China buyer defaults on US soy as CBOT slumps -trade
HONG KONG, March 20 (Reuters) - Word that a Chinese buyer had defaulted on the purchase of a U.S. soy cargo has stoked concerns that more defaults may occur, as international prices of oilseeds and vegetable oils slide from record highs early this month.
Traders said the default involved a buyer in the northern province of Shandong, but they declined to provide further details.
There also had been defaults of one or two cargoes of soyoil from Argentine, and quite a few on palm oils since the buyers could not afford to pay cancellation fees of more than $200 a tonne following the slump in futures, they said.
“There has been a default on an expensive soy by a small player in Shandong. This has been confirmed,” said a senior trader at an international house.
The trader added there had been some defaults on soyoil and possibly as much as 150,000-200,000 tonnes of palmoil.
ICBC, Standard Chartered May Bid for Wing Lung Bank
March 20 (Bloomberg) -- Industrial & Commercial Bank of China Ltd. and Standard Chartered Plc are among banks that may bid for a majority stake in Hong Kong's family-controlled Wing Lung Bank Ltd., two people familiar with the matter said.
Chairman Michael Wu and his family are considering selling their combined 53 percent stake, the company said in a statement to the Hong Kong exchange today. The shareholders have appointed financial advisers, the release said, without identifying potential buyers.
A takeover would be the first of a Hong Kong-traded bank in more than four years and may prompt other family-run lenders such as Wing Hang Bank Ltd. to seek buyers. Under Hong Kong law, a buyer of the Wu family's stake would be required to make a full tender offer for the 75-year-old bank, valued at $3 billion as of yesterday.
“A successful sale sends a good signal and may increase the availability of willing sellers,” said Ivan Li, an analyst at Kim Eng Securities in Hong Kong. “It makes sense for the Chinese banks seeking to make inroads into international markets like Hong Kong, and they're more confident in doing so.”
Wu, his extended family and associates together control 63 percent of the stock, according to the bank's 2007 annual report.
China Merchants Bank Co., China Construction Bank Corp. and Australia and New Zealand Banking Group Ltd. are also among possible suitors, the people said, declining to be identified before a public announcement.
Lending Boom
Shares of Wing Lung Bank jumped 9.4 percent yesterday before being suspended, after Apple Daily said the bank's major shareholders hired UBS AG and Credit Suisse Group to sell their stake. The stock rose 3.9 percent to a record HK$106.50 today at 2:38 local time after trading resumed.
Josephine Lee, a Credit Suisse spokeswoman in Hong Kong, and Mark Panday, a UBS spokesman, declined to comment.
A combination of rising employment, higher property prices and falling interest rates has driven a credit boom in Hong Kong. Lending rose 20 percent in January from a year earlier, according to the Hong Kong Monetary Authority.
Hong Kong's publicly traded, family-run banks include Wing Lung, Wing Hang Bank Ltd., Dah Sing Banking Group Ltd. and Chong Hing Bank Ltd. All are valued at less than $4.1 billion. Bank of East Asia Ltd., controlled by the family of Chief Executive Officer David Li, has a market capitalization of $7.4 billion.
California Branch
Wing Lung, established in 1933 as Wing Lung Ngan Ho, suspended operations in Hong Kong when the territory was occupied by the Japanese in 1941 and resumed business in the city in 1945.
The company went public in 1980, and set up its first overseas branch in California four years later. It entered China in 1994 by setting up a representative office in Guangzhou. Wing Lung's Shenzhen branch, which was approved in 2004, provides foreign currency deposits, loans, remittances and trade finance services.
Wing Lung has 35 branches in Hong Kong and HK$93 billion of assets as of Dec. 31. It also has two outlets in Shanghai and Shenzhen and one sub-branch in Nanshan district in southern China, said Poon. The bank gets more than 90 percent of its profit from Hong Kong, according to its 2007 annual report.
“We are interested in expanding our business in Asia and we look at opportunities from time to time however we are only interested in acquisitions which create value,” said ANZ spokesman Paul Edwards. He declined to comment on Wing Lung Bank.
CDO Charges
The selling shareholders plan to select potential buyers by the end of this month and ask them to submit official bids for the stake, the people said. China's Bank of Communications Co. may also be interested in Wing Lung, one of the people said.
Wing Lung's stock has gained 7.3 percent this year, the second-best performance among banks traded in Hong Kong, valuing the bank at 2.1 times book value. The 11-member Hang Seng Finance Index has slumped 20 percent.
On March 15, Wing Lung said 2007 profit fell 15 percent as it booked HK$503.4 million in charges related to collateralized debt obligations and structured investment vehicles, sending the shares to their biggest daily drop in almost four years.
Chinese banks and insurers, buoyed by rising profits and cash from stock sales, have bought $9.9 billion of overseas financial assets in the past year, according to data compiled by Bloomberg. ICBC, the world's largest bank by market value, agreed in October to pay $5.6 billion for a fifth of South Africa's Standard Bank.
Seeking Purchases
China Merchants Bank, China Construction Bank and ICBC all said this month they're interested in buying assets overseas, after $195 billion of writedowns and losses related to the U.S. mortgage-market collapse drove stocks lower.
“To the Chinese bidders, Wing Lung may deserve a premium to other markets because the cultural similarity between Hong Kong and China would make integration easier,” Kim Eng's Li said. “It also improves the product mix and distribution network of those who don't have a strong presence here.”
Standard Chartered spokeswoman Gabriel Kwan, China Merchants Bank spokesman Guo Xiaoli, and ICBC spokesman Xie Taifeng declined to comment, as did Construction Bank spokesman Yu Baoyue and Bank of Communications spokesman Song Feng.
Taiwan's Fubon Financial Holding Co. bought International Bank of Asia, formerly owned by Arab Banking Corp., in 2003 for about $415 million, according to Bloomberg data. China Construction Bank agreed to buy Bank of America Corp.'s Hong Kong and Macau unit for HK$9.7 billion ($1.25 billion) in August 2006.
Endeavour loses 27% value on leveraged Japanese bond trading bets
20 Mar 2008
Endeavour Capital, a $3bn (€1.9bn) London hedge fund, on Monday lost more than a quarter of its value as it became the biggest victim of the unwinding of a popular Japanese government bond trade that hit many rivals this week.
Endeavour, run by former Salomon Smith Barney fixed income traders, told investors it fell 27% as a highly leveraged bet on the spread between short- and long-dated JGBs was hit by contagion from the US financial crisis and domestic worries. The loss triggered conditions in bank borrowing agreements, forcing Endeavour to close other trades in an effort to reduce its leverage from 18 times to almost nothing.
Hedge funds scrambled to unwind the so-called “box trade” - betting that 20-year bond and swap spreads would widen as seven-year spreads narrowed - early on Monday when the market moved sharply against them. Hedge fund investors said other well-known funds lost 5% and 20%, although Endeavour was believed to be the biggest loser.
In a separate move, it has emerged that a fixed income hedge fund run by JWM Partners - the investment firm headed by John Meriwether, the founder of Long Term Capital Management - lost 24% of its value between January 1 and March 14.
The fund suffered as increasing margin calls by nervous creditors forced hedge funds such as Peloton to unload assets. JWM opened a year after Russia’s 1998 default resulted in almost $4bn of losses for LTCM, Meriwether’s previous hedge fund.
March 19 (Bloomberg) -- U.S. stocks, which surged the most in five years yesterday, will likely continue their rally this year because the “out of control” Federal Reserve is cutting interest rates to save investment banks from collapse, investor Jim Rogers said.
The Fed’s support is “why we’re having a big rally, but that’s not going to solve the problem,” Rogers, chairman of Rogers Holdings and co-founder of the Quantum Hedge Fund with George Soros, said during an interview with Bloomberg Television from Singapore. “The system is terribly corroded.”
The central bank is helping financial stocks while delaying and deepening a bear market and recession, he said. The Fed cut its benchmark for overnight lending between banks yesterday, continuing the most aggressive series of reductions since the rate became an explicit policy target in the late 1980s.
“What are they going to do when the stock market is down 40 percent or 50 percent?” Rogers said. “They’re not going to have any bullets left. They’re not going to be able to solve the problems at that point.”
The Standard & Poor’s 500 Index this week dropped as much as 19.7 percent from its October record, nearing the 20 percent threshold of a bear market, following $195 billion in bank losses from the collapse of the subprime-mortgage market. The index jumped 4.2 percent yesterday, the most since October 2002.
Short Financials
Rogers said he continues to short Citigroup Inc., Fannie Mae and investment banks via an exchange-traded fund tracking financial firms and increased his bearish bet last week. Short selling is the sale of borrowed stock in the hope of profiting by repurchasing the securities later at a lower price.
Rogers, who predicted the start of the commodities rally in 1999, travelled the world by motorcycle and car in the 1990s researching investment ideas for his books, which include “Adventure Capitalist” and “Hot Commodities.”
Taiwan stocks are attractive, Rogers said. The nation’s Taiex stock index has slumped 3.8 percent this year, trailing only Brazil and Argentina as the best-performing stock market among the world’s 20 largest, according to Bloomberg data.
Baltic Dry Index Falls for Seventh Day on Disruptions to Cargo
March 19 (Bloomberg) -- The Baltic Dry Index, a measure of shipping costs for commodities, fell for a seventh consecutive day as disruptions to coal and iron-ore supplies reduced cargoes.
The index, which tracks transport costs on international trade routes, retreated 92 points to 7,801 points today, the lowest this month. All vessel types declined, ranging from handymaxes, capable of hauling 50,000 metric tons to capesizes, which carry loads of as much as 170,000 tons.
“There are just slightly too many ships for the spot market and not as many spot cargoes on the horizon,” Susan Oatway, an analyst at Drewry Shipping Consultants Ltd. in London, said by phone.
Supplies of coal, which ship in capesizes, have been disrupted by rain in South Africa and a derailment in Australia this month. Cia. Vale do Rio Doce, the world’s largest producer of iron ore, had to halt shipments after protesters blocked the Brazilian company’s main railroad. The index’s 10 percent decline from its peak this month isn’t part of an “ongoing trend,” Oatway said.
“For the first half, all the fundamentals are still fairly strong,” she said.
The index gained 52 percent in the past 12 months and reached a high of 11,039 points on Nov. 13. The gauge is currently “very volatile” and swinging “quite spectacularly,” Oatway said.
Forward freight agreements, which traders buy and sell to hedge the future cost of shipping commodities, rose.
The contracts for capesizes rose 0.3 percent to $132,875 a day for the April-to-June period, according to prices from Imarex NOSA ASA, an Oslo-based freight-derivatives broker. Contracts for panamaxes that ship 70,000-ton cargoes gained 1.2 percent.
More Building
Freight costs may start to fall in 2009 because the shipping fleet is set to expand.
Next year “might be the turning point,” Philip Soutter, a senior shipbroker at London-based Galbraith’s Ltd. told the Sugaronline World Sugar & Ethanol Conference in Geneva today. “Demand is there and the ships are not coming out today. Next year, we will see a raft of new building coming through.”
Dry bulk ships on order for this year total 28 million deadweight tons and 55.9 million deadweight tons for 2009, according to Drewry’s Dry Bulk Insight published this month. The existing fleet totals 397.1 million deadweight tons.
Coal derivatives, bets made on future prices for the fuel, fell today. The contract for delivery to Amsterdam, Rotterdam or Antwerp with settlement next year declined $2.50, or 1.9 percent, to $126.50 a metric ton as of 12:49 p.m. in London, according to GFI Group Inc. prices.
Coal and iron ore rose to records this year on Chinese steel demand and coal supplies disrupted by Australian floods, Chinese storms and power shortages in South Africa. India, the world’s second-biggest iron ore supplier to China, must restrict overseas sales of the material to ensure supply for domestic mills, Steel Minister Vilas Paswan said March 14.
Avoid leveraged companies, countries and consumers, bank's strategists say
By Alistair Barr March 19, 2008
As markets and economies de-leverage across the globe, investors should avoid companies and countries that have grown to rely too much on borrowed money, they said.
That means favoring public-equity markets over hedge funds, private-equity and real estate, while leaning toward emerging market countries and away from developed nations like the U.S., the bank's global equity strategy team advised.
Within equity markets, the financial-services should be avoided because it's still over-leveraged, while other companies have stronger balance sheets, the strategists said.
"Steady growth, low inflation and rock-bottom interest rates encouraged economic and financial participants across the world economy to gear up over the past few years," Robert Buckland and his colleagues on Citi's global strategy team wrote in a note to clients. "Easy money encouraged many to buy a bigger house, a bigger car or a bigger speculative position."
"But now, any behavior that relied upon continued access to easy money is being dramatically reassessed," they added. "Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less."
Financial-services companies are the most vulnerable to this reduction of borrowed money across the globe, they said.
During the last credit crisis in 1998, European banks were leveraged 26 to 1. In the early part of this decade, leverage grew to 32 to 1. Now the sector is geared 40 to 1 on average, according to Citi's European bank research team.
"The banks have a long way to go," the strategists said. "We would continue to avoid the sector while they are de-leveraging."
Other companies are in much better shape, having rebuilt cash from strong earnings since 2003. Emerging market companies have developed particularly strong balance sheets, having learnt hard lessons from the Asian financial crisis a decade ago.
However, even though some companies may not have much debt themselves, they may be exposed to over-leveraged customers or highly leveraged investors, Citigroup warned.
Automakers, home builders and electronics retailers benefited as customers borrowed money cheaply in recent years to buy cars, houses and flat-screen TVs. That attractive financing is now being withdrawn.
"There will be plenty of companies that have strong balance sheets, so may not be most immediately vulnerable to the credit crunch," Citi said. "But they may find that their leveraged customers are vulnerable."
The difference, or spread, between interest rates on investment-grade corporate bonds and Treasury bonds has jumped in recent months, even though most companies aren't very leveraged.
This widening may be caused by leveraged investors such as hedge funds having to sell good quality assets to meet margin calls, or requests for more cash or collateral.
"It is the leverage of the investors who hold these bonds that is now being brutally exposed," Matt King, a Citigroup credit strategist, said.
"We are now confronted by a broad bloodbath in the credit markets," Citigroup said. " The most leveraged paper is falling in value because it is leveraged, and now the least leveraged paper is also falling in value because it is owned by leveraged investors."
Investors should also avoid hedge funds themselves, along with private equity, Citi added. Both types of investment rely at least partly on borrowed money to generate returns.
"Private equity returns have been especially strong. Without leverage it will be much harder to meet excessive investor expectations [most surveys suggest 20% annual returns are expected from the asset class]," Citi warned. "Similarly, many hedge funds have generated healthy uncorrelated returns by adopting cautious underlying strategies, but applying significant leverage. Again, that looks unsustainable in the current environment."
Leveraged economies, like the U.S., should also be avoided, in favor of emerging market countries, which have reduced borrowing, the bank advised.
With less capital sloshing around the world, and the dollar falling, the U.S. may have to compete more to finance its deficits.
"The U.S. shows up as the world's greatest consumer of external capital," Citi noted. So it "has the most to lose as this capital becomes less freely available."
China in tax break for mutuals By Jamil Anderlini in Beijing
Published: March 19 2008 20:18 | Last updated: March 19 2008 21:59
Beijing has temporarily suspended the collection of corporate taxes from Chinese mutual funds in an attempt to boost the country’s slumping stock prices.
China’s finance ministry and State Administration of Taxation announced the exemption in a brief statement carried by state media last night but did not say how long the measure would last.
The exemption applies to all income from investment funds from securities markets – including stock and bond trading, and interest or dividends from stock or bond investments – according to state news agency Xinhua.
The exemption also applies to investors who receive income from such funds, the notice said.
The move is aimed at shoring up a market that has dropped almost 40 per cent since the historic peak it reached in October and contrasts with the situation a year ago, when officials were casting around for a way to slow a raging bull market.
The government raised the stamp duty on all stock trading in May in an attempt to damp its meteoric rise. The market fell more than 15 per cent in the days following the announcement but soon rebounded and ended the year up nearly 100 per cent.
Mutual funds make up the most significant group of institutional investors in China, with more than 350 funds controlling more than $450bn in assets. Cancelling the corporate tax they pay on their investments in securities will boost returns for them and for investors.
The corporate tax rate in China can be as high as 33 per cent although there are exemptions and the government has recently lowered the rate for most domestic companies.
The mutual fund industry is one of the most open to foreign investors, who are allowed to hold up to 49 per cent in joint ventures with local partners.
Some of China’s biggest funds are partially owned by western groups.
Global investors, including mutual funds, are not allowed to invest directly in Chinese stocks except through a carefully controlled scheme known as the qualified foreign institutional investor programme, under which the government has issued total investment quotas of just over $10bn, with promises to allow up to $30bn.
Citigroup plans to lay off another 2,000 investment bankers and traders before the end of the month, people close to the situation said on Wednesday.
In January, the company announced plans to eliminate about 4,200 jobs, the bulk of them in Citigroup's investment bank.
The new layoffs will bring job cuts at Citigroup's investment bank to 6,000, or about 10 percent of its employee base. The company over all has more than 320,000 employees worldwide.
Most of the cuts will come from the bank's major offices in New York and London, the people said, though other markets in Europe and Asia could lose jobs.
The layoffs will be spread throughout the unit, though traders are more likely to be at risk given market conditions. Some bankers have already been notified; others will be told in coming weeks.
Daniel Noonan, a Citigroup spokesman, said that the investment bank identified the bottom 5 percent of employees each year and some of them leave.
"This year, we will have more reductions as we continue to strengthen the business and lower our expense base," Noonan added.
Credit Suisse Drops Most Since 2002 as Bank Sees Loss
By Elena Logutenkova
March 20 (Bloomberg) -- Credit Suisse Group fell the most in more than five years in Swiss trading after the company said it may post a first-quarter loss because of writedowns on debt securities deliberately mispriced by employees.
Switzerland's second-largest bank dropped as much as 11 percent, the most since October 2002, and was down 4.52 francs to 47.28 francs by 3:09 p.m. The Zurich-based bank said today it will write down $2.65 billion over the fourth quarter and first three months of 2008, making a profit this quarter ``unlikely.''
An internal review found that the pricing errors, first announced last month, were made intentionally ``by a small number'' of traders who have since been fired or suspended. The episode is the biggest setback for Chief Executive Officer Brady Dougan since he took over from Oswald Gruebel in May after heading the investment banking unit for three years.
``This is clearly embarrassing for Credit Suisse and further damages the reputation that it had worked so hard to improve,'' said Peter Thorne, a London-based analyst at Helvea SA, in a note. He has a ``neutral'' rating on the shares.
The quarterly loss would be the first since 2003. The markdowns led Credit Suisse to reduce fourth-quarter net income by almost 60 percent to 540 million francs ($532 million). Profit for 2007 was cut to 7.76 billion francs.
`Unacceptable'
``This incident is unacceptable,'' Dougan, 48, said in a statement. ``We are taking strong action to remediate and move forward.''
The announcement of writedowns as a result of pricing errors came as a surprise on Feb. 19, just a week after the bank said its risk management systems helped it sidestep the worst of the U.S. subprime mortgage market crash. Under Gruebel, 64, and Dougan, Credit Suisse had returned to stable earnings after a decade of management turnover, bungled acquisitions and the first criminal conviction of a bank in Japan.
The incident follows revelations of unauthorized trades at Societe Generale SA, France's second-largest bank, and MF Global Inc., the largest broker of exchange-traded futures and options.
Societe Generale said in January that the bank lost 4.9 billion euros ($7.6 billion) after 31-year-old trader Jerome Kerviel took unauthorized positions on European stock index futures. Last month MF Global said Evan Dooley lost $141.5 million with bets on the wheat market.
`Severe Consequences'
The Swiss bank hasn't disclosed the names of the traders responsible for the incorrect pricing of residential mortgage- backed bonds and collateralized debt obligations. Credit Suisse said it reassigned trading responsibility for the CDO business and took measures to improve controls to prevent and detect misconduct.
``This is quite disappointing,'' said Dirk Sebrechts, a fund manager at KBC Asset Management SA, which oversees more than $15 billion in equities. ``Apart from writedowns, we've seen earnings come down and they will come down further.''
Traders are required to mark their trading books to market levels daily, and managers have to sign off, Dougan said on a conference call with analysts and journalists. The misconduct was limited to traders and didn't involve managers or controllers, he said. About half of the 1.18 billion-franc writedown on these trading positions in the fourth quarter was attributed to incorrect pricing.
``There will be very severe consequences for the traders,'' said Dougan, who added that he had difficulty understanding their motivation. ``We are in the process of putting together a robust remediation plan.''
He declined to comment on whether the traders received their 2007 bonuses before being suspended or whether the bank plans to take any legal action against them.
`Difficult' March
Credit Suisse said it was profitable through the end of February, though will probably have a loss for the quarter because of worsening market conditions this month. The world's biggest financial firms have fired more than 30,000 workers in the last seven months and reported at least $195 billion in writedowns and losses.
``March has been a very difficult month,'' Dougan said. ``Trading results have been very difficult given the extreme volatility in the markets.''
At the end of February, the bank held 15.7 billion francs in CDOs that were marked down because of pricing errors and 13.3 billion francs in hedges for those bonds.
Dougan, a native of the U.S., earned 22.3 million francs last year, the bank said in its annual report today, publishing the CEO's salary for the first time. Dougan said on the conference call that his compensation declined 40 percent last year. Chairman Walter Kielholz took a pay cut of 8.7 percent to 14.6 million francs in 2007.
The investment bank's ``core businesses continue to perform quite well,'' Paul Calello, who took over the division from Dougan, said on the conference call. The wealth management unit saw ``good inflows in line with our targets,'' Dougan said.
The bank aims to complete its share buyback program, though ``in the near term we won't be buying much stock,'' Dougan said. Credit Suisse still plans to pay a dividend of 2.50 francs per share for 2007.
Bear Stearns Lawsuits: A Trickle Will Soon Become a Flood
March 18, 2008
The first of many class action lawsuits against Bear Stearns has been filed this week in the United States District Court for the Southern District of New York. One of the first companies that I have seen bring a suit against Bear Stearns is Coughlin Stoia Geller Rudman & Robbins LLP. They issued a press release on March 17th, and are currently seeking a lead plaintiff for their lawsuit. Eastside Holding Inc. also filed on Monday in Manhattan federal court, and I believe that they were technically the first company to file against Bear Stearns.
There will obviously be many, many lawsuits and motions filed against the company. When you have a company that is as well-established as Bear Stearns is, you will naturally have many people that have financial ties to the company. You will have your large shareholders, such as Joe Lewis, and your smaller shareholders, such as the company employees, who will be up in arms about this proposed transaction between JPM and Bear Stearns.
Bear Stearns employees own a reported 30% of the company. Joe Lewis, a British billionaire who just recently invested in Bear Stearns, stands to lose a billion dollars if this transaction goes through. Old Mutual's Barrow, Hanley, Mewhinney & Strauss is the largest single shareholder at 9.7%, and I am sure that they will have problems with the deal as well.
Obviously there are many that think that Bear Stearns will end up fetching a higher price than the $2 per share offer that is currently on the table. Bear Stearns closed today at $5.91, almost triple the offer price, so people either a) are living on false hope or b) are betting on a higher offering price and undoing of the current deal.
So far, the lawsuits that I have seen filed are seeking shareholders who purchased the stock between late 2006 and March 14th, 2008. The lawsuits claim that Bear Stearns issued "materially false" and "misleading" statements regarding the company's business and financial results. They go on to claim that Bear Stearns traded at "artificially high" price of $150+ per share due to these misleading statements, and that the company should have informed the public about the problems that they were having with their hedge funds that had exposure to the subprime market.
What a mess!
Obviously when you have a company with a multi-billion dollar market cap that collapses overnight and then sells for a couple hundred million dollars, you are going to have some very angry shareholders. From $60 to $30 to $2 in just two trading sessions.
Most people are asking the question: how could such a well-established and profitable company suddenly have so much "bad stuff" on their balance sheet? Enough so that they just basically disappear overnight into the hands of an eagerly awaiting JPM?
It surely won't make BSC shareholders feel any better when they tune in to CNBC and have to listen to talk of JPM making "billions" from this deal. Wall Street obviously thinks that it is a good deal for JPM as well, as the stock traded much higher even during the doom and gloom of Monday's trading session.
I don't have an answer as to what is going to happen. There are so many questions going through my head as it relates to this transaction. Can a group of angry shareholders block this deal, even if it means possibly going against the Fed and throwing the global financial markets into another unsettled period? Is this deal doesn't go through, who would step up to buy BSC? Were there other suitors who were willing to offer more? What happened to them? Were they allowed a fair opportunity to negotiate? Or was the Fed only offering a "$30 billion dollar line of credit" to JP Morgan and not other companies?
I know one thing. This story has plenty more zigs and zags left in it.
The US Market Crisis and the Perils to Brazil and LatAm
By Anoop Singh 18 March 2008
Over the past four years, Latin America has generally done well in taking advantage of a very favorable global environment to strengthen policy frameworks and lower long-standing vulnerabilities. However, the external environment has abruptly changed, led by mutually reinforcing financial sector shocks in the United States, that are spilling over into the global economy.
Thus far, our baseline forecasts show Latin American growth holding up pretty well. However, how robust is the region to the exceptional downside risks that still affect the U.S. and global outlook? To address this question, we need to look closely at the various elements of the downside risks facing the world today and what they could portend for emerging markets in general and Latin America in particular.
The U.S. Outlook-Downside Risks
This is clearly a period of exceptional uncertainty. The distribution of risks for the U.S. outlook is wide and skewed clearly toward the downside, and the probability of additional shocks leading to a U.S. recession, is quite high. There are at least three broad factors that could potentially reinforce each other and derail consumption - the mainstay of the U.S. economy - pushing growth into the negative tail of the distribution:
Housing
This has been ground zero for the current financial market turmoil. An asset price bubble is in the process of deflating, and it is difficult to know how far the process will have to go before it bottoms out. We know from past experiences that output effects from housing price busts last about twice as long as those from, say, a bursting equity price bubble. (1)
Thus, we are almost certainly looking at a protracted process. Indeed, there is now nearly ten months' supply of new houses for sale - the highest since 1981 - and with rising foreclosures putting more houses back on the market, it will take quite some time - and substantial price declines - before the situation normalizes.
In such a market the decline in housing prices could very well turn out much worse than in our baseline forecast (that has average housing prices falling by some 15% over the next two years), given the still large gap in their historical relation with disposable income.
There are various elements that are not yet clear. First, loans made in 2006 and 2007 - the riskiest - are only now undergoing rate resets and, although delinquency rates have risen sharply, their full force has probably yet to be felt. Second, widening spreads on mortgages have meant that the monetary easing that began last year has not translated into substantially lower rates on consumer loans and mortgages, largely due to the weakening position of banks.
Third, there are emerging indicators that the problems in U.S. housing are starting to spread beyond subprime to other segments of the real estate market. For example, foreclosure rates on prime mortgages have recently started to increase. Finally, there is a concern that similar housing price increases abroad - many of which have been larger than in the United States - might deflate abruptly, with potential financial feedback effects.
Strains in the core financial system. The ongoing process of adjustment in capital markets has led the large financial institutions in the United States to absorb onto their balance sheets sizeable losses from off-balance sheet entities, securitized special investment vehicles, asset-backed commercial paper, and other innovative financial products with a resulting downgrade in the perceived strength of these banks as captured by credit default swap rates.
To cope with the assumption of these losses, banks have started raising capital, including through infusions from sovereign wealth funds. This is positive. However, as with the housing market, many uncertainties remain. The size of bank losses remains extremely difficult to assess.
At this point, preliminary estimates suggest that banks' subprime-related losses to mount further to around US$ 230 billion worldwide, with about half of that amount residing in the U.S. banking system and the remainder mostly in Europe. An additional US$ 100 billion or so in losses may also arise from bank holdings of other financial assets (including commercial mortgages, leveraged loans, credit card debts, and others).
However, losses could mount much further as an economic downturn brings with it a widening deterioration of credit across a broad range of household and corporate credit. In an adverse scenario, bank losses could be much larger, putting pressure on the capital position of some of the main global banks and forcing them to curb credit growth and shore up capital.
This would restrict credit availability to both household and corporate sectors and further disrupt the economic recovery. Indeed, there is already evidence that such a deleveraging process is underway with banks reporting a substantial tightening of lending standards.
Outside of the banking system, a broader global deleveraging process could also unfold with asset price declines triggering margin calls on hedge funds and other leveraged investors, as we have seen in recent days, and forcing asset sales and greater asset price declines. This, when combined with weakening bank balance sheets, could lead banks to raise margin requirements, fueling an already volatile mix.
Contagion to Other Markets
Contagion to other credit markets and nonbanks in the United States and Europe in particular is another key risk in the downside scenario and would have mutually reinforcing effects on a weakening economy. Beyond the subprime-related losses mentioned above, losses are likely on other asset classes, such as commercial mortgage-backed securities, high-yield corporate debt, collateralized loan obligations (CLOs), and a variety of unsecuritized loan types.
All in all, a range of estimates from a number of sources place possible losses that the global financial system could be facing at close to $800 billion spread across banks, insurance companies, hedge funds, and pension funds (a little over one-half of which resides in U.S. institutions), although some analysts are projecting much higher losses.
As a share of GDP, such losses are already at a level similar to those seen during the U.S. Savings and Loan episode. This would have direct implications for credit extension and for growth outcomes, which could, in turn, drive asset values further downward and impose more losses on the financial system.
To summarize, were these combined additional shocks to housing, the core financial system, and other credit markets to materialize, they would affect the wider U.S. and global economic situation by curtailing the availability of credit and intensifying the negative wealth effect on households.
Although aggregate data suggest that corporate balance sheets are resilient, we have seen similar credit indiscipline in the leveraged buyout and high-yield corporate bonds. Though default rates are low, they could rise quickly in a sharper U.S. slowdown and those corporations with high leverage could face significant refinancing risks.
If these risk factors materialize, a credit crunch could become global, marked by rising costs of cross-border financing and reduced availability of funding. Together with slowing activity in an array of industrial countries, this would lower the demand for various emerging market exports, with a key risk being a loss of export momentum in China.
Such a coordinated slowdown could create downward pressure on commodity prices - for food, fuels, and minerals - that are crucial to Latin America, reverse the capital flow into emerging market economies, and result in a considerably deeper and more protracted slowdown of global growth, well below our current baseline, and raising the specter of a global recession.
The Impact on Latin America
Our baseline scenario foresees a modest slowing of regional growth, to about 4½% in 2008, but there could be more serious effects if the downside risks in the global economy materialize. Let's examine how resilient Latin America is to the kind of shocks affecting the advanced economies, and outline some reasons why Latin America may escape recession, even with downside outcomes in the United States.
Asset Price Bubbles?
Are there similar asset price bubbles that could threaten Latin America? Here the assessment is cautiously positive. No substantial exposure is reported in Latin America to the subprime-related distressed credit products that we have seen in the United States, even though the trend in some countries has been toward increased domestic securitization.
It has helped that in many countries, including here in Brazil, regulatory frameworks have made it difficult for banks to either buy the kind of structured products that have been at the center of events in the United States or accumulate significant off-balance sheet exposures.
Second, housing price trends do not indicate the kind of price run-up that we have seen in the United States and some European economies, although the data here is very incomplete. Against this, equities have boomed in the region, especially for commodity-linked companies, which account for a substantial share of market capitalization in Brazil, Peru, and Chile.
It should help that, broadly speaking, valuations appear in line with real earnings prospects, although the performance of more commodity-dependent stock markets will depend greatly on the impact on global commodity prices if a global recession were to unfold.
Implications for the Sovereign?
Similarly, our sense is that the external environment should not put exceptional pressure on Latin American sovereigns, at least not in the near term. To be sure, spreads on Latin American sovereign debt have already risen but the increases have been much more moderate than has historically been the case, in large part due to the strong fiscal positions, improved structure of public debt, and large build-up of international reserves.
Our assessment is that further increases in global risk aversion, while raising spreads, should be manageable for many countries in the region. However, there will likely be a greater discrimination between high- and low-risk countries which may put pressure on those in the region with weaker policy frameworks. Having said this, much again will depend on commodity price developments, a subject to which I will return.
This time around, greater corporate stress? What are the risks that, this time, it is the corporate sector that could be disproportionately affected? On the one hand, corporations in Latin America are used to operating in an environment of macroeconomic volatility, and still rely on retained earnings for the bulk of their financing. (2) Nonetheless, cross-border funding flows have grown in importance for corporates in the region, and this may open new channels of contagion. Indeed, there are already signs of some stress:
Corporate bond financing. Spreads on Latin American corporate bonds have widened by over 200 basis points, more than the rise in spreads on sovereign bonds.
Since corporate balance sheets appear generally strong, this should have little effect on investment decisions in the short run and many corporates are in a sufficiently comfortable position that they can choose to delay issuing new debt. Indeed, we have already seen a marked decline in bond and loan issuance by Latin corporates over the last six months, and especially in the first two months of this year.
As yet this does not appear to have materially curtailed investment decisions. However, if the cost of financing continues to rise and becomes more protracted, the less advantageous market for corporate credit could represent a constraint on new investments. This is particularly the case given that domestic bond markets in the region are small and do not provide an adequate alternative to external financing.
Equity Issuance
Up until the first half of 2007, strong demand for emerging market equities led to a marked increase in new equity financing by Latin corporates.
In Brazil alone, over 100 firms launched new IPOs in 2007, targeted at both local and international investors, raising US$ 47 billion in new capital. While Latin equity prices have fallen of late, perhaps of more concern is the sharp reduction in primary equity issuance since end-2007.
Risks to Domestic Bank Credit
Although private credit growth - especially of consumer credit - has been very rapid in the region (averaging 25-35%), so far, this has been generally reflective of structural and regulatory improvements.
Moreover, much of the funding of this growth in credit has come from domestic sources - especially from an expanding domestic deposit base - and so it has not generally mattered that access to longer-term structured loans in domestic currency, financed by offshore investors, has been curtailed.
This explains why domestic currency interbank spreads, such as here in Brazil, have remained stable despite the global financial turmoil. Against this, there are some risks that need to be monitored closely. There has been an uptick of delinquency rates, especially at smaller banks in some countries.
In addition, in several countries in the region, subsidiaries of global banks are an important and successful part of the local banking system. There is the risk that liquidity or capital pressures in their parent companies in the United States and Europe could lead these banks to downsize their operations or draw on the capital or liquidity resources of their subsidiaries in the region.
The Key Influence of Commodities
Many countries in Latin America have benefited greatly from the commodity boom, which has helped improve the terms of trade for the region by over 10% since 2005, a result of strong increases in crude oil, metals, and agricultural product prices. The value of commodity exports for the region is now around 10% of regional GDP and accounts for over 40% of export revenues.
This strength has bolstered regional growth, strengthened current account positions, and also been a major factor behind the increase in the fiscal surplus in many countries. Even with the baseline for the U.S. and global outlook, commodity prices should hold up well over the next year as a whole, reflecting the importance of demand from emerging economies for the near-term prospects for many commodities, as well as the combination of low interest rates and a depreciating U.S. dollar.
Our model-based estimates suggest that even with a U.S. recession, commodity prices may decline only modestly, especially if key emerging market countries, such as China and India, continue to grow rapidly. This said, a deep U.S. recession that triggers large output declines elsewhere in the industrial world and slows growth significantly in key emerging market countries could have a larger impact on commodity prices, as has been the case during previous global downturns.
If this precipitated an unwinding of sizeable speculative positions in many of these commodities, price declines could be abrupt. Such a large drop in commodity prices would have an important impact on the region. For example, if commodity prices were to fall back to the levels seen at the end of 2005 (an average decline of 35%), fiscal and trade balances on average in the region would deteriorate sharply, raising financing requirements at a time of tighter global credit markets, and potentially resulting in a regional recession.
Where does that leave policymakers? In closing, what message should policy makers draw when thinking about the various global risks now facing Latin America? It is true that many of the aspects of a possible downside scenario are beyond the control of regional authorities. However, I would gravitate, perhaps, to four broad themes that are relevant:
The region is now reaping the rewards from a decade of investment in reducing vulnerabilities. The investments that policymakers have made in recent years - to lower fiscal deficits, build international reserves, improve the structure of public liabilities, strengthen bank supervision and regulation, and build credibility in their monetary frameworks - are now going to show their true value.
The reduction in vulnerabilities has the potential to allow Latin America to pass through our baseline scenario relatively unscathed and certainly without the major macroeconomic swings that were evident since the Tequila crisis. This should not lead to complacency but rather further convince policymakers of the importance of their achievements to date and the need to continue along the path they are currently on.
However, the prospects for weaker commodity prices should translate into greater conservatism in public spending growth. While the fiscal position has been strong for many countries in the region, a not insignificant share of the improvement has been due, either indirectly or directly, to commodity revenues.
The strong revenue performance, while in part saved, has also facilitated a rapid real rate of growth in public expenditures in the past couple of years. Policymakers should now reexamine their expenditure priorities and, in particular, look to preemptively lessen the rate of growth of current outlays, to protect the fiscal position in the event of a significant shock to world commodity markets.
Supervisory authorities should monitor particularly carefully the situation in foreign bank subsidiaries. While supervisory authorities in many countries are clearly watching closely their own financial institutions, it would be valuable for them also to cast a wider net and enter a dialogue with their counterparts in the home countries of their main foreign bank subsidiaries.
This will facilitate a greater understanding of the overall position of the banking group and also will allow supervisors in Latin America to react quickly should foreign parents start to come under greater financial stress.
Well functioning disclosure and reporting frameworks are vital. We have seen in the industrial countries how uncertainty can have a pervasive effect on the workings of the most fundamental capital markets. Both foreign and domestic investors need to be able to see clearly the health of the region's financial institutions to make judgments about asset allocation, particularly in periods of stress.
The region's policymakers should turn their attention to ensuring that reporting frameworks provide timely information and reliable valuations of financial institutions' balance sheets to better insulate the region from contagion from external confidence shocks.
(1) Real and Financial Effects of Bursting Asset Price Bubbles, World Economic Outlook (IMF, April 2003).
(2) A recent World Bank survey indicates internally generated funds finance over 60% of Latin American corporate investments and working capital (World Bank Enterprise Survey, 2006).
Anoop Singh is the International Monetary Fund's (IMF) Director, Western Hemisphere Department. The text above was his speech at the Conference on "The Euro: Global Implications and Relevance for Latin America" in São Paulo, Brazil.
Argentina, Brazil to drop U.S. dollar in bilateral commercial transactions
ChinaView – CN March 15, 2008
BUENOS AIRES, March 15 (Xinhua) -- Argentina and Brazil are to scrap bilateral commercial transactions in U.S. dollars and start using their own currencies from August, an official in charge of currency settlement at the Argentine Central Bank said here Saturday.
The new payment system is aimed at reducing costs in commercial transactions and would benefit small and medium-sized enterprises, the official said.
Under the new system, there will be a unified exchange rate between the real and peso, the so-called reference rate, which will be applied by Brazilian and Argentine central banks at the end of each day.
Brazilian President Luiz Inacio Lula da Silva reached an agreement to establish a new payment system with his Argentine counterpart Cristina Fernandez de Kirchner during his visit to Argentina in February.
Technical preparations are underway for the new system, which the two countries will adopt in several steps due to the large amount of bilateral trade.
Brazil is Argentina's largest trading partner, while Argentina is Brazil's second-biggest trading partner after the United States.
Bilateral trade stood at around 23.6 billion U.S. dollars last year.
NEW YORK (MarketWatch) -- Gold prices lost another 3% in morning trade Thursday, sliding further after the metal's worst one-day drop in nearly two years, fueled by dollar strength.
April gold futures were down $26.20, or 2.8%, at $919.10 an ounce on the New York Mercantile Exchange. On Wednesday, gold had plummeted $59 as traders began selling most commodities, many of which had recently rallied to historic highs. After hitting a record high of $1,034 an ounce Monday, gold's subsequent sharp drop put it on track for a 7.9% weekly decline. U.S. markets, including the Nymex, will be closed Friday. Among other metals, copper for May delivery lost 10 cents, or 2.8%, to $3.53 a pound. June palladium slid $24.45, or 5.3%, to $440.00 an ounce. April platinum lost $16.50, or 0.9%, to $1,870 an ounce. May silver fell $1.18, or 6.4%, to $17.27 an ounce. Alongside metals, crude-oil futures also continued to fall, with the May contract losing $2.25, or 2.2%, to $100.29 a barrel.
Other commodities also slid, with the Reuters-Jefferies CRB index off 1.7%.
Fist full of dollars The dollar continued to rally, with the dollar index -- which measures the U.S. unit against a basket of major currencies -- up 1%.
The greenback found new strength this week, with some analysts pointing to the Federal Reserve's comment on inflation concerns and its cutting interest rates less than the market expected.
"Commodities have had a great run, but the action by the Fed seems to be helping the dollar hold firm. That means we may be seeing the end of the dollar devaluation run in commodities," said Marc Pado, market strategist at Cantor Fitzgerald.
Some analysts said the sell-off in dollar-denominated commodities, such as gold and crude oil, actually helped boost the dollar further.
They said the plunge in commodities was fueled by hedge funds and other fast-money players liquidating positions to meet margin calls.
The margin calls have been precipitated by the fast-falling value of many assets used as collateral, such as mortgage-backed securities, collateralized debt obligations (CDOs) and other assets hit by the credit crisis, according to Cantor's Pado. "It has to do with leverage and the many hedge funds that may have used leverage to buy CDOs and other mortgage paper," he said. "As these funds face write-downs and possible margin calls, whatever they could move, they did move."
"Since hedge funds don't have the same oversight or scrutiny as other funds, we don't have a clear picture of exactly how much leverage is out there, and investors hate uncertainty," Pado said.
As for the sector's exchange-traded funds, the StreetTracks Gold Trust ETF fell 2.3% to $90.93, the iShares Silver Trust ETF fell 6.5% to $170.73 and the Market Vectors-Gold Miners ETF slumped 4.4% to $47.20.
NEW YORK (Reuters) - Investment banks Goldman Sachs Group Inc, Lehman Brothers Holdings Inc and Morgan Stanley are testing a new program that allows investment banks to borrow directly from the Federal Reserve, according to people at the banks.
In a bid to stabilize jittery markets, the Fed said on Sunday that it would allow investment banks to borrow from its discount window using a wide range of investment-grade securities as collateral.
Markets were unstable after a run on the bank at Bear Stearns Cos Inc forced the investment bank to sell itself to JPMorgan Chase & Co at a fire-sale price.
The Fed has also cut the rate at which dealers borrow at the discount window to 2.5 percent from 3.5 percent, in two separate actions this week.
Goldman Sachs plans to test the program sometime this week, a spokesman said. Morgan Stanley Chief Financial Officer Colm Kelleher said his bank has already tested the program, and a spokeswoman for Lehman said the investment bank has also done so.
Erin Callan, CFO at Lehman Brothers Holdings Inc, said in a conference call on Tuesday that dealers can borrow from the discount window at attractive terms.
"We would expect that the dealer community will actively begin to access the new program," Callan said. The program is a statement of confidence to parties that trade with and finance Lehman, and will also allow Lehman to fund more business with clients, she added.
In August, when commercial paper markets were seizing up, the Fed cut the discount rate for commercial banks. Soon after that, the four largest U.S. banks and a major international bank borrowed more than $2 billion total at the discount window, to help remove the stigma of getting short-term financing from the central bank.
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China buyer defaults on US soy as CBOT slumps -trade
HONG KONG, March 20 (Reuters) - Word that a Chinese buyer had defaulted on the purchase of a U.S. soy cargo has stoked concerns that more defaults may occur, as international prices of oilseeds and vegetable oils slide from record highs early this month.
Traders said the default involved a buyer in the northern province of Shandong, but they declined to provide further details.
There also had been defaults of one or two cargoes of soyoil from Argentine, and quite a few on palm oils since the buyers could not afford to pay cancellation fees of more than $200 a tonne following the slump in futures, they said.
“There has been a default on an expensive soy by a small player in Shandong. This has been confirmed,” said a senior trader at an international house.
The trader added there had been some defaults on soyoil and possibly as much as 150,000-200,000 tonnes of palmoil.
ICBC, Standard Chartered May Bid for Wing Lung Bank
March 20 (Bloomberg) -- Industrial & Commercial Bank of China Ltd. and Standard Chartered Plc are among banks that may bid for a majority stake in Hong Kong's family-controlled Wing Lung Bank Ltd., two people familiar with the matter said.
Chairman Michael Wu and his family are considering selling their combined 53 percent stake, the company said in a statement to the Hong Kong exchange today. The shareholders have appointed financial advisers, the release said, without identifying potential buyers.
A takeover would be the first of a Hong Kong-traded bank in more than four years and may prompt other family-run lenders such as Wing Hang Bank Ltd. to seek buyers. Under Hong Kong law, a buyer of the Wu family's stake would be required to make a full tender offer for the 75-year-old bank, valued at $3 billion as of yesterday.
“A successful sale sends a good signal and may increase the availability of willing sellers,” said Ivan Li, an analyst at Kim Eng Securities in Hong Kong. “It makes sense for the Chinese banks seeking to make inroads into international markets like Hong Kong, and they're more confident in doing so.”
Wu, his extended family and associates together control 63 percent of the stock, according to the bank's 2007 annual report.
China Merchants Bank Co., China Construction Bank Corp. and Australia and New Zealand Banking Group Ltd. are also among possible suitors, the people said, declining to be identified before a public announcement.
Lending Boom
Shares of Wing Lung Bank jumped 9.4 percent yesterday before being suspended, after Apple Daily said the bank's major shareholders hired UBS AG and Credit Suisse Group to sell their stake. The stock rose 3.9 percent to a record HK$106.50 today at 2:38 local time after trading resumed.
Josephine Lee, a Credit Suisse spokeswoman in Hong Kong, and Mark Panday, a UBS spokesman, declined to comment.
A combination of rising employment, higher property prices and falling interest rates has driven a credit boom in Hong Kong. Lending rose 20 percent in January from a year earlier, according to the Hong Kong Monetary Authority.
Hong Kong's publicly traded, family-run banks include Wing Lung, Wing Hang Bank Ltd., Dah Sing Banking Group Ltd. and Chong Hing Bank Ltd. All are valued at less than $4.1 billion. Bank of East Asia Ltd., controlled by the family of Chief Executive Officer David Li, has a market capitalization of $7.4 billion.
California Branch
Wing Lung, established in 1933 as Wing Lung Ngan Ho, suspended operations in Hong Kong when the territory was occupied by the Japanese in 1941 and resumed business in the city in 1945.
The company went public in 1980, and set up its first overseas branch in California four years later. It entered China in 1994 by setting up a representative office in Guangzhou. Wing Lung's Shenzhen branch, which was approved in 2004, provides foreign currency deposits, loans, remittances and trade finance services.
Wing Lung has 35 branches in Hong Kong and HK$93 billion of assets as of Dec. 31. It also has two outlets in Shanghai and Shenzhen and one sub-branch in Nanshan district in southern China, said Poon. The bank gets more than 90 percent of its profit from Hong Kong, according to its 2007 annual report.
“We are interested in expanding our business in Asia and we look at opportunities from time to time however we are only interested in acquisitions which create value,” said ANZ spokesman Paul Edwards. He declined to comment on Wing Lung Bank.
CDO Charges
The selling shareholders plan to select potential buyers by the end of this month and ask them to submit official bids for the stake, the people said. China's Bank of Communications Co. may also be interested in Wing Lung, one of the people said.
Wing Lung's stock has gained 7.3 percent this year, the second-best performance among banks traded in Hong Kong, valuing the bank at 2.1 times book value. The 11-member Hang Seng Finance Index has slumped 20 percent.
On March 15, Wing Lung said 2007 profit fell 15 percent as it booked HK$503.4 million in charges related to collateralized debt obligations and structured investment vehicles, sending the shares to their biggest daily drop in almost four years.
Chinese banks and insurers, buoyed by rising profits and cash from stock sales, have bought $9.9 billion of overseas financial assets in the past year, according to data compiled by Bloomberg. ICBC, the world's largest bank by market value, agreed in October to pay $5.6 billion for a fifth of South Africa's Standard Bank.
Seeking Purchases
China Merchants Bank, China Construction Bank and ICBC all said this month they're interested in buying assets overseas, after $195 billion of writedowns and losses related to the U.S. mortgage-market collapse drove stocks lower.
“To the Chinese bidders, Wing Lung may deserve a premium to other markets because the cultural similarity between Hong Kong and China would make integration easier,” Kim Eng's Li said. “It also improves the product mix and distribution network of those who don't have a strong presence here.”
Standard Chartered spokeswoman Gabriel Kwan, China Merchants Bank spokesman Guo Xiaoli, and ICBC spokesman Xie Taifeng declined to comment, as did Construction Bank spokesman Yu Baoyue and Bank of Communications spokesman Song Feng.
Taiwan's Fubon Financial Holding Co. bought International Bank of Asia, formerly owned by Arab Banking Corp., in 2003 for about $415 million, according to Bloomberg data. China Construction Bank agreed to buy Bank of America Corp.'s Hong Kong and Macau unit for HK$9.7 billion ($1.25 billion) in August 2006.
Endeavour loses 27% value on leveraged Japanese bond trading bets
20 Mar 2008
Endeavour Capital, a $3bn (€1.9bn) London hedge fund, on Monday lost more than a quarter of its value as it became the biggest victim of the unwinding of a popular Japanese government bond trade that hit many rivals this week.
Endeavour, run by former Salomon Smith Barney fixed income traders, told investors it fell 27% as a highly leveraged bet on the spread between short- and long-dated JGBs was hit by contagion from the US financial crisis and domestic worries. The loss triggered conditions in bank borrowing agreements, forcing Endeavour to close other trades in an effort to reduce its leverage from 18 times to almost nothing.
Hedge funds scrambled to unwind the so-called “box trade” - betting that 20-year bond and swap spreads would widen as seven-year spreads narrowed - early on Monday when the market moved sharply against them. Hedge fund investors said other well-known funds lost 5% and 20%, although Endeavour was believed to be the biggest loser.
In a separate move, it has emerged that a fixed income hedge fund run by JWM Partners - the investment firm headed by John Meriwether, the founder of Long Term Capital Management - lost 24% of its value between January 1 and March 14.
The fund suffered as increasing margin calls by nervous creditors forced hedge funds such as Peloton to unload assets. JWM opened a year after Russia’s 1998 default resulted in almost $4bn of losses for LTCM, Meriwether’s previous hedge fund.
Big Rally for Stocks to Continue, Jim Rogers Says
March 19 (Bloomberg) -- U.S. stocks, which surged the most in five years yesterday, will likely continue their rally this year because the “out of control” Federal Reserve is cutting interest rates to save investment banks from collapse, investor Jim Rogers said.
The Fed’s support is “why we’re having a big rally, but that’s not going to solve the problem,” Rogers, chairman of Rogers Holdings and co-founder of the Quantum Hedge Fund with George Soros, said during an interview with Bloomberg Television from Singapore. “The system is terribly corroded.”
The central bank is helping financial stocks while delaying and deepening a bear market and recession, he said. The Fed cut its benchmark for overnight lending between banks yesterday, continuing the most aggressive series of reductions since the rate became an explicit policy target in the late 1980s.
“What are they going to do when the stock market is down 40 percent or 50 percent?” Rogers said. “They’re not going to have any bullets left. They’re not going to be able to solve the problems at that point.”
The Standard & Poor’s 500 Index this week dropped as much as 19.7 percent from its October record, nearing the 20 percent threshold of a bear market, following $195 billion in bank losses from the collapse of the subprime-mortgage market. The index jumped 4.2 percent yesterday, the most since October 2002.
Short Financials
Rogers said he continues to short Citigroup Inc., Fannie Mae and investment banks via an exchange-traded fund tracking financial firms and increased his bearish bet last week. Short selling is the sale of borrowed stock in the hope of profiting by repurchasing the securities later at a lower price.
Rogers, who predicted the start of the commodities rally in 1999, travelled the world by motorcycle and car in the 1990s researching investment ideas for his books, which include “Adventure Capitalist” and “Hot Commodities.”
Taiwan stocks are attractive, Rogers said. The nation’s Taiex stock index has slumped 3.8 percent this year, trailing only Brazil and Argentina as the best-performing stock market among the world’s 20 largest, according to Bloomberg data.
Baltic Dry Index Falls for Seventh Day on Disruptions to Cargo
March 19 (Bloomberg) -- The Baltic Dry Index, a measure of shipping costs for commodities, fell for a seventh consecutive day as disruptions to coal and iron-ore supplies reduced cargoes.
The index, which tracks transport costs on international trade routes, retreated 92 points to 7,801 points today, the lowest this month. All vessel types declined, ranging from handymaxes, capable of hauling 50,000 metric tons to capesizes, which carry loads of as much as 170,000 tons.
“There are just slightly too many ships for the spot market and not as many spot cargoes on the horizon,” Susan Oatway, an analyst at Drewry Shipping Consultants Ltd. in London, said by phone.
Supplies of coal, which ship in capesizes, have been disrupted by rain in South Africa and a derailment in Australia this month. Cia. Vale do Rio Doce, the world’s largest producer of iron ore, had to halt shipments after protesters blocked the Brazilian company’s main railroad. The index’s 10 percent decline from its peak this month isn’t part of an “ongoing trend,” Oatway said.
“For the first half, all the fundamentals are still fairly strong,” she said.
The index gained 52 percent in the past 12 months and reached a high of 11,039 points on Nov. 13. The gauge is currently “very volatile” and swinging “quite spectacularly,” Oatway said.
Forward freight agreements, which traders buy and sell to hedge the future cost of shipping commodities, rose.
The contracts for capesizes rose 0.3 percent to $132,875 a day for the April-to-June period, according to prices from Imarex NOSA ASA, an Oslo-based freight-derivatives broker. Contracts for panamaxes that ship 70,000-ton cargoes gained 1.2 percent.
More Building
Freight costs may start to fall in 2009 because the shipping fleet is set to expand.
Next year “might be the turning point,” Philip Soutter, a senior shipbroker at London-based Galbraith’s Ltd. told the Sugaronline World Sugar & Ethanol Conference in Geneva today. “Demand is there and the ships are not coming out today. Next year, we will see a raft of new building coming through.”
Dry bulk ships on order for this year total 28 million deadweight tons and 55.9 million deadweight tons for 2009, according to Drewry’s Dry Bulk Insight published this month. The existing fleet totals 397.1 million deadweight tons.
Coal derivatives, bets made on future prices for the fuel, fell today. The contract for delivery to Amsterdam, Rotterdam or Antwerp with settlement next year declined $2.50, or 1.9 percent, to $126.50 a metric ton as of 12:49 p.m. in London, according to GFI Group Inc. prices.
Coal and iron ore rose to records this year on Chinese steel demand and coal supplies disrupted by Australian floods, Chinese storms and power shortages in South Africa. India, the world’s second-biggest iron ore supplier to China, must restrict overseas sales of the material to ensure supply for domestic mills, Steel Minister Vilas Paswan said March 14.
The Great Unwind has begun, Citigroup warns
Avoid leveraged companies, countries and consumers, bank's strategists say
By Alistair Barr
March 19, 2008
As markets and economies de-leverage across the globe, investors should avoid companies and countries that have grown to rely too much on borrowed money, they said.
That means favoring public-equity markets over hedge funds, private-equity and real estate, while leaning toward emerging market countries and away from developed nations like the U.S., the bank's global equity strategy team advised.
Within equity markets, the financial-services should be avoided because it's still over-leveraged, while other companies have stronger balance sheets, the strategists said.
"Steady growth, low inflation and rock-bottom interest rates encouraged economic and financial participants across the world economy to gear up over the past few years," Robert Buckland and his colleagues on Citi's global strategy team wrote in a note to clients. "Easy money encouraged many to buy a bigger house, a bigger car or a bigger speculative position."
"But now, any behavior that relied upon continued access to easy money is being dramatically reassessed," they added. "Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less."
Financial-services companies are the most vulnerable to this reduction of borrowed money across the globe, they said.
During the last credit crisis in 1998, European banks were leveraged 26 to 1. In the early part of this decade, leverage grew to 32 to 1. Now the sector is geared 40 to 1 on average, according to Citi's European bank research team.
"The banks have a long way to go," the strategists said. "We would continue to avoid the sector while they are de-leveraging."
Other companies are in much better shape, having rebuilt cash from strong earnings since 2003. Emerging market companies have developed particularly strong balance sheets, having learnt hard lessons from the Asian financial crisis a decade ago.
However, even though some companies may not have much debt themselves, they may be exposed to over-leveraged customers or highly leveraged investors, Citigroup warned.
Automakers, home builders and electronics retailers benefited as customers borrowed money cheaply in recent years to buy cars, houses and flat-screen TVs. That attractive financing is now being withdrawn.
"There will be plenty of companies that have strong balance sheets, so may not be most immediately vulnerable to the credit crunch," Citi said. "But they may find that their leveraged customers are vulnerable."
The difference, or spread, between interest rates on investment-grade corporate bonds and Treasury bonds has jumped in recent months, even though most companies aren't very leveraged.
This widening may be caused by leveraged investors such as hedge funds having to sell good quality assets to meet margin calls, or requests for more cash or collateral.
"It is the leverage of the investors who hold these bonds that is now being brutally exposed," Matt King, a Citigroup credit strategist, said.
"We are now confronted by a broad bloodbath in the credit markets," Citigroup said. " The most leveraged paper is falling in value because it is leveraged, and now the least leveraged paper is also falling in value because it is owned by leveraged investors."
Investors should also avoid hedge funds themselves, along with private equity, Citi added. Both types of investment rely at least partly on borrowed money to generate returns.
"Private equity returns have been especially strong. Without leverage it will be much harder to meet excessive investor expectations [most surveys suggest 20% annual returns are expected from the asset class]," Citi warned. "Similarly, many hedge funds have generated healthy uncorrelated returns by adopting cautious underlying strategies, but applying significant leverage. Again, that looks unsustainable in the current environment."
Leveraged economies, like the U.S., should also be avoided, in favor of emerging market countries, which have reduced borrowing, the bank advised.
With less capital sloshing around the world, and the dollar falling, the U.S. may have to compete more to finance its deficits.
"The U.S. shows up as the world's greatest consumer of external capital," Citi noted. So it "has the most to lose as this capital becomes less freely available."
China in tax break for mutuals
By Jamil Anderlini in Beijing
Published: March 19 2008 20:18 | Last updated: March 19 2008 21:59
Beijing has temporarily suspended the collection of corporate taxes from Chinese mutual funds in an attempt to boost the country’s slumping stock prices.
China’s finance ministry and State Administration of Taxation announced the exemption in a brief statement carried by state media last night but did not say how long the measure would last.
The exemption applies to all income from investment funds from securities markets – including stock and bond trading, and interest or dividends from stock or bond investments – according to state news agency Xinhua.
The exemption also applies to investors who receive income from such funds, the notice said.
The move is aimed at shoring up a market that has dropped almost 40 per cent since the historic peak it reached in October and contrasts with the situation a year ago, when officials were casting around for a way to slow a raging bull market.
The government raised the stamp duty on all stock trading in May in an attempt to damp its meteoric rise. The market fell more than 15 per cent in the days following the announcement but soon rebounded and ended the year up nearly 100 per cent.
Mutual funds make up the most significant group of institutional investors in China, with more than 350 funds controlling more than $450bn in assets. Cancelling the corporate tax they pay on their investments in securities will boost returns for them and for investors.
The corporate tax rate in China can be as high as 33 per cent although there are exemptions and the government has recently lowered the rate for most domestic companies.
The mutual fund industry is one of the most open to foreign investors, who are allowed to hold up to 49 per cent in joint ventures with local partners.
Some of China’s biggest funds are partially owned by western groups.
Global investors, including mutual funds, are not allowed to invest directly in Chinese stocks except through a carefully controlled scheme known as the qualified foreign institutional investor programme, under which the government has issued total investment quotas of just over $10bn, with promises to allow up to $30bn.
Copyright The Financial Times Limited 2008
Citigroup to lay off 2,000 more employees
By The New York Times Published: March 20, 2008
Citigroup plans to lay off another 2,000 investment bankers and traders before the end of the month, people close to the situation said on Wednesday.
In January, the company announced plans to eliminate about 4,200 jobs, the bulk of them in Citigroup's investment bank.
The new layoffs will bring job cuts at Citigroup's investment bank to 6,000, or about 10 percent of its employee base. The company over all has more than 320,000 employees worldwide.
Most of the cuts will come from the bank's major offices in New York and London, the people said, though other markets in Europe and Asia could lose jobs.
The layoffs will be spread throughout the unit, though traders are more likely to be at risk given market conditions. Some bankers have already been notified; others will be told in coming weeks.
Daniel Noonan, a Citigroup spokesman, said that the investment bank identified the bottom 5 percent of employees each year and some of them leave.
"This year, we will have more reductions as we continue to strengthen the business and lower our expense base," Noonan added.
Credit Suisse Drops Most Since 2002 as Bank Sees Loss
By Elena Logutenkova
March 20 (Bloomberg) -- Credit Suisse Group fell the most in more than five years in Swiss trading after the company said it may post a first-quarter loss because of writedowns on debt securities deliberately mispriced by employees.
Switzerland's second-largest bank dropped as much as 11 percent, the most since October 2002, and was down 4.52 francs to 47.28 francs by 3:09 p.m. The Zurich-based bank said today it will write down $2.65 billion over the fourth quarter and first three months of 2008, making a profit this quarter ``unlikely.''
An internal review found that the pricing errors, first announced last month, were made intentionally ``by a small number'' of traders who have since been fired or suspended. The episode is the biggest setback for Chief Executive Officer Brady Dougan since he took over from Oswald Gruebel in May after heading the investment banking unit for three years.
``This is clearly embarrassing for Credit Suisse and further damages the reputation that it had worked so hard to improve,'' said Peter Thorne, a London-based analyst at Helvea SA, in a note. He has a ``neutral'' rating on the shares.
The quarterly loss would be the first since 2003. The markdowns led Credit Suisse to reduce fourth-quarter net income by almost 60 percent to 540 million francs ($532 million). Profit for 2007 was cut to 7.76 billion francs.
`Unacceptable'
``This incident is unacceptable,'' Dougan, 48, said in a statement. ``We are taking strong action to remediate and move forward.''
The announcement of writedowns as a result of pricing errors came as a surprise on Feb. 19, just a week after the bank said its risk management systems helped it sidestep the worst of the U.S. subprime mortgage market crash. Under Gruebel, 64, and Dougan, Credit Suisse had returned to stable earnings after a decade of management turnover, bungled acquisitions and the first criminal conviction of a bank in Japan.
The incident follows revelations of unauthorized trades at Societe Generale SA, France's second-largest bank, and MF Global Inc., the largest broker of exchange-traded futures and options.
Societe Generale said in January that the bank lost 4.9 billion euros ($7.6 billion) after 31-year-old trader Jerome Kerviel took unauthorized positions on European stock index futures. Last month MF Global said Evan Dooley lost $141.5 million with bets on the wheat market.
`Severe Consequences'
The Swiss bank hasn't disclosed the names of the traders responsible for the incorrect pricing of residential mortgage- backed bonds and collateralized debt obligations. Credit Suisse said it reassigned trading responsibility for the CDO business and took measures to improve controls to prevent and detect misconduct.
``This is quite disappointing,'' said Dirk Sebrechts, a fund manager at KBC Asset Management SA, which oversees more than $15 billion in equities. ``Apart from writedowns, we've seen earnings come down and they will come down further.''
Traders are required to mark their trading books to market levels daily, and managers have to sign off, Dougan said on a conference call with analysts and journalists. The misconduct was limited to traders and didn't involve managers or controllers, he said. About half of the 1.18 billion-franc writedown on these trading positions in the fourth quarter was attributed to incorrect pricing.
``There will be very severe consequences for the traders,'' said Dougan, who added that he had difficulty understanding their motivation. ``We are in the process of putting together a robust remediation plan.''
He declined to comment on whether the traders received their 2007 bonuses before being suspended or whether the bank plans to take any legal action against them.
`Difficult' March
Credit Suisse said it was profitable through the end of February, though will probably have a loss for the quarter because of worsening market conditions this month. The world's biggest financial firms have fired more than 30,000 workers in the last seven months and reported at least $195 billion in writedowns and losses.
``March has been a very difficult month,'' Dougan said. ``Trading results have been very difficult given the extreme volatility in the markets.''
At the end of February, the bank held 15.7 billion francs in CDOs that were marked down because of pricing errors and 13.3 billion francs in hedges for those bonds.
Dougan, a native of the U.S., earned 22.3 million francs last year, the bank said in its annual report today, publishing the CEO's salary for the first time. Dougan said on the conference call that his compensation declined 40 percent last year. Chairman Walter Kielholz took a pay cut of 8.7 percent to 14.6 million francs in 2007.
The investment bank's ``core businesses continue to perform quite well,'' Paul Calello, who took over the division from Dougan, said on the conference call. The wealth management unit saw ``good inflows in line with our targets,'' Dougan said.
The bank aims to complete its share buyback program, though ``in the near term we won't be buying much stock,'' Dougan said. Credit Suisse still plans to pay a dividend of 2.50 francs per share for 2007.
Bear Stearns Lawsuits: A Trickle Will Soon Become a Flood
March 18, 2008
The first of many class action lawsuits against Bear Stearns has been filed this week in the United States District Court for the Southern District of New York. One of the first companies that I have seen bring a suit against Bear Stearns is Coughlin Stoia Geller Rudman & Robbins LLP. They issued a press release on March 17th, and are currently seeking a lead plaintiff for their lawsuit. Eastside Holding Inc. also filed on Monday in Manhattan federal court, and I believe that they were technically the first company to file against Bear Stearns.
There will obviously be many, many lawsuits and motions filed against the company. When you have a company that is as well-established as Bear Stearns is, you will naturally have many people that have financial ties to the company. You will have your large shareholders, such as Joe Lewis, and your smaller shareholders, such as the company employees, who will be up in arms about this proposed transaction between JPM and Bear Stearns.
Bear Stearns employees own a reported 30% of the company. Joe Lewis, a British billionaire who just recently invested in Bear Stearns, stands to lose a billion dollars if this transaction goes through. Old Mutual's Barrow, Hanley, Mewhinney & Strauss is the largest single shareholder at 9.7%, and I am sure that they will have problems with the deal as well.
Obviously there are many that think that Bear Stearns will end up fetching a higher price than the $2 per share offer that is currently on the table. Bear Stearns closed today at $5.91, almost triple the offer price, so people either a) are living on false hope or b) are betting on a higher offering price and undoing of the current deal.
So far, the lawsuits that I have seen filed are seeking shareholders who purchased the stock between late 2006 and March 14th, 2008. The lawsuits claim that Bear Stearns issued "materially false" and "misleading" statements regarding the company's business and financial results. They go on to claim that Bear Stearns traded at "artificially high" price of $150+ per share due to these misleading statements, and that the company should have informed the public about the problems that they were having with their hedge funds that had exposure to the subprime market.
What a mess!
Obviously when you have a company with a multi-billion dollar market cap that collapses overnight and then sells for a couple hundred million dollars, you are going to have some very angry shareholders. From $60 to $30 to $2 in just two trading sessions.
Most people are asking the question: how could such a well-established and profitable company suddenly have so much "bad stuff" on their balance sheet? Enough so that they just basically disappear overnight into the hands of an eagerly awaiting JPM?
It surely won't make BSC shareholders feel any better when they tune in to CNBC and have to listen to talk of JPM making "billions" from this deal. Wall Street obviously thinks that it is a good deal for JPM as well, as the stock traded much higher even during the doom and gloom of Monday's trading session.
I don't have an answer as to what is going to happen. There are so many questions going through my head as it relates to this transaction. Can a group of angry shareholders block this deal, even if it means possibly going against the Fed and throwing the global financial markets into another unsettled period? Is this deal doesn't go through, who would step up to buy BSC? Were there other suitors who were willing to offer more? What happened to them? Were they allowed a fair opportunity to negotiate? Or was the Fed only offering a "$30 billion dollar line of credit" to JP Morgan and not other companies?
I know one thing. This story has plenty more zigs and zags left in it.
The US Market Crisis and the Perils to Brazil and LatAm
By Anoop Singh
18 March 2008
Over the past four years, Latin America has generally done well in taking advantage of a very favorable global environment to strengthen policy frameworks and lower long-standing vulnerabilities. However, the external environment has abruptly changed, led by mutually reinforcing financial sector shocks in the United States, that are spilling over into the global economy.
Thus far, our baseline forecasts show Latin American growth holding up pretty well. However, how robust is the region to the exceptional downside risks that still affect the U.S. and global outlook? To address this question, we need to look closely at the various elements of the downside risks facing the world today and what they could portend for emerging markets in general and Latin America in particular.
The U.S. Outlook-Downside Risks
This is clearly a period of exceptional uncertainty. The distribution of risks for the U.S. outlook is wide and skewed clearly toward the downside, and the probability of additional shocks leading to a U.S. recession, is quite high. There are at least three broad factors that could potentially reinforce each other and derail consumption - the mainstay of the U.S. economy - pushing growth into the negative tail of the distribution:
Housing
This has been ground zero for the current financial market turmoil. An asset price bubble is in the process of deflating, and it is difficult to know how far the process will have to go before it bottoms out. We know from past experiences that output effects from housing price busts last about twice as long as those from, say, a bursting equity price bubble. (1)
Thus, we are almost certainly looking at a protracted process. Indeed, there is now nearly ten months' supply of new houses for sale - the highest since 1981 - and with rising foreclosures putting more houses back on the market, it will take quite some time - and substantial price declines - before the situation normalizes.
In such a market the decline in housing prices could very well turn out much worse than in our baseline forecast (that has average housing prices falling by some 15% over the next two years), given the still large gap in their historical relation with disposable income.
There are various elements that are not yet clear. First, loans made in 2006 and 2007 - the riskiest - are only now undergoing rate resets and, although delinquency rates have risen sharply, their full force has probably yet to be felt. Second, widening spreads on mortgages have meant that the monetary easing that began last year has not translated into substantially lower rates on consumer loans and mortgages, largely due to the weakening position of banks.
Third, there are emerging indicators that the problems in U.S. housing are starting to spread beyond subprime to other segments of the real estate market. For example, foreclosure rates on prime mortgages have recently started to increase. Finally, there is a concern that similar housing price increases abroad - many of which have been larger than in the United States - might deflate abruptly, with potential financial feedback effects.
Strains in the core financial system. The ongoing process of adjustment in capital markets has led the large financial institutions in the United States to absorb onto their balance sheets sizeable losses from off-balance sheet entities, securitized special investment vehicles, asset-backed commercial paper, and other innovative financial products with a resulting downgrade in the perceived strength of these banks as captured by credit default swap rates.
To cope with the assumption of these losses, banks have started raising capital, including through infusions from sovereign wealth funds. This is positive. However, as with the housing market, many uncertainties remain. The size of bank losses remains extremely difficult to assess.
At this point, preliminary estimates suggest that banks' subprime-related losses to mount further to around US$ 230 billion worldwide, with about half of that amount residing in the U.S. banking system and the remainder mostly in Europe. An additional US$ 100 billion or so in losses may also arise from bank holdings of other financial assets (including commercial mortgages, leveraged loans, credit card debts, and others).
However, losses could mount much further as an economic downturn brings with it a widening deterioration of credit across a broad range of household and corporate credit. In an adverse scenario, bank losses could be much larger, putting pressure on the capital position of some of the main global banks and forcing them to curb credit growth and shore up capital.
This would restrict credit availability to both household and corporate sectors and further disrupt the economic recovery. Indeed, there is already evidence that such a deleveraging process is underway with banks reporting a substantial tightening of lending standards.
Outside of the banking system, a broader global deleveraging process could also unfold with asset price declines triggering margin calls on hedge funds and other leveraged investors, as we have seen in recent days, and forcing asset sales and greater asset price declines. This, when combined with weakening bank balance sheets, could lead banks to raise margin requirements, fueling an already volatile mix.
Contagion to Other Markets
Contagion to other credit markets and nonbanks in the United States and Europe in particular is another key risk in the downside scenario and would have mutually reinforcing effects on a weakening economy. Beyond the subprime-related losses mentioned above, losses are likely on other asset classes, such as commercial mortgage-backed securities, high-yield corporate debt, collateralized loan obligations (CLOs), and a variety of unsecuritized loan types.
All in all, a range of estimates from a number of sources place possible losses that the global financial system could be facing at close to $800 billion spread across banks, insurance companies, hedge funds, and pension funds (a little over one-half of which resides in U.S. institutions), although some analysts are projecting much higher losses.
As a share of GDP, such losses are already at a level similar to those seen during the U.S. Savings and Loan episode. This would have direct implications for credit extension and for growth outcomes, which could, in turn, drive asset values further downward and impose more losses on the financial system.
To summarize, were these combined additional shocks to housing, the core financial system, and other credit markets to materialize, they would affect the wider U.S. and global economic situation by curtailing the availability of credit and intensifying the negative wealth effect on households.
Although aggregate data suggest that corporate balance sheets are resilient, we have seen similar credit indiscipline in the leveraged buyout and high-yield corporate bonds. Though default rates are low, they could rise quickly in a sharper U.S. slowdown and those corporations with high leverage could face significant refinancing risks.
If these risk factors materialize, a credit crunch could become global, marked by rising costs of cross-border financing and reduced availability of funding. Together with slowing activity in an array of industrial countries, this would lower the demand for various emerging market exports, with a key risk being a loss of export momentum in China.
Such a coordinated slowdown could create downward pressure on commodity prices - for food, fuels, and minerals - that are crucial to Latin America, reverse the capital flow into emerging market economies, and result in a considerably deeper and more protracted slowdown of global growth, well below our current baseline, and raising the specter of a global recession.
The Impact on Latin America
Our baseline scenario foresees a modest slowing of regional growth, to about 4½% in 2008, but there could be more serious effects if the downside risks in the global economy materialize. Let's examine how resilient Latin America is to the kind of shocks affecting the advanced economies, and outline some reasons why Latin America may escape recession, even with downside outcomes in the United States.
Asset Price Bubbles?
Are there similar asset price bubbles that could threaten Latin America? Here the assessment is cautiously positive. No substantial exposure is reported in Latin America to the subprime-related distressed credit products that we have seen in the United States, even though the trend in some countries has been toward increased domestic securitization.
It has helped that in many countries, including here in Brazil, regulatory frameworks have made it difficult for banks to either buy the kind of structured products that have been at the center of events in the United States or accumulate significant off-balance sheet exposures.
Second, housing price trends do not indicate the kind of price run-up that we have seen in the United States and some European economies, although the data here is very incomplete. Against this, equities have boomed in the region, especially for commodity-linked companies, which account for a substantial share of market capitalization in Brazil, Peru, and Chile.
It should help that, broadly speaking, valuations appear in line with real earnings prospects, although the performance of more commodity-dependent stock markets will depend greatly on the impact on global commodity prices if a global recession were to unfold.
Implications for the Sovereign?
Similarly, our sense is that the external environment should not put exceptional pressure on Latin American sovereigns, at least not in the near term. To be sure, spreads on Latin American sovereign debt have already risen but the increases have been much more moderate than has historically been the case, in large part due to the strong fiscal positions, improved structure of public debt, and large build-up of international reserves.
Our assessment is that further increases in global risk aversion, while raising spreads, should be manageable for many countries in the region. However, there will likely be a greater discrimination between high- and low-risk countries which may put pressure on those in the region with weaker policy frameworks. Having said this, much again will depend on commodity price developments, a subject to which I will return.
This time around, greater corporate stress? What are the risks that, this time, it is the corporate sector that could be disproportionately affected? On the one hand, corporations in Latin America are used to operating in an environment of macroeconomic volatility, and still rely on retained earnings for the bulk of their financing. (2) Nonetheless, cross-border funding flows have grown in importance for corporates in the region, and this may open new channels of contagion. Indeed, there are already signs of some stress:
Corporate bond financing. Spreads on Latin American corporate bonds have widened by over 200 basis points, more than the rise in spreads on sovereign bonds.
Since corporate balance sheets appear generally strong, this should have little effect on investment decisions in the short run and many corporates are in a sufficiently comfortable position that they can choose to delay issuing new debt. Indeed, we have already seen a marked decline in bond and loan issuance by Latin corporates over the last six months, and especially in the first two months of this year.
As yet this does not appear to have materially curtailed investment decisions. However, if the cost of financing continues to rise and becomes more protracted, the less advantageous market for corporate credit could represent a constraint on new investments. This is particularly the case given that domestic bond markets in the region are small and do not provide an adequate alternative to external financing.
Equity Issuance
Up until the first half of 2007, strong demand for emerging market equities led to a marked increase in new equity financing by Latin corporates.
In Brazil alone, over 100 firms launched new IPOs in 2007, targeted at both local and international investors, raising US$ 47 billion in new capital. While Latin equity prices have fallen of late, perhaps of more concern is the sharp reduction in primary equity issuance since end-2007.
Risks to Domestic Bank Credit
Although private credit growth - especially of consumer credit - has been very rapid in the region (averaging 25-35%), so far, this has been generally reflective of structural and regulatory improvements.
Moreover, much of the funding of this growth in credit has come from domestic sources - especially from an expanding domestic deposit base - and so it has not generally mattered that access to longer-term structured loans in domestic currency, financed by offshore investors, has been curtailed.
This explains why domestic currency interbank spreads, such as here in Brazil, have remained stable despite the global financial turmoil. Against this, there are some risks that need to be monitored closely. There has been an uptick of delinquency rates, especially at smaller banks in some countries.
In addition, in several countries in the region, subsidiaries of global banks are an important and successful part of the local banking system. There is the risk that liquidity or capital pressures in their parent companies in the United States and Europe could lead these banks to downsize their operations or draw on the capital or liquidity resources of their subsidiaries in the region.
The Key Influence of Commodities
Many countries in Latin America have benefited greatly from the commodity boom, which has helped improve the terms of trade for the region by over 10% since 2005, a result of strong increases in crude oil, metals, and agricultural product prices. The value of commodity exports for the region is now around 10% of regional GDP and accounts for over 40% of export revenues.
This strength has bolstered regional growth, strengthened current account positions, and also been a major factor behind the increase in the fiscal surplus in many countries. Even with the baseline for the U.S. and global outlook, commodity prices should hold up well over the next year as a whole, reflecting the importance of demand from emerging economies for the near-term prospects for many commodities, as well as the combination of low interest rates and a depreciating U.S. dollar.
Our model-based estimates suggest that even with a U.S. recession, commodity prices may decline only modestly, especially if key emerging market countries, such as China and India, continue to grow rapidly. This said, a deep U.S. recession that triggers large output declines elsewhere in the industrial world and slows growth significantly in key emerging market countries could have a larger impact on commodity prices, as has been the case during previous global downturns.
If this precipitated an unwinding of sizeable speculative positions in many of these commodities, price declines could be abrupt. Such a large drop in commodity prices would have an important impact on the region. For example, if commodity prices were to fall back to the levels seen at the end of 2005 (an average decline of 35%), fiscal and trade balances on average in the region would deteriorate sharply, raising financing requirements at a time of tighter global credit markets, and potentially resulting in a regional recession.
Where does that leave policymakers? In closing, what message should policy makers draw when thinking about the various global risks now facing Latin America? It is true that many of the aspects of a possible downside scenario are beyond the control of regional authorities. However, I would gravitate, perhaps, to four broad themes that are relevant:
The region is now reaping the rewards from a decade of investment in reducing vulnerabilities. The investments that policymakers have made in recent years - to lower fiscal deficits, build international reserves, improve the structure of public liabilities, strengthen bank supervision and regulation, and build credibility in their monetary frameworks - are now going to show their true value.
The reduction in vulnerabilities has the potential to allow Latin America to pass through our baseline scenario relatively unscathed and certainly without the major macroeconomic swings that were evident since the Tequila crisis. This should not lead to complacency but rather further convince policymakers of the importance of their achievements to date and the need to continue along the path they are currently on.
However, the prospects for weaker commodity prices should translate into greater conservatism in public spending growth. While the fiscal position has been strong for many countries in the region, a not insignificant share of the improvement has been due, either indirectly or directly, to commodity revenues.
The strong revenue performance, while in part saved, has also facilitated a rapid real rate of growth in public expenditures in the past couple of years. Policymakers should now reexamine their expenditure priorities and, in particular, look to preemptively lessen the rate of growth of current outlays, to protect the fiscal position in the event of a significant shock to world commodity markets.
Supervisory authorities should monitor particularly carefully the situation in foreign bank subsidiaries. While supervisory authorities in many countries are clearly watching closely their own financial institutions, it would be valuable for them also to cast a wider net and enter a dialogue with their counterparts in the home countries of their main foreign bank subsidiaries.
This will facilitate a greater understanding of the overall position of the banking group and also will allow supervisors in Latin America to react quickly should foreign parents start to come under greater financial stress.
Well functioning disclosure and reporting frameworks are vital. We have seen in the industrial countries how uncertainty can have a pervasive effect on the workings of the most fundamental capital markets. Both foreign and domestic investors need to be able to see clearly the health of the region's financial institutions to make judgments about asset allocation, particularly in periods of stress.
The region's policymakers should turn their attention to ensuring that reporting frameworks provide timely information and reliable valuations of financial institutions' balance sheets to better insulate the region from contagion from external confidence shocks.
(1) Real and Financial Effects of Bursting Asset Price Bubbles, World Economic Outlook (IMF, April 2003).
(2) A recent World Bank survey indicates internally generated funds finance over 60% of Latin American corporate investments and working capital (World Bank Enterprise Survey, 2006).
Anoop Singh is the International Monetary Fund's (IMF) Director, Western Hemisphere Department. The text above was his speech at
the Conference on "The Euro: Global Implications and Relevance for Latin America" in São Paulo, Brazil.
Goodbye US dollar . . .
Argentina, Brazil to drop U.S. dollar in bilateral commercial transactions
ChinaView – CN
March 15, 2008
BUENOS AIRES, March 15 (Xinhua) -- Argentina and Brazil are to scrap bilateral commercial transactions in U.S. dollars and start using their own currencies from August, an official in charge of currency settlement at the Argentine Central Bank said here Saturday.
The new payment system is aimed at reducing costs in commercial transactions and would benefit small and medium-sized enterprises, the official said.
Under the new system, there will be a unified exchange rate between the real and peso, the so-called reference rate, which will be applied by Brazilian and Argentine central banks at the end of each day.
Brazilian President Luiz Inacio Lula da Silva reached an agreement to establish a new payment system with his Argentine counterpart Cristina Fernandez de Kirchner during his visit to Argentina in February.
Technical preparations are underway for the new system, which the two countries will adopt in several steps due to the large amount of bilateral trade.
Brazil is Argentina's largest trading partner, while Argentina is Brazil's second-biggest trading partner after the United States.
Bilateral trade stood at around 23.6 billion U.S. dollars last year.
Gold continues slide as dollar rallies
By Nick Godt
March 20, 2008
NEW YORK (MarketWatch) -- Gold prices lost another 3% in morning trade Thursday, sliding further after the metal's worst one-day drop in nearly two years, fueled by dollar strength.
April gold futures were down $26.20, or 2.8%, at $919.10 an ounce on the New York Mercantile Exchange. On Wednesday, gold had plummeted $59 as traders began selling most commodities, many of which had recently rallied to historic highs.
After hitting a record high of $1,034 an ounce Monday, gold's subsequent sharp drop put it on track for a 7.9% weekly decline. U.S. markets, including the Nymex, will be closed Friday.
Among other metals, copper for May delivery lost 10 cents, or 2.8%, to $3.53 a pound. June palladium slid $24.45, or 5.3%, to $440.00 an ounce. April platinum lost $16.50, or 0.9%, to $1,870 an ounce. May silver fell $1.18, or 6.4%, to $17.27 an ounce.
Alongside metals, crude-oil futures also continued to fall, with the May contract losing $2.25, or 2.2%, to $100.29 a barrel.
Other commodities also slid, with the Reuters-Jefferies CRB index off 1.7%.
Fist full of dollars
The dollar continued to rally, with the dollar index -- which measures the U.S. unit against a basket of major currencies -- up 1%.
The greenback found new strength this week, with some analysts pointing to the Federal Reserve's comment on inflation concerns and its cutting interest rates less than the market expected.
"Commodities have had a great run, but the action by the Fed seems to be helping the dollar hold firm. That means we may be seeing the end of the dollar devaluation run in commodities," said Marc Pado, market strategist at Cantor Fitzgerald.
Some analysts said the sell-off in dollar-denominated commodities, such as gold and crude oil, actually helped boost the dollar further.
They said the plunge in commodities was fueled by hedge funds and other fast-money players liquidating positions to meet margin calls.
The margin calls have been precipitated by the fast-falling value of many assets used as collateral, such as mortgage-backed securities, collateralized debt obligations (CDOs) and other assets hit by the credit crisis, according to Cantor's Pado.
"It has to do with leverage and the many hedge funds that may have used leverage to buy CDOs and other mortgage paper," he said. "As these funds face write-downs and possible margin calls, whatever they could move, they did move."
"Since hedge funds don't have the same oversight or scrutiny as other funds, we don't have a clear picture of exactly how much leverage is out there, and investors hate uncertainty," Pado said.
As for the sector's exchange-traded funds, the StreetTracks Gold Trust ETF fell 2.3% to $90.93, the iShares Silver Trust ETF fell 6.5% to $170.73 and the Market Vectors-Gold Miners ETF slumped 4.4% to $47.20.
Investment banks are borrowing from Fed
Mar 19, 2008
NEW YORK (Reuters) - Investment banks Goldman Sachs Group Inc, Lehman Brothers Holdings Inc and Morgan Stanley are testing a new program that allows investment banks to borrow directly from the Federal Reserve, according to people at the banks.
In a bid to stabilize jittery markets, the Fed said on Sunday that it would allow investment banks to borrow from its discount window using a wide range of investment-grade securities as collateral.
Markets were unstable after a run on the bank at Bear Stearns Cos Inc forced the investment bank to sell itself to JPMorgan Chase & Co at a fire-sale price.
The Fed has also cut the rate at which dealers borrow at the discount window to 2.5 percent from 3.5 percent, in two separate actions this week.
Goldman Sachs plans to test the program sometime this week, a spokesman said. Morgan Stanley Chief Financial Officer Colm Kelleher said his bank has already tested the program, and a spokeswoman for Lehman said the investment bank has also done so.
Erin Callan, CFO at Lehman Brothers Holdings Inc, said in a conference call on Tuesday that dealers can borrow from the discount window at attractive terms.
"We would expect that the dealer community will actively begin to access the new program," Callan said. The program is a statement of confidence to parties that trade with and finance Lehman, and will also allow Lehman to fund more business with clients, she added.
In August, when commercial paper markets were seizing up, the Fed cut the discount rate for commercial banks. Soon after that, the four largest U.S. banks and a major international bank borrowed more than $2 billion total at the discount window, to help remove the stigma of getting short-term financing from the central bank.
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