The Parallax Brief

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

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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, , , , , , , , , , ,

Redwood Supporter in Sense of Humour Shocker; the Pound

So coldly logical is John Redwood’s delivery that he has been dubbed “Mr Spock” in his time, but for one of his supporters at least, wit is not “a difficult, alien concept, captain.”

Responding to Redwood’s short blog on the pound’s latest fall, one poster drolly asked, “I wonder if we can persuade Obama to invade us in the name of ‘regime change’?”

Of course, he then went on to spoil it with a paragraph of right-wing invective about the UK going bust, his sterling savings being devalued along with the pound and me-me-me, but at least his opening gambit managed to raise a cackle from here in Moscow.

On this matter, I’ve been rather irritated by the right’s response to sterling’s drop. Although the phrase “strong pound” sounds very nice, in a chest out, chin up patriotic kind of way, it really wouldn’t be very beneficial in current times.  

A weak pound lowers the relative cost of British goods and raises the relative cost of foreign goods. This has three, extremely beneficial effects: First, British goods become cheaper in both the home market and export markets, materially aiding British companies. Second, encouagement to buy British will help rebalance the UK’s current account deficit. Finally, making foreign goods more expensive will bring at least a small amount of inflationary pressure to bear on the British economy. The Bank of England’s precipitous interest rate reductions, and the current yields on British gilts, give a pretty terrifying indication of just how very close we are to slipping into full blown debt deflation. Anything to encourage inflationary expectations in this environment can be considered A Good Thing.

In boom times, these factors might be negative, as they would likely fan the flames of inflation and discourage saving. And of course, much more of a drop, and investors may get frightened off British investments, and especially our gilts, making financing our current, essential-for-survival budget deficit more expensive — or perhaps impossible — which would be an outright Russia 98-style disaster.

But so far so good.

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

City of Moscow Bond Auction Fails

News emerged this week that a City of Moscow bond auction raised only RUB1.5 bn of the total RUB15 bn offered. For the uninitiated, that’s flirting uncomfortably close to levels where the entire auction would be declared null as a complete failure (usually set at 10%). However, what’s surprising about this news, in my view, isn’t the paucity of investor interest, but that Moscow City managed to sell any at all.

Last week, the world was dealt an arresting reminder of just how cautious investors have become, when a German Sovereign bond auction failed to garner bids for the full amount offered. German bunds are among the safest, most liquid securities in the world, so covering only 87% of the EUR6 bn the German government hoped to raise is a shocking, once-a-decade rarity.

It is clear then, that the investor flight to safety has gone supersonic. When investors eschew even uber-safe securities guaranteed by the Bundesbank, what chance does the City of Moscow have? Certainly, Moscow’s credit image isn’t going to be helped by the revelations that the Moscow Oblast Government (a separate entity not related to Moscow City) looks as though it will liquidate its huge quasi-sovereign subsidiary companies MOITK and MOIA due to “mismanagement” (a codeword for “endemic corruption”) at those companies, and possibly within (code for “definitely within”) the Oblast government itself. Both MOITK and MOIA are fully owned by Moscow Oblast, are major players in the Russian capital market, and have bond issues outstanding.

And all this doesn’t account for the currently devaluing ruble in which the bonds are denominated.

The interest rate for the bonds the city government did manage to sell was set at 15%. Considering it would not be a surprise – by some estimates – for inflation to run as high as 20% this year in Russia, and that most analysts expect the government to allow the ruble to devalue by at least another 15%, investing in the Moscow City bonds at 15% interest means one will likely be left with a hefty loss – even excluding from the equation the default risk spread over AAA securities such as bunds, T-bonds or British gilts.

Where do I sign up?

I asked a contact with more knowledge of capital markets than I (not difficult), and he admitted that there was no fundamental justification to buy these bonds. He claimed, however, that they do make sense as a method of managing ruble liquidity – people need somewhere to park their cash, and if one needs to hold significant quantities of rubles the Moscow City bonds at least offer some return, even if it is negative.

What’s really funny, he said, is that after the auction Moscow City claimed it expected to sell only RUB4-5 bn (about 30% of the total), but were surprised that it did even worse than expected. I think I covered above the reasons why the issue was blatantly going to struggle, but why on God’s green Earth would one try to issue RUB15 bn if at best one expects to sell RUB5 bn?

It’s a crazy world.

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