A prediction about the end to the recession

Searching for various opinions and predictions about the end of this recession, I came across the blog called Angry Bear, written by a number of US economists, some of them PhDs, which I found interesting hence I am going to quote heavily from it.

In this article, the author writes his prediction about the end of this recession in the US:

UK: Recession starting to bite

The onset of the recession on the UK High street has not really been noticeable up until now, but is starting to get quite visible.

We live in a small town in England. One could call our county fairly affluent, but it’s still a small town (full of history, too many tourists on Bank holiday weekends, some shabby buildings, some shops stuck in the 1960ies, and hundreds of grannies going about their chores on a daily basis… you know what it’s like).

There are plenty of shops in our town. There has been a move towards “premium shops” in the last 4 years that we’ve been here. A deli opened up and Costa coffee made its mark, loud and proud as it always does, on the main square (at least it’s not Starbucks, I say). But the outlook is changing.

Assigning blame for the financial crisis: Auditors on the defensive

Much has been said over the past few months about the responsibility of regulators in the current global financial crisis. I’ve written about it myself back in September suggesting that they are yet to acknowledge their role and their own failings.

Three months on, it still seems that the regulators are either in denial, or suffering from a debilitating shock of their own past incompetence, as we are still not seeing much positive change from them. Even with the current obvious trend for greater regulation promoted on the government level, there is no clear evidence of regulators stepping up their game.

What do I mean by that, I hear you say? Well, there are two aspects to this. The first one is about acknowledging regulators’ failure to prevent the financial crisis – and in this, I am going to specifically focus on auditors in this post. The second aspect is about regulators changing their attitudes immediately, not at some point in the future. That would be the subject of another post.  

UK tax cuts: Something just does not add up

It would have been a bombshell for many, but in good old British tradition details of this annoucement were leaked this weekend, so here we are picking this apart before Alistair Darling has made his speech due later on today.

The jist of it: Labour want to spend their way out of this unprecedented recession. And we are all seriously concerned that the numbers behind the justification of the intention to spend our way out of the recession just does not seem to add up.

Shock move by the Bank of England to slash interest rates

Yesterday interest rates in the UK were slashed 1.5%, an unprecedented move which literally drew gasps of surprise from the City of London. At most perhaps 1% was expected.

Recapturing the initiative: The move was meant, the Bank claims, to be that decisive step in dragging the country out of the unfolding recession. But it seems that the investors were not impressed. UK shares continued falling on the day and the FTSE ended up 5.7% lower.

The Bank is seemingly trying to re-capture the initiative so that it is seen to be in control of the economy. It does not feel like it is in control, though, and the latest surprise interest rate cut feels like a knee-jerk reaction to events.

Economic outlook: UK interest rates have been quite high for some time and the Bank of England has been trying to micro-manage its inflation targets by fine-tuning its rates at 0.25% at a time. It lost track of the bigger picture long ago, being obsessed with inflation for way too long. Now the economy is shrinking, unemployment is on the rise, no-one is lending, no-one is spending, the markets are unstable and panicky and the financial system is in a mess. And they think they are going to be seen as leaders saving the day with a rate cut out of the blue? I don’t think so; too little, too late.

The rates should have been cut much earlier, then they could have had an impact when it mattered. That was at the latest at the start of 2008.

Retail banks’ response: One of the reasons this is not going to be an economic remedy that the Bank of England wants is to be is that retail banks are going to pass on as little of the rate cut as possible to their customers. Retail banks are in a big spot of bother themselves, needing to regroup after the credit crunch contraction set in and wiped out their balance sheets assets.

Being aggressive competetive profit-making organisation (= or fat cats as others will call them) that they are, they have no altruistic tendencies to help out consumers in need of cheaper credit – they are out to squeeze as much money as possible out of all of us.

We might argue it is socially irresponsible to act in this way when they ended the global economy in an unprecedented mess. But banks are exactly that – always have been – probably always will be – out for themselves. At best they will say they are serving their shareholders’ interests, although I have argued
before that often these are just lofty words of intent.

Yesterday’s interest rate cut will benefit banks which will now be able to secure cheaper credit for themselves at the time when credit is scarce. Banks are not going to willingly give all of this money away to its customers by correspondingly reducing their own lending rate and thus eliminating their chance of taking a profit, at the time when they are making losses on their past bad loans and derivatives transactions gone sour.

Lend me an umbrella: The confidence in making sensible lending decisions has been shattered by recent global events and it will take time for banks to start being cooperative once again. Remember the saying

“A bank is an institution that lends you an umbrella when the sun shines, only to take it away when it pours”.

We are seeing this process in action right now.

Low confidence is driving the recession: So if the government wants for retail banks to re-start lending, it is a bit like ordering the water to flow upstream. Lending policies are being drastically tightened, tolerance of customers in arrears is probably approaching zero, and rate cuts are not being passed on in a desperate bid to increase banks’ own profitability.

The promise of a recession is as ever becoming self-fulfilling, and we seem to have little control over this downward spiral at this stage – until we think we’ve gone far enough and confidence starts returning again.

 

Copyright 2008 by CuriouslyInspired

Russia at risk of government debt default

A serious financial crisis is continuing to unfold in Russia.

Capital outflow: In the last few weeks, foreign investors withdrew their money out of Eastern Europe, the Russian stock market has fallen over 60%, and the government has been on a spending spree trying to prop up the collapsing markets. The very small rally Russian markets have experienced in the last 5 days are rumoured to be due purely to government’s share-buying activities.

As I wrote recently, the government committed a package of $120bn (and some sources say, $200bn) to bail out struggling large Russian banks – against the backdrop of some bank runs and bankrupcies of the smaller players.

Oil price collapse: Coupled with the above, the price of oil has recently fallen back beyond the $70 per barrel, now standing at about $67. Russia needs the oil price to be above $70 to break even and balance its national budgets (compare this to $95 for Iran and and Venezuela, and $50 for Saudi Arabia. Source – NY Times).

So, as Russia makes less and less money through its oil exports and wasting ever-increasing sums of money on propping its markets, where does this leave it?

Debt overload: Predictably, not in a very good position. Russia has accumulated a lot of foreign loans and in the next couple of months, needs to roll over $47bn of them. As there are very few investors left wishing to extend their support to struggling economies, this task will be exceedingly challenging. In total, Russia has $530bn worth of foreign debts, clocked up during the recent years of massive market expansion and over-confidence. Of these, another $150bn are falling due to be refinanced in 2009.

On track for downgrading: S&P issued a warning that it might downgrade Russian government bonds reflecting the declining credit-worthiness of the state. However presently, it maintains a credit rating of BBB+, the third lowest investment grade. If Russian bonds are downgraded further, this means they will lose their investment grade status, and any further credit to the country will cost it even more.

Moody’s downgraded the Russian financial outlook from “stable” to “negative” in the last week, citing “slowing asset growth, higher inflation, the slump in equities and funds leaving the country, all of which could result in deteriorating fundamentals for banks” as reason for its decision.

Credit default swaps, which are being taken out as means of insuring investors against (in this case) Russian government bankruptcy, are reflecting this in their pricing. CDS spreads (the difference between the buy and sell quotes), which serve as a measure of risk tolerance, are widening massively, reaching a 1,123, which is higher than spreads on Iceland’s debt before it sought a rescue from the International Monetary Fund, reports the Telegraph.

Russian government heading for bankruptcy? Thus the creditworthiness of the Russian state is in itself in question. It may be that the Russian government is heading for a default on its foreign debt, as it did fairly recently in 1998 – although the situation in 1998 and 2008 is somewhat different.

 

Copyright 2008 by CuriouslyInspired

The culture of banking bonuses: All change?

The role of stratospheric banking bonuses in encouraging the culture of greed and excessive short-term risk-taking by bankers has now been fairly widely publicised in the context of the financial meltdown of 2008. Is this the full story, however? Should bonuses be reduced, controlled, set differently, or abolished altogether?

Conflicting interests: The biggest problem that massive remuneration packages cause is the misalignment between the interests of bank executives, who want to maximise their year-end cash reward by any means open to them, and the companies’ shareholders, who are interested in long-term growth and stability of their investments. There is thus a different appetite for risk between these groups: bankers are risk-takers as incentivised by their pay structure; shareholders are much more risk-averse.

Banks’ top management will say all the right things about the duty they have to responsibly manage their shareholders’ investments. The truth remains, that if one’s banking bonus is many times the basic salary, in the heat of daily deal-making and profit-chasing it seems all too easy to forget this duty to the ultimate investor. It seems that presently, there is no 100% effective mechanism ensuring bankers are fulfilling their responsibilities to look after this money.

Ultimately, if a banker messes up and loses their firm a lot of money, they tend to be able to find another job elsewhere. And they might not feel strong pangs of conscience – as the money they gambled never felt like it was their own, duty to the shareholder forgotten, and their own assets retained. However if shares become worthless, shareholders feel the pain immediately as it was their own money.

Fancy words: Whilst banks’ management will all say (in AGMs, on their mission statements, in the press, etc) that they aim to maximise shareholder value, effectively they often allow more junior staff to do this with risky strategies that take a short term view despite being long term in their execution. This can backfire like it did with sub-prime mortgage investments in America: bankers who packaged these very dubious loans and sold them on as over-rated investment bundles only wanted to earn a bigger bonus in that particular year.  

Internal compliance and risk control departments – here to give comfort to senior management that all is well – cannot have kept tabs on such activities effectively, otherwise banks would not have gotten into trouble.

Thus we have a lack of accountability of the real deal-makers, plus a disconnect between senior management’s eloquent words of responsibility to shareholders and the reality. The few high-profile court cases where senior people were brought in before legislative bodies to answer for the negligent financial misdeeds of their firms are presently the exception, not the norm. And the real deal-makers are never being brought in to answer.

Banking bonuses in recent years: Let’s look at some recent numbers.

UK: In 2006, 4000 people earned more than £1m each in bonuses in the City of London.

In 2007, with the global credit crunch already in full swing, City million-pound bonuses seem to have been given to over 4200 people. In total, the City paid out about £14 billion in bonuses for 2007 to 1 million City employees – an increase of 30% on 2006 (2006 bonuses: $10.9bn. Source – Office for National Statistics (ONS) ).

Overall, bonus payments in the UK financial sector have more than trebled since 2003, when about £5bn was paid out (Source: ONS).

US: Wall Street bonuses were approximately $24 billion in New York City for 2006. In 2007, despite the credit crunch, mounting billion-dollar losses and write-downs on Wall Street, bonuses were $38 billion.

So, we can see that bonuses have been on the rise up until 2008, the year when the proverbial really hit the fan. Bankers have been heard justifying the increase in 2007 bonuses citing large profits of early 2007, before the credit crunch really hit. Yet again, it just shows bankers taking a short-term view of their activities.

Are bonuses to blame for the current crisis?  To some extent, yes, although there is a danger of over-focussing on bonuses themselves as THE only culprit.

We have seen how the promise of bonuses can encourage short term irresponsible risk-taking. But some trading strategies can yield large profits in a short space of time and not destabilise the bank.

What is really missing is the ability of management to assess the riskiness of activities of its deal-makers, and adjust their bonuses accordingly – not just look at the bottom line profit number earned in the current year.

For instance, if the effect of banker’s transaction can be felt over several years, rewards for its success should be deferred and spread over a number of years years and not paid immediately. So if a deal goes sour in the longer run, the individual will not get rewarded for it at all.

To encourage longer-term view of banking, more bonuses should be paid in shares or options rather than cash. Such share or option schemes can be sellable only several years down the line, encouraging the individual to stay with the firm, work hard and wait for their incentive schemes to come into force.

And I think that there needs to be more accountability by more layers of bankers – not just top CEOs and an odd rogue trader. Regulations should be watertight so that irresponsible behaviour is easier to spot and stop, and if need be taken to court.

Will bonuses be reduced? In the short term, definitely. 2008 bonuses are expected to fall 60% in the City.

However big bonuses are probably here to stay to some extent. This is partially because bankers make big investments to get top jobs (an MBA can set you back £100,000) – and give up their personal lives for their careers.

But crucially, I feel that the external regulators and internal risk controllers must step up their game and play a strong role in defining the guidelines and recommendations on how banking rewards should be set. The objective is to incentivise responsible risk-taking behaviour that takes a long term view.

If this line is taken and successfully implemented, then surely rewarding some exceptionally hard working bankers will not be such a big deal – as long as we know they are taking good care of our finances?

Then I would suggest the answer becomes – bonuses should to some extent be controlled through following new regulatory guidelines and should be set using different methods and types of incentive, but not abolished or reduced on a whim.  

… but the culprit goes unpunished today: What hurts most is that even as the global credit crunch is unravelling this year, bankers who caused it and earned their massive bonuses in recent years are currently in the Bahamas sunning themselves not knowing how to best spend their money.

Apparently there is a real shortage of luxury accomodation in exotic tropical destinations.

And that really shows that we are letting the real culprits get away with it today.

 

Copyright 2008 by CuriouslyInspired

Russian banking situation deteriorates sharply

As the global credit crunch and deterioration of confidence is starting to bite Russia harder, Russian banks are experiencing panic deposit withdrawals. Add to this the rapidly falling stock markets – and you have a dangerous cocktail of financial instability.

Customers want their money back: Last week, Russian bank Globex banned depositors from taking their money after a run on its deposits sparked by crumbling confidence. It is the first bank to suffer this problem in 2008 – but undoubtedly not the last. A number of other banks also experienced an unexpected rise in people withdrawing their money and closing their accounts. Long queues of investors desperate to have their cash back are starting to form outside smaller banks. Many failed to get their money as bank operations were suspended. So this crisis is not doing anything for the average consumer who is now seriously worried about losing their hard-earned money.

In the last couple of months, three banks have been forced into mergers because of the liquidity crisis brought on by the global credit crunch. There is anecdotal evidence that banks are being bought for nominal sums, one of them quoted to have been sold for $5,000.

Bailout Russian style: The Russian government’s financial bailout package of $120bn is aimed primarily at large captive state-controlled institutions such as Vneshtorgbank (VTB – the Bank for Foreign trade) and Sberbank (the Savings bank). The government also intended to spend a portion of it on shares purchase to support the tumbling stock market, but not so much at lending activities. Overall however, there seemed to be insufficient detail and transparency about the total package which caused the market a lot of concern.

The package itself is an astronomic size of money in terms of its size relative to Russia’s GDP. For comparison, US’s $700bn bailout is around 5.5% of its GDP (US GDP is approx $14trillion), whereas Russia’s bailout is about 10% of its GDP (Russia’s GDP is approx $1.2trillion). Since the bailout has been announced in September, it has had little impact on the Russian stock market, which fell down around 60% from its high in May 2008.

The crash of Russian stock market has been the most dramatic event of all the world’s stock markets collapses in 2008.

Market correction: In itself, the Russian crash is a huge adjustment back to the shaky economic fundamentals. Russian economy is still set to grow by about 7% in 2008 according to the IMF. However, the foreign investors who were attracted by speculative expectations of high returns in Russia are all gone and the money is gone with them, making the huge market bubble go “pop” spectacularly quickly.

Financial outlook: This is tricky as there are a few moving parts. Oil is a key one, but I am not going to touch upon it today, only noting that a fall in world oil prices is causing major concern to Russia. 

From the point of view of banking, we are seeing the start of consolidation of the Russian banking sphere, and there is a fear, which the government will strongly deny, that the financial situation is pretty grim: the major concern is that widespread bank failures will spark panic. Still, the population is pretty pleased about one thing – that a bunch of super-rich Russian oligarchs will lose their ill-gotten money in the stock market crash. That’s some consolation, isn’t it?

 
Copyright 2008 by CuriouslyInspired

Euphoria over as realisation we are heading for recession sinks in

The euphoria of earlier this week, which followed an announcement of the UK bailout by Gordon Brown, has seemingly finished – as it was feared to. Shares have yet again collapsed. Asia showed probably the worst results today, with the Nikkei dropping 11% on the 16th October. As I am writing this, the FTSE has fallen below 4,000 again. And Dow will be perilously close to its 8,000 mark.

Shifting sands: Investor sentiment, similar to voter sentiment, is a funny thing. Markets are driven by it, same as elections are won on the strength of popular feeling. However stock market sentiment is also fickle and impermanent, and prone to wild swings especially in troubled times such as now. We are nowhere close to being out of the woods yet. In the weeks to come, there will be significant market volatility, and the market will trend downwards. Perhaps my fears of FTSE at 3,000 have yet to be realised.

Credit crunch biting hard: Interbank lending is still pretty frozen, although short term rates have fallen a little – with banks still not keen to do any longer term lending. Despite all government intentions and declarations, banks cannot be forced to start lending against their will if they do not have confidence in their financial partners. Somebody compared this to “asking water to flow upstream” – just is not going to happen. The impact of this has already spilt out into the real economy: businesses are finding it very hard to refinance their existing loans. This will have a negative impact on the whole economy, reducing business activity and forcing some to cease trading altogether.

Recession: What is driving the stock markets plunges at this very moment are investors realising that we are heading full steam into a global recession – and the existing bailout funds will not be enough to prevent it. A lot of government money is being pumped into the banking system – yet as long as investors think we are heading for a recession, they will keep on selling, and the money will keep on burning up and vanishing into the bottomless pit. It’s a vicious circle which under the current financial system, only restored consumer confidence can stop – and we just are not getting any positive economic news for this to happen.

On Pakistan in financial crisis

The global financial crisis is threatening to engulf yet another state. This time we are talking about Pakistan.

Background: It’s a very different story from Iceland – and has a heavy political spin to it. Pakistan has had 9 years of military rule headed by Pervez Musharraf. He recently stepped down to avoid being impeached. Pakistan’s new civilian government is just 5 months old and is now headed by the widower of Benazir Bhutto, Asif Ali Zardari.

The challenge the new government faces is dealing with the aftermath of Pervez Musharraf’s outdated economic and security policies, and changing these policies to rescue the country from its current brink of default.

During Musharraf’s rule, Pakistan has been propped by aid from the USA. Now these loans have stopped, the country started rapidly running out of money.

As Reuters reports, “Pakistan has been running unsustainable fiscal and balance of payments deficits”. In the last few months, Pakistan’s foreign currency reserves have fallen sharply to just under $9bn (compared to $16bn in Nov 07), as the country is spending a lot of money on importing increasinly expensive oil, whilst also maintaining a large army and supporting programmes to fight militant extremists.

Impact of the crisis: As the result, Pakistan’s currency rupee has dropped in value by 19% in 2008. The country’s stock index the KSE (Karachi Stock Exchange) has slumped 41% from the April’s peak.

The inflation is running at 25%, and although the government has stated that it will aim to cut central bank’s borrowing, tightening the monetary policy, there is fear that heavy government borrowing (a much looser fiscal policy) will actually fuel inflation further.

Security fears: Pakistan’s people are living in poverty and many cannot now afford fuel and food staples. There have been protests where people expressed their anger at the situation. Strong popular discontent is fuelling support for militant extremist groups. This creates a big problem for the new government as it has vowed to deal with militant groups near the Afgan border. Pakistan have a large army to support at present, and lack of money will make it difficult to finance existing planned programmes.

Trouble is near: It is forecast that if the country carries on as is, it will need $10bn to prevent going bankrupt in February 2009. Government bonds traded internationally have already dropped down in value implying the market fears the government will default upon its debt.

Whilst the government has been denying it is facing a crisis of balance of payments, it has been reaching out to China for a large loan instead of the IMF.  

China is set to benefit: China presently has $2 trillion in foreign exchange reserves, and although it cannot be seen as totally immune from the ravages of the global financial crisis, it certainly seems well insulated at present. In fact, China might do quite well out of the Global meltdown, strenghening ties with other countries in trouble and acquiring new allies. Its prospects are presently far better than for many other states. Watch this space – China is set to grow and grow and grow…

 

Copyright 2008 by CuriouslyInspired