The Parallax Brief


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

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.


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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, , , , , , , , , , , , ,

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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