The Parallax Brief

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Unrepentant Subjectivity on Economics, Politics, Defence, Foreign Policy, and Russia

Paradox of Thrift Hits Moscow

Thrift, as my grandmother always reminds me, a good thing. If I save money, rather than spending it on electronic gadgets, more wine than I can really afford, and eating in restaurants five days a week, I build a safety cushion for rainy days and emergencies, and, hopefully, get richer, because the money I save pays me interest, or is in the form of investments that promise to pay a return.

Thrift is even good for the economy, because even though Moscow’s restaurateurs don’t benefit quite as much from my patronage, the bank at which I deposit my money will then loan it out to businesses, which can then invest to expand, and people, who are then able to buy things like cars or houses. My money still stimulates the economy, even when saved.

But there is one problem with thrift: the moment when businesses and people are frightened into becoming thrifty suddenly and all at once.

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Filed under: Economics, Russia, , , , , , , , , ,

Barclays Beggars Belief

Barclays have officially entered ga-ga land. Desperation and efforts to bolster the balance sheet have overridden common sense.

From Willem Buiter’s Maverecon blog on the Financial Times website:

In its report today on Barclays’ Annual results for 2008, the Financial Times writes:

“The bank confirmed it had written down its exposures to complex debt instruments by £8bn in 2008, though the impact was reduced by a £1.66bn gain it booked from the reduced value of its own debt.”

My immediate thought was: surely that report cannot be true. When your market-traded debt becomes worth less because the market considers you less creditworthy than before, and prices your debt to reflect that perception of increased default risk, this does not add to your profits – it simply makes you a worse credit risk.

This is mark-to-market gone mad.

Of course, as Willem points out exasperatedly, this does have a certain basis in real life — a real life scam. A company can make a pretty packet from the bond market by issuing bonds, spending the cash, and then persuading the market that it is highly unlikely to pay back the bonds. The value of the bonds plummets and the company then buys back the (by now valued as next to worthless) bonds for a nominal sum. Hey presto! Free money.

But to imagine that one’s declining credit risk — and therefore declining value of debt — counts as a mark-to-market profit is truly absurd. Barclays still has to pay back the full amount, if it wants to maintain its good reputation and wants access to reasonably priced debt in the future — quite important for a bank, I would imagine. So when will these ‘profits’ be realized? Never. The real value of Barclays’ debt is the same as it was; only its credit worthiness has gone down.

Who does Barclays’ accounting? Arthur Anderson?

And we wonder why it went so wrong.

Filed under: Economics, , , , , , , , , , ,

Russian Bank Sector Debt Scare Story Sends Euro Down

The euro lost nearly 1% against the dollar at one stage of trading today after news broke that Russian banks may seek to restructure over USD400 bn in debt (much held in euros) with foreign creditors.

According to Bloomberg, Anatoly Aksakov, Duma deputy and the head of the Association of Russian Banks, told Japanese paper Nikkei that Russian banks may try to restructure debt, leading to speculation that European banks may face heavy losses on their Russian exposure.

The news pushed the euro down at one stage against 12 of the 16 most traded currencies in the world.

The Parallax Brief believes this is nothing more than a storm in a teacup.

Although there are plenty of other reasons to be terrified about European banks, the euro, and the Russian banking system, this isn’t one of them.

First, Russian banks don’t owe USD400 bn between them. This is the approximate figure for all Russian corporates and financial institutions in total. Second, the majority of that debt comes from investment grade companies like Gazprom, TNK-BP and VTB, not from heavily leveraged oligarch projects on the brink of extinction.

Third, it was the European banks which initiated the process, not Russian banks desperate to restructure debt. Finally, the idea of impartial arbitration seems now to have been nothing more than a potentially helpful proposal from the Russian Association of Regional Banks in the event restructering by an individual bank was required, rather than the response to events it was reported as.

It is indicative of just how jittery the market is when it can be spooked by garbled quotes and misunderstood journalism into a micro-run on the euro, but the Parallax Brief expects this to come to nought, and sure enough, Bloomberg’s most recent update (Update 3) of its article on the matter (linked above) is far less sensationalistic in its tone.

Filed under: Economics, Russia, , , , , , , , , , ,

Toxic Bank a Supine Move to Avoid N-Word.

Britain has become the first nation to attempt to resuscitate its banking system through the creation of a so-called ‘toxic’ or ‘bad bank’. The government hopes to transfer to an ‘aggregator’ those assets which are dragging the banks down, leaving the banks free to perform their usual economic duties, and, fingers crossed, leaving the tax payer with a nice profit once the world economy recovers from its economic heart attack.

The business community breathed a sigh of relief when it learned of the government’s plan, but is it a really good idea?

I’m afraid the obvious answer is no, it is not a good idea. The government should have bitten the bullet and nationalized all banks of systemic importance. It should have nationalized them back in October instead its of original bailout. And it should have nationalized them instead of this latest bailout. Ultimately, it’ll probably have to nationalize the banks anyway.

The government’s chosen alternative, the ‘bad bank’, in effect argues “even though the market says these assets are worth X, we are willing to pay Y,” because the only way the government can make these banks solvent again is by paying more than the market would. Of course, it hopes prays that in doing this it will finally purge the financial arsenic from the banking system’s blood stream, allowing for recovery, while getting valuable assets at an ultimately profitable price. But how likely is the government to be able to successfully second guess the market? And will this really prepare the ground for recovery?

Nobel Laureate Paul Krugman is skeptical:

“Now, maybe private buyers aren’t willing to pay what toxic waste is really worth… But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make [the banks] solvent again?”

Krugman believes that the government, in effect, is handing the banks a huge stack of tax payers’ cash, while taking risks that the banks cannot.

“What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.”

Clearly, something had to be done. The banking system is currently on life support, breathing only through the mechanisms the government provides. Last time things were this bad we tried turning off the machines, causing the Great Depression. Doing nothing, therefore, was not an option. But gifting the shareholders and management of the banks should not have been the first course of action.

Of course, a Labour government nationalizing banks is a public relations open goal for the Conservative Party, and this government is nothing if not supine, so perhaps we should have expected Brown and Co. to writhe and thrash a bit before succumbing to the inevitable.

But the sooner the government plucks up enough courage to use the N-word, and makes an announcement that it is nationalizing the British banking system for a strictly limited period of time, the better it will be for everyone.

Filed under: Economics, Politics, , , , , , , , , , , , ,

Time for RBS, HSBC, and LloydsTSB-HBOS to become British Sberbanks

News slithered uncomfortably down the wires yesterday that the British government had agreed to convert its GBP5 bn of Royal Bank of Scotland preference shares into ordinary shares, taking its stake in the beleaguered bank to 70%. RBS is now, effectively, a nationalized government bank.

Predictably, the denizens of the Right have savaged the decision. On his excellent blog, John Redwood, made some wholly rational points about the move:

“…RBS will announce losses of over £6 billion, or one third of the government capital… The government is now risking huge sums of money. Of course I hope they get the terms of the scheme right and that credit starts to flow again. Even if that were it happen, I will still worry about the high risk…”

Mr. Redwood is reasonable, but wrong. He is right to argue that we don’t really want the government to be risking our money. He is also correct to question, as he did earlier in his piece, whether the government should be dabbling in nationalization in this day and age. “Didn’t we,” Mr. Redwood and many others from the Right seem to be asking, “get past this in the 70s?”

But the Right is completely missing the point. In ordinary times, people like Mr. Redwood would be right. But these aren’t ordinary times. This process is not ideal, but given the alternatives, we must hold a pomander under our noses and plough ahead.

Willem Buiter, Professor of European Political Economy at the London School of Economics and former chief economist of the EBRD and member of the MPC, argues in his latest blog for the FT that the banks are:

“…dead banks walking, held up both by actual government financial support (directly through capital injections and indirectly through such facilities as the Special Liquidity Scheme and the Treasury’s guarantee on new bank debt) and through the anticipation of future government financial support.”

And he’s right. These banks would have gone bust but for implicit or tacit government support. We tried doing nothing and letting banks go bankrupt between 1929 and 1932, and it led to the Great Depression, so I would respectfully suggest that repeating that course of action would not necessarily be best for the country. This leaves us with two options: bail outs or nationalizations, of which nationalization is surely most desirable.

Nationalizing the banking system, along the Swedish model, would give us the best chance of defibrillating inter-bank lending, boosting credit provision, and, most important, would provide tax payers the best chance of getting a return on their investment in the long run, while avoiding moral hazard by wiping out current shareholders and the banks’ egregious management.

What the Right need to understand is that we who argue for nationalization aren’t communists, and would never countenance such actions in usual circumstances – even in a ‘normal recession’. But without government support, the British banking system will collapse, consigning the country to untold misery and hardship. None of us wants that. Given the remaining options, nationalization best fits the bill. And better nationalize now than try injecting capital, buying up bad debt – and generally throwing the kitchen sink at the problem in the hope of avoiding the inevitable – only to have to nationalize every major bank anyway.

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