiscal deficit is preventing a natural fall in the exchange rate sufficient to boost exports. The tortuous logic seems to be that “fiscal consolidation” will cause the rate of interest to fall and the fall in interest rates will cause the exchange rate to fall, thus increasing the demand for British exports. It is often alleged that something like this happened in 1931 when Britain left the gold standard for the last time.
Empirical evidence supporting the view that cutting the deficit causes the exchange rate to fall is very thin. A 1997 study by the International Monetary Fund showed that in only 14 out of 74 studied instances did fiscal consolidation promote a recovery via a fall in the exchange rate. In all the other cases fiscal policy either had no discernible exchange rate effect or it was the expansion of the deficit that caused the exchange rate to fall.
This only confirms what common sense and elementary Keynesian theory would lead one to expect. In a slump there is no natural tendency for the rate of interest to fall, because people’s desire to hoard money is increasing. So printing enough money to “satisfy the hoarder” is the only way of getting interest rates or the exchange-rate down.
But, of course, there is always “market sentiment” to fall back on. The government must cut its spending now, because this is what “the markets” expect. These are the same markets that so wounded the banking system that it had to be rescued by the taxpayer. They are now demanding fiscal consolidation as the price of their continued support for governments whose fiscal troubles they have largely caused.
Why on earth should we take this market sentiment any more seriously than that which led to the great debauch of 2007? Markets, it is sometimes said, may not know what they are talking about, but governments have no choice but to do what they tell them. This is unacceptable. The duty of governments is to govern in the best interests of the people who elected them not of the City of London. If that means calling the bankers’ bluff, so be it.
Lord Skidelsky is emeritus professor of political economy at the University of Warwick. His latest book Keynes: The Return of the Master was published in September
Published: December 22 2009 20:30 Last updated: December 22 2009 20:30
It is not surprising that Britain’s largest economic downturn since the war should have seen the largest ever peacetime government budget deficit. By the end of this year Britain’s output will have fallen by about 5 per cent since the crisis started; in the same period the budget deficit will have risen by between 5 per cent and 8 per cent of output. Arithmetic so simple that even a child can understand it: smaller output, smaller revenues, larger deficit. And the corollary: larger output, larger revenues, smaller deficit.
The deficit for 2009-10 is projected to be £178bn (€200bn, $287bn), about 11 per cent of gross domestic product. There is some dispute as to how much of this is “structural” and how much “cyclical”. The “structural” deficit is the gap between government revenue and spending that will have to be closed by higher taxes or lower spending. The “cyclical” deficit is the gap that will automatically disappear when the economy has recovered. Those who say the downturn has added 8 per cent rather than 5 per cent to the deficit argue the recovered UK economy will be smaller than the pre-recession one, hence the recovery will leave a gap of £132bn rather than £100bn. Whatever the right number, no one doubts that there will remain a sizeable fiscal problem, even after the downturn has been reversed.
But why has the financial press been almost unanimous in condemning the modest pre-Budget measures announced by Alistair Darling, chancellor of the exchequer, to protect total spending in the face of a massive collapse of private demand? Why are the markets howling for “fiscal consolidation” now – ie cutting fiscal support to the economy immediately – when it has plainly not yet recovered?
To understand “market sentiment”, one has to go back to two ideas in the minds of most financial analysts which almost unconsciously shape their arguments. The first is the belief that economies are always at full employment. The second is the belief that even if they are not (obviously contradicting the first), they very soon would be if only governments would stop bailing them out.
The first is perhaps the most pervasive. It takes the form of denying that there is an output gap. That is, at all points in time output is no more or less than what the economy is able to produce. If this is so, government attempts to close an imaginary output gap by running a deficit will either take money better spent by the private sector or be inflationary. (Output-gap deniers always see the microbe of inflation in the air.) Either way deficits are bad, which is why “fiscal consolidation” needs to happen immediately. In the early days of the crisis this deep theoretical commitment to the existence of continuous full employment was temporarily overcome by common sense. But as the fear of apocalypse receded normal intellectual service was resumed.
The more cautious version of “output gap denial” is the view that the pre-crisis level of output was the result of bank-financed debt, and that much of it went for good with the credit crunch. Public finances cannot rely on a recovery of output to produce a stream of revenue to reduce the deficit because – wait for it – there is little or no output to be recovered.
Even the normally sober Martin Wolf has fallen for this line (FT, December 16 2009). The pre-crisis UK economy, he says, was a “bubble economy”. The bubble made UK output seem larger than it actually was! This is old-fashioned Puritanism: the boom was the illusion, the slump is the return of reality. However, experience of past recessions suggests that, once the corner is turned, output recovers vigorously from slump conditions (as do prices). Between 1933 and 1937 the UK economy expanded by 4 per cent a year, much higher than its “trend” rate of growth. Yet in 1931 orthodox economists were denying there was an output gap at the bottom of the greatest depression in history.
The second theoretical commitment of most financial analysts is that economies, if disturbed, revert quickly back to full employment if not further deranged by government actions. Thus contrary to the commonsense view that massive government intervention last autumn stopped the slide down to another Great Depression, the new conservative commentators (having got their breath and confidence back!) now argue that ill-conceived government measures have stopped, or are hindering, the natural recovery mechanisms.
For example, it is argued that massive government borrowing is keeping yields higher than they would otherwise be. Thus government efforts to stimulate spending have the effect only of retarding a natural fall in the rate of interest. If its borrowing is not rapidly reduced there will be a “gilt strike” – investors will demand higher and higher prices for holding government paper. Faced with the evidence that, despite increased government borrowing, gilt yields have been at a historic low, the critics say that this is only because the gilts are being bought by the Bank of England. Once the Bank stops buying government debt, interest rates will shoot up.
A parallel argument is that the expansion of the fiscal deficit is preventing a natural fall in the exchange rate sufficient to boost exports. The tortuous logic seems to be that “fiscal consolidation” will cause the rate of interest to fall and the fall in interest rates will cause the exchange rate to fall, thus increasing the demand for British exports. It is often alleged that something like this happened in 1931 when Britain left the gold standard for the last time.
Empirical evidence supporting the view that cutting the deficit causes the exchange rate to fall is very thin. A 1997 study by the International Monetary Fund showed that in only 14 out of 74 studied instances did fiscal consolidation promote a recovery via a fall in the exchange rate. In all the other cases fiscal policy either had no discernible exchange rate effect or it was the expansion of the deficit that caused the exchange rate to fall.
This only confirms what common sense and elementary Keynesian theory would lead one to expect. In a slump there is no natural tendency for the rate of interest to fall, because people’s desire to hoard money is increasing. So printing enough money to “satisfy the hoarder” is the only way of getting interest rates or the exchange-rate down.
But, of course, there is always “market sentiment” to fall back on. The government must cut its spending now, because this is what “the markets” expect. These are the same markets that so wounded the banking system that it had to be rescued by the taxpayer. They are now demanding fiscal consolidation as the price of their continued support for governments whose fiscal troubles they have largely caused.
Why on earth should we take this market sentiment any more seriously than that which led to the great debauch of 2007? Markets, it is sometimes said, may not know what they are talking about, but governments have no choice but to do what they tell them. This is unacceptable. The duty of governments is to govern in the best interests of the people who elected them not of the City of London. If that means calling the bankers’ bluff, so be it.
Lord Skidelsky is emeritus professor of political economy at the University of Warwick. His latest book Keynes: The Return of the Master was published in September
Securitisation rules
Published: December 21 2009 09:26 Last updated: December 21 2009 09:26
Grappling with unintended consequences is like stuffing the proverbial genie back in its bottle. Accounting rule changes in June, which will see US banks bring securitisations back on balance sheet at the turn of the year, prompted concerns that those assets could be commandeered by the Federal Deposit Insurance Corporation as part of resolving bank failures. Loss of so-called “safe harbour” protection, warned rating agencies, could mean downgrades of bank-originated securitisations and deter new issues. So this week, the FDIC confirmed that assets securitised before the end of March would remain safe from seizure. Meanwhile, it wants feedback on possible rules that would determine whether future deals are protected.
Rather by the backdoor, then, the FDIC adds another voice on reform of securitisation markets. Coordinating its elaborate list of possible conditions with the US legislative process is a priority, as should be ensuring consistency internationally. Differing standards could drive securitisation activity from deposit-takers to non-bank or non-US institutions. The preliminary nature of the FDIC’s thoughts reflects, too, some disagreement between regulators, meaning an extension to the March deadline appears likely. Prolonged uncertainty is not ideal. But for consumer credit-backed securities, at least, the FDIC’s possible rules chime with what has been proposed elsewhere.
However, new FDIC suggestions – which may be restricted to only residential mortgages – include a six-tranche limit in capital structures, a requirement to hold loans for 12 months before they are securitised, and a portion of deal fees paid over time. True, the mortgage-backed securities market spawned the most complex structures and worst performance of pre-crisis issuance. But these strictures could make securitisations less viable in a market that, still, remains closed. They also smack of rear view regulation, before the new rules are in place to prevent the next one.
Grappling with unintended consequences is like stuffing the proverbial genie back in its bottle. Accounting rule changes in June, which will see US banks bring securitisations back on balance sheet at the turn of the year, prompted concerns that those assets could be commandeered by the Federal Deposit Insurance Corporation as part of resolving bank failures. Loss of so-called “safe harbour” protection, warned rating agencies, could mean downgrades of bank-originated securitisations and deter new issues. So this week, the FDIC confirmed that assets securitised before the end of March would remain safe from seizure. Meanwhile, it wants feedback on possible rules that would determine whether future deals are protected.
Rather by the backdoor, then, the FDIC adds another voice on reform of securitisation markets. Coordinating its elaborate list of possible conditions with the US legislative process is a priority, as should be ensuring consistency internationally. Differing standards could drive securitisation activity from deposit-takers to non-bank or non-US institutions. The preliminary nature of the FDIC’s thoughts reflects, too, some disagreement between regulators, meaning an extension to the March deadline appears likely. Prolonged uncertainty is not ideal. But for consumer credit-backed securities, at least, the FDIC’s possible rules chime with what has been proposed elsewhere.
However, new FDIC suggestions – which may be restricted to only residential mortgages – include a six-tranche limit in capital structures, a requirement to hold loans for 12 months before they are securitised, and a portion of deal fees paid over time. True, the mortgage-backed securities market spawned the most complex structures and worst performance of pre-crisis issuance. But these strictures could make securitisations less viable in a market that, still, remains closed. They also smack of rear view regulation, before the new rules are in place to prevent the next one.
The resurgent dollar
Published: December 21 2009 09:17 Last updated: December 21 2009 09:17
Investment Bible, Lesson One: whenever universal agreement is reached, the opposite soon follows. So it seems for the dollar. A month ago, America’s currency was written off by everyone. The widespread view was that a double digit fiscal deficit and a bloated Federal Reserve balance sheet spelt trouble. Inflation was imminent. The financial hegemony of the US was over.
But the dollar has stopped listening. Since the beginning of December, it has risen seven cents against the euro. It is also up almost 5 per cent versus the yen, itself no slouch lately. Also in retreat are the commodity currencies such as the Australian dollar. These are not gigantic moves. Still, all told, it has been the biggest monthly rally in the dollar on a trade weighted basis since February.
What is going on? After all, the arguments for the dollar’s longer-term decline have not changed. Four reasons jump out. First, US bond yields are ticking up: for example, by 30 basis points on 10-year Treasuries since November. Second, (and partially related), positive econommic data has some economists lifting America’s growth prospects next year versus other countries. Third, the US’s balance of payments will fall to 1.4 per cent of output next year, according to Morgan Stanley, from almost four times that today. Finally, US policy makers such as Fed chairman Ben Bernanke seem to be talking up the dollar with a tad more urgency.
Fair enough. But where investors could get it wrong is on interest rates. Yields are rising partly because of the expectation that quantitative easing will end early next year. But over 2009 the Fed bought roughly the same amount of long-term securities as the $1,500bn issued by the Treasury. Ending that in a hurry could push rates higher – so the Fed may delay. Careful before chasing the dollar.
Investment Bible, Lesson One: whenever universal agreement is reached, the opposite soon follows. So it seems for the dollar. A month ago, America’s currency was written off by everyone. The widespread view was that a double digit fiscal deficit and a bloated Federal Reserve balance sheet spelt trouble. Inflation was imminent. The financial hegemony of the US was over.
But the dollar has stopped listening. Since the beginning of December, it has risen seven cents against the euro. It is also up almost 5 per cent versus the yen, itself no slouch lately. Also in retreat are the commodity currencies such as the Australian dollar. These are not gigantic moves. Still, all told, it has been the biggest monthly rally in the dollar on a trade weighted basis since February.
What is going on? After all, the arguments for the dollar’s longer-term decline have not changed. Four reasons jump out. First, US bond yields are ticking up: for example, by 30 basis points on 10-year Treasuries since November. Second, (and partially related), positive econommic data has some economists lifting America’s growth prospects next year versus other countries. Third, the US’s balance of payments will fall to 1.4 per cent of output next year, according to Morgan Stanley, from almost four times that today. Finally, US policy makers such as Fed chairman Ben Bernanke seem to be talking up the dollar with a tad more urgency.
Fair enough. But where investors could get it wrong is on interest rates. Yields are rising partly because of the expectation that quantitative easing will end early next year. But over 2009 the Fed bought roughly the same amount of long-term securities as the $1,500bn issued by the Treasury. Ending that in a hurry could push rates higher – so the Fed may delay. Careful before chasing the dollar.
Short View: Yield curve
By Aline van Duyn, US markets editor
Published: December 22 2009 19:50 Last updated: December 22 2009 19:50
The bond markets have notched up another record for 2009. This time, the indicator in question measures the gap between short- and long-dated yields.
"Curve-steepening" so called...
The yield curve has steepened to its highest ever. That means the gap between 10-year US yields and the 2-year is wider than ever before. The gap is 286 basis points, eclipsing last week’s new peak of 276bp and the previous record set in August 2003 of 274bp.
With official US interest rates close to zero, it is not surprising that unusual dynamics are taking place in bond markets. Not only are near zero rates a historical anomaly, so is the fact that central banks are buying government bonds. There are plenty of reasons to expect strange things to happen to bond yields.
The question is what this steep yield curve signals. In the past, steepening has been a buy signal for equity investors. That was the case in 2003, as well as in July 1992, when it steepened to 268bp. Low short-term interest rates were expected to fuel economic growth and a return to inflationary pressures. These expectations were reflected in rising long-term yields.
There are sensible reasons why this interpretation could be hasty this time around.
First, the trigger for the steeper yield curve came last week, when the Fed signalled it would stay on hold for much of 2010. Short-term Treasury yields fell. This suggests growth will be weak and unemployment will stay high.
Second, an analysis by RBC Capital Markets shows that steep yield curves are not unusual in the middle of a period when interest rates are unchanged.
Third, markets often get it wrong.
The yield curve might be a bullish signal, or it might not. Investors are entering 2010 with a big question about the strength of growth in the US. There is no hope of a clear signal yet, from bond tea leaves or anywhere else.
Published: December 22 2009 19:50 Last updated: December 22 2009 19:50
The bond markets have notched up another record for 2009. This time, the indicator in question measures the gap between short- and long-dated yields.
"Curve-steepening" so called...
The yield curve has steepened to its highest ever. That means the gap between 10-year US yields and the 2-year is wider than ever before. The gap is 286 basis points, eclipsing last week’s new peak of 276bp and the previous record set in August 2003 of 274bp.
With official US interest rates close to zero, it is not surprising that unusual dynamics are taking place in bond markets. Not only are near zero rates a historical anomaly, so is the fact that central banks are buying government bonds. There are plenty of reasons to expect strange things to happen to bond yields.
The question is what this steep yield curve signals. In the past, steepening has been a buy signal for equity investors. That was the case in 2003, as well as in July 1992, when it steepened to 268bp. Low short-term interest rates were expected to fuel economic growth and a return to inflationary pressures. These expectations were reflected in rising long-term yields.
There are sensible reasons why this interpretation could be hasty this time around.
First, the trigger for the steeper yield curve came last week, when the Fed signalled it would stay on hold for much of 2010. Short-term Treasury yields fell. This suggests growth will be weak and unemployment will stay high.
Second, an analysis by RBC Capital Markets shows that steep yield curves are not unusual in the middle of a period when interest rates are unchanged.
Third, markets often get it wrong.
The yield curve might be a bullish signal, or it might not. Investors are entering 2010 with a big question about the strength of growth in the US. There is no hope of a clear signal yet, from bond tea leaves or anywhere else.
Valuation fundamentals
Published: December 22 2009 09:35 Last updated: December 22 2009 10:09
Like death, investment fundamentals matter but are often forgotten or ignored, pushed aside by the immediacy of day-to-day living. This approach can bring happiness for years – until a life or death moment intervenes. Late last year was just such an occasion. But, since March, asset classes from stocks to commodities have soared again. Are investors deluding themselves once more?
Take bonds. Their valuation depends on the outlook for growth, inflation and, where applicable, quantitative easing programmes. A useful way for investors to think about bonds is to compare nominal yields today with historic real yields to see what expectations for inflation are spat out. For example, Merrill Lynch believes that over the past 300-odd years, real bond returns in the UK have been about 3 per cent. That means those holding 20-year gilts with a nominal yield of 4.2 per cent expect inflation to stay about 1 per cent for two decades. That’s a big call. Most other bond markets are supported by similarly low expectations for long-term inflation.
Then there are equity markets. Here it is best to use long-run, adjusted earnings based valuations, or methodologies comparing prices to real assets, such as replacement ratios. On such measures, US stocks are now almost 50 per cent overvalued, according to Smithers & Co. Unfortunately, historical data are less reliable for other equity markets, but most also look expensive on this basis, albeit to a lesser extent.
Finally, commodities and property. For the former, price rises have outpaced absolute improvements in global industrial production. The fundamentals for certain housing markets, however, look good. In the US, for example, values relative to disposable income are well below trend having fallen by more than a third. House prices are ticking up again across the globe, although the commercial sector remains soggy. Investors should not get carried away, but compared with other asset classes at least, fundamental valuation metrics suggest bricks and mortar are not the stupidest things to buy right now.
Like death, investment fundamentals matter but are often forgotten or ignored, pushed aside by the immediacy of day-to-day living. This approach can bring happiness for years – until a life or death moment intervenes. Late last year was just such an occasion. But, since March, asset classes from stocks to commodities have soared again. Are investors deluding themselves once more?
Take bonds. Their valuation depends on the outlook for growth, inflation and, where applicable, quantitative easing programmes. A useful way for investors to think about bonds is to compare nominal yields today with historic real yields to see what expectations for inflation are spat out. For example, Merrill Lynch believes that over the past 300-odd years, real bond returns in the UK have been about 3 per cent. That means those holding 20-year gilts with a nominal yield of 4.2 per cent expect inflation to stay about 1 per cent for two decades. That’s a big call. Most other bond markets are supported by similarly low expectations for long-term inflation.
Then there are equity markets. Here it is best to use long-run, adjusted earnings based valuations, or methodologies comparing prices to real assets, such as replacement ratios. On such measures, US stocks are now almost 50 per cent overvalued, according to Smithers & Co. Unfortunately, historical data are less reliable for other equity markets, but most also look expensive on this basis, albeit to a lesser extent.
Finally, commodities and property. For the former, price rises have outpaced absolute improvements in global industrial production. The fundamentals for certain housing markets, however, look good. In the US, for example, values relative to disposable income are well below trend having fallen by more than a third. House prices are ticking up again across the globe, although the commercial sector remains soggy. Investors should not get carried away, but compared with other asset classes at least, fundamental valuation metrics suggest bricks and mortar are not the stupidest things to buy right now.
Smithers: ‘There’s no reason to hold bonds’
Posted by Gwen Robinson on Dec 22 13:39.
Economist and commentator Andrew Smithers (of Smithers & Co) — famed for some of the decade’s more bearish (yet accurate) calls — leaves us with a very clear cut view on for 2010.
In short, while stocks remain overvalued, there’s no reason at all to buy bonds. As his his latest World Market Update surmises (our emphasis):
● The world economy is picking up with sufficient strength to make a return to recession in 2010 or 2011 unlikely. The main risks now are for a rapid recovery with rising inflationary expectations and a further rise in asset prices.
● Fortunately we think that a relatively slow recovery is more likely, with demand constrained by tight credit conditions due to the continued reluctance of banks to expand their balance sheets.
● US equities are overpriced and more so than shares in other major markets. We suggest that investors should underweight the US in equity portfolios.
● US profit margins are at record levels. This is unusual for a recession and will no doubt produce claims that “this time it’s different” and that profit margins are not mean reverting but have moved to a permanently higher level.
● While almost anything is possible in economics, this seems extremely unlikely and a bad bet for investors to make.
● The record high levels of US margins are particularly exceptional in finance. This reflects unusually low interest rates, central bank subsidies via quantitative easing and monopolistic profits.
● While less exalted, non-financial margins are also high. This is probably due to recent exceptional cuts in employment, the weak dollar and low contributions to pension funds.
● US profits are therefore likely to disappoint expectations over the next few years as margins fall back. There is a strong chance that this will start in 2010.
● The sharp cuts in employment, which have been much more marked in the US than in other G5 countries, seem likely to be followed by a stronger bounce in US employment and wages.
● Productivity has improved much faster in the US than in other G5 countries and this is likely to reverse as the recovery strengthens.
● We see no reason for investors to hold bonds.
So would that be an inflationary or deflationary view then Mr. Smithers?
Related links:China: The heat is on - FT Alphaville
Economist and commentator Andrew Smithers (of Smithers & Co) — famed for some of the decade’s more bearish (yet accurate) calls — leaves us with a very clear cut view on for 2010.
In short, while stocks remain overvalued, there’s no reason at all to buy bonds. As his his latest World Market Update surmises (our emphasis):
● The world economy is picking up with sufficient strength to make a return to recession in 2010 or 2011 unlikely. The main risks now are for a rapid recovery with rising inflationary expectations and a further rise in asset prices.
● Fortunately we think that a relatively slow recovery is more likely, with demand constrained by tight credit conditions due to the continued reluctance of banks to expand their balance sheets.
● US equities are overpriced and more so than shares in other major markets. We suggest that investors should underweight the US in equity portfolios.
● US profit margins are at record levels. This is unusual for a recession and will no doubt produce claims that “this time it’s different” and that profit margins are not mean reverting but have moved to a permanently higher level.
● While almost anything is possible in economics, this seems extremely unlikely and a bad bet for investors to make.
● The record high levels of US margins are particularly exceptional in finance. This reflects unusually low interest rates, central bank subsidies via quantitative easing and monopolistic profits.
● While less exalted, non-financial margins are also high. This is probably due to recent exceptional cuts in employment, the weak dollar and low contributions to pension funds.
● US profits are therefore likely to disappoint expectations over the next few years as margins fall back. There is a strong chance that this will start in 2010.
● The sharp cuts in employment, which have been much more marked in the US than in other G5 countries, seem likely to be followed by a stronger bounce in US employment and wages.
● Productivity has improved much faster in the US than in other G5 countries and this is likely to reverse as the recovery strengthens.
● We see no reason for investors to hold bonds.
So would that be an inflationary or deflationary view then Mr. Smithers?
Related links:China: The heat is on - FT Alphaville
Opec eyes OECD demand
Posted by Izabella Kaminska on Dec 22 12:12.
The Organisation of Petroleum Exporting Countries meeting in Luanda, Angola, agreed on Tuesday to leave oil output curbs unchanged, while calling for greater compliance with existing output targets — a signal the cartel currently believes the market to be well supplied.
One of the big debate points in Luanda, however, focused on how quick demand recovery in OECD countries would be in 2010. Remarks from Opec’s opening address highlighted the main issues as follows (our emphasis):
We also saw how crude oil prices had continued to improve from the lows experienced late last year, even though the market was still very volatile. Since then, the economic recovery has gathered pace. More OECD countries are coming out of recession and growth is accelerating in emerging markets, especially in Asia.
However, doubts remain about the dynamics of the recovery. This is not helped by continued uncertainty in the financial sector and worries regarding growth momentum on the back of still-rising unemployment and fears that stimulus measures may come to an end too soon. The weak, fluctuating dollar is adding to the uncertainty.
Turning to oil demand, there is a mixed picture in the market. Demand growth in the emerging economies is improving, but the OECD remains in negative territory. The market continues to be well supplied with crude and inventories are at high levels. Prices have moved up to more comfortable levels. This is good news for investment in production capacity and future supply. Some postponed projects have already been started up again in our Member Countries. However, the fragility remains in the market and we should not forget the detrimental volatility we experienced last year.
This is one of the issues we must again address at today’s meeting. For our part, we will continue our efforts to restore stability and balance to the market, in the interests of producers and consumers alike.
Considering the drop in OECD demand this year proved much stronger than many in the market — especially peak oilists — had expected, it makes sense for Opec to have stressed the issue so prominently in Tuesday’s meeting.
On that note, we’d flag up the following two charts from oil analyst Morgan Downey, auther of Oil 101, which neatly expresses the situation as it stands today (click to enlarge):
Related links:
Goldman warns of near-term downside risk in WTI - FT Alphaville
Goldman still bullish on crude (even in the face of weakness)- FT Alphaville
2009 Oil Market Review as OPEC Meets - Scarce Whales
The Organisation of Petroleum Exporting Countries meeting in Luanda, Angola, agreed on Tuesday to leave oil output curbs unchanged, while calling for greater compliance with existing output targets — a signal the cartel currently believes the market to be well supplied.
One of the big debate points in Luanda, however, focused on how quick demand recovery in OECD countries would be in 2010. Remarks from Opec’s opening address highlighted the main issues as follows (our emphasis):
We also saw how crude oil prices had continued to improve from the lows experienced late last year, even though the market was still very volatile. Since then, the economic recovery has gathered pace. More OECD countries are coming out of recession and growth is accelerating in emerging markets, especially in Asia.
However, doubts remain about the dynamics of the recovery. This is not helped by continued uncertainty in the financial sector and worries regarding growth momentum on the back of still-rising unemployment and fears that stimulus measures may come to an end too soon. The weak, fluctuating dollar is adding to the uncertainty.
Turning to oil demand, there is a mixed picture in the market. Demand growth in the emerging economies is improving, but the OECD remains in negative territory. The market continues to be well supplied with crude and inventories are at high levels. Prices have moved up to more comfortable levels. This is good news for investment in production capacity and future supply. Some postponed projects have already been started up again in our Member Countries. However, the fragility remains in the market and we should not forget the detrimental volatility we experienced last year.
This is one of the issues we must again address at today’s meeting. For our part, we will continue our efforts to restore stability and balance to the market, in the interests of producers and consumers alike.
Considering the drop in OECD demand this year proved much stronger than many in the market — especially peak oilists — had expected, it makes sense for Opec to have stressed the issue so prominently in Tuesday’s meeting.
On that note, we’d flag up the following two charts from oil analyst Morgan Downey, auther of Oil 101, which neatly expresses the situation as it stands today (click to enlarge):
Related links:
Goldman warns of near-term downside risk in WTI - FT Alphaville
Goldman still bullish on crude (even in the face of weakness)- FT Alphaville
2009 Oil Market Review as OPEC Meets - Scarce Whales
Hamp, what is it good for?
Posted by Tracy Alloway on Dec 22 11:26.
In addition to the difficulty of converting temporary mortgage modifications into permanent ones, one of the big question marks hanging over the US Treasury’s Home Affordable Modification Plan is the redefault rate. That is, the percentage of homeowners who redefault on their modified mortgage.
FT Alphaville has mentioned before that in cases of severe negative equity, it might make more sense for a homeowner to make a couple of Hamp-reduced interest payments on his or her mortgage and then walk away. The US Treasury hasn’t given an official default rate for the programme yet, but figures like 25 per cent and 50 per cent have been bandied about.
In their US Securitised Product Outlook for 2010, however, Barclays Capital take a slightly more negative outlook on the redefault rate. It might be better than previous mortgage modification plans — but it’s still likely to be pretty dismal, they say:
Re-default performance for loans modified in Q3 08 has been dismal, with more than 60% relapsing into deep delinquency already. However, HAMP has been more aggressive than earlier mods – reducing borrower payments by 30-40%, compared with earlier modification efforts that typically reduced monthly payments by 15-20%. As Figure 6 shows, higher payment reductions reduce re-default rates, but only by 5-10% for that magnitude of payment change . . .
On the flip side, HAMP does not address the issue of negative equity, which is one of the primary drivers behind default . . . Taking these factors into account, we expect overall HAMP re-default rates to show not more than a 10-20% improvement over the default rates seen in past mods.
With the redefault issue then, plus the conversion rate for permanent modifications and various servicer problems, BarCap thinks we’ll see some sort of revision or significant tweaking of the programme.
Possible changes could include further streamlining the documentation requirement for Hamp applications, creating a lower debt-to-income target or second-lien programme, or, perhaps most significantly, starting principal forgiveness instead of just forbearance.
Here’s a summary:
Finally, watch out for new policy changes from Washington on the mortgage front. If HAMP does not work well (as we expect), and foreclosures keep rising, Congress might revisit some of the more radical suggestions from earlier this year, such as cram-downs, forced debt forgiveness, etc. On the agency MBS side, one tail risk is the prospect of an off-market, low mortgage rate provided by the government. MBS investors fearful of this shift compressed the coupon stack sharply in Q1 09 – if such an off-market rate is actually offered by the government, it could greatly hurt premiums and, thus, all agency MBS valuations
. . .
A greater share of debt forbearance mods would lead to upfront losses on the pool, in turn leading to higher initial [constand default rates]. However, since debt forgiveness mods typically perform better than comparable rate reduction mods, re-default rates would be lower (Figure 27). Higher losses upfront on the forgiven amount would imply that subordinates would be written down faster on subprime deals, causing crossover to occur sooner. This would benefit the second and third cash flows at the expense of the first cash flow bond as the principal waterfall switches from sequential to pro rata.
Given all of the above, readers might well be scratching their heads as to what the Hamp is actually good for. And on that point Barclays is very clear — shadows and cans:
To be clear, the modification program (HAMP) is not a silver bullet. As Figure 6 shows, historical re-default rates for all types of modifications are high – HAMP should be better, but not hugely so. But the process of modification buys time. It increases the number of months between the borrower turning delinquent and the home hitting the market. This is shown in the REO (real estate owned) line in Figure 5; even as foreclosures keep rising, the REO bucket has gone down. So kicking the foreclosure ‘can’ down the road has helped prices stabilize.
Intuitively, if there are millions of foreclosures to still work through the system, it is better to spread them over a few years than have them hit the market in six months – this prevents prices from over-correcting to the downside. And with the Administration focused on modifications, we expect long delinquency-to-liquidation timelines to help home prices.
As a result, our forecast calls for prices to drop 8% from current levels, before stabilizing in Q2 2010. The macro impact of this decline should be muted. After all, a house worth $100 is now worth $67 (prices have fallen around 33% from peak in Case Schiller). A further 8% decline from current levels is simply another $5.3. As every month passes without a sharp increase in the REO bucket or a sharp drop in home prices, the tail risk posed by housing declines ever so further.
`Real estate owned’ means the properties owned by banks and mortgage companies — the stuff we call `shadow housing inventory‘ since it’s not included in official measures of unsold housing inventory.
Related links:
FT Alphaville coverage of HampWill the groundhog see a shadow housing inventory? – WSJ Developments
Mitchell a key vote in cramdown battle – Phoenix Business Journal
OCC and OTS: Foreclosures Increase, but HAMP Mods Performing Better – HousingStorm.com
In addition to the difficulty of converting temporary mortgage modifications into permanent ones, one of the big question marks hanging over the US Treasury’s Home Affordable Modification Plan is the redefault rate. That is, the percentage of homeowners who redefault on their modified mortgage.
FT Alphaville has mentioned before that in cases of severe negative equity, it might make more sense for a homeowner to make a couple of Hamp-reduced interest payments on his or her mortgage and then walk away. The US Treasury hasn’t given an official default rate for the programme yet, but figures like 25 per cent and 50 per cent have been bandied about.
In their US Securitised Product Outlook for 2010, however, Barclays Capital take a slightly more negative outlook on the redefault rate. It might be better than previous mortgage modification plans — but it’s still likely to be pretty dismal, they say:
Re-default performance for loans modified in Q3 08 has been dismal, with more than 60% relapsing into deep delinquency already. However, HAMP has been more aggressive than earlier mods – reducing borrower payments by 30-40%, compared with earlier modification efforts that typically reduced monthly payments by 15-20%. As Figure 6 shows, higher payment reductions reduce re-default rates, but only by 5-10% for that magnitude of payment change . . .
On the flip side, HAMP does not address the issue of negative equity, which is one of the primary drivers behind default . . . Taking these factors into account, we expect overall HAMP re-default rates to show not more than a 10-20% improvement over the default rates seen in past mods.
With the redefault issue then, plus the conversion rate for permanent modifications and various servicer problems, BarCap thinks we’ll see some sort of revision or significant tweaking of the programme.
Possible changes could include further streamlining the documentation requirement for Hamp applications, creating a lower debt-to-income target or second-lien programme, or, perhaps most significantly, starting principal forgiveness instead of just forbearance.
Here’s a summary:
Finally, watch out for new policy changes from Washington on the mortgage front. If HAMP does not work well (as we expect), and foreclosures keep rising, Congress might revisit some of the more radical suggestions from earlier this year, such as cram-downs, forced debt forgiveness, etc. On the agency MBS side, one tail risk is the prospect of an off-market, low mortgage rate provided by the government. MBS investors fearful of this shift compressed the coupon stack sharply in Q1 09 – if such an off-market rate is actually offered by the government, it could greatly hurt premiums and, thus, all agency MBS valuations
. . .
A greater share of debt forbearance mods would lead to upfront losses on the pool, in turn leading to higher initial [constand default rates]. However, since debt forgiveness mods typically perform better than comparable rate reduction mods, re-default rates would be lower (Figure 27). Higher losses upfront on the forgiven amount would imply that subordinates would be written down faster on subprime deals, causing crossover to occur sooner. This would benefit the second and third cash flows at the expense of the first cash flow bond as the principal waterfall switches from sequential to pro rata.
Given all of the above, readers might well be scratching their heads as to what the Hamp is actually good for. And on that point Barclays is very clear — shadows and cans:
To be clear, the modification program (HAMP) is not a silver bullet. As Figure 6 shows, historical re-default rates for all types of modifications are high – HAMP should be better, but not hugely so. But the process of modification buys time. It increases the number of months between the borrower turning delinquent and the home hitting the market. This is shown in the REO (real estate owned) line in Figure 5; even as foreclosures keep rising, the REO bucket has gone down. So kicking the foreclosure ‘can’ down the road has helped prices stabilize.
Intuitively, if there are millions of foreclosures to still work through the system, it is better to spread them over a few years than have them hit the market in six months – this prevents prices from over-correcting to the downside. And with the Administration focused on modifications, we expect long delinquency-to-liquidation timelines to help home prices.
As a result, our forecast calls for prices to drop 8% from current levels, before stabilizing in Q2 2010. The macro impact of this decline should be muted. After all, a house worth $100 is now worth $67 (prices have fallen around 33% from peak in Case Schiller). A further 8% decline from current levels is simply another $5.3. As every month passes without a sharp increase in the REO bucket or a sharp drop in home prices, the tail risk posed by housing declines ever so further.
`Real estate owned’ means the properties owned by banks and mortgage companies — the stuff we call `shadow housing inventory‘ since it’s not included in official measures of unsold housing inventory.
Related links:
FT Alphaville coverage of HampWill the groundhog see a shadow housing inventory? – WSJ Developments
Mitchell a key vote in cramdown battle – Phoenix Business Journal
OCC and OTS: Foreclosures Increase, but HAMP Mods Performing Better – HousingStorm.com
‘More bad news’ on bank CDO exposures to come, BofAML says
Posted by Tracy Alloway on Dec 22 09:15.
FT Alphaville wrote in October 2008 that, by and large, banks’ holdings of synthetic corporate CDOs had yet to be written down. Fast forward to December 2009, and it looks like the same might still be true for the majority of those holdings.
Recall that synthetic CDOs are not backed by tangible collateral (RMBS, CMBS and the like) but by CDS contracts which reference such collateral. In this case, CDS on corporations.
According to Bank of America Merrill Lynch European banking analysts Stuart Graham and Alexander Tsirigotis, the issue is that lots of those corporations were rather lacklustre financial companies.
Here’s what they say:
We have been talking in our research about the risks for banks as holders of synthetic corporate CDOs since early September. This is a $1.6 trillion market, with very little clarity on which banks hold such instruments. Until recently, it has been a “dog which hasn’t barked”. However, the credit events at several US financials are now filtering through into rating agency downgrades of CDO tranches. The credit events at the Icelandic banks will also provide further downgrades. We think we will be hearing more bad news on exposures to synthetic corporate CDOs in the coming weeks.
We have long argued that a major risk for corporate synthetics was the over-exposure to the financials sector and certain names within that sector. In late September S&P downgraded 168 tranches of RM European Banks 20 October 2008 19 synthetic corporate CDOs and placed a further 600+ on rating watch negative. Chart 18 shows that these downgrades are very severe – nearly ¾ of all US tranches were downgraded by a full letter or more, while European tranches saw 60% of all affected tranches downgraded by a full letter or more. Moreover, the migration from investment grade to high yield was also significant with 30 US tranches (and 19 European) moving from investment grade ratings to speculative grade ones – or c. 30% of all downgraded tranches, in Europe and US. Recent events at KBC show how such downgrades can translate into large impairments.
And if you’re curious as to just what kind of financials those could be, the analysts have provided the below, rather interesting, table. Lehman Brothers and AIG, among others, make an appearance:
Related links:CDOs, a tendency to liquidate – FT Alphaville
S&P’s CDO rating methodology is unpatriotic – FT Alphaville
The CDO unwind waiting to happen – FT Alphaville
FT Alphaville wrote in October 2008 that, by and large, banks’ holdings of synthetic corporate CDOs had yet to be written down. Fast forward to December 2009, and it looks like the same might still be true for the majority of those holdings.
Recall that synthetic CDOs are not backed by tangible collateral (RMBS, CMBS and the like) but by CDS contracts which reference such collateral. In this case, CDS on corporations.
According to Bank of America Merrill Lynch European banking analysts Stuart Graham and Alexander Tsirigotis, the issue is that lots of those corporations were rather lacklustre financial companies.
Here’s what they say:
We have been talking in our research about the risks for banks as holders of synthetic corporate CDOs since early September. This is a $1.6 trillion market, with very little clarity on which banks hold such instruments. Until recently, it has been a “dog which hasn’t barked”. However, the credit events at several US financials are now filtering through into rating agency downgrades of CDO tranches. The credit events at the Icelandic banks will also provide further downgrades. We think we will be hearing more bad news on exposures to synthetic corporate CDOs in the coming weeks.
We have long argued that a major risk for corporate synthetics was the over-exposure to the financials sector and certain names within that sector. In late September S&P downgraded 168 tranches of RM European Banks 20 October 2008 19 synthetic corporate CDOs and placed a further 600+ on rating watch negative. Chart 18 shows that these downgrades are very severe – nearly ¾ of all US tranches were downgraded by a full letter or more, while European tranches saw 60% of all affected tranches downgraded by a full letter or more. Moreover, the migration from investment grade to high yield was also significant with 30 US tranches (and 19 European) moving from investment grade ratings to speculative grade ones – or c. 30% of all downgraded tranches, in Europe and US. Recent events at KBC show how such downgrades can translate into large impairments.
And if you’re curious as to just what kind of financials those could be, the analysts have provided the below, rather interesting, table. Lehman Brothers and AIG, among others, make an appearance:
Related links:CDOs, a tendency to liquidate – FT Alphaville
S&P’s CDO rating methodology is unpatriotic – FT Alphaville
The CDO unwind waiting to happen – FT Alphaville
Moody’s downgrades Greece to A2
Posted by FT Alphaville on Dec 22 08:09.
It looks like Moody’s has finally barked.
Following in the footsteps of Fitch and S&P, the ratings agency has downgraded Greece to A2 from A1 on Tuesday morning. Fitch and S&P already have the Hellenic Republic on BBB+.
The move means Greek debt is one step closer to being cut off from eligibility as ECB collateral. Crucially though, Moody’s doesn’t think the central bank would let that happen…
Here’s the full press release, with our highlights:
London, 22 December 2009 — Moody’s Investors Service has today downgraded Greece’s government bond ratings to A2 from A1. Today’s rating action concludes the review for possible downgrade initiated by Moody’s on 29 October 2009. The outlook is negative.
This rating action does not affect the ratings of Greece’s country ceilings for bonds and bank deposits, which remain Aaa (like the rest of the Eurozone).
“Greece’s repositioned rating of A2 balances the Greek government’s very limited short-term liquidity risks on the one hand, and its medium- to long-term solvency risks on the other,” says Sarah Carlson, Moody’s lead sovereign analyst for Greece. Moody’s notes that the country’s longer-term risks have only partly been offset by the government’s announced policy response.
Moody’s had initiated its review of Greece’s A1 sovereign rating in response to mounting evidence that the government’s long-term credit strength was eroding materially. In particular, the rating agency intended to assess the new government’s policy intentions and its room for manoeuvre.
“Moody’s believes that Greece is extremely unlikely to face short-term liquidity/refinancing problems unless the European Central Bank decides to take the unusual step of making the sovereign debt of a member state ineligible as collateral for bank repurchase operations — a risk that we consider very remote,” says Arnaud Mares, Senior Vice President in Moody’s Sovereign Risk Group.
Moreover, as evidenced by other support operations within the EU, Moody’s indicated that there are potentially other means to mobilize emergency liquidity funding should it be required — but Moody’s does not believe that this will be necessary.
Moody’s also does not believe that the Greek government’s difficulties represent a vital test for the future of the eurozone, but rather a repricing of relative risks that had been concealed by years of abundant global liquidity and somewhat above-potential growth.
“The Greek government’s credit challenges are of a longer-term nature,” explains Ms. Carlson. “They stem from a slow erosion in competitiveness and economic potential, which implies that the government’s debt problem cannot be resolved by growth alone. They also result from chronically weak fiscal institutions, which cast a shadow over the government’s ability to implement decisive fiscal retrenchment in order to restore debt sustainability.”
Furthermore, the combination of a global post-crisis environment that is less favourable to Greek public finance dynamics (with increased risk discrimination and muted global demand) and an equally challenging domestic environment (with accelerating demographic pressure on public finances in coming years) will make any fiscal adjustment increasingly difficult and costly to postpone. However, Moody’s continues to think that a migration of liabilities from the banks’ balance sheets to that of the sovereign is unlikely.
Moody’s acknowledges that last week’s announcements by the Greek government clearly identify these weaknesses and pave the way for a lasting solution. However, the long-term credit standing of Greece will depend on the Greek population’s acceptance of these measures and the government’s vigorous implementation of them. “As neither of these can be taken for granted, and because these measures will also take time to bear fruit, Moody’s has placed a negative outlook on the Greek government’s new A2 rating,” says Ms. Carlson.
At A2, Greece’s bond rating compares with those of other high-income but highly indebted countries that do not face external payment vulnerabilities. However, the rating is positioned well below those of Belgium, Ireland or Italy (which are rated at Aa1-Aa2) to reflect Greece’s poor track record in terms of real fiscal adjustment. Greece’s rating also remains higher than Baa-rated Mexico, Brazil or Hungary, all of which have better or similar debt metrics but much lower income levels. These countries also do not benefit from the protection against external payment crises afforded by Greece’s membership in the European Monetary Union.
Looking ahead, the question of whether the negative outlook will evolve into a stable outlook or into a further downgrade will depend on the Greek government’s plan being followed through — as demonstrated for instance by a sustained increase in tax revenues and/or the effectiveness in reining-in expenditure.
Moody’s last rating action with respect to the government of Greece was on October 29, 2009, when its A1 long-term debt ratings were placed on review for possible downgrade.
The principal methodology used in rating the government of Greece is Moody’s Sovereign Bond Methodology, published in September 2008, which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody’s website.
Related links:Moody’s whip hand over Greece – FT Alphaville
Please have confidence in us! – FT Alphaville
How do you say vicious circle in Greek? – FT Alphaville
It looks like Moody’s has finally barked.
Following in the footsteps of Fitch and S&P, the ratings agency has downgraded Greece to A2 from A1 on Tuesday morning. Fitch and S&P already have the Hellenic Republic on BBB+.
The move means Greek debt is one step closer to being cut off from eligibility as ECB collateral. Crucially though, Moody’s doesn’t think the central bank would let that happen…
Here’s the full press release, with our highlights:
London, 22 December 2009 — Moody’s Investors Service has today downgraded Greece’s government bond ratings to A2 from A1. Today’s rating action concludes the review for possible downgrade initiated by Moody’s on 29 October 2009. The outlook is negative.
This rating action does not affect the ratings of Greece’s country ceilings for bonds and bank deposits, which remain Aaa (like the rest of the Eurozone).
“Greece’s repositioned rating of A2 balances the Greek government’s very limited short-term liquidity risks on the one hand, and its medium- to long-term solvency risks on the other,” says Sarah Carlson, Moody’s lead sovereign analyst for Greece. Moody’s notes that the country’s longer-term risks have only partly been offset by the government’s announced policy response.
Moody’s had initiated its review of Greece’s A1 sovereign rating in response to mounting evidence that the government’s long-term credit strength was eroding materially. In particular, the rating agency intended to assess the new government’s policy intentions and its room for manoeuvre.
“Moody’s believes that Greece is extremely unlikely to face short-term liquidity/refinancing problems unless the European Central Bank decides to take the unusual step of making the sovereign debt of a member state ineligible as collateral for bank repurchase operations — a risk that we consider very remote,” says Arnaud Mares, Senior Vice President in Moody’s Sovereign Risk Group.
Moreover, as evidenced by other support operations within the EU, Moody’s indicated that there are potentially other means to mobilize emergency liquidity funding should it be required — but Moody’s does not believe that this will be necessary.
Moody’s also does not believe that the Greek government’s difficulties represent a vital test for the future of the eurozone, but rather a repricing of relative risks that had been concealed by years of abundant global liquidity and somewhat above-potential growth.
“The Greek government’s credit challenges are of a longer-term nature,” explains Ms. Carlson. “They stem from a slow erosion in competitiveness and economic potential, which implies that the government’s debt problem cannot be resolved by growth alone. They also result from chronically weak fiscal institutions, which cast a shadow over the government’s ability to implement decisive fiscal retrenchment in order to restore debt sustainability.”
Furthermore, the combination of a global post-crisis environment that is less favourable to Greek public finance dynamics (with increased risk discrimination and muted global demand) and an equally challenging domestic environment (with accelerating demographic pressure on public finances in coming years) will make any fiscal adjustment increasingly difficult and costly to postpone. However, Moody’s continues to think that a migration of liabilities from the banks’ balance sheets to that of the sovereign is unlikely.
Moody’s acknowledges that last week’s announcements by the Greek government clearly identify these weaknesses and pave the way for a lasting solution. However, the long-term credit standing of Greece will depend on the Greek population’s acceptance of these measures and the government’s vigorous implementation of them. “As neither of these can be taken for granted, and because these measures will also take time to bear fruit, Moody’s has placed a negative outlook on the Greek government’s new A2 rating,” says Ms. Carlson.
At A2, Greece’s bond rating compares with those of other high-income but highly indebted countries that do not face external payment vulnerabilities. However, the rating is positioned well below those of Belgium, Ireland or Italy (which are rated at Aa1-Aa2) to reflect Greece’s poor track record in terms of real fiscal adjustment. Greece’s rating also remains higher than Baa-rated Mexico, Brazil or Hungary, all of which have better or similar debt metrics but much lower income levels. These countries also do not benefit from the protection against external payment crises afforded by Greece’s membership in the European Monetary Union.
Looking ahead, the question of whether the negative outlook will evolve into a stable outlook or into a further downgrade will depend on the Greek government’s plan being followed through — as demonstrated for instance by a sustained increase in tax revenues and/or the effectiveness in reining-in expenditure.
Moody’s last rating action with respect to the government of Greece was on October 29, 2009, when its A1 long-term debt ratings were placed on review for possible downgrade.
The principal methodology used in rating the government of Greece is Moody’s Sovereign Bond Methodology, published in September 2008, which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody’s website.
Related links:Moody’s whip hand over Greece – FT Alphaville
Please have confidence in us! – FT Alphaville
How do you say vicious circle in Greek? – FT Alphaville
2009年12月21日 星期一
Greece's budget crisis - Papandreou tries to prop up the pillars
Dec 17th 2009 ATHENSFrom The Economist print edition
The prime minister’s promises of fiscal austerity have not convinced the markets
Reuters
SUCCESSIVE Greek governments have managed to hoodwink the European Union over the size of the country’s budget deficit and its public debt by blaming their predecessors and then promising to do better. No longer. The European Commission’s fury over a leap in the projected deficit for 2009 from 6.7% of GDP (the figure from the old centre-right New Democracy-led lot) to 12.7% (the figure produced by the new centre-left Pasok government) helped to trigger a collapse in the Greek bond markets and even provoke dire warnings that the country might go bust.
For now, the idea of Greece having to seek a bail-out from its euro-area partners or appealing to the IMF for help is just talk. The finance minister, George Papaconstantinou, says he has had no such negotiations with his European colleagues. He adds that no euro-area government could ever go to the fund. But the markets’ grim mood could yet change things.
Since Pasok came to power only ten weeks ago, the cost of raising new two-year debt has risen by 1.35 percentage points. Meanwhile, its stock of debt will rise to 125% of GDP next year, from 113% this year. On December 15th Greece resorted to a €2 billion ($2.8 billion) private placement of five-year floating-rate notes with local banks because public-debt managers feared that investors would have shunned a fixed-rate offering.
Greece’s white-knuckle ride in the financial markets will continue. It needs to raise about €55 billion in 2010 to refinance existing debt and keep paying salaries and pensions, and most of that is front-loaded into the first six months. Indeed, the government plans to raise 40% of it in the first four months, whatever the cost—which to some observers smacks of desperation. Talk of default is dismissed as alarmist by the finance ministry. But bankers are less sanguine. “The markets will give the government two more months to turn things around, no more,” says one.
The government’s dithering (慌亂;緊張) is one reason why Greece has come under such fierce attack in the markets. George Papandreou, the new prime minister, was reluctant to abandon his campaign promises of real wage rises and extra welfare spending, even after Jean-Claude Trichet, president of the European Central Bank, visited Athens to call for “courageous measures”—code for cutting public-sector pay, as Ireland has done. At an EU summit on December 10th Mr Papandreou shocked his colleagues by admitting that Greece was riddled with corruption, which he claimed was the main reason for its economic woes. Cynical Greeks concluded that Mr Papandreou was trying to use the issue of corruption, “as central a part of Greece as the Acropolis”, says one, to build consensus for unpopular reforms.
On December 14th Mr Papandreou tried a little harder. He announced a pay freeze for civil servants earning more than €2,000 a month and a 10% cut in allowances. This is harsher than it looks because allowances an extra 60-90% to basic salaries, and because they will in future be taxed in the 40% band, not the 10% one as now. A near-freeze on public-sector recruitment and military spending, a 10% cut in operating budgets and tax rises for wealthy Greeks are all meant to bring the deficit down to 8.7% of GDP next year. Mr Papandreou insisted that Greece would cut its deficit below the euro area’s approved ceiling of 3% of GDP (a target that, even by its own dodgy numbers, the country has met just once since joining the euro in 2001) by 2013.
Sceptics were unconvinced. Standard & Poor’s, a rating agency, reacted by downgrading Greece only a week after Fitch, another agency, had done so. The downgrade came just as Mr Papaconstantinou was wrapping up a roadshow around European capitals that was meant to restore Greece’s credibility. (He seems confident that the third agency, Moody’s, will not downgrade Greece so swiftly.)
Mr Papaconstantinou, a British-trained economist, has a grip of the numbers and knows what has to be done. He is proud of his plans to establish the statistical office as an independent agency, as a way of regaining lost credibility. But he has struggled to win Mr Papandreou’s confidence and he may not keep it. Louka Katseli, the development minister, thinks Greece should borrow and spend its way back to growth, with generous handouts to low-income families. She appeals to Mr Papandreou’s idealistic side, and also goes down well with tax-and-spend socialists who recall Mr Papandreou’s father, Andreas, as prime minister in the 1980s.
It does not help that Pasok’s return to power has been so chaotic. Senior civil-service jobs were advertised online in a bid to boost transparency but, because of a lack of suitable applicants, the government fell back on the familiar habit of appointing party loyalists. Even so, many administrative posts are still unfilled, including that of economic adviser to the prime minister. Mr Papandreou, who chose to be his own foreign minister and also decided to retain the job of president of the Socialist International, prefers the diplomatic stage to the tedious business of putting the public finances in order.
There is much to do on the foreign front, too. Greece’s friendship with Turkey, neglected under the previous government, needs tending. It has frayed recently over Turkey’s reluctance to stop large numbers of Central Asian and Middle Eastern migrants crossing from its Aegean coast to the Greek islands—despite the EU’s Frontex team of helicopters and patrol boats keeping watch on illegal immigration. Greece also needs to patch up ties with America, strained by a veto, which Mr Papandreou has chosen to uphold, on Macedonia’s entry to NATO because of an 18-year-long dispute over the name of Greece’s northern neighbour. For the time being, though, Mr Papandreou may have to stay at home a bit more—and be sure that somebody in his office is keeping a close eye on the bond-trading screen
The prime minister’s promises of fiscal austerity have not convinced the markets
Reuters
SUCCESSIVE Greek governments have managed to hoodwink the European Union over the size of the country’s budget deficit and its public debt by blaming their predecessors and then promising to do better. No longer. The European Commission’s fury over a leap in the projected deficit for 2009 from 6.7% of GDP (the figure from the old centre-right New Democracy-led lot) to 12.7% (the figure produced by the new centre-left Pasok government) helped to trigger a collapse in the Greek bond markets and even provoke dire warnings that the country might go bust.
For now, the idea of Greece having to seek a bail-out from its euro-area partners or appealing to the IMF for help is just talk. The finance minister, George Papaconstantinou, says he has had no such negotiations with his European colleagues. He adds that no euro-area government could ever go to the fund. But the markets’ grim mood could yet change things.
Since Pasok came to power only ten weeks ago, the cost of raising new two-year debt has risen by 1.35 percentage points. Meanwhile, its stock of debt will rise to 125% of GDP next year, from 113% this year. On December 15th Greece resorted to a €2 billion ($2.8 billion) private placement of five-year floating-rate notes with local banks because public-debt managers feared that investors would have shunned a fixed-rate offering.
Greece’s white-knuckle ride in the financial markets will continue. It needs to raise about €55 billion in 2010 to refinance existing debt and keep paying salaries and pensions, and most of that is front-loaded into the first six months. Indeed, the government plans to raise 40% of it in the first four months, whatever the cost—which to some observers smacks of desperation. Talk of default is dismissed as alarmist by the finance ministry. But bankers are less sanguine. “The markets will give the government two more months to turn things around, no more,” says one.
The government’s dithering (慌亂;緊張) is one reason why Greece has come under such fierce attack in the markets. George Papandreou, the new prime minister, was reluctant to abandon his campaign promises of real wage rises and extra welfare spending, even after Jean-Claude Trichet, president of the European Central Bank, visited Athens to call for “courageous measures”—code for cutting public-sector pay, as Ireland has done. At an EU summit on December 10th Mr Papandreou shocked his colleagues by admitting that Greece was riddled with corruption, which he claimed was the main reason for its economic woes. Cynical Greeks concluded that Mr Papandreou was trying to use the issue of corruption, “as central a part of Greece as the Acropolis”, says one, to build consensus for unpopular reforms.
On December 14th Mr Papandreou tried a little harder. He announced a pay freeze for civil servants earning more than €2,000 a month and a 10% cut in allowances. This is harsher than it looks because allowances an extra 60-90% to basic salaries, and because they will in future be taxed in the 40% band, not the 10% one as now. A near-freeze on public-sector recruitment and military spending, a 10% cut in operating budgets and tax rises for wealthy Greeks are all meant to bring the deficit down to 8.7% of GDP next year. Mr Papandreou insisted that Greece would cut its deficit below the euro area’s approved ceiling of 3% of GDP (a target that, even by its own dodgy numbers, the country has met just once since joining the euro in 2001) by 2013.
Sceptics were unconvinced. Standard & Poor’s, a rating agency, reacted by downgrading Greece only a week after Fitch, another agency, had done so. The downgrade came just as Mr Papaconstantinou was wrapping up a roadshow around European capitals that was meant to restore Greece’s credibility. (He seems confident that the third agency, Moody’s, will not downgrade Greece so swiftly.)
Mr Papaconstantinou, a British-trained economist, has a grip of the numbers and knows what has to be done. He is proud of his plans to establish the statistical office as an independent agency, as a way of regaining lost credibility. But he has struggled to win Mr Papandreou’s confidence and he may not keep it. Louka Katseli, the development minister, thinks Greece should borrow and spend its way back to growth, with generous handouts to low-income families. She appeals to Mr Papandreou’s idealistic side, and also goes down well with tax-and-spend socialists who recall Mr Papandreou’s father, Andreas, as prime minister in the 1980s.
It does not help that Pasok’s return to power has been so chaotic. Senior civil-service jobs were advertised online in a bid to boost transparency but, because of a lack of suitable applicants, the government fell back on the familiar habit of appointing party loyalists. Even so, many administrative posts are still unfilled, including that of economic adviser to the prime minister. Mr Papandreou, who chose to be his own foreign minister and also decided to retain the job of president of the Socialist International, prefers the diplomatic stage to the tedious business of putting the public finances in order.
There is much to do on the foreign front, too. Greece’s friendship with Turkey, neglected under the previous government, needs tending. It has frayed recently over Turkey’s reluctance to stop large numbers of Central Asian and Middle Eastern migrants crossing from its Aegean coast to the Greek islands—despite the EU’s Frontex team of helicopters and patrol boats keeping watch on illegal immigration. Greece also needs to patch up ties with America, strained by a veto, which Mr Papandreou has chosen to uphold, on Macedonia’s entry to NATO because of an 18-year-long dispute over the name of Greece’s northern neighbour. For the time being, though, Mr Papandreou may have to stay at home a bit more—and be sure that somebody in his office is keeping a close eye on the bond-trading screen
London as a financial centre - Foul-weather friends
Dec 17th 2009 HONG KONG, LONDON AND NEW YORKFrom The Economist print edition
How London risks losing its global appeal
Illustration by S. Kambayashi
AT THE start of the 1960s London’s status as a financial centre was in gentle decline, reflecting Britain’s waning importance in the global economy. Then the American government helpfully imposed Regulation Q and the Interest Equalisation Tax, two measures that encouraged investors to hold a lot of their dollars offshore. London became the centre of the so-called Euromarket, attracting more international banks than New York.
Despite its terrible weather and creaking transport infrastructure, London has continued to punch above Britain’s economic weight as a financial centre. The city built up critical mass in legal, accounting and fund-management expertise, and big American investment banks such as Goldman Sachs steadily increased their presence. London is not just Europe’s dominant financial hub (see chart). Before the credit crunch, talk that London would replace New York as the world’s financial centre was commonplace.
That claim sounds rather hollow now, thanks to a change in the political and regulatory climate. “London’s position as a financial centre is now threatened,” says Robin Bowie of Dexion Capital, which runs a listed fund-of-hedge-funds group. A special levy on bankers’ bonuses announced earlier this month has come on top of a forthcoming 50% tax rate on high earners, a charge on the worldwide earnings of expats living in Britain (also known as “non-doms”), pension rules that create marginal tax rates of over 100% and some unfriendly words from Adair Turner, the head of Britain’s financial regulator.
A poll of Bloomberg subscribers in October found that Britain had dropped behind Singapore into third place as the city most likely to be the best financial hub two years from now. A survey of executives this month by Eversheds, a law firm, found that Shanghai could overtake London within the next ten years.
To those affected it is the arbitrary nature of the tax changes that has them rattled. “There has always been a belief that Britain gets it,” says Simon Ruddick of Albourne Partners, a hedge-fund consultancy. “By ‘it’ I mean the fact that any tax gathered from the nomadic nom-doms, itinerant hedge-fund managers and overpaid bankers is all fiscal manna from heaven. Now that this truth has been un-learned, there is the real fear and strong expectation that it cannot be relearned.”
So far, Heathrow has not been packed with financiers fleeing the country (if staff at British Airways and Eurostar go on strike, they may find it hard to leave). But it takes time for people to adjust their plans. A survey of financial analysts in September by the CFA Institute found that 20% expected to leave Britain over the next year.
British banks report that since the bonus tax was announced, overseas rivals have launched aggressive attempts to poach staff away, using lower taxes as a lure. One French-born but London-based entrepreneur says he has a letter on his desk from the French government, offering a cap on his taxes if he brings his business back home. He has not taken up the offer but thinks it is “red alert” time for London, which has a large base of French expatriates. Tullett Prebon, a brokerage, is offering its staff the chance to relocate out of Britain, noting that many had expressed concern about the “increased uncertainty of the future tax regime”.
Hedge funds, always the most mobile of firms, are likely to be in the vanguard of any exodus. BlueCrest Capital Management, a leading British hedge-fund group, is establishing a Geneva office. Odey Asset Management, another hedge-fund titan, says it is in the process of establishing a Swiss operation in order to give itself some options, although it is unlikely that the whole operation would leave Britain. “Taxation is no longer being organised on the basis of what maximises revenue or creates the best set of incentives,” says Nick Carn, an Odey partner.
Driving the wealthy abroad may satisfy a political need for vengeance but could harm taxpayers in the end. The British government estimates that the top 1% of all taxpayers (many of whom work in finance or related industries) will pay 24.1% of all income-tax revenues in 2009-10, with the top 5% paying 43% of the total. It is likely that such taxpayers also pay a big proportion of stamp duty, capital-gains tax and inheritance tax. In the decade before the crisis, financial companies were paying 20-27% of all corporation-tax receipts.
A big decline in tax revenues would come not from the departure of a few hedge-fund managers, but from the loss of a big bank. There is no sign of this yet. The chief executive of HSBC is moving his main office to Hong Kong in February, but this decision is for “strategic reasons” and involves only 12-15 people. The bank says there are “no current plans” to move the headquarters of the overall group. But it may be wrong to assume that no big bank would leave Britain.
In a speech on December 14th Bob Diamond, president of Barclays, said it was worrisome that Britain is “looking inward” and added that the bonus tax “is separate from what we agreed” at the G20, where a code was drawn up to push banks into paying bonuses over much longer periods, to discourage short-term risk-taking.
For every loser
If there were an exodus from London, where might the financiers go? The grass may not necessarily be greener on the other side of the Atlantic. Congress is still pushing ahead with reform of the finance industry—the House of Representatives passed its bill on December 11th. Anger at Wall Street bonuses is widespread. “I did not run for office to be helping out a bunch of fat-cat bankers on Wall Street,” said Barack Obama on December 13th. Kenneth Feinberg, the administration’s pay tsar, has imposed restrictions on firms that have taken lots of government cash. Others are having to show more self-restraint: Goldman Sachs has promised to pay bonuses to its top 30 employees purely in shares.
Asia will naturally become more important as a financial centre, given its economic power and its role as the provider of global savings. Much of that money is directed at other emerging markets and need not flow through London or New York. There is no big city in Asia that does not have at least some aspiration to become a financial hub. Stymied by a small home market, Kuala Lumpur dreams of being a Mecca for Islamic finance. Seoul and Tokyo say they want to become regional financial centres; Mumbai and Shanghai say they want to become global ones. Hong Kong and Singapore, without size, money or resources, have shown what is possible: they are crawling with international fund managers and bankers, plus all the accoutrements of accountants and lawyers.
The success of these last two places shows how important a welcoming regulatory regime can be. It also helps if near-neighbours are far less welcoming. London has benefited from being perceived as an outcrop of “Anglo-Saxon” capitalism within the more dirigiste European Union. This difference has blurred. France has said that it will follow Britain’s lead in imposing a bonus tax, while Greece has promised a 90% levy (Athens is not renowned as a global financial hub). The heads of Germany’s biggest banks and insurers have agreed to implement G20 rules on bonus limits this year, ahead of the official 2010 implementation elsewhere, in what seemed a clear move to head off political pressure for a windfall tax like Britain’s. Earlier this year Josef Ackermann, the head of Deutsche Bank, warned that unilateral pay limits would leave it unable to attract good staff. Outside the EU, Switzerland is an obvious threat.
Some of the complaints of London’s financiers are special pleading. It is easier to threaten to leave the country than actually to do so. But those threats should not be taken lightly. The city’s status as a financial centre is not a God-given right.
How London risks losing its global appeal
Illustration by S. Kambayashi
AT THE start of the 1960s London’s status as a financial centre was in gentle decline, reflecting Britain’s waning importance in the global economy. Then the American government helpfully imposed Regulation Q and the Interest Equalisation Tax, two measures that encouraged investors to hold a lot of their dollars offshore. London became the centre of the so-called Euromarket, attracting more international banks than New York.
Despite its terrible weather and creaking transport infrastructure, London has continued to punch above Britain’s economic weight as a financial centre. The city built up critical mass in legal, accounting and fund-management expertise, and big American investment banks such as Goldman Sachs steadily increased their presence. London is not just Europe’s dominant financial hub (see chart). Before the credit crunch, talk that London would replace New York as the world’s financial centre was commonplace.
That claim sounds rather hollow now, thanks to a change in the political and regulatory climate. “London’s position as a financial centre is now threatened,” says Robin Bowie of Dexion Capital, which runs a listed fund-of-hedge-funds group. A special levy on bankers’ bonuses announced earlier this month has come on top of a forthcoming 50% tax rate on high earners, a charge on the worldwide earnings of expats living in Britain (also known as “non-doms”), pension rules that create marginal tax rates of over 100% and some unfriendly words from Adair Turner, the head of Britain’s financial regulator.
A poll of Bloomberg subscribers in October found that Britain had dropped behind Singapore into third place as the city most likely to be the best financial hub two years from now. A survey of executives this month by Eversheds, a law firm, found that Shanghai could overtake London within the next ten years.
To those affected it is the arbitrary nature of the tax changes that has them rattled. “There has always been a belief that Britain gets it,” says Simon Ruddick of Albourne Partners, a hedge-fund consultancy. “By ‘it’ I mean the fact that any tax gathered from the nomadic nom-doms, itinerant hedge-fund managers and overpaid bankers is all fiscal manna from heaven. Now that this truth has been un-learned, there is the real fear and strong expectation that it cannot be relearned.”
So far, Heathrow has not been packed with financiers fleeing the country (if staff at British Airways and Eurostar go on strike, they may find it hard to leave). But it takes time for people to adjust their plans. A survey of financial analysts in September by the CFA Institute found that 20% expected to leave Britain over the next year.
British banks report that since the bonus tax was announced, overseas rivals have launched aggressive attempts to poach staff away, using lower taxes as a lure. One French-born but London-based entrepreneur says he has a letter on his desk from the French government, offering a cap on his taxes if he brings his business back home. He has not taken up the offer but thinks it is “red alert” time for London, which has a large base of French expatriates. Tullett Prebon, a brokerage, is offering its staff the chance to relocate out of Britain, noting that many had expressed concern about the “increased uncertainty of the future tax regime”.
Hedge funds, always the most mobile of firms, are likely to be in the vanguard of any exodus. BlueCrest Capital Management, a leading British hedge-fund group, is establishing a Geneva office. Odey Asset Management, another hedge-fund titan, says it is in the process of establishing a Swiss operation in order to give itself some options, although it is unlikely that the whole operation would leave Britain. “Taxation is no longer being organised on the basis of what maximises revenue or creates the best set of incentives,” says Nick Carn, an Odey partner.
Driving the wealthy abroad may satisfy a political need for vengeance but could harm taxpayers in the end. The British government estimates that the top 1% of all taxpayers (many of whom work in finance or related industries) will pay 24.1% of all income-tax revenues in 2009-10, with the top 5% paying 43% of the total. It is likely that such taxpayers also pay a big proportion of stamp duty, capital-gains tax and inheritance tax. In the decade before the crisis, financial companies were paying 20-27% of all corporation-tax receipts.
A big decline in tax revenues would come not from the departure of a few hedge-fund managers, but from the loss of a big bank. There is no sign of this yet. The chief executive of HSBC is moving his main office to Hong Kong in February, but this decision is for “strategic reasons” and involves only 12-15 people. The bank says there are “no current plans” to move the headquarters of the overall group. But it may be wrong to assume that no big bank would leave Britain.
In a speech on December 14th Bob Diamond, president of Barclays, said it was worrisome that Britain is “looking inward” and added that the bonus tax “is separate from what we agreed” at the G20, where a code was drawn up to push banks into paying bonuses over much longer periods, to discourage short-term risk-taking.
For every loser
If there were an exodus from London, where might the financiers go? The grass may not necessarily be greener on the other side of the Atlantic. Congress is still pushing ahead with reform of the finance industry—the House of Representatives passed its bill on December 11th. Anger at Wall Street bonuses is widespread. “I did not run for office to be helping out a bunch of fat-cat bankers on Wall Street,” said Barack Obama on December 13th. Kenneth Feinberg, the administration’s pay tsar, has imposed restrictions on firms that have taken lots of government cash. Others are having to show more self-restraint: Goldman Sachs has promised to pay bonuses to its top 30 employees purely in shares.
Asia will naturally become more important as a financial centre, given its economic power and its role as the provider of global savings. Much of that money is directed at other emerging markets and need not flow through London or New York. There is no big city in Asia that does not have at least some aspiration to become a financial hub. Stymied by a small home market, Kuala Lumpur dreams of being a Mecca for Islamic finance. Seoul and Tokyo say they want to become regional financial centres; Mumbai and Shanghai say they want to become global ones. Hong Kong and Singapore, without size, money or resources, have shown what is possible: they are crawling with international fund managers and bankers, plus all the accoutrements of accountants and lawyers.
The success of these last two places shows how important a welcoming regulatory regime can be. It also helps if near-neighbours are far less welcoming. London has benefited from being perceived as an outcrop of “Anglo-Saxon” capitalism within the more dirigiste European Union. This difference has blurred. France has said that it will follow Britain’s lead in imposing a bonus tax, while Greece has promised a 90% levy (Athens is not renowned as a global financial hub). The heads of Germany’s biggest banks and insurers have agreed to implement G20 rules on bonus limits this year, ahead of the official 2010 implementation elsewhere, in what seemed a clear move to head off political pressure for a windfall tax like Britain’s. Earlier this year Josef Ackermann, the head of Deutsche Bank, warned that unilateral pay limits would leave it unable to attract good staff. Outside the EU, Switzerland is an obvious threat.
Some of the complaints of London’s financiers are special pleading. It is easier to threaten to leave the country than actually to do so. But those threats should not be taken lightly. The city’s status as a financial centre is not a God-given right.
The slumbering CLO awakes?
Earlier this month, FT Alphaville asked whether synthetic CLOs were gone for good, or merely hibernating?
This week it looks like the synthetic CLOs’ simpler cousin, your run-of-the-mill business loan-packed CLO, is beginning to awaken:
Dec. 16 (Bloomberg) — Banks may arrange as many as 100 collateralized debt obligations backed by high-yield, high-risk loans in 2010 following Wells Fargo & Co.’s “landmark” offering yesterday, according to Guggenheim Partners LLC.
Guggenheim was the main investor in the securities of Newstar Commercial Loan Trust 2009-1, a $250 million CLO arranged by Wells Fargo, said Scott Minerd, who helps supervise more than $100 billion as Guggenheim’s chief investment officer.
Wells Fargo is joined by JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. in approaching managers of leveraged loans to offer terms for new CLOs following a record rally this year in the debt. The $440 billion market for CLOs, which pool loans and slice them into securities of varying risk, largely disappeared at the end of 2007 as losses on subprime mortgages led investors to flee bundled debt.
. . . Leveraged loans have returned a record 49.8 percent this year after losing an unprecedented 28.2 percent in 2008 following the failure of Lehman Brothers Holdings Inc., according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index. Leveraged loans are rated below BBB- by S&P and less than Baa3 at Moody’s Investors Service.
Ironically the stated reasoning behind this latest CLO is almost the polar opposite to the thing that fueled the early 2008 (mini) CLO boom-of-desperation.
This for instance, is from a February 2008 Wall Street Journal article:
In the past few days, low-rated corporate loans — the kind that fueled the buyout boom of recent years — have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices.
`Unloading’ eventually became synonymous with `creating CLOs’ — which helps banks shift high-risk loans off their balance sheets.
And the plummeting value of leveraged loans in 2008 saw a plethora of `landmark’ deals like Carlyle’s CLO funds, and err, Lehman’s Freedom CLO, which was packed with stuff like bank credit lines to CountryWide Financial — the mortgage house hit hard by the crisis and taken over by Bank of America.
The issue in 2008 was that the dropping value of leveraged loans essentially created margin calls — forcing sales of the CLOs’ assets in the event that counterparties couldn’t make the payments– which in turn led to further reductions in loan values. A sort of vicious CLO-circle, if you will.
Lots has of course changed since 2008 — but then again, lots hasn’t.
For instance, the pricing difference between the primary and secondary market for loans is still pretty wide, which makes some people doubt an imminent CLO comeback.
From Structured Finance News:
However, some still doubted the likelihood of an imminent comeback for the market. Several CLO market participants noted that the arbitrage between the senior financing and the yield on other assets, mainly those that are trading on the secondary, will continue to make it difficult for any new CLOs to launch. “You need two pieces — attractive equity rates and reasonable financings — to create that arbitrage,” a New York-based CLO manager told Leveraged Finance News.
For those interested, The AAA-rated tranche of the Newstar CLO will pay 375bps over Libor, for instance, while the AA-rated is priced at 750bps. The BB-rated bit and the unrated remainder reportedly weren’t offered to Guggenheim.
Related links:
Guggenheim Partners buys most of a new $275m CLO – WSJ
Leveraged loans are the new bonds – FT
Ratings agencies draw fire from CLOs – FT
訂閱：
文章 (Atom)