Oh to have been a mouse in the corner last Friday morning in the World Bank’s Finance and Private Sector research department! In a guest article for this week’s The Economist, World Bank chief economist Justin Yifu Lin argued that “small, local banks” are the best entities for providing financial services in developing countries where SMEs are critical to growth.
Not ground-breaking stuff you might say. Heterodox economists have been making this point for years. Developing both relations with local businesspeople and project assessment skills are critical if local banks are to support the development process. Big international banks tend to cherry pick large corporate clients, and use their technological advantage in credit scoring to rapidly increase household indebtedness (witness Mexico).
But the Lin article takes on more importance in the context of nearly two decades of Bank research and policy advice which has advocated a position contrary to his own. From Clarke et al. (2001) (‘Foreign bank penetration improves financing conditions for enterprises of all sizes’) to the much-cited Claessens et al. (2001) to Beck et al. (2003) (‘a larger share of foreign-owned banks removes financing obstacles’), and much more beyond, the Bank has been a cheerleader for the benefits of big banks in little countries.
Moreover, the Bank’s private sector arm, the IFC, has eagerly supported the development of loan securitisation, mortgage-backed securities, collateralised debt obligations and originate-and-distribute banking models (dos Santos, 2008) - hardly the “simple banking systems” whose merits Lin extols.
(Lin also praises Japan, South Korea and China for resisting the rush to prematurely develop stock markets or integrate into international financial networks. Again, not new (Ajit Singh has made this case for over two decades), but decidedly against the World Bank flow.)
Could this be a portent of good things to come at the Bank? Or will Lin be slapped down by Wall Street via the US Treasury (a la Stiglitz) or quietly sidelined (cf. Bourguignon’s inequality agenda)? Perhaps Lin’s carefully chosen words later in the article (‘small, private domestic banks’) will have been just enough to avoid rocking the boat. After all, HSBC is the ‘world’s local bank’…
(nb. I’m not the only one to be struck by Lin’s editorial – a vigorous debate of the great and the good, including several former Bank economists, has broken out on The Economist)
Wednesday, 15 July 2009
Monday, 13 July 2009
Head and Shoulders Update: Could this be a new definition of Financialisation?
So as I type the S&P is up around 2.5%, and the puts I was talking about earlier are now trading at .28 / 1.28 - so a massive loss so far if you bought them this afternoon... dooh.
And to what do we owe this remarkable rally? Well no-one knows but the press are co-joining the rally and the news that a famous analyst is predicting massive profits for Goldman Sachs when they announce tomorrow.
So financial markets are up because Goldman Sachs took enourmous profits from trading in financial markets.... THIS is financialisation!
Head and Shoulders
Lots of talk in the last week or so of “head and shoulders”. Many markets are forming this legendary trading pattern and several mature markets have “broken the neckline” – meaning this could be the moment for the fall in equities that many predict. Moreover as this piece points out, the Vix is doing strange things with it’s moving averages.
Talk has also re-surfaced of the dark forces of the Plunge Protection Team. This is the White House appointed team has the right to intervene and support
In the coming week or so we have option expiries and earnings announcements. If financial proces are as arbitrary as the above isn’t it earnings that will bring them back in line with the forces of production? Well, not really when what really matters is i) where expectations have been managed to, and ii) what the companies tell us they are predicting for the future. So still a decent amount of guess work in there.
Once you start seeing head and shoulders it seems it’s rather catching and you start to see them everywhere... MacroMan sees one in the MSCI today although the neckline isn’t broken yet.
Today you could buy 850 strike, July expiry, S&P puts for $2.8 on igindex. This is a statement of fact not investment advice. As discussed, prices might go up, might go down, might be politically influenced, might not. Pretty arbitrary actually.
Monday, 6 July 2009
How the dead live...
You thought it was dead but it seems it's having another go-around. Securitisation is back, only this time it's better, smarter, safer... honestly! Barclays Capital are calling it "smart securitisation", Goldmans "Insurance". From what we can see it seems to follow the complicated formula: diversify, improve rating. Apparently this time it's ok though as the instruments are taking existing assets from bank's balance sheets not generating new ones. Well, my friends that's how securitisation started the first time around.
It seems similar moves are afoot in the market for Commercial Real estate Mortgage Backed Securities (CMBS). Here the incentive seems to be from S&P who are to downgrade a load of bonds such that they will no longer qualify for the FED's TALF liquidity facility. Not that anyone went anywhere near it the first time around - the banks need capital not liquidity. Instead the private side is constructing what they are calling "re-Remics". I quote Risk Magazine: "This involves splitting existing CMBS into new tranches with fresh ratings." (Who is buying this stuff?!). Crucially this "might also provide regulatory capital relief for banks and insurance companies". Well they won't be doing otherwise!! Groundhog day anyone? Let's go round again?
Lack of meaningful action by regulaltors is leading to private side innovation to fill the space they are creating, be it Sovereign CDS indices, re-Remics or whatever. The financial press at least this time around can see that this is somewhat peculiar, and understand the instruments better than previously (note the altered the phrasing around "ratings instability"). But on it goes never-the-less. Do we really want another go-around?
You thought it was dead but it seems it's having another go-around. Securitisation is back, only this time it's better, smarter, safer... honestly! Barclays Capital are calling it "smart securitisation", Goldmans "Insurance". From what we can see it seems to follow the complicated formula: diversify, improve rating. Apparently this time it's ok though as the instruments are taking existing assets from bank's balance sheets not generating new ones. Well, my friends that's how securitisation started the first time around.
It seems similar moves are afoot in the market for Commercial Real estate Mortgage Backed Securities (CMBS). Here the incentive seems to be from S&P who are to downgrade a load of bonds such that they will no longer qualify for the FED's TALF liquidity facility. Not that anyone went anywhere near it the first time around - the banks need capital not liquidity. Instead the private side is constructing what they are calling "re-Remics". I quote Risk Magazine: "This involves splitting existing CMBS into new tranches with fresh ratings." (Who is buying this stuff?!). Crucially this "might also provide regulatory capital relief for banks and insurance companies". Well they won't be doing otherwise!! Groundhog day anyone? Let's go round again?
Lack of meaningful action by regulaltors is leading to private side innovation to fill the space they are creating, be it Sovereign CDS indices, re-Remics or whatever. The financial press at least this time around can see that this is somewhat peculiar, and understand the instruments better than previously (note the altered the phrasing around "ratings instability"). But on it goes never-the-less. Do we really want another go-around?
Friday, 3 July 2009
A Rolling Stone gathers no moss...
A few stories have caught the eye in the last week that potentially tell us a little about where derivatives / financial markets are going.
Firstly this week saw the launch of Indices for sovereign CDS. The Alphaville Blog post and comments really summarize this, in particular the first comment which begins, “This is a pointless punting instrument”.
- What exactly could you hedge with this?
- Who would you buy the hedge from?
- Which currency would you denominate it in?
In short this is a very awkward hedging tool and a very useful trading / speculating tool.
If that is the private side response to the current situation the public one is not too dissimilar. The US and others are still calling for more standardized derivatives as a key part of the regulatory overhaul. Indeed we have seen standard CDS coupons put in place in the US and in Europe.
- Does standardisation bring derivatives closer to production, giving capitalists a risk management tool to help them manage their specific business risks? NO.
- Does standardization help those that want to trade vast volumes of derivatives? YES
- Does standardization and large volume trading help speculators? YES
- Does anyone still think that the problem with CDS pre-crisis was not enough volume? That price efficiency will follow if we can just make the market ‘purer’? SURELY NOT!?
Finally, in the same vein of financial instruments divorcing further from production and becoming simply investment vehicles Bloomberg noted that correlation between asset classes is at all time highs. “The Standard & Poor’s 500 Index … is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds.”
The fact of ever increasing numbers of asset prices moving in lockstep would be consistent with the rise of anything and everything as an investment vehicle. Now the forces of supply and demand for the investment outstrip the forces of demand and supply from production. Herd mentality, risk aversion and so on rule the roost (incidentally, fear is often said to manifest itself in the VIX another abstractr index; Macro Man notes “for the first time in quite a while, the ambient temperature in SE England is higher, in degrees Celsius, than the VIX.” – a vital technical???)
Why does this matter? Well first of all the alleged benefits of derivatives and financial markets are risk sharing, hedging and so on. Surely these are best served if derivatives move towards and not away from production, become more hedger friendly not less. Secondly the further from production the more fictitious financial prices become and the more open to herd behavior, bubbles and outright manipulation. This leaves financial capitalists in the position we find them now of trading the hell out of the markets as they rise and resisting the fall by either getting out at the top or using their political clout to avoid the consequences.
Which leads finally to a piece in Rolling Stone magazine highlighting the activities of those Masters of the Universe, Goldman Sachs. It shows in irreverent language but damning detail how bankers inflated and rode the dot com, the housing and the oil bubbles, have come out of the crisis bailout as shiny as ever and how they are now looking at global warming, carbon markets and the rest as the new “asset class”.
A few stories have caught the eye in the last week that potentially tell us a little about where derivatives / financial markets are going.
Firstly this week saw the launch of Indices for sovereign CDS. The Alphaville Blog post and comments really summarize this, in particular the first comment which begins, “This is a pointless punting instrument”.
- What exactly could you hedge with this?
- Who would you buy the hedge from?
- Which currency would you denominate it in?
In short this is a very awkward hedging tool and a very useful trading / speculating tool.
If that is the private side response to the current situation the public one is not too dissimilar. The US and others are still calling for more standardized derivatives as a key part of the regulatory overhaul. Indeed we have seen standard CDS coupons put in place in the US and in Europe.
- Does standardisation bring derivatives closer to production, giving capitalists a risk management tool to help them manage their specific business risks? NO.
- Does standardization help those that want to trade vast volumes of derivatives? YES
- Does standardization and large volume trading help speculators? YES
- Does anyone still think that the problem with CDS pre-crisis was not enough volume? That price efficiency will follow if we can just make the market ‘purer’? SURELY NOT!?
Finally, in the same vein of financial instruments divorcing further from production and becoming simply investment vehicles Bloomberg noted that correlation between asset classes is at all time highs. “The Standard & Poor’s 500 Index … is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds.”
The fact of ever increasing numbers of asset prices moving in lockstep would be consistent with the rise of anything and everything as an investment vehicle. Now the forces of supply and demand for the investment outstrip the forces of demand and supply from production. Herd mentality, risk aversion and so on rule the roost (incidentally, fear is often said to manifest itself in the VIX another abstractr index; Macro Man notes “for the first time in quite a while, the ambient temperature in SE England is higher, in degrees Celsius, than the VIX.” – a vital technical???)
Why does this matter? Well first of all the alleged benefits of derivatives and financial markets are risk sharing, hedging and so on. Surely these are best served if derivatives move towards and not away from production, become more hedger friendly not less. Secondly the further from production the more fictitious financial prices become and the more open to herd behavior, bubbles and outright manipulation. This leaves financial capitalists in the position we find them now of trading the hell out of the markets as they rise and resisting the fall by either getting out at the top or using their political clout to avoid the consequences.
Which leads finally to a piece in Rolling Stone magazine highlighting the activities of those Masters of the Universe, Goldman Sachs. It shows in irreverent language but damning detail how bankers inflated and rode the dot com, the housing and the oil bubbles, have come out of the crisis bailout as shiny as ever and how they are now looking at global warming, carbon markets and the rest as the new “asset class”.
Thursday, 7 May 2009
Aspects of Financialisation in Greece: what’s next?
by George Lambrinidis
In 2008, there were 360.000 unemployed workers, 350.000 in temporary employment, 270.000 part-time workers, 400.000 in employment with very low, if any, rights and 600.000 were working without insurance. At the same time, 400.000 workers have to have a second job or cover basic needs through borrowing under burdensome terms[1]. Just for the record, the labor force of the country is no more than 3.9 million.
Following the gist of our previous posts, the unemployment situation sketched above can be partly attributed to the capitalist restructure and reformation of the 1990s, as well as to the political dominance of the social democrats. Both processes tipped the scales in the interests of the bourgeoisie. Nevertheless, this would not be possible had it not been for an underlying ideological process. This is no other than the process of destroying ideologically the belief that solutions for the working class can come about only through collective action. It cannot be ascribed solely to the social democratic party, but the latter undertook successfully its political realization and overview. This very process is quite significant for financialisation.
Still, a major break was needed for any savings of the wage earners to be swept up and to damage seriously the ability of the social network to provide solutions at times of difficulty. Operation “stock market”, orchestrated by the social democrats, sold by them as the arrival of “popular capitalism” climaxed in 1999 and channeled savings of over one million people to the pockets of the capitalists. Apart from the direct effect on the latter’s profitability, the operation exposed workers, mostly, and low income self employed to the grip of the banks.
The entering of Greece in the EMU accelerated these processes. Capitalist restructuring was driven now through integrated competition and new opportunities. As for the latter, one has only to take a look at the position of Greek investments in the newcomers of the EU, and especially those in the neighborhood. In the same spirit, one may understand Greek foreign policy toward the entering of Turkey in the EU. Further, the EMU provided the framework as well as the political alibi for those ventures to flourish.
It is now evident that the individual seeking of solutions is a dead end. The alternative though is still misty. It seems that there is a turn to collective action, while the bourgeoisie is turning to the militarization of everyday life. This is also one of the major pillars of the political crisis that accompanies the economic one and the events of December should be understood under this light.
I would risk arguing that processes in Greece were not slow, its not logn since the early 1990s when most banks were unable to accomplish their role in the era of financialisation and under state – although never public – ownership. Greece had to run through all the evolution of financialisation in much less than half the time of the leading capitalist countries. This hardly implies that Greek capitalists didn’t do well, it’s just that the situation is now very complicated and not easy for them to manage politically, let alone economically.
To return to where we started and the events of December, it is evident that these scenes will be repeated: the time for elections is approaching, with the ability of the two identical parties – the social democrats and the new liberals – to switch government strongly contested and the workers movement is rising, despite its recent weakness.. Another December will inevitably be provoked to justify the violent imposition of the political power of the bourgeoisie. The ground is ready for the next round, the margins are much tighter and each will be ready for the fight.
[1] Interest rates for credit cards are no less than 17% and, recently,banks were obliged to stop charging interest on a loan when customers have been paid 3 times the value of original loan.
In 2008, there were 360.000 unemployed workers, 350.000 in temporary employment, 270.000 part-time workers, 400.000 in employment with very low, if any, rights and 600.000 were working without insurance. At the same time, 400.000 workers have to have a second job or cover basic needs through borrowing under burdensome terms[1]. Just for the record, the labor force of the country is no more than 3.9 million.
Following the gist of our previous posts, the unemployment situation sketched above can be partly attributed to the capitalist restructure and reformation of the 1990s, as well as to the political dominance of the social democrats. Both processes tipped the scales in the interests of the bourgeoisie. Nevertheless, this would not be possible had it not been for an underlying ideological process. This is no other than the process of destroying ideologically the belief that solutions for the working class can come about only through collective action. It cannot be ascribed solely to the social democratic party, but the latter undertook successfully its political realization and overview. This very process is quite significant for financialisation.
Still, a major break was needed for any savings of the wage earners to be swept up and to damage seriously the ability of the social network to provide solutions at times of difficulty. Operation “stock market”, orchestrated by the social democrats, sold by them as the arrival of “popular capitalism” climaxed in 1999 and channeled savings of over one million people to the pockets of the capitalists. Apart from the direct effect on the latter’s profitability, the operation exposed workers, mostly, and low income self employed to the grip of the banks.
The entering of Greece in the EMU accelerated these processes. Capitalist restructuring was driven now through integrated competition and new opportunities. As for the latter, one has only to take a look at the position of Greek investments in the newcomers of the EU, and especially those in the neighborhood. In the same spirit, one may understand Greek foreign policy toward the entering of Turkey in the EU. Further, the EMU provided the framework as well as the political alibi for those ventures to flourish.
It is now evident that the individual seeking of solutions is a dead end. The alternative though is still misty. It seems that there is a turn to collective action, while the bourgeoisie is turning to the militarization of everyday life. This is also one of the major pillars of the political crisis that accompanies the economic one and the events of December should be understood under this light.
I would risk arguing that processes in Greece were not slow, its not logn since the early 1990s when most banks were unable to accomplish their role in the era of financialisation and under state – although never public – ownership. Greece had to run through all the evolution of financialisation in much less than half the time of the leading capitalist countries. This hardly implies that Greek capitalists didn’t do well, it’s just that the situation is now very complicated and not easy for them to manage politically, let alone economically.
To return to where we started and the events of December, it is evident that these scenes will be repeated: the time for elections is approaching, with the ability of the two identical parties – the social democrats and the new liberals – to switch government strongly contested and the workers movement is rising, despite its recent weakness.. Another December will inevitably be provoked to justify the violent imposition of the political power of the bourgeoisie. The ground is ready for the next round, the margins are much tighter and each will be ready for the fight.
[1] Interest rates for credit cards are no less than 17% and, recently,banks were obliged to stop charging interest on a loan when customers have been paid 3 times the value of original loan.
Tuesday, 28 April 2009
The UK budget: What is really going on…?
by Juan Pablo Painceira
The debate on the nature of the UK budget has been hot over the last week in all media. The main issues addressed are the taxation on the wealthy, Darling’s economic forecasts and the huge climb in public debt since October 2008. The rise to 50% taxation on the top income earners (over £150,000) has been called a revival of class war, a return to Old Labour policy or even a populist measure targeting the next election.
The UK growth forecasts of a fall of 3.5% and rise of 1.2%, respectively, for 2009 and 2010 have been ridiculed by many analysts. It does seem a bit unrealistic given that the IMF and consensus forecasts are a drop of 4% in 2009 and growth of only 0.3% in 2010. Besides, it is well known that governmental forecasts are always more optimistic than the market’s: if a finance minister forecasts less than the market for sure they should be fired! It’s all about information and expectations my dear! Surely we can all agree that growth forecast of 3.5% to 2011 is somewhat exaggerated. According to the debate in the media the other areas to focus on included a rise in the annual limit for tax-free ISAs to more than £10,000 - to come in from October 2009 for the over 50s; the stamp duty holiday for homes up to £175,000 is to be extended to the end of the year; and there will be more job help for the long term young unemployed.
The rise of public sector borrowing and, consequently in public sector debt have raised concerns about the sustainability of the UK’s finances over the coming years which is affecting the pound and is reflected in a possible downgrade by a rating agency from AAA. Since last Wednesday there has also been capital outflow from the Gilts with the benchmark yield Gilt-10 rising more than 20bp.
Basically, the economic debate on budget which has played out in the media has been whether the UK government has to cut more on public expenditure or to increase taxation in the coming years. It sounds familiar, doesn’t it? This is the same old debate re-heated.
What we haven’t heard so much about is the huge public exposure to the bank bail-outs which is around £1,000 bn. since the Northern Rock rescue. It’s off the agenda already?!?!
Or even the cuts in planned public spending, where the public sector, in particular the NHS is expected to generate savings, but which are being labelled efficiency savings.
It is a strange world where via a cut in spending, the system suddenly becomes more efficient and generates cash! We can only imagine how this will work at the micro level…
The Economist's reaction to the budget is at least harsh. They are calling for a more realistic budget where the government should say explicitly to the British nation that the costs for getting the UK out of the financial crisis and recession should be shared (or paid) by everyone, including you!
In the same rhythm, the IMF is just as concerned by the extension of fiscal stimulus in Spain, talking of the need for institutional reforms (mainly in the labour markets) in order to keep the sustainability of the Spanish long-term economic growth. There is no free lunch.
Yet for all the criticism, slowly events are potentially generating a situation and political environment where the fiscal adjustment could be implemented, the cost borne by the tax payer, perhaps with some neo-liberal reforms thrown in to convince us it won’t happen again. That way the fiscal expansion could be calibrated according to the needs of banking system and we can get back to business as usual…
For the time being…as we have addressed in past posts, it seems ‘plus ca change’… let’s see how the GDP predictions turn out and if they really have enough in the tank to plough on through…
The debate on the nature of the UK budget has been hot over the last week in all media. The main issues addressed are the taxation on the wealthy, Darling’s economic forecasts and the huge climb in public debt since October 2008. The rise to 50% taxation on the top income earners (over £150,000) has been called a revival of class war, a return to Old Labour policy or even a populist measure targeting the next election.
The UK growth forecasts of a fall of 3.5% and rise of 1.2%, respectively, for 2009 and 2010 have been ridiculed by many analysts. It does seem a bit unrealistic given that the IMF and consensus forecasts are a drop of 4% in 2009 and growth of only 0.3% in 2010. Besides, it is well known that governmental forecasts are always more optimistic than the market’s: if a finance minister forecasts less than the market for sure they should be fired! It’s all about information and expectations my dear! Surely we can all agree that growth forecast of 3.5% to 2011 is somewhat exaggerated. According to the debate in the media the other areas to focus on included a rise in the annual limit for tax-free ISAs to more than £10,000 - to come in from October 2009 for the over 50s; the stamp duty holiday for homes up to £175,000 is to be extended to the end of the year; and there will be more job help for the long term young unemployed.
The rise of public sector borrowing and, consequently in public sector debt have raised concerns about the sustainability of the UK’s finances over the coming years which is affecting the pound and is reflected in a possible downgrade by a rating agency from AAA. Since last Wednesday there has also been capital outflow from the Gilts with the benchmark yield Gilt-10 rising more than 20bp.
Basically, the economic debate on budget which has played out in the media has been whether the UK government has to cut more on public expenditure or to increase taxation in the coming years. It sounds familiar, doesn’t it? This is the same old debate re-heated.
What we haven’t heard so much about is the huge public exposure to the bank bail-outs which is around £1,000 bn. since the Northern Rock rescue. It’s off the agenda already?!?!
Or even the cuts in planned public spending, where the public sector, in particular the NHS is expected to generate savings, but which are being labelled efficiency savings.
It is a strange world where via a cut in spending, the system suddenly becomes more efficient and generates cash! We can only imagine how this will work at the micro level…
The Economist's reaction to the budget is at least harsh. They are calling for a more realistic budget where the government should say explicitly to the British nation that the costs for getting the UK out of the financial crisis and recession should be shared (or paid) by everyone, including you!
In the same rhythm, the IMF is just as concerned by the extension of fiscal stimulus in Spain, talking of the need for institutional reforms (mainly in the labour markets) in order to keep the sustainability of the Spanish long-term economic growth. There is no free lunch.
Yet for all the criticism, slowly events are potentially generating a situation and political environment where the fiscal adjustment could be implemented, the cost borne by the tax payer, perhaps with some neo-liberal reforms thrown in to convince us it won’t happen again. That way the fiscal expansion could be calibrated according to the needs of banking system and we can get back to business as usual…
For the time being…as we have addressed in past posts, it seems ‘plus ca change’… let’s see how the GDP predictions turn out and if they really have enough in the tank to plough on through…
Monday, 20 April 2009
Plus ca change… Finance Capitalists (still) rool ok?
by Duncan Lindo
A month or so ago the world seemed about to change: bankers were bad, Sir Fred was in hiding, AIG was being punished and a rethink of financialised capitalism seemed possible. Today the bad banker headlines are fading, banks’ results are improving and there’s talk of repaying TARP funds. In fact finance capitalists seem to be winning the struggle by some margin. Three news stories of recent weeks show that so far there has been no fundamental questioning whatsoever of financialised capitalism; indeed is anything the crisis is being used to usher in ever more market-friendly measures.
A review of fair value accounting led to a relaxation of the rules, resulting in less mark-to-market, but no fundamental questioning of the idea that market prices in financial markets are efficient and result in correct allocation of resources – despite the crisis. In a previous blog we explored how expansion of mark to market expands the “everything-for-sale” attitude with it’s short-termist outcomes and ever more power to the financial elites.
The so-called CDS big bang cedes some power from banks to other investment firms such as PIMCO. But let’s be clear here, PIMCO or any other investment firm are just as much interested in trading revenues as the banks. This is not a big bang it’s only a small shift. Are these really the hedgers / investors that the literature makes so central to the ability of derivatives to spread risks? I don’t think so. The contract changes all work in the direction of further standardisation in preparation for central clearing. This flies in the face of returning CDS to be a hedging tool. Credit transfer products such as CDS have become steadily more standardised over the last 20 years inviting ever increasing trading volumes for those who spend the day buying and selling. But a true hedger requires the opposite - a bespoke contract which they will hold until maturity. As explored previously “counterparty risk” is a red herring being used to usher in ever more trading / market friendly conditions.
These two stories trends are manifesting themselves in a slight upturn in the latest banks’ results. Banks have taken advantage of the relaxation of fair value accounting to report better numbers and are also reporting better trading revenues on wider bid-ask spreads. Strange world where large spreads are due to the low level of liquidity that is caused by the financial crunch which was caused by…..banks!
When the vast majority of economists are trained to believe markets work we shouldn’t be surprised that when markets fail (again) the response is to look past the facts and attempt to implement markets yet harder and faster. How long will it take for the realisation to sink in that something more fundamental needs to change? Well don’t hold your breath! It takes a long time to turn a tanker even as it hits a storm, what’s more there are powerful forces trying to ensure the route through the storm is to keep in the same direction but go even faster!
PS: Should we be surprised that the finance capitalists are winning the day when two of their number are holding the most relevant posts in the White House? As Stiglitz puts it: “America has had a revolving door. People go from Wall Street to Treasury and back to Wall Street. Even if there is no quid pro quo, that is not the issue. The issue is the mindset.”
A month or so ago the world seemed about to change: bankers were bad, Sir Fred was in hiding, AIG was being punished and a rethink of financialised capitalism seemed possible. Today the bad banker headlines are fading, banks’ results are improving and there’s talk of repaying TARP funds. In fact finance capitalists seem to be winning the struggle by some margin. Three news stories of recent weeks show that so far there has been no fundamental questioning whatsoever of financialised capitalism; indeed is anything the crisis is being used to usher in ever more market-friendly measures.
A review of fair value accounting led to a relaxation of the rules, resulting in less mark-to-market, but no fundamental questioning of the idea that market prices in financial markets are efficient and result in correct allocation of resources – despite the crisis. In a previous blog we explored how expansion of mark to market expands the “everything-for-sale” attitude with it’s short-termist outcomes and ever more power to the financial elites.
The so-called CDS big bang cedes some power from banks to other investment firms such as PIMCO. But let’s be clear here, PIMCO or any other investment firm are just as much interested in trading revenues as the banks. This is not a big bang it’s only a small shift. Are these really the hedgers / investors that the literature makes so central to the ability of derivatives to spread risks? I don’t think so. The contract changes all work in the direction of further standardisation in preparation for central clearing. This flies in the face of returning CDS to be a hedging tool. Credit transfer products such as CDS have become steadily more standardised over the last 20 years inviting ever increasing trading volumes for those who spend the day buying and selling. But a true hedger requires the opposite - a bespoke contract which they will hold until maturity. As explored previously “counterparty risk” is a red herring being used to usher in ever more trading / market friendly conditions.
These two stories trends are manifesting themselves in a slight upturn in the latest banks’ results. Banks have taken advantage of the relaxation of fair value accounting to report better numbers and are also reporting better trading revenues on wider bid-ask spreads. Strange world where large spreads are due to the low level of liquidity that is caused by the financial crunch which was caused by…..banks!
When the vast majority of economists are trained to believe markets work we shouldn’t be surprised that when markets fail (again) the response is to look past the facts and attempt to implement markets yet harder and faster. How long will it take for the realisation to sink in that something more fundamental needs to change? Well don’t hold your breath! It takes a long time to turn a tanker even as it hits a storm, what’s more there are powerful forces trying to ensure the route through the storm is to keep in the same direction but go even faster!
PS: Should we be surprised that the finance capitalists are winning the day when two of their number are holding the most relevant posts in the White House? As Stiglitz puts it: “America has had a revolving door. People go from Wall Street to Treasury and back to Wall Street. Even if there is no quid pro quo, that is not the issue. The issue is the mindset.”
Tuesday, 14 April 2009
Financial Literacy - important points to think about
by Christina Laskaridis
Provision of services to enable consumers to handle money, debt and their overall finances better has expanded considerably in recent years. In the UK the FSA are leading initiatives in financial capability and literacy e.g. spending £90m on it’s National Financial Capability Strategy, in conjunction with government, the financial sector and a multitude of non-profit organisations. This follows the discovery that the UK’s population has a low level of financial literacy, manifested as money and debt mismanagement, little planning, limited shopping around for alternative financial products and low product awareness. In 2006 an estimated 10.5 million people around the UK were experiencing difficulties in at least one of these areas, a figure which has probably risen since. The campaigns aim to improve personal financial administration through better budgeting and debt prioritisation and improved maths’ skills.
Despite the belated effort to address a serious problem by introducing such support, the strategy raises a few points of contention. Firstly, it focuses on debt prioritisation but leaves unaddressed the choice this will leave for the most vulnerable between rent and food. The National Strategy does not encompass food support for those in such a position, as has been proposed for example in Canada’s financial capability raising programmes.
Secondly, if the National Financial Capability Strategy is taking the form of a larger scale social welfare programme should the responsibility of leading it lie with the FSA – the financial services ‘regulator’, a body that is not subject to the public’s scrutiny, or should it lie with the government – through the Departments with the capability in providing social and education services? Given the experience and access to provision channels would it make more sense for this to be publicly provided?
Thirdly such a strategy implicitly accepts without argument that households have and should accept these responsibilities. Arguments focusing on the recklessness of consumers and home-buyers evade the discussion about the structures that cause oppression through finance. Households are now burdened with a much greater individual responsibility of financial risk management as finance has expanded into ever more areas of everyday life, e.g. the decline in public welfare policies and wide-spread privatisations, which means a precarious balance of risks are transferred and borne by the household.
The debate on raising financial literacy and capability – the crux of this financial education approach - does not ask what the institutional factors that have led people to find themselves in the situation they do and, as corollary why others do not. Without addressing the inequality within the financial system, the whole debate on financial capability resigns those deemed financially incapable to being seen as irresponsible and out of date – quite ironic as concurrently masses of analysts highly specialised in finance are also defamed for irresponsibility. Should we all be learning the theories which have guided us into the current crisis?! The focus of the National Financial Capability Strategy is in educating the innumerate, financially incapable segments of the population, rather than identifying let alone re-arranging the provision of financial services as a cause of the problem to start with. It orientates itself around educating the public about becoming better consumers, evading altogether the content of economic and financial relations that people are in.
Lastly, an entirely different model of education about finance and economics could be put in place, in which adult education is not used as a disciplinary mechanism to assist conforming and adapting to society. Community-wide education in economics and finance can be work by looking at one's own position and linking it to others; by connecting knowledge and action, education can lead to a critical assessment of one’s situation. Education fostering critical thought in the sphere of economics and finance can lead to comprehending a historical specific situation which is susceptible to change. Financial capability need not be only about better budgeting support but a wider and deeper awareness raising programme to assist people in demanding more equal treatment in the sphere of finance.
Provision of services to enable consumers to handle money, debt and their overall finances better has expanded considerably in recent years. In the UK the FSA are leading initiatives in financial capability and literacy e.g. spending £90m on it’s National Financial Capability Strategy, in conjunction with government, the financial sector and a multitude of non-profit organisations. This follows the discovery that the UK’s population has a low level of financial literacy, manifested as money and debt mismanagement, little planning, limited shopping around for alternative financial products and low product awareness. In 2006 an estimated 10.5 million people around the UK were experiencing difficulties in at least one of these areas, a figure which has probably risen since. The campaigns aim to improve personal financial administration through better budgeting and debt prioritisation and improved maths’ skills.
Despite the belated effort to address a serious problem by introducing such support, the strategy raises a few points of contention. Firstly, it focuses on debt prioritisation but leaves unaddressed the choice this will leave for the most vulnerable between rent and food. The National Strategy does not encompass food support for those in such a position, as has been proposed for example in Canada’s financial capability raising programmes.
Secondly, if the National Financial Capability Strategy is taking the form of a larger scale social welfare programme should the responsibility of leading it lie with the FSA – the financial services ‘regulator’, a body that is not subject to the public’s scrutiny, or should it lie with the government – through the Departments with the capability in providing social and education services? Given the experience and access to provision channels would it make more sense for this to be publicly provided?
Thirdly such a strategy implicitly accepts without argument that households have and should accept these responsibilities. Arguments focusing on the recklessness of consumers and home-buyers evade the discussion about the structures that cause oppression through finance. Households are now burdened with a much greater individual responsibility of financial risk management as finance has expanded into ever more areas of everyday life, e.g. the decline in public welfare policies and wide-spread privatisations, which means a precarious balance of risks are transferred and borne by the household.
The debate on raising financial literacy and capability – the crux of this financial education approach - does not ask what the institutional factors that have led people to find themselves in the situation they do and, as corollary why others do not. Without addressing the inequality within the financial system, the whole debate on financial capability resigns those deemed financially incapable to being seen as irresponsible and out of date – quite ironic as concurrently masses of analysts highly specialised in finance are also defamed for irresponsibility. Should we all be learning the theories which have guided us into the current crisis?! The focus of the National Financial Capability Strategy is in educating the innumerate, financially incapable segments of the population, rather than identifying let alone re-arranging the provision of financial services as a cause of the problem to start with. It orientates itself around educating the public about becoming better consumers, evading altogether the content of economic and financial relations that people are in.
Lastly, an entirely different model of education about finance and economics could be put in place, in which adult education is not used as a disciplinary mechanism to assist conforming and adapting to society. Community-wide education in economics and finance can be work by looking at one's own position and linking it to others; by connecting knowledge and action, education can lead to a critical assessment of one’s situation. Education fostering critical thought in the sphere of economics and finance can lead to comprehending a historical specific situation which is susceptible to change. Financial capability need not be only about better budgeting support but a wider and deeper awareness raising programme to assist people in demanding more equal treatment in the sphere of finance.
Tuesday, 7 April 2009
The SDR by IMF: could it become a new World Money?
by Juan Pablo Painceira
The size and spread of present financial crisis has shown to analysts and public alike how important the dynamic of world money is to the global economy. Surely this crisis would not have the same magnitude if the heart of crisis was not the US economy, the issuer of world money. The importance of international money in the unfolding of financial crisis was addresses by this author in an earlier RMF discussion paper (http://www.soas.ac.uk/rmf/papers/).
It is well know that the Federal Reserve has taken conventional and extraordinary measures to tackle the 2007-08 financial crisis in order to rescue/recover the financial system’s ability to perform their normal functions, and in particular banks,. Among the FED’s measures, the swap currency lines, initially offered to the major central banks and extended to the key developing countries after September 2008, are directly related to the role of dollar as world money. Basically, the Federal Reserve has offered credit lines in dollars around the global economy.
The spread of those swap lines and the monetisation of US public debt have raised questions about the functionality and stability of international money, ie the US dollar. Recently, the China’s central bank chief and the Russian government have proposed a bigger role for the IMF’s SDR in global financial operations in order to achieve a supra-national reserve currency to replace the dollar as world money. The Special Drawing Rights (SDR) created by IMF in the 1970s is a basket of major currencies traded in the international financial and commercial operations. The value of SDRs daily is determined by summing, in US dollars, the values of a weighted basket of currencies and used as monetary reference to the IMF’s operations. So, the SDR are reserve assets.
The emergence of new world money and the reform of international financial system has been widely discussed in the last weeks e.g. G. Soros addressed the need for the IMF to take care of some developing countries external financing immediately in order to avoid a Great Depression; the increase of issuance of SDR would be the instrument to use. Some analysts are arguing that a new global reserve currency would lead also to changes in the process of reserve accumulation and exchange rate regimes among the major countries. A UN commission lead by J. Stiglitz advocates that to deal properly with the consequences of global imbalances it is necessary to have a new global reserve system based on the expansion of the SDR.
It seems that this new world money would lead a more stable and equitable global financial system.
However, some questions are still remained…Would China be really interested in walking away from dollar denomination, considering that its foreign exchange portfolio is highly concentrated in dollar? The same question could be asked for Japan. If the IMF becomes the global lender of last resort, who would be the Treasury of last resort? Who will control the political decisions to lend or not lend? I recognise that those questions are hard but we know from the economic history that a change in the global monetary standard can be painful and that effects can last many years as did the change from the gold standard to the dollar-gold standard. Lastly, a currency has a political force behind it, even when it is a supra-national currency, are the conditions ripe for the IMF / World Bank to take on such a role?
The size and spread of present financial crisis has shown to analysts and public alike how important the dynamic of world money is to the global economy. Surely this crisis would not have the same magnitude if the heart of crisis was not the US economy, the issuer of world money. The importance of international money in the unfolding of financial crisis was addresses by this author in an earlier RMF discussion paper (http://www.soas.ac.uk/rmf/papers/).
It is well know that the Federal Reserve has taken conventional and extraordinary measures to tackle the 2007-08 financial crisis in order to rescue/recover the financial system’s ability to perform their normal functions, and in particular banks,. Among the FED’s measures, the swap currency lines, initially offered to the major central banks and extended to the key developing countries after September 2008, are directly related to the role of dollar as world money. Basically, the Federal Reserve has offered credit lines in dollars around the global economy.
The spread of those swap lines and the monetisation of US public debt have raised questions about the functionality and stability of international money, ie the US dollar. Recently, the China’s central bank chief and the Russian government have proposed a bigger role for the IMF’s SDR in global financial operations in order to achieve a supra-national reserve currency to replace the dollar as world money. The Special Drawing Rights (SDR) created by IMF in the 1970s is a basket of major currencies traded in the international financial and commercial operations. The value of SDRs daily is determined by summing, in US dollars, the values of a weighted basket of currencies and used as monetary reference to the IMF’s operations. So, the SDR are reserve assets.
The emergence of new world money and the reform of international financial system has been widely discussed in the last weeks e.g. G. Soros addressed the need for the IMF to take care of some developing countries external financing immediately in order to avoid a Great Depression; the increase of issuance of SDR would be the instrument to use. Some analysts are arguing that a new global reserve currency would lead also to changes in the process of reserve accumulation and exchange rate regimes among the major countries. A UN commission lead by J. Stiglitz advocates that to deal properly with the consequences of global imbalances it is necessary to have a new global reserve system based on the expansion of the SDR.
It seems that this new world money would lead a more stable and equitable global financial system.
However, some questions are still remained…Would China be really interested in walking away from dollar denomination, considering that its foreign exchange portfolio is highly concentrated in dollar? The same question could be asked for Japan. If the IMF becomes the global lender of last resort, who would be the Treasury of last resort? Who will control the political decisions to lend or not lend? I recognise that those questions are hard but we know from the economic history that a change in the global monetary standard can be painful and that effects can last many years as did the change from the gold standard to the dollar-gold standard. Lastly, a currency has a political force behind it, even when it is a supra-national currency, are the conditions ripe for the IMF / World Bank to take on such a role?
Monday, 30 March 2009
NGO reaction to the financial crisis
by Jeff Powell
Clearly NGOs around the world are too diverse to allow meaningful generalizations of their reactions to the evolving crisis. Some have seized the opportunity, embracing new ideas and reaching out to different actors and constituencies. Others are grafting new issues on to an old agenda: add crisis and stir. Still others are finding their agenda drowned out, at the same time as direct debits get cancelled and stock-market dependent foundations pull up the funding drawbridges.
Here in the UK, development and environment NGOs have come together with the Trades Union Congress in an unprecedented coalition (which, in the name of transparency it should be stated that the author is a part of), initiated by the Bretton Woods Project. The Put People First coalition (PPF) has come together around a short manifesto highlighting jobs, social justice and the environment. The focus for the time being is on the G20 meetings in London in April and then in St. Andrews in November. It's too early to say whether the coalition will be longer-lasting, and if it will be able to get beyond the 'lowest common denominator' politics which held back the Make Poverty History campaign in 2005.
On finance, PPF has joined the general chorus for increased transparency and accountability, without yet articulating a clear vision of what this means. More developed are its ideas on eliminating tax havens, drawing on the groundwork done by the Tax Justice Network. The investigation that TJN inspired in The Guardian has shamed the Labour government into its first tentative (and long-overdue) steps on tax havens, particularly those in the City of London or UK protectorates. Gordon Brown has announced plans to discuss multilateral exchange of information on offshore accounts at the G20 meeting. The PPF coalition is trying to use the crisis as an opportunity to broaden the reform agenda to include a re-invigoration of public services and a shift of economic priorities towards environmental sustainability. Managing the need to focus on shorter-term policy developments with these longer-term objectives will not be easy.
Similar networks and coalitions have formed across Europe. Brussels-based groups Eurodad (the European network of NGOs working on debt, development and poverty reduction) and CONCORD (the European Confederation of Relief and Development NGOs) have started to work with some European trade unions at National and Supra-national level. Like the UK's PPF, Eurodad has a developed campaign on capital flight issues. Groups in these networks with a history of advocacy on financial issues include Germany's World Ecology Economy and Development (WEED), the Dutch group SOMO and of course the ATTAC network which, with others, has been working for over a decade on issues of regulating and democratising finance.
At the international level, the key cue for NGO policy positions comes from agreed positions at the World Social Forum in Brazil, earlier this year. The WSF attempts to bridge the (sometimes elusive) divide between NGOs, trade unions and social movements. While it is short on details, and the process of getting from A to B is absent, the principles of the WSF statement ('Put finance in its place') are radical and clear. They include a call to “implement a global mechanism of state and citizen control of banks and financial institutions” and the creation of “regional reserve currencies”. Taking up the issues of financial sector reform is Re-thinking finance, a new coalition which brings together the Bretton Woods Project, Eurodad, Amsterdam-based Transnational Institute, the Asian network Focus on the Global South, and Latin American network Choike.
In the coming months the ability of all of these NGOs to sharpen and deepen their analysis of financial sector issues, and their capacity to communicate these ideas to a wider audience and build broad-based movements for fundamental change is critical if the crisis is to be transformed into opportunity.
Clearly NGOs around the world are too diverse to allow meaningful generalizations of their reactions to the evolving crisis. Some have seized the opportunity, embracing new ideas and reaching out to different actors and constituencies. Others are grafting new issues on to an old agenda: add crisis and stir. Still others are finding their agenda drowned out, at the same time as direct debits get cancelled and stock-market dependent foundations pull up the funding drawbridges.
Here in the UK, development and environment NGOs have come together with the Trades Union Congress in an unprecedented coalition (which, in the name of transparency it should be stated that the author is a part of), initiated by the Bretton Woods Project. The Put People First coalition (PPF) has come together around a short manifesto highlighting jobs, social justice and the environment. The focus for the time being is on the G20 meetings in London in April and then in St. Andrews in November. It's too early to say whether the coalition will be longer-lasting, and if it will be able to get beyond the 'lowest common denominator' politics which held back the Make Poverty History campaign in 2005.
On finance, PPF has joined the general chorus for increased transparency and accountability, without yet articulating a clear vision of what this means. More developed are its ideas on eliminating tax havens, drawing on the groundwork done by the Tax Justice Network. The investigation that TJN inspired in The Guardian has shamed the Labour government into its first tentative (and long-overdue) steps on tax havens, particularly those in the City of London or UK protectorates. Gordon Brown has announced plans to discuss multilateral exchange of information on offshore accounts at the G20 meeting. The PPF coalition is trying to use the crisis as an opportunity to broaden the reform agenda to include a re-invigoration of public services and a shift of economic priorities towards environmental sustainability. Managing the need to focus on shorter-term policy developments with these longer-term objectives will not be easy.
Similar networks and coalitions have formed across Europe. Brussels-based groups Eurodad (the European network of NGOs working on debt, development and poverty reduction) and CONCORD (the European Confederation of Relief and Development NGOs) have started to work with some European trade unions at National and Supra-national level. Like the UK's PPF, Eurodad has a developed campaign on capital flight issues. Groups in these networks with a history of advocacy on financial issues include Germany's World Ecology Economy and Development (WEED), the Dutch group SOMO and of course the ATTAC network which, with others, has been working for over a decade on issues of regulating and democratising finance.
At the international level, the key cue for NGO policy positions comes from agreed positions at the World Social Forum in Brazil, earlier this year. The WSF attempts to bridge the (sometimes elusive) divide between NGOs, trade unions and social movements. While it is short on details, and the process of getting from A to B is absent, the principles of the WSF statement ('Put finance in its place') are radical and clear. They include a call to “implement a global mechanism of state and citizen control of banks and financial institutions” and the creation of “regional reserve currencies”. Taking up the issues of financial sector reform is Re-thinking finance, a new coalition which brings together the Bretton Woods Project, Eurodad, Amsterdam-based Transnational Institute, the Asian network Focus on the Global South, and Latin American network Choike.
In the coming months the ability of all of these NGOs to sharpen and deepen their analysis of financial sector issues, and their capacity to communicate these ideas to a wider audience and build broad-based movements for fundamental change is critical if the crisis is to be transformed into opportunity.
Monday, 23 March 2009
In the Hot Seat: Private Equity and the Financial Crisis
by Sherif H. Elkholy
Private Equity History
For a long time spanning from the 1980s private equity has been one of the main drivers of market-based finance, catalyzing the transformation of the processes and institutions of direct finance. Back then private equity was a specialized form of finance characterized by its long-term investment strategy, its hands-on approach, and its capacity to add tangible value by investing in companies. This changed significantly over the 2003-2007 boom cycle: private equity was no longer confined to savvy investors, it no longer needed to have a long-term horizon, and it no longer needed to add real value in order to make money. This was made possible by three factors: a seemingly endless supply of cheap debt (annual LBO debt issuance rose from $71 billion in 2003 to $669 in 2007), growing reported profits across all sectors (16% annual growth in the S&P 500 earnings from 2003 to 2007), escalating asset prices (41% growth in US valuation multiples and 43% in European valuation multiples between 2003 and 2007), and more portfolio allocations to private equity by institutional investors (around triple the historical amounts). Then came the perfect storm.
Where it Currently Stands
The financial crisis has hit all the pressure points of private equity at once. Corporate earnings are down thus negatively effecting the financial position and the fundamental value of companies owned by private equity funds. Asset prices are also down, thus deferring any divestiture of companies by private equity owners. More critically, debt markets are extremely tight, virtually freezing the previously flourishing leveraged buy-out market. Finally, portfolio allocation to private equity by institutional investors is down due to limited liquidity and heavy losses across all asset classes. The immediate problem which private equity has to wrestle with is keeping it’s investments afloat. It is unavoidable that many private equity owned companies will default on their debt obligations- simply because the debt levels piled up during the boom years are not in line with current earnings. However, every cloud has a silver lining. Amidst the financial crisis many babies are being thrown out with the bath water- the smartest private equity companies will pick up under-valued high quality businesses for a fraction of the fair value... if they have the liquidity to do so.
The Future of Private Equity
Private equity is facing the ultimate truth test. A close look at the private equity model of the 1980s reveals that private equity had a lot of shared similarities with bank-based finance: investment decisions premised on relationships and knowledge of companies, hands-on control, monitoring through board representation, active management, and long-term “buy and hold” approach. Private equity needs to re-invent itself back to this initial form and it needs to do so fast to guarantee a place in the new financial system which will rise from the ashes of the global crisis. Whatever form private equity will take in the coming years, it will most certainly involve less fees, more work, real operational value-add, and less debt. For the real economy, perhaps this shake out is not so bad after all.
Private Equity History
For a long time spanning from the 1980s private equity has been one of the main drivers of market-based finance, catalyzing the transformation of the processes and institutions of direct finance. Back then private equity was a specialized form of finance characterized by its long-term investment strategy, its hands-on approach, and its capacity to add tangible value by investing in companies. This changed significantly over the 2003-2007 boom cycle: private equity was no longer confined to savvy investors, it no longer needed to have a long-term horizon, and it no longer needed to add real value in order to make money. This was made possible by three factors: a seemingly endless supply of cheap debt (annual LBO debt issuance rose from $71 billion in 2003 to $669 in 2007), growing reported profits across all sectors (16% annual growth in the S&P 500 earnings from 2003 to 2007), escalating asset prices (41% growth in US valuation multiples and 43% in European valuation multiples between 2003 and 2007), and more portfolio allocations to private equity by institutional investors (around triple the historical amounts). Then came the perfect storm.
Where it Currently Stands
The financial crisis has hit all the pressure points of private equity at once. Corporate earnings are down thus negatively effecting the financial position and the fundamental value of companies owned by private equity funds. Asset prices are also down, thus deferring any divestiture of companies by private equity owners. More critically, debt markets are extremely tight, virtually freezing the previously flourishing leveraged buy-out market. Finally, portfolio allocation to private equity by institutional investors is down due to limited liquidity and heavy losses across all asset classes. The immediate problem which private equity has to wrestle with is keeping it’s investments afloat. It is unavoidable that many private equity owned companies will default on their debt obligations- simply because the debt levels piled up during the boom years are not in line with current earnings. However, every cloud has a silver lining. Amidst the financial crisis many babies are being thrown out with the bath water- the smartest private equity companies will pick up under-valued high quality businesses for a fraction of the fair value... if they have the liquidity to do so.
The Future of Private Equity
Private equity is facing the ultimate truth test. A close look at the private equity model of the 1980s reveals that private equity had a lot of shared similarities with bank-based finance: investment decisions premised on relationships and knowledge of companies, hands-on control, monitoring through board representation, active management, and long-term “buy and hold” approach. Private equity needs to re-invent itself back to this initial form and it needs to do so fast to guarantee a place in the new financial system which will rise from the ashes of the global crisis. Whatever form private equity will take in the coming years, it will most certainly involve less fees, more work, real operational value-add, and less debt. For the real economy, perhaps this shake out is not so bad after all.
Monday, 16 March 2009
Mark to market madness
by Duncan Lindo
The news last week that only 2% of GE’s assets are market-to-market will have shocked some investors. What murky mischievous mark-to-model is being used to mask the mess that is the remaining 98% of assets (98% by what measure we might ask…). The stock has plummeted and now they’ve lost their 50year old AAA rating.
But wait..! GE doesn’t intend to sell these assets (not at these prices anyway the cynic might add) – so of what relevance is their mark-to-market (MTM). Whilst we’re right to worry about how they are valued why on earth should mark-to-market be better?
Firstly what happens when there is no market? As noted in a House Committee on Thursday: “Illiquid markets have resulted in great difficulty in valuing sizable assets”. The assumption of ever increasing markets for assets implicit in the spread of MTM across balance sheets is looking a little bogus. Most famously the secondary markets for mortgage assets have disappeared… albeit from a low base.
Blessed are the financial intermediaries
Perhaps given a bit more time it was hoped that MTM would become self fulfilling. As more of balance sheet value becomes subject to market valuation more opportunities have arisen for the derivative traders to sell hedging instruments to mute the volatility of market valuation. Thus markets for the assets appear. This is less chicken-and-egg than golden goose eggs for financial intermediaries inserted into yet another area of the economy. The alternative is the constant surveillance of the balance sheet for restructuring possibilities – selling businesses with high hedging costs. There are always investment bankers ready to advise you on that too. Everything market to market means everything for sale.
Procycliality
Market to market accounting is also pro-cyclical – even Hank Paulson admits it. The classic mechanism of bubbles through collateralised lending against rising market value of assets fuelled by leveraged buying and the deleveraging spiral that follows the burst. As soon as you admit herd behaviour, euphoria, bubbles then accounts based on market price look non-sensical. For the time being though it doesn’t look like the law-makers are ready to make the U-turn on the law. It’s pro-cyclical but… err… we don’t want to change it.
Symmetry and the Farce of Own Credit
“Fair Value” was also partly born of a desire for symmetry between buyers and sellers of instruments – an idea at odds with neoclassical theory which requires differing utilities in order for trade to occur! One consequence was billions of dollars of profit for banks during the crisis in the form of “Own Credit”. Holders of bank debt have marked down their assets as bank default probabilities rise (as measured by CDS spreads) taking losses; conversely arguments of symmetry under “fair value” accounting regulations have required banks to reduce the value of the equal and opposite liability resulting in a “profit” for the bank! The more the market writes down their debt the bigger the profits banks can book! The more debt they have the bigger this profit is! The incentives created are clearly crazy. Furthermore the balance sheet as a description of reality further distorted – e.g the distance between “retained earnings” and bank’s ability to pay dividend clearly increases. At least here it might be argued that MTM is anti-cyclical!
Yeah and –what you gonna do about it?
You’ll notice that I’ve spent 500+ words knocking MTM accounting with not one constructive suggestion.. well… as Hank P agrees.. it’s tricky. Any ideas out there???
The news last week that only 2% of GE’s assets are market-to-market will have shocked some investors. What murky mischievous mark-to-model is being used to mask the mess that is the remaining 98% of assets (98% by what measure we might ask…). The stock has plummeted and now they’ve lost their 50year old AAA rating.
But wait..! GE doesn’t intend to sell these assets (not at these prices anyway the cynic might add) – so of what relevance is their mark-to-market (MTM). Whilst we’re right to worry about how they are valued why on earth should mark-to-market be better?
Firstly what happens when there is no market? As noted in a House Committee on Thursday: “Illiquid markets have resulted in great difficulty in valuing sizable assets”. The assumption of ever increasing markets for assets implicit in the spread of MTM across balance sheets is looking a little bogus. Most famously the secondary markets for mortgage assets have disappeared… albeit from a low base.
Blessed are the financial intermediaries
Perhaps given a bit more time it was hoped that MTM would become self fulfilling. As more of balance sheet value becomes subject to market valuation more opportunities have arisen for the derivative traders to sell hedging instruments to mute the volatility of market valuation. Thus markets for the assets appear. This is less chicken-and-egg than golden goose eggs for financial intermediaries inserted into yet another area of the economy. The alternative is the constant surveillance of the balance sheet for restructuring possibilities – selling businesses with high hedging costs. There are always investment bankers ready to advise you on that too. Everything market to market means everything for sale.
Procycliality
Market to market accounting is also pro-cyclical – even Hank Paulson admits it. The classic mechanism of bubbles through collateralised lending against rising market value of assets fuelled by leveraged buying and the deleveraging spiral that follows the burst. As soon as you admit herd behaviour, euphoria, bubbles then accounts based on market price look non-sensical. For the time being though it doesn’t look like the law-makers are ready to make the U-turn on the law. It’s pro-cyclical but… err… we don’t want to change it.
Symmetry and the Farce of Own Credit
“Fair Value” was also partly born of a desire for symmetry between buyers and sellers of instruments – an idea at odds with neoclassical theory which requires differing utilities in order for trade to occur! One consequence was billions of dollars of profit for banks during the crisis in the form of “Own Credit”. Holders of bank debt have marked down their assets as bank default probabilities rise (as measured by CDS spreads) taking losses; conversely arguments of symmetry under “fair value” accounting regulations have required banks to reduce the value of the equal and opposite liability resulting in a “profit” for the bank! The more the market writes down their debt the bigger the profits banks can book! The more debt they have the bigger this profit is! The incentives created are clearly crazy. Furthermore the balance sheet as a description of reality further distorted – e.g the distance between “retained earnings” and bank’s ability to pay dividend clearly increases. At least here it might be argued that MTM is anti-cyclical!
Yeah and –what you gonna do about it?
You’ll notice that I’ve spent 500+ words knocking MTM accounting with not one constructive suggestion.. well… as Hank P agrees.. it’s tricky. Any ideas out there???
Tuesday, 10 March 2009
Part 2: Protagonists of an old game: Political Processes behind Greece’s troubles
By George Lambrinidis
Picking up the story behind the recent riots described in the last post, it is helpful to delve deeper into the relations between the working class and capitalists in Greece by way of a few key observations.
First, we have to observe that Greek financial capital is bank-based, rather than market-based. Banking was until recently under state control, privatization was forced by industrial capitalists which partly explains the strong links between industrial and financial capital.
Second, Greece is a small place. Over 99% of firms employ less than 50 employees and the Greek bourgeoisie is made up of only ~300 families – not that this limits their prosperity; Greek capital is found amongst the first positions of OECD countries in terms of profitability. The Greek commercial fleet is the largest in the world with around 19.5% of world capacity. Moreover, a (very) small group of capitalists control most forms of media. The political influence of the bourgeoisie is indisputable e.g. the minister of mercantile marine (a crucial post given Greece’s concentration) is assigned directly, or must be approved by the ship owners.
Finally, Greek-oriented capital has a strong regional presence, especially in the Balkans and SE Europe, with what might be labeled minor imperialistic tendencies. Of major significance are the contracts signed for the building of a couple of oil pipes that will provide Europe through Turkey, Greece and Italy with Russian oil and gas.
Leaving financialisation aside until the third post in the series we can see how this economic, political and ideological power was built by focusing on the Greek working class. There were two major evolutions in the condition of the working class. The first, common to many nations is the pressure on real wages, volatile working practices, extension of retirement age etc., which is in somehow related to the subversion of the USSR. The second more specifically Greek process is a weakening of the unity of the working class during the rule of the Social Democrats from the early 1980s’ until 2004. An ideological split emerged between a model where worker’s leaders moved into government and one of unified struggle. It can be argued that many were led or even forced to see the Unions as a road to personal advancement by political cooperation with the ruling party e.g. it became natural that the president of the workers confederation became Minister of Labour. Increasing disillusionment with this approach led to falling union numbers. Meanwhile the Communist party enjoyed deep roots in Greek society and it managed to slow this process and stabilize the situation in the unions from the early 2000s. From mid 1990s onwards protests were often marked by two separate demonstrations (a class frontier of unions of all levels and individual workers backed primarily by the CP, and one by the compromised leadership of the unions and their political allies), with different content, demands and direction, reflecting the two conflicting views of consent and conflict.
In our next post, we will see how these political processes link with financialisation in Greece, review December’s events in this light and finally attempt to look into the future.
Picking up the story behind the recent riots described in the last post, it is helpful to delve deeper into the relations between the working class and capitalists in Greece by way of a few key observations.
First, we have to observe that Greek financial capital is bank-based, rather than market-based. Banking was until recently under state control, privatization was forced by industrial capitalists which partly explains the strong links between industrial and financial capital.
Second, Greece is a small place. Over 99% of firms employ less than 50 employees and the Greek bourgeoisie is made up of only ~300 families – not that this limits their prosperity; Greek capital is found amongst the first positions of OECD countries in terms of profitability. The Greek commercial fleet is the largest in the world with around 19.5% of world capacity. Moreover, a (very) small group of capitalists control most forms of media. The political influence of the bourgeoisie is indisputable e.g. the minister of mercantile marine (a crucial post given Greece’s concentration) is assigned directly, or must be approved by the ship owners.
Finally, Greek-oriented capital has a strong regional presence, especially in the Balkans and SE Europe, with what might be labeled minor imperialistic tendencies. Of major significance are the contracts signed for the building of a couple of oil pipes that will provide Europe through Turkey, Greece and Italy with Russian oil and gas.
Leaving financialisation aside until the third post in the series we can see how this economic, political and ideological power was built by focusing on the Greek working class. There were two major evolutions in the condition of the working class. The first, common to many nations is the pressure on real wages, volatile working practices, extension of retirement age etc., which is in somehow related to the subversion of the USSR. The second more specifically Greek process is a weakening of the unity of the working class during the rule of the Social Democrats from the early 1980s’ until 2004. An ideological split emerged between a model where worker’s leaders moved into government and one of unified struggle. It can be argued that many were led or even forced to see the Unions as a road to personal advancement by political cooperation with the ruling party e.g. it became natural that the president of the workers confederation became Minister of Labour. Increasing disillusionment with this approach led to falling union numbers. Meanwhile the Communist party enjoyed deep roots in Greek society and it managed to slow this process and stabilize the situation in the unions from the early 2000s. From mid 1990s onwards protests were often marked by two separate demonstrations (a class frontier of unions of all levels and individual workers backed primarily by the CP, and one by the compromised leadership of the unions and their political allies), with different content, demands and direction, reflecting the two conflicting views of consent and conflict.
In our next post, we will see how these political processes link with financialisation in Greece, review December’s events in this light and finally attempt to look into the future.
Monday, 2 March 2009
The Political and Analytical Diversions of ‘Financial Regulation’
by Paulo L dos Santos
The only thing governments seem to be doling out in greater amounts than bailouts to private banks these days are promises for all sorts of ‘financial regulation’. The EU recently promised sweeping financial regulation. Gordon Brown insists it must be international, while the Obama administration promises it will be wide-ranging and strict.
My first problem with these promises is not simply that the horses bolted long ago. It is that those now calling for doors to be shut are the same political forces that only yesterday sang the virtues of open barns and assured us that competition would ensure horses always came back. That in itself should give pause and good reason to question the motivations behind these proposals.
But my bigger problem is the implicit presumption that the current financial crisis is simply the result of a lack of effective (sweeping, international or wide-ranging) regulation, with little to no serious relationship to the underlying economic and social trends of recent years. This is not only plain wrong, but also politically diversionary.
Analytically, this presumption mirrors the weaknesses of mainstream economic theory. First there were perfect markets, financial or otherwise, and they would lead to socially efficient outcomes. Then came ‘imperfections’, typically caused by ‘informational’ or other micro-level problems with transactions, which gave rise to conflicts of interest, potential misallocations of capital and crises. Virtue lies in deducing the contracts, ‘institutions’ and state regulation that can ameliorate these microeconomic conflicts, align incentives, and help earthly markets become more perfect.
This scheme not only leaves out the destructive endogenous tendencies of financial markets towards instability, but also abstracts from the historical, social, economic and political processes that condition the formulation, enforcement and avoidance of regulation. There is no ‘optimal regulation’ that applies equally to all periods and benefits the interests of all social groups. Financial regulation is an important but nevertheless secondary element of broader economic and political regimes. It is only ‘optimal’ in relation to specific socio-political interests.
Following the Second World War, financial regulation imposed a degree of ‘financial repression’ to facilitate the reindustrialisation of Europe and Japan, the restoration of international trade, and the stabilisation of capitalism in the face of the USSR and radicalised domestic working classes. Over the past two or three decades, financial regulation has served the broader push for international market liberalisation and privatisation. The result of this push has been growing inequality, falling real investment and the rising levels of household debt that triggered the current crisis. Sustainable economic recovery requires the reversal of these realities.
The first issue for those committed to equitable societies and economic justice cannot be what kind of financial regulation is necessary. The first issue is the kind of economy we want—more equitable distributions of income, full employment, increases in environmentally sound productive investment, increases in the growth of physical productivity, high standard of universal social services, the rapid and environmentally responsible industrialisation of developing countries, etc. The second issue is the kind of political, economic and financial institutions that can help deliver those goals. A third issue arises if and only if those institutions include private financial firms (and I take a dim view on that possibility): how to ensure regulation represses their destructive tendencies and forces them to deliver in line with broader social aims.
A debate that jumps straight into discussions about financial regulation and its minutiae, without questioning the economic and policy regime of the past few years, will be a debate on how to build the shiniest new pails to serve up the old garbage of rising inequality, privatisation, low investment and underdevelopment.
The only thing governments seem to be doling out in greater amounts than bailouts to private banks these days are promises for all sorts of ‘financial regulation’. The EU recently promised sweeping financial regulation. Gordon Brown insists it must be international, while the Obama administration promises it will be wide-ranging and strict.
My first problem with these promises is not simply that the horses bolted long ago. It is that those now calling for doors to be shut are the same political forces that only yesterday sang the virtues of open barns and assured us that competition would ensure horses always came back. That in itself should give pause and good reason to question the motivations behind these proposals.
But my bigger problem is the implicit presumption that the current financial crisis is simply the result of a lack of effective (sweeping, international or wide-ranging) regulation, with little to no serious relationship to the underlying economic and social trends of recent years. This is not only plain wrong, but also politically diversionary.
Analytically, this presumption mirrors the weaknesses of mainstream economic theory. First there were perfect markets, financial or otherwise, and they would lead to socially efficient outcomes. Then came ‘imperfections’, typically caused by ‘informational’ or other micro-level problems with transactions, which gave rise to conflicts of interest, potential misallocations of capital and crises. Virtue lies in deducing the contracts, ‘institutions’ and state regulation that can ameliorate these microeconomic conflicts, align incentives, and help earthly markets become more perfect.
This scheme not only leaves out the destructive endogenous tendencies of financial markets towards instability, but also abstracts from the historical, social, economic and political processes that condition the formulation, enforcement and avoidance of regulation. There is no ‘optimal regulation’ that applies equally to all periods and benefits the interests of all social groups. Financial regulation is an important but nevertheless secondary element of broader economic and political regimes. It is only ‘optimal’ in relation to specific socio-political interests.
Following the Second World War, financial regulation imposed a degree of ‘financial repression’ to facilitate the reindustrialisation of Europe and Japan, the restoration of international trade, and the stabilisation of capitalism in the face of the USSR and radicalised domestic working classes. Over the past two or three decades, financial regulation has served the broader push for international market liberalisation and privatisation. The result of this push has been growing inequality, falling real investment and the rising levels of household debt that triggered the current crisis. Sustainable economic recovery requires the reversal of these realities.
The first issue for those committed to equitable societies and economic justice cannot be what kind of financial regulation is necessary. The first issue is the kind of economy we want—more equitable distributions of income, full employment, increases in environmentally sound productive investment, increases in the growth of physical productivity, high standard of universal social services, the rapid and environmentally responsible industrialisation of developing countries, etc. The second issue is the kind of political, economic and financial institutions that can help deliver those goals. A third issue arises if and only if those institutions include private financial firms (and I take a dim view on that possibility): how to ensure regulation represses their destructive tendencies and forces them to deliver in line with broader social aims.
A debate that jumps straight into discussions about financial regulation and its minutiae, without questioning the economic and policy regime of the past few years, will be a debate on how to build the shiniest new pails to serve up the old garbage of rising inequality, privatisation, low investment and underdevelopment.
Wednesday, 25 February 2009
European sovereign debt: how sovereign is it?
By Juan Pablo Painceira
The possibility of a sovereign default in the Eurozone has been worrying not only the countries in question, but also European authorities and the global financial system. CDS spreads (or risk premiums) on European sovereign debt have widened dramatically in the last 6 months. In February, the situation deteriorated further and European sovereign CDS traded higher than companies rated close to the “junk” level! The main suspects for sovereign default would be Ireland and Greece with the risk premium around 250bp (over Germany) and to a lesser degree Spain and Portugal; but, even Germany (the benchmark EU sovereign), Austria and Belgium have suffered from the widening of CDS spreads.
So, what are the main reasons for this dark scenario? The causes, of course, lie in the unfolding of 2007-08 financial crisis and range from current account concerns to government deficit financing, passing on export demand and external finance problems. This year was already a scheduled year with huge sovereign bond issuance in which has been piled up with new finance needs, mainly stemming from banking bailout plans.
However, the role of ECB interventions to shore up the European money market has not been fully highlighted by the media and analysts as one of the main causes of widening on European risk premiums. Since the beginning of crisis, the ECB has decreased the quality of credit collateral in its repo-operations and other lending operations with the banking system. Basically, the banking system has been allowed to access the ECB’s standing facilities using securities with lower ratings or, even worse, with no trading at all. In simple words, the banking system has raised its finance needs through financial operations where they pump their bad assets into ECB’s balance sheet. In the end, it has effectively created an over supply of prime rated securities in the market and mostly important for European countries there has been a kind of crowding out between “toxic” banking securities and sovereign bonds. Financial investors can transform a “frog” into a “princess” through the ECB’s standing facilities so what would be the reason of buying a “princess” if you can buy much cheaper a “frog” and.…..
In the traditional economic theory, the solution to deal with the problem is straight forward, increased labour market flexibility! The relative price of wages would be the only adjustment mechanism in these countries given that devaluation is not possible within a single currency. So, it is clear that we have a great asymmetry between banking and sovereign debt! The result is that European states have to raise funds to cover their banking recapitalisation plans at a much higher fiscal cost and this is partly caused by its own central bank’s interventions!!
George Soros raised a related point in the FT, he claims the creation of Eurozone government bond market would help deal with the government finance problem. The problem is that right now the implementation of a European Treasury would only reinforce the financial interests managing the banking recapitalisation and not meet the needs of European population as might at first appear to be the case. The promises in public social investments coming with this new authority would be only carrots, in the end the sticks would be on our heads!
The possibility of a sovereign default in the Eurozone has been worrying not only the countries in question, but also European authorities and the global financial system. CDS spreads (or risk premiums) on European sovereign debt have widened dramatically in the last 6 months. In February, the situation deteriorated further and European sovereign CDS traded higher than companies rated close to the “junk” level! The main suspects for sovereign default would be Ireland and Greece with the risk premium around 250bp (over Germany) and to a lesser degree Spain and Portugal; but, even Germany (the benchmark EU sovereign), Austria and Belgium have suffered from the widening of CDS spreads.
So, what are the main reasons for this dark scenario? The causes, of course, lie in the unfolding of 2007-08 financial crisis and range from current account concerns to government deficit financing, passing on export demand and external finance problems. This year was already a scheduled year with huge sovereign bond issuance in which has been piled up with new finance needs, mainly stemming from banking bailout plans.
However, the role of ECB interventions to shore up the European money market has not been fully highlighted by the media and analysts as one of the main causes of widening on European risk premiums. Since the beginning of crisis, the ECB has decreased the quality of credit collateral in its repo-operations and other lending operations with the banking system. Basically, the banking system has been allowed to access the ECB’s standing facilities using securities with lower ratings or, even worse, with no trading at all. In simple words, the banking system has raised its finance needs through financial operations where they pump their bad assets into ECB’s balance sheet. In the end, it has effectively created an over supply of prime rated securities in the market and mostly important for European countries there has been a kind of crowding out between “toxic” banking securities and sovereign bonds. Financial investors can transform a “frog” into a “princess” through the ECB’s standing facilities so what would be the reason of buying a “princess” if you can buy much cheaper a “frog” and.…..
In the traditional economic theory, the solution to deal with the problem is straight forward, increased labour market flexibility! The relative price of wages would be the only adjustment mechanism in these countries given that devaluation is not possible within a single currency. So, it is clear that we have a great asymmetry between banking and sovereign debt! The result is that European states have to raise funds to cover their banking recapitalisation plans at a much higher fiscal cost and this is partly caused by its own central bank’s interventions!!
George Soros raised a related point in the FT, he claims the creation of Eurozone government bond market would help deal with the government finance problem. The problem is that right now the implementation of a European Treasury would only reinforce the financial interests managing the banking recapitalisation and not meet the needs of European population as might at first appear to be the case. The promises in public social investments coming with this new authority would be only carrots, in the end the sticks would be on our heads!
Monday, 16 February 2009
A definition of financialisation (one among many):
by Duncan Lindo
I wanna tell you a story:
It is a sunny day in early 2007. Robin Banks slips into the hushed corridors of the plush building in mid-town Manhattan that houses his wealth manager. It’s time to try one of these hedge funds.
Robin decides to invest $1milllion and his private bank is willing to lend him $3million more against his stake giving a total investment of $4m. Of course the private bank will charge some interest and a fee for arranging the purchase of the hedge fund stake.
The hedge fund they choose is big on structured credit trades – Collateralised Debt Obligations (CDOs) are the hottest deal in town. First thing, the hedge fund takes its 2% upfront fee. Because they understand the statistical models better than the rating agencies, they decide to go for the riskiest part of the CDO. They buy exposure to the equity tranche of a credit default swap (CDS) Index in derivative format from an investment bank. A fairly standard instrument and therefore one that their investment bank will sell to them for a 5% deposit (initial margin). Robin’s $1m which became $4m becomes $4m ÷ 5% = $80m of equity tranche exposure.
Over at the investment bank they can make money between the price at which they sold the risk and the price at which their models value it - but to capture the profit they need to hedge. Their pricing models tell them that with correlation trading as low as it is their delta hedge is 18.75. So to hedge their exposure to changes in the price of the CDS Index they need 18.75 x 80 = $1.5 billion of the index itself. The investment bank calls their most trusted market maker and starts to work an order for $1.5bn of index – a big order but should be manageable over a day or so. Robin’s 1million became 1.5bn!!
The market maker is more than happy – for such an order he can widen his bid-ask spread and should make 4-5bps running or approx 0.2% of $1,5bn.
Laying off that much risk though moves the market slightly. Across the room the index arbitrage desk notices that the spread between the price of the index and the combined price of the constituents is wide enough for him to put on a trade. It will pay off when the price of the index and the constituents come back into line – even if it’s at maturity. He trades the index and gets to work trading the underlying, single name CDS.
The single name CDS market makers know the index guy and get to work passing the risk to their clients – taking their bid ask. In a few of the less liquid names their hedging trades are enough to move the price of the CDS. Upstairs on the convertibles trading desk, someone notices that the new price for the credit risk (automatically input into their models) tells them that in order to remain hedged they need to trade…so they call their market maker….across the road an equity trader notices the price has changed…time to re-hedge, so they call their market makers…
I wanna tell you a story:
It is a sunny day in early 2007. Robin Banks slips into the hushed corridors of the plush building in mid-town Manhattan that houses his wealth manager. It’s time to try one of these hedge funds.
Robin decides to invest $1milllion and his private bank is willing to lend him $3million more against his stake giving a total investment of $4m. Of course the private bank will charge some interest and a fee for arranging the purchase of the hedge fund stake.
The hedge fund they choose is big on structured credit trades – Collateralised Debt Obligations (CDOs) are the hottest deal in town. First thing, the hedge fund takes its 2% upfront fee. Because they understand the statistical models better than the rating agencies, they decide to go for the riskiest part of the CDO. They buy exposure to the equity tranche of a credit default swap (CDS) Index in derivative format from an investment bank. A fairly standard instrument and therefore one that their investment bank will sell to them for a 5% deposit (initial margin). Robin’s $1m which became $4m becomes $4m ÷ 5% = $80m of equity tranche exposure.
Over at the investment bank they can make money between the price at which they sold the risk and the price at which their models value it - but to capture the profit they need to hedge. Their pricing models tell them that with correlation trading as low as it is their delta hedge is 18.75. So to hedge their exposure to changes in the price of the CDS Index they need 18.75 x 80 = $1.5 billion of the index itself. The investment bank calls their most trusted market maker and starts to work an order for $1.5bn of index – a big order but should be manageable over a day or so. Robin’s 1million became 1.5bn!!
The market maker is more than happy – for such an order he can widen his bid-ask spread and should make 4-5bps running or approx 0.2% of $1,5bn.
Laying off that much risk though moves the market slightly. Across the room the index arbitrage desk notices that the spread between the price of the index and the combined price of the constituents is wide enough for him to put on a trade. It will pay off when the price of the index and the constituents come back into line – even if it’s at maturity. He trades the index and gets to work trading the underlying, single name CDS.
The single name CDS market makers know the index guy and get to work passing the risk to their clients – taking their bid ask. In a few of the less liquid names their hedging trades are enough to move the price of the CDS. Upstairs on the convertibles trading desk, someone notices that the new price for the credit risk (automatically input into their models) tells them that in order to remain hedged they need to trade…so they call their market maker….across the road an equity trader notices the price has changed…time to re-hedge, so they call their market makers…
Wednesday, 11 February 2009
Economic inequality and asset inflation
by Jan Toporowski
In the discussion about the financial crisis, one important factor has been overlooked, namely the distribution of income and wealth. It is obvious that the social consequences of the financial crisis have been made so much more painful by the growing inequalities of income and wealth in the United States and the United Kingdom. But there are also connections between such inequalities and financial instability. These have been highlighted by many critics of financialised capitalism. For example, John Hobson, most famous for his 1902 classic Imperialism A Study, argued that inequalities of wealth and income gave rise to over-saving, and hence economic stagnation. More recently, the late John Kenneth Galbraith noted the connection between tax cuts for the rich and asset inflation.
Asset inflation and income and economic inequalities are intimately linked. Asset inflation means rising values of financial assets and housing. Such inflation allows owners of such assets to write off debts against capital gains, buying an asset with borrowed money, and then repaying that borrowing together with interest and obtaining a profit when the asset is sold. Hence the proliferation of borrowing by households and consumption ultimately financed by debt. When the asset is housing, its inflation is especially pernicious. The housing market then redistributes income and wealth from young people earning less at the start of their careers and indebting themselves hugely in order to get somewhere decent to live, to people enjoying highest earnings at the end of their careers. But housing inflation is also like a pyramid banking scheme because it requires more and more credit to be put into the housing market in order to allow those profiting from house inflation to be able to realise their profits.
Nevertheless, even those entering the system with large debts hope to be able to profit from it. Such has been the dependence of recent governments and society in general on asset inflation that the political consensus is ‘intensely relaxed’ about such regressive redistribution of income. That consensus has encouraged the belief that the best that young people can do to enhance their prospects is to indebt themselves in order to ‘get on the property ladder’, i.e., enrich themselves (or at least improve their housing) through housing inflation.
Those at the bottom of the income distribution inevitably suffer most from rising house prices because, living in the worst housing, they have the least possibility to accommodate their house purchase to their income by buying cheaper, smaller housing. Having little other option but to over-indebt themselves in order to secure their housing, default rates among households in this social group are also most likely to rise with house price inflation. This inequality lies behind the problems in the sub-prime market in the U.S. and the equivalents of that market in the U.K. and elsewhere. Paradoxically, a more equal distribution of income and wealth is more likely to keep the housing market in equilibrium, because any increase in house prices above the rate of increase in income and wealth is more likely to result in a fall in demand for housing. Where income and wealth are already unequally distributed, and house prices rise faster than incomes, a fall in demand from those who can no longer afford a given class of housing is off-set by the increased demand for that class of housing among households that previously could afford better housing. In this way, the redistribution of income and wealth from those with more modest incomes to those with on higher incomes also facilitates asset inflation in the housing market.
Thus asset inflation has increased inequalities of wealth and income and those inequalities have further fed that inflation. Such inflation is therefore a self-reinforcing pathology of financial markets and society, rather than, as the economics establishment tells us, a temporary disequilibrium (a ‘bubble’) in the markets. Financial stability rests not only on sound banking and financial institutions. It also requires a much more equal distribution of income and wealth.
In the discussion about the financial crisis, one important factor has been overlooked, namely the distribution of income and wealth. It is obvious that the social consequences of the financial crisis have been made so much more painful by the growing inequalities of income and wealth in the United States and the United Kingdom. But there are also connections between such inequalities and financial instability. These have been highlighted by many critics of financialised capitalism. For example, John Hobson, most famous for his 1902 classic Imperialism A Study, argued that inequalities of wealth and income gave rise to over-saving, and hence economic stagnation. More recently, the late John Kenneth Galbraith noted the connection between tax cuts for the rich and asset inflation.
Asset inflation and income and economic inequalities are intimately linked. Asset inflation means rising values of financial assets and housing. Such inflation allows owners of such assets to write off debts against capital gains, buying an asset with borrowed money, and then repaying that borrowing together with interest and obtaining a profit when the asset is sold. Hence the proliferation of borrowing by households and consumption ultimately financed by debt. When the asset is housing, its inflation is especially pernicious. The housing market then redistributes income and wealth from young people earning less at the start of their careers and indebting themselves hugely in order to get somewhere decent to live, to people enjoying highest earnings at the end of their careers. But housing inflation is also like a pyramid banking scheme because it requires more and more credit to be put into the housing market in order to allow those profiting from house inflation to be able to realise their profits.
Nevertheless, even those entering the system with large debts hope to be able to profit from it. Such has been the dependence of recent governments and society in general on asset inflation that the political consensus is ‘intensely relaxed’ about such regressive redistribution of income. That consensus has encouraged the belief that the best that young people can do to enhance their prospects is to indebt themselves in order to ‘get on the property ladder’, i.e., enrich themselves (or at least improve their housing) through housing inflation.
Those at the bottom of the income distribution inevitably suffer most from rising house prices because, living in the worst housing, they have the least possibility to accommodate their house purchase to their income by buying cheaper, smaller housing. Having little other option but to over-indebt themselves in order to secure their housing, default rates among households in this social group are also most likely to rise with house price inflation. This inequality lies behind the problems in the sub-prime market in the U.S. and the equivalents of that market in the U.K. and elsewhere. Paradoxically, a more equal distribution of income and wealth is more likely to keep the housing market in equilibrium, because any increase in house prices above the rate of increase in income and wealth is more likely to result in a fall in demand for housing. Where income and wealth are already unequally distributed, and house prices rise faster than incomes, a fall in demand from those who can no longer afford a given class of housing is off-set by the increased demand for that class of housing among households that previously could afford better housing. In this way, the redistribution of income and wealth from those with more modest incomes to those with on higher incomes also facilitates asset inflation in the housing market.
Thus asset inflation has increased inequalities of wealth and income and those inequalities have further fed that inflation. Such inflation is therefore a self-reinforcing pathology of financial markets and society, rather than, as the economics establishment tells us, a temporary disequilibrium (a ‘bubble’) in the markets. Financial stability rests not only on sound banking and financial institutions. It also requires a much more equal distribution of income and wealth.
Monday, 9 February 2009
The Brazilian Real’s “Fundamental” Problem
by Annina Kaltenbrunner
Between August and December 2008 the Brazilian Real depreciated by more than 60 %. At the same time, foreign exchange reserves at the central bank stood at over US$ 200 billion in August 2008 and for the first time in its history the country had acquired “net creditor status”. Forgotten were the claims of “decoupling”, as the international financial crisis (once again) hit the countries at the periphery. However initially, “decoupling” seemed to have become reality.
When financial markets in the developed world first started to be shaken by the sub-prime implosion in autumn 2007, money continued to pour in some emerging markets as high real interest rates became particularly interesting in the face of falling yields in developed markets. Indeed foreign reserves at the Brazilian central bank continued to increase by near 30% between August 2007 and 2008 and the Real gained another 20% against the US dollar over the period.
Then, in August 2008 the market turned, first slowly and later in an accelerated fashion as the US government refused to support the struggling Lehman Brothers. Although expectations of faltering domestic growth – on reduced external demand – and slowing commodity prices might have contributed to the currency’s decline, the Brazilian Real’s main “fundamental” problem was (and is) the country’s increased and ongoing integration into international financial markets and the financialisation of the domestic economy.
First, as losses in international financial markets mounted, deleveraging and the flight from risky assets did not spare emerging markets. Brazilian (currency) assets are among the most liquid and widely traded emerging market assets in (international) investors’ portfolios, whose adjustments can result in large capital flows and currency movements, seemingly unwarranted by “fundamentals”. And indeed, Brazil’s capital account reversed from an average monthly surplus of around US$ 6 billion over the first half of the year to a deficit of more than US$ 9 billion in October and November 2008!
Second, the reversal in the currency’s value hit several of Brazil’s biggest companies, which – on the backdrop of years of sustained currency appreciation – had taken substantial currency bets on the derivatives market. The increased involvement of real sector companies in the financial market weighed on the currency through two channels: first, a scramble for foreign exchange as the affected companies hurried to cover their losses; and second, concerns about financial sector stability, as uncertainty about banks’ exposure to the affected companies reigned.
Finally, and probably most importantly for currency dynamics, increased financial integration has not only affected exchange rate behaviour through capital markets, but also through the banking sector. Although unique among Latin American countries in having a strong presence of domestic banks, Brazilian banks have increasingly used the wholesale market to acquire - short-term - funding. Thus, as international money markets dried up in the wake of the crisis, so did credit lines to Brazilian banks, which found themselves unable to extend short-term financing, mainly trade credit lines. The inability to obtain and/or rollover outstanding external debt and the necessity to meet other foreign exchange payments again led to scrambling in an already strained foreign exchange market, pushing the currency to recently experienced depreciated level.
And why should we care? Around 44% of the income generated in Brazil continues to accrue to the richest 10% of the population (and this excludes wealth!), while the 20% poorest of the population earn a total of 2.9%. This is also related to the processes described above, because while gains on currency speculation are reaped by a few market participants, the costs of (currency) crisis are borne by the population as a whole!!
Between August and December 2008 the Brazilian Real depreciated by more than 60 %. At the same time, foreign exchange reserves at the central bank stood at over US$ 200 billion in August 2008 and for the first time in its history the country had acquired “net creditor status”. Forgotten were the claims of “decoupling”, as the international financial crisis (once again) hit the countries at the periphery. However initially, “decoupling” seemed to have become reality.
When financial markets in the developed world first started to be shaken by the sub-prime implosion in autumn 2007, money continued to pour in some emerging markets as high real interest rates became particularly interesting in the face of falling yields in developed markets. Indeed foreign reserves at the Brazilian central bank continued to increase by near 30% between August 2007 and 2008 and the Real gained another 20% against the US dollar over the period.
Then, in August 2008 the market turned, first slowly and later in an accelerated fashion as the US government refused to support the struggling Lehman Brothers. Although expectations of faltering domestic growth – on reduced external demand – and slowing commodity prices might have contributed to the currency’s decline, the Brazilian Real’s main “fundamental” problem was (and is) the country’s increased and ongoing integration into international financial markets and the financialisation of the domestic economy.
First, as losses in international financial markets mounted, deleveraging and the flight from risky assets did not spare emerging markets. Brazilian (currency) assets are among the most liquid and widely traded emerging market assets in (international) investors’ portfolios, whose adjustments can result in large capital flows and currency movements, seemingly unwarranted by “fundamentals”. And indeed, Brazil’s capital account reversed from an average monthly surplus of around US$ 6 billion over the first half of the year to a deficit of more than US$ 9 billion in October and November 2008!
Second, the reversal in the currency’s value hit several of Brazil’s biggest companies, which – on the backdrop of years of sustained currency appreciation – had taken substantial currency bets on the derivatives market. The increased involvement of real sector companies in the financial market weighed on the currency through two channels: first, a scramble for foreign exchange as the affected companies hurried to cover their losses; and second, concerns about financial sector stability, as uncertainty about banks’ exposure to the affected companies reigned.
Finally, and probably most importantly for currency dynamics, increased financial integration has not only affected exchange rate behaviour through capital markets, but also through the banking sector. Although unique among Latin American countries in having a strong presence of domestic banks, Brazilian banks have increasingly used the wholesale market to acquire - short-term - funding. Thus, as international money markets dried up in the wake of the crisis, so did credit lines to Brazilian banks, which found themselves unable to extend short-term financing, mainly trade credit lines. The inability to obtain and/or rollover outstanding external debt and the necessity to meet other foreign exchange payments again led to scrambling in an already strained foreign exchange market, pushing the currency to recently experienced depreciated level.
And why should we care? Around 44% of the income generated in Brazil continues to accrue to the richest 10% of the population (and this excludes wealth!), while the 20% poorest of the population earn a total of 2.9%. This is also related to the processes described above, because while gains on currency speculation are reaped by a few market participants, the costs of (currency) crisis are borne by the population as a whole!!
Tuesday, 3 February 2009
The Current Situation in Greece: a sketch
by George Lambrinidis
The state of affairs in Greece is hot, no doubt about that. This is not new, nor is it directly correlated to the current financial crisis; rather, we have a scaling of the tension that is definitely related to the fact that the Greek oriented capital manages to achieve very high rates of profitability, while there is a very strong political movement. The key factors in this contradiction are the low level of organization of the workers and the historical roots of the Communist Party in society. This post is the first of a series that will highlight some key features of the current situation in Greece, starting with the presentation of the main frontiers.
At the time of writing the farmers were in the 9th day of their blockage of the highways, borders and other major roads with their tractors, practically paralyzing the road network. Some of their claims are against the Common Agricultural Policy and the policies that shrink the income of smaller producers to the benefit of big companies. This has been an open frontier for years, and has its own issues.
In the cities, now, there are two frontiers. The first one concerns education. The students are preparing their next move, after the demonstrations of December and those supporting the Palestinians. The main issues concern the founding of private universities (until now constitutionally forbidden), the abolishment of asylum (so police can enter the universities), the equalization of diplomas from universities with those from private colleges, the breakdown of the undergraduate into two cycles (until now 4 years minimum), the imposition of fees, the salaries and the working conditions of the professors, the facilities; practically everything.
The events of December following the execution of a 15-year old by a policeman also deserve some comment. First, they occurred against a background of already heightened tension due to very low wages and incomes, strict fiscal policy, inflation, persistent unemployment at the official rate of 9% (the real figure is at least 14%), state terrorism and government corruption and, most importantly, no perspective for improvement; on the contrary, the country was on the brink of crisis. So the murder of the child was the last straw.
Second, several other factors were less reported. Another pupil was shot on the 10th, outside his school, while discussing with other pupils their participation in next day’s demo. The bullet stuck in his arm and that prevented him from dying. On the 22nd, the secretary of the union of the cleaners, a 44-year old woman from Bulgaria was murderously attacked with acid in response to her fighting stance the previous period. The murderers even forced her to drink the acid! During the time that the cities were on fire, the police forces were beating and arresting 10- to 15-year old pupils in the morning, while successfully playing an old game with rioters at night.
Finally, big strikes were held, workers demonstrated in the streets with their children and teachers with their pupils, but the media of the bourgeoisie ignored them, presenting only repeated scenes of destruction, appalling people and discouraging them from participating in the demonstrations.
Which brings us to the third frontier: that of the workers. Despite the fact that the workers are struggling, there are serious limits to their fight. In the next post we will discuss the working movement and the political situation.
The state of affairs in Greece is hot, no doubt about that. This is not new, nor is it directly correlated to the current financial crisis; rather, we have a scaling of the tension that is definitely related to the fact that the Greek oriented capital manages to achieve very high rates of profitability, while there is a very strong political movement. The key factors in this contradiction are the low level of organization of the workers and the historical roots of the Communist Party in society. This post is the first of a series that will highlight some key features of the current situation in Greece, starting with the presentation of the main frontiers.
At the time of writing the farmers were in the 9th day of their blockage of the highways, borders and other major roads with their tractors, practically paralyzing the road network. Some of their claims are against the Common Agricultural Policy and the policies that shrink the income of smaller producers to the benefit of big companies. This has been an open frontier for years, and has its own issues.
In the cities, now, there are two frontiers. The first one concerns education. The students are preparing their next move, after the demonstrations of December and those supporting the Palestinians. The main issues concern the founding of private universities (until now constitutionally forbidden), the abolishment of asylum (so police can enter the universities), the equalization of diplomas from universities with those from private colleges, the breakdown of the undergraduate into two cycles (until now 4 years minimum), the imposition of fees, the salaries and the working conditions of the professors, the facilities; practically everything.
The events of December following the execution of a 15-year old by a policeman also deserve some comment. First, they occurred against a background of already heightened tension due to very low wages and incomes, strict fiscal policy, inflation, persistent unemployment at the official rate of 9% (the real figure is at least 14%), state terrorism and government corruption and, most importantly, no perspective for improvement; on the contrary, the country was on the brink of crisis. So the murder of the child was the last straw.
Second, several other factors were less reported. Another pupil was shot on the 10th, outside his school, while discussing with other pupils their participation in next day’s demo. The bullet stuck in his arm and that prevented him from dying. On the 22nd, the secretary of the union of the cleaners, a 44-year old woman from Bulgaria was murderously attacked with acid in response to her fighting stance the previous period. The murderers even forced her to drink the acid! During the time that the cities were on fire, the police forces were beating and arresting 10- to 15-year old pupils in the morning, while successfully playing an old game with rioters at night.
Finally, big strikes were held, workers demonstrated in the streets with their children and teachers with their pupils, but the media of the bourgeoisie ignored them, presenting only repeated scenes of destruction, appalling people and discouraging them from participating in the demonstrations.
Which brings us to the third frontier: that of the workers. Despite the fact that the workers are struggling, there are serious limits to their fight. In the next post we will discuss the working movement and the political situation.
Subscribe to:
Posts (Atom)
