Wednesday, 28 April 2010

Preparing for the worst...

Risk.net comments on the latest measures by banks to protect themselves from a potential escalating debt crisis in Europe.
With markets anticipating a Greek debt restructuring, bank traders and risk managers are preparing for a wider crisis that could drag in northern European countries, tip the euro into a tailspin or even threaten the eurozone’s integrity.
Banks are shorting the euro, along with German and French government bonds, as a hedge against an escalation of the Greek debt crisis. Their fear is that a Greek restructuring is inevitable and will scare investors away from other vulnerable members of the eurozone. One obvious consequence would be a weakening of the single currency, but banks have entertained a variety of other, wilder scenarios as they seek to immunise their books against a possible Europe-wide crisis.
"The big question for us, though, is how bad the contagion will be into northern Europe, the UK and the US." The problem for banks is the potential range of outcomes. An agreement by the International Monetary Fund (IMF) and European Union (EU) on April 11 to provide a €45 billion standby aid package initially seemed to ease pressure on Greek assets. It quickly proved to be a false dawn. Yesterday, as Standard & Poor's downgraded Greek debt three notches to junk territory, and a German government official suggested Greece might need to exit the eurozone, the cost of five-year credit default swap (CDS) protection on Hellenic Republic debt hit a new high of 710 basis point, roughly twice the level seen in mid-April.
Commentators are still split on whether a restructuring will happen sooner or later - but banks should, by now, be protected, says the London-based market risk head at a large UK bank: "If Greece defaults tomorrow and some bank stands up and says ‘I've lost a billion dollars on Greece', they should fire everybody. Greece is a very old story. What we're trying to figure out is what happens next. Is it Portugal? Italy? Spain?"

Or something even nastier. Some analysts have suggested that if the capital markets close to other eurozone countries, forcing them to go cap-in-hand to the EU, it could test the commitment of countries like Germany to economic union - richer nations could choose to go it alone, or they might just boot out the weaker countries. The consequences for European assets would be enormous.

"Germany pulling out of the eurozone would be great for Germany and terrible for everybody else," says one European bank's market risk head. "But it doesn't have to be that. You can imagine some statement from the EU saying the enlargement project is on hold, so the Czech Republic, Poland, and Hungary get caned. You really have to look at anything related to the EU including potential break-up. There's a pretty much unlimited set of scenarios."
Based on CDS spreads, the market sees contagion to other, weaker countries as the next likely step. Spreads on Portugal and Spain have more or less doubled in recent weeks. Portugal was trading at 157bp as recently as April 13 and hit 315bp on April 27 as it too was downgraded. Spain has leapt from 93bp to 188bp in roughly the same period.

Monday, 19 April 2010

Beware the global imbalances!

One of the "culprits" of the recent financial crisis has been the global imbalances between the surplus and deficit countries. Most notably it was seen by the enormous US deficits and China's massive trade surplus. The European Central Bank (ECB) recently issued a warning that not much has changed and that global economic recovery is under threat. The Financial Times reported:

The ECB has made clear its fear that governments are not doing enough to put the global economy back on a sustainable growth path – despite international policy initiatives in the past year. “At the current juncture, global imbalances continue to pose a key risk to global macroeconomic and financial stability . . . The stakes are high to prevent a disorderly adjustment in the future that would be costly to all economies,” it concludes in a special article in its monthly bulletin published on Thursday.

The ECB argues that the 16-country eurozone had “remained very close to external balance”, even though the large trade surplus of Germany, its largest member, is seen by many economists as restricting growth prospects elsewhere in the region.

Since the outbreak of the crisis, the imbalances have narrowed. However, the report argues that such trends are likely to be temporary. Cyclical factors that led to a narrowing, such as lower oil and commodity prices, have gone into reverse. At the same time, structural factors that contributed to the build-up in imbalances remain – including the lack of a social “safety net” in emerging Asian economies, which has encouraged domestic saving, and the desire of countries to build up reserves as insurance against future crises. Moreover, differences in growth rates have widened, with export-led emerging economies becoming an increasing source of global growth, the ECB adds.
Speaking in Washington, J├╝rgen Stark, ECB executive board member, said Asian emerging market economies were powering global growth, with prospects still weak in many advanced economies. “Questions can be raised as to whether such an uneven pattern of the recovery will prove sustainable.”
He warned that advanced economies would “continue to face severe macro-economic imbalances in the years to come”, as highlighted by the dramatic deterioration in public finances. “We may already have entered the next phase of the crisis: a sovereign debt crisis.”
Mr Stark concluded: “There is no doubt that the crisis will leave us a heritage of severe macro-economic imbalances. Dealing with them will represent one of the most daunting challenges for policymakers in modern history.”

Thursday, 15 April 2010

China does it again, and at a faster rate...

The Chinese economy is continuing to grow at a rapid pace but with concerns about overheating. Financial Times reports:


The Chinese economy expanded at an accelerated rate of 11.9 per cent in the first quarter. The economy grew at the fastest rate in nearly three years and more quickly than economists had expected. The pace of growth puts new pressure on Beijing to consider tougher tightening measures, including appreciating the exchange rate and increasing interest rates.

House prices increased by 11.7% over the past 12 months - the fastest rate since the figures were first published five years ago and prompting new concerns about a potential bubble in the property market.

Despite rising fears of overheating, consumer price inflation dipped to 2.4 per cent last month, from 2.7 per cent in February. However, factory-gate inflation continued to accelerate, increasing from 5.4 per cent to 5.9 per cent in March.
The government has already taken some steps to reduce the stimulus it is injecting into the economy, including much tighter control over bank lending in March. However, domestic concerns about potential inflation come at a time of growing international pressure to abandon China’s de facto currency peg against the US dollar.

Tuesday, 13 April 2010

The blaming game...

Alan Greenspan, once regarded as the hero of the financial system before its implosion in 2008, recently had to appear before a Financial Crisis Inquiry Commission (FCIC) meeting on Capitol Hill explaining his role, or rather the lack of preventing an economic meltdown at the helm of the Federal Reserve. Financial Times reported on the events of this dramatic hearing:
Phil Angelides, who leads the FCIC, asked the former chairman of the Federal Reserve if the Bank’s failure to curb subprime lending as the housing bubble unfolded fell into the category of “oops”. “My view is, you could have, you should have and you didn’t,” Mr Angelides said.
Mr Greenspan, 84, led the Fed between 1987 and 2006 and has been criticised for helping foster the conditions that led to the collapse of US mortgage markets and, ultimately, the global financial crisis two years after his departure.
“In the business I was in, I was right 70 per cent of the time, but I was wrong 30 per cent of the time”, Greenspan said. “What we tried to do was the best we could with the data that we had.”

Mr Greenspan said it was likely that Congress would have blocked any attempt by the Fed to rein in the subprime mortgage industry, since it was bolstering home ownership across the country. He said lawmakers were now suffering from “amnesia” about their stance on the issue.

In his opening statement, Mr Greenspan said there was no evidence that Fed monetary policy during his tenure contributed to the housing bubble. He argued that it was low long-term interest rates, not the short-term rates that the central bank controls directly, that nourished the proliferation of subprime mortgages. “The house-price bubble, the most prominent global bubble in generations, was caused by lower interest rates but . . . it was long-term mortgage rates that galvanized prices, not the overnight rates of central banks, as has become the seeming conventional wisdom,” Mr Greenspan said.
He also noted that the Fed did not regulate many of the independent mortgage companies that issued subprime loans during the bubble, and lacked enforcement powers to protect consumers more aggressively.
Mr Greenspan said higher capital and liquidity requirements for banks and increased collateral requirements for financial products would mitigate future crises.
“The next pending crisis will no doubt exhibit a plethora of new assets which have unintended toxic characteristics, which no one has heard of before, and which no one can forecast today,” Mr Greenspan said. “But if capital and collateral are adequate, and enforcement against misrepresentation is enhanced, losses will be restricted to equity shareholders . . . Taxpayers will not be at risk.”

Monday, 12 April 2010

The next set of asset bubbles...

Kenneth Rogoff, Harvard professor and co-author with Carmen Reinhart of "This Time is Different: Eight Centuries of Financial Crises" should know something about price bubbles. He discussed the prospects of new bubbles forming in an article published in the Financial Times:
As the global economy reflates, many people are asking: “Is the next bubble in gold? Is it in Chinese real estate? Emerging market stocks? Or something else?” A short answer is “no, yes, no, government debt”.
We find that debt-fuelled real estate price explosions are a frequent precursor to financial crises. A prolonged explosion of government debt is, in turn, an exceedingly common characteristic of the aftermath of crises. But a deeper question is whether economists really have any handle on ferreting out dangerous price bubbles. There is much literature devoted to asking whether price bubbles are possible in theory. I should know, I contributed to it early in my career.
In the classic bubble, an asset (say, a house) can have a price far above its “fundamentals” (say, the present value of imputed rents) as long as it is expected to rise even higher in the future. But as prices soar ever higher above fundamentals, investors have to expect they will rise at ever faster rates to make sense of ever crazier prices. In theory, “rational” investors should realise that no matter how many suckers are born every minute, it will be game over when house prices exceed world income. Working backwards from the inevitable collapse, investors should realise that the chain of expectations driving the bubble is illogical and therefore it can never happen. But then along came some rather clever theorists who noticed that bubbles might still be possible (in theory), if we lived in a world where the long-run risk-adjusted real rate of interest is less than the trend growth rate of the economy.
The real issue is not whether conventional economic theory can rationalise bubbles. The real challenge for investors and policymakers is to detect large, systemically dangerous departures from economic fundamentals that pose threats to economic stability beyond mere price volatility.
The answer is to look particularly for situations with large rapid surges in leverage and asset prices, surges that can suddenly implode if confidence fades. When equity bubbles burst, investors who made money in the boom typically swallow their losses and the world trudges on, for example after the bursting of the technology bubble in 2001. But when debt markets collapse, there inevitably follows a long, drawn-out conversation about who should bear the losses. Unfortunately, all too often the size of debts, especially government debts, is hidden from investors until it comes jumping out of the woodwork after a crisis.
In China today, the real problem is that no one seems to have very good data on how debt is distributed, much less an understanding of the web of implicit and explicit guarantees underlying it. But this is hardly a problem unique to China.
The timing is very difficult to call, as always, but even as global markets continue to trend up, it is not so hard to guess where bubbles might be lurking.

Wednesday, 7 April 2010

Turning the corner?

Financial Times reported on the latest employment figures coming out of the United States:

The US economy created 162,000 jobs last month as the unemployment rate remained unchanged at 9.7 per cent, the government said on Friday, bolstering hopes that the economic recovery is gathering steam.
The economy shed about 8.4m jobs during the recession, as employers made severe cutbacks and learned to cope with a leaner workforce. Productivity soared to historically high rates last year.
The Obama administration, which has been under pressure to find a solution to persistently high unemployment, welcomed the gains.
High unemployment has been a key reason why the Federal Reserve has maintained rates at historically low levels. At last month’s meeting of the Fed’s interest rate setting committee, monetary policy makers said rates would remain at their current range of 0-0.25 per cent for an “extended period”.
The construction and manufacturing sectors, which suffered some of the biggest job losses during the downturn, respectively added 15,000 and 17,000 positions in March. But weakness in the financial industry continued, as companies shed 21,000 jobs. Overall private sector payrolls increased by 123,000 jobs, a big improvement over gains of 8,000 in February and 16,000 in January.

Why some financial advisors are much better than others

FA news (USA) reported why some financial advisors are doing much better than their peers:
The best advisors aren't just beating their peers. The numbers show them practically pounding them into the ground. A recent survey of more than 1,000 financial advisors by consulting firm Quantuvis Consulting reveals that the top 25% in the business generate total average annual revenue of $1.2 million—more than five times the $225,000 in annual revenue that other advisors enjoy. Even more important, the top 25%—a group Quantuvis calls 1QAs—earn $225,800 in operating profits on average, versus just $44,400 for the rest. "It tells us there is an inflection point in a practice's growth where you see exponential gains in performance," says Quantuvis Chief Executive Officer Stephanie Bogan.
Bogan sees three primary drivers behind success:
1. Commitment to the wealth management business model. It is the dominant business model among 1QA advisors, used by 52% of this group. The most common business model among the non-1QAs is financial planning (32%). Just as important as the model, says Bogan, is the top advisors' commitment to it. "The top wealth managers operate proactively, not reactively. They're disciplined and systematic in their approach, and they've segmented their clients and service offering to deliver wealth management profitably," she notes. "Lots of firms segment their clients but don't do anything with the information."
2. A focus on a fee-based revenue model. 1QA firms generate far more revenue from fees than other firms ($670,243 versus $67,631 on average). Also, their fee-based revenue is three times greater than all other revenue sources combined. That focus is also evident in their client base: More than half are fee-based, versus just 30% of non-1QAs' clients."In a commission-based business, the advisor must essentially start over at the beginning of each year. In a fee-based business, revenue might be lower initially but the lifetime value of each client is like an annuity that builds," says Bogan. "As a firm grows, it builds up its base of recurring revenue from fee-based assets. And that allows the owner to focus on service and improving business performance instead of just focusing on selling more stuff to recreate the revenue stream."
3. Significant operational leverage. Top advisors make better use of their resources than do less successful advisors, giving them more time to focus on client service and business development. For example, the 1QA advisors tend to use technology and take advantage of opportunities to outsource more than their peers. Two-thirds of 1QA advisors (66%) use customer-relationship-management software, compared with just under half (49%) of non-1QAs. What's more, 1QA advisors are more likely to outsource a variety of functions--bookkeeping, payroll processing and the like--to third-party providers."
A practice's greatest asset is its advisors' time," says Bogan. "In a factory, the machinery that turns out goods is maintained for optimal efficiency. In an advisory practice, the advisor is the income engine. If it's clogged up doing paperwork or scheduling appointments, the engine isn't running optimally."She's quick to point out, however, that operational leverage doesn't necessarily mean getting bigger. "A two-person firm that outsources its investment management duties and uses technology well can have better operational leverage than a six-person firm that doesn't do either of those things."