Tuesday, September 30, 2008
Rich nations not keeping aid promises -Blair
Credit crisis will hit developing countries hardest
A poverty summit convened last week at the UN in New York City. The main topic of discussion was the progress towards the Millennium Development Goals (MDGs) which were created to halve global poverty by 2015. Many speakers also talked about an African aid goal set by the G8 in 2008. (Please refer to this previous post for more discussion.) In 2005, the G8 pledged to double its aid to Africa by 2010.
Tony Blair, the former British Prime Minister and the main proponent of the G8 pledge, urged rich countries to uphold their pledges and continue to increase aid to Africa. Mr. Blair cited many improvements that were the result of the increased aid, but warned that much more needed to be done. Blair said, “The truth is there's been a substantial increase but it's not the increase that we pledged, and therefore there's more that's got to happen."
Tony Blair’s successor, Gordon Brown, added that the current credit crisis cannot be an excuse for rich countries to back out on their aid pledges, whether to the MDGs or to Africa. He was not alone. Dutch Development Minister Bert Koenders was also worried that leaders, especially in the US, may not fulfill their pledge. He said, “People in Wall Street who turn out to have cheated everyone are receiving 38 billion in bonuses. That's equal to all the aid to Africa.”
Right now it is unclear whether the credit crisis and the proposed US bailout (which is still in limbo) will affect the US and other rich countries’ ability to give the pledged aid to Africa. The UN has pledged its continued support of the MDGs. It is clear that a vocal group of leaders around the world will do what they can to hold other rich countries accountable for their pledged aid. Only time will tell if they are successful.
1) It is true that the US did pledge to increase aid to Africa and to meet the MDGs. However, these pledges came before the enormous problems the US faces with its credit crisis. Is it right to still expect the US to contribute large amounts of aid when, arguably, the money could be used at home? Does the US have a special responsibility to live up to their promises because of its vast wealth and influence? If the US doesn’t live up to its promises will other nations follow suit?
2) What do you think the public perception is about aid to poor countries? Should there be a grassroots effort to raise public awareness of the increased African aid and the MDG? Could more public awareness lead to more governmental accountability?
Monday, September 29, 2008
Sources: IMF: A systemic crisis demands systemic solutions
FT.com: IMF welcomes step to reform
IMF managing director Dominique Strauss-Kahn, in an interview Sunday with French newspaper Journal du Dimanche, followed up on his earlier remarks in support of the proposed U.S. bailout of the financial sector. He said he supported the plan “because it’s global...[b]ut it has to be the first step of international political action.”
The Director said that it was necessary for the U.S. to pass the bill to “put out the fire,” but that the effort could not stop there. In his remarks earlier this week he stated specifically that “[o]ther advanced economies should also be preparing comprehensive contingency plans,” something that many countries have been reluctant to consider.
He also stressed the need for international regulatory reform to follow in the wake of the meltdown and said that the IMF would be willing to serve as a leader of any new regulatory framework, perhaps as what he termed a “global guarantor.”
Finally, while Strauss-Kahn acknowledged the worldwide economic slowdown likely to result from the financial crisis, he emphasized that the “real economy” is strong enough to survive and that the central banks were thus far succeeding in managing the crisis.
Is Strauss-Kahn correct when he asserts that a global solution is needed, implying that other countries will need to follow the U.S. in bailing out their respective financial sectors? Would this be possible in the Eurozone, where governments are already subject to strict budgetary and deficit restrictions? What do you think about Strauss-Kahn’s suggestion that the IMF play a lead role in future regulatory reforms?
There seems to be some debate as to how sovereign wealth funds (SWFs) in the Middle East will respond to the recent credit crisis. Some assert that SWFs in the Middle East, not unaffected by the credit crisis, will now turn their attention, and billions of petrodollars, to their home countries.
Although oil prices have experienced a five-fold increase since 2002, stocks in the Gulf, specifically, have plunged in recent weeks as fears of fallout from the credit crisis spreads. In addition, the UAE central bank opened up an emergency facility to prevent lending from seizing up. As a result of these spillover effects from the credit crisis and growing domestic social pressure, SWFs in the Gulf have claimed that they will now spend their money at home.
For example, a leading executive of Qatar’s SWF recently disclosed that he had rejected the chance to help recapitalize troubled Wall Street banks. However, people close to the Qatar Investment Authority suggest that it is likely to become more active in the US market when the US government’s bail-out of Wall Street is complete. Similarly, it is also reported that Arab SWFs are likely to seize upon distressed US assets after the US government bail-out plan eases the severe tensions in the financial markets. SWFs, especially in the Gulf, recognize that after a period of turmoil there will be a time when market opportunities are great, and at that point, they will likely be looking for opportunities to invest.
Discussion: If the government bail-out bill goes through, do you think that Arab SWFs will then begin to invest in the US economy? What if the bill doesn't go through? Do you think that the Gulf SWFs have a responsibility to put money into their own economies first?
Sunday, September 28, 2008
Although still growing at rates other nations envy, the world’s fastest growing economy is starting to slow down. Economists predict that the Chinese economy could grow by as little as eight percent next year, as opposed to the double digit rates of years past. It is unclear yet whether China is facing real financial problems or is merely experiencing a positive step back from unsustainable growth rates.
However, there is growing worry that a variety of Chinese markets will begin to fall off. For example, while exports continue to increase, business with Europe—China’s main export market—is decreasing as European consumers are affected by the credit crisis. Economists are also worried about China’s property market, a driving force in the Chinese economy. Although growth rates vary substantially by city, many cities are reporting a decline in property prices, as well as in sales and floor area under construction. Production of building materials and mortgage approvals are also down. It is hoped that, because Chinese homebuyers must put down much larger deposits on homes than homebuyers in many developed nations, the property market will stabilize. If the property market does begin to collapse, however, it will have a direct negative effect on private sector investment and—in turn—on the rest of the Chinese economy. Should the Chinese economy experience a sharp decline, Middle Eastern and Latin American countries will be hit hard, as well, since they rely on China to buy up the commodities they are producing.
China is not sitting back idly, waiting for its economy to collapse, however. It recognized several years ago that double digit growth rates could not be sustained indefinitely and is looking for ways to introduce a large structural shift into its economy. Several options to further this plan include improving social security so that workers feel more confident about their savings and willing to spend more money, and loosening its restrictions on credit. It has already reduced interest rates and reserve requirements for small banks.
(1) Is China’s economy experiencing the beginnings of a true crisis or does its slowing growth rate reflect a welcome and inevitable step back from inevitable growth rates?
(2) If the Chinese economy were to experience its own recession, how would such a recession affect the rest of the world’s economies?
(3) Are China’s options for shifting its economic structure viable and likely to work?
For over 20 years, Spain has permitted a constant flow of migrant workers to openly participate in its labor force, much to the objection of many other EU countries. With open EU borders, Northern European states such as France, Germany, and the Netherlands have worried about the impact of Spain’s immigration policies on their own unemployment rates. Spain has run 6 legalization programs since 1987. Italy and Spain together account for an estimated two thirds of the undocumented immigrants in the EU. Spain offers free health care, including free hospital care and treatments such as dialysis for diabetes, and public schools to both documented and undocumented immigrants. These social services alone could be enough to draw some migrants from developing countries. The Spanish government has asserted that promoting inclusivity deters political protests, desperation, and consequential terrorism, and that such social order should be prioritized over economic motives, not to mention the income tax revenue Spain collects from registered immigrants.
Historically, both socialist and conservative parties in Spain have supported a quick path to legalization for immigrants. When the EU economy skyrocketed in 2001, Spain’s relatively lax attitude served it well; a substantial senior citizen population meant that labor needed to be outsourced and immigrants quickly filled that void. In 2003, Spain even created a policy to give legal status and documentation to those migrants that had already acquired legitimate work. Two thirds of the applicants came from five countries: Ecuador, Romania, Morocco, Colombia and Bolivia. Immigration grew by 30% that year (not accounting for undocumented migrants already living in Spain who registered after the policy was announced), as opposed to the previous rate of 3%. Yet, it all seemed to be working, as Spain still had fewer clashes than other immigrant-heavy countries such as the U.S.
And then came global economic crisis.
Unemployment among immigrants has skyrocketed 40% in recent months, with a 14.7% unemployment rate for foreigners versus an 8.7% rate for native Spaniards. In fact, immigration was a contingent issue in this year’s election for the first time in decades. With the lull in the construction boom and cuts in the tourism industry, many newly-arrived immigrants cannot find the work they were expecting. Violence has begun to escalate, as demonstrated by the rioting and consequential stabbing of a Senegalese man in southern Spain earlier this month. The Labour and Immigration Minister further fueled controversy when he declared that visas for migrant workers would be stopped completely during the coming year. To discourage further immigration, Spain has even enacted a plan to pay jobless migrants unemployment compensation in advance, on the condition that they return to their home country and promise to stay away for at least 3 years. Experts predict about 10,000 of the 165,000 legal immigrant residents, most of whom are from Ecuador and Morocco, to take advantage of the policy. The hospitality that has made Spain a haven for immigrants will undoubtedly need to be further adjusted in light of global financial crisis.
1. Do you think financial crisis will lessen or increase migration from developing countries to the United States and Europe?
2. Economic crisis aside, do you agree with Spain’s philosophy that inclusive immigration policies deter crime and terrorism?
Sweeping Bailout Bill Unveiled, Washington Post
Bailout Plan in Hand, House Braces for Tough Vote, New York Times
After days of speculation and political maneuvering, it appeared on Sunday that Congress had reached a compromise in its efforts to pass a bailout of the United States' economy. The 110-page, $700 billion financial rescue legislation still needs the official approval of the House and Senate, but leaders from both the Democratic and Republican parties expressed confidence that the bill will pass quickly.
The proposed $700 billion package comes in three parts. $250 billion would be available for immediate distribution by the U.S. Treasury Department, with an additional $100 billion distributable with approval by the President. The remaining $350 billion would be made available with the approval of a congressional joint resolution.
While both Democratic congressional leaders and members of the Republican administration seemed pleased with the final draft of the legislation, each party had to make substantial compromises in its formulation. Among the most significant of these compromises was the administration's concession to congressional demands that the bill include a provision allowing for a potential repayment by the financial industry of the money invested in the bailout by the federal government. Other concessions included the Republicans' allowance of caps on executive compensation and Democrats' giving up their plan allowing restructuring of mortgages by bankruptcy judges.
Despite the compromises and deals made by the Bush Administration and congressional leaders, there remains a vocal, bipartisan opposition to the bailout legislation--the bulk of which is centered on the notion that it is inappropriate to use public tax dollars to make up for the mistakes of the private-sector financial community.
1. Is the bailout legislation, in its current incarnation, the answer to the potentially worsening predicament facing the American financial community?
2. Which, if any, of the compromises made by the parties negotiating the legislation should not have been made?
3. What, if anything, is the legislation missing? What, if any, provision of the legislation should have been left out?
4. Does the bailout bill provide sufficient oversight for the Treasury Department and its infusion of money into the market?
After the two-day suspension of trading on the Russian stock market last week, the government’s massive injection of money into the market averted a major crisis in the short term. When the market re-opened, in fact, buyers moved in so quickly that the market had to close again. The government considers this move not a bailout but an investment, as stocks are expected to rise significantly in the next several years. Either way, it remains to be seen how effective this strategy will be in the long term.
Medvedev and the rest of the Russian government blame Russian economic troubles principally on the U.S. government’s economic policies and the resulting financial crisis in this country. Since speculative money from foreign investors makes up nearly 70% of the Russian stock market, and hedge funds were forced to quickly sell Russian assets to cover huge losses in the U.S. subprime mortgage market, it is easy to see a connection between the financial climate in the two countries. Though the Russian economy at first seemed insulated from global troubles, it now appears that this is not the case, with an obvious tie between the AIG bailout and the Russian stock market crash.
However, there are other reasons for Russia to be having a difficult year that do not depend on U.S. successes or failures. Analysts have long warned that Russia’s dependence on oil and gas revenues would eventually become dangerous, and it seems that they were right, as a significant drop in oil prices is clearly responsible for a large part of slowing growth. The Georgia conflict is another important factor, with about 30% of losses on the RTS index occurring after hostilities began, and $30 billion in investor pullouts in six weeks following the conflict.
The Russian government has reacted by trying to reduce the importance of foreign investors in its markets and encourage long-term domestic investments, including investments of the National Wealth Fund in Russian markets. The liquidity injections are part of this plan, as is a change in tax structure that makes stock and mutual fund earnings tax-free for private Russian citizens after one year. The government hopes that this will encourage Russians to invest in their own economy and loosen dependence on volatile Western markets.
Aside from the stock market, capital outflows and troubles in the banking system are major issues that need to be addressed if Russia is to continue on a trend of long-term growth. In a speech on Thursday, economic aide Arkady Dvorkovich espoused high hopes for Moscow as a possible financial center and Russia as a world financial leader, but also noted drastic changes in the way the banking system operates worldwide. Russia, like the U.S., has been forced to think about bailouts, starting with Svyaz Bank on Tuesday. There is also a possibility that the government will create more state-owned banks, on the theory that they are less vulnerable.
Though Russians are looking to the future and hoping that a world economic realignment would be beneficial, two international indicators were cautious this week in assessing the Russian situation. Moody’s Investor Service on Friday issued a report that rated the banking system overall rather poorly based on failure to apply best practices, failure to obtain more liquid assets and curb expansion of lending, and dependence on the interbank market. The IMF also reduced its 2008 growth forecast for Russia from 7.7 to 7.1% and for 2009 from 7.3% to 6 or 6.5%. The IMF does, however, still expect strong growth long-term as long as appropriate policy responses materialize.
1) Do you think Russia has the potential to become a major world financial leader in the next five to ten years, and the ruble one of the principle reserve currencies?
2) Is the government right to blame U.S. policies for the recent downturn, or are internal problems such as corruption and dependence on oil exports to blame?
Saturday, September 27, 2008
"Los nervios de argentinos con depositos en EEUU" Grupo de diarios de America
"El terremoto financiero" El Universal
The ongoing financial earthquake that has shaken the wealth in the U.S. directly impacts investors throughout the world. Among those affected are citizens of other countries who hold accounts in U.S. banks and investment companies. Many Argentineans fall within this affected group.
It is common practice for Argentinean investors and savers both large and small to keep their funds in the U.S., away from the historically turbulent Argentinean economy. During the last week, the credit crisis in the U.S. translated into a temporary decrease of capital outflow from Argentina to the U.S. Many Argentineans are now facing the realization that their investments in the U.S. are not as secure as they believed.
Some Argentinean investors and savers did not fully appreciate the risk they were taking on with certain U.S. investments, for example they assumed most investment accounts in the U.S. carried equally low risk, simply given the fact that both accounts were in the U.S. and in U.S. dollars as compared to Argentina, where the peso has a history of violent turbulence. They did not account for the risk inherent in certain investments, such as money market accounts, where the funds are invested in short-term securities. As one Argentinean explained, people place money in a U.S. account to forget about the Argentinean risk, but do not take the time to look where their funds end up.”
Now Argentineans who are concerned about their U.S. investments face certain barriers to bringing their money back into Argentina. Besides the uncertainty of where better to place their hard-earned funds, moving their money between countries entails bank and/or governmental administrative fees of between 0.5 and 3.0 percent. This is only one way that the U.S. credit crisis is effecting countries around the world, in a phenomenon that Argentinean President Cristina Fernandez has dubbed the “jazz effect” after the “tequila effect” that stemmed from the Mexican peso crisis in 1994.President Fernandez, in comments to the United Nations earlier this week, criticized the U.S. for what she called its runaway capitalism and for the global effects of the deregulation and lack of economic intervention that has traditionally been championed by the U.S. She pointed out the irony of the U.S. bailout efforts, stating that the “the most formidable state intervention [in the economy] is now produced by the country that said the state could not intervene in the economy.” President Fernandez has pointed to this fact while pushing for her economic interventionist policies for the Argentinean financial system.
1) How can Argentina support its citizens looking for safe investments?
2) How analogous is the "tequila effect" stemming from the Mexican peso crisis of 1994 to what President Fernandez has dubbed the "jazz effect" stemming from the current credit crisis in the U.S.?
3) Is it time, as President Fernandez suggests, to pursue a more interventionist policy in the financial system and the wider economy?
Thursday, September 25, 2008
On October 2nd, the International Accounting Standards Board (IASB) will be holding an unprecedented "special meeting" to discuss proposed amendments to International Financial Reporting Standard 7 (IFRS 7). IFRS 7 currently requires companies to disclose information regarding, first, how important their financial instruments are to their financial position, and second, the risks that their financial instruments entail and how companies manage those risks. Financial instruments are contracts, such as loans and investments, whereby parties exchange assets and liabilites. The disclosure requirements set forth in IFRS 7 are meant to ensure that companies clearly communicate to investors the risks that will arise out of prospective transactions.
At the October 2nd meeting, IASB officials will specifically discuss whether to amend IFRS 7 to prohibit fair-value accounting. Fair-value accounting, also known as mark-to-market accounting, is the practice of determining the value of a financial istrument by looking at what the instrument is worth on the market at the time of a transaction. Fair-value accounting has been referred to as one of the "lightning rods" that spurred the credit crisis, so the IASB's potential prohibition of the practice is undoubtedly a reaction to the events that have recently taken place.
Supporters of the prohibition against fair-value accounting have suggested that IFRS 7 use banks' estimates of hold-to-maturity prices as replacements for the values that result from fair-value marketing. Hold-to-maturity prices do not reflect fluctuations of the fair value of financial instruments, but are rather reported at amortized cost. Unsurprisingly, banks favor the idea of replacing fair values with hold-to-maturity values, because doing so would give them more power to estimate what instruments are worth without having to take into account fluctuations in the market. Others argue, however, that using hold-to-maturity prices as replacements for fair-value prices would be dangerous to investors who would have to rely on banks' internal estimates of the value of securities. Forcing investors to rely on banks' estimates would shake their confidence and make them less likely to participate in the market.
IASB officials will also discuss off balance-sheet accounting, another so-called "lightning rod" of the credit crisis, during the meeting. Officials will review drafts of proposed standards controlling how parent companies report subsidiaries' results on their balance sheets. These proposed standards specifically address how parent companies report special-purpose and structured-investment vehicles, two items that have played a role in the rise of the credit crisis as well.
While the meeting will be taking place in just a few days, the IASB also hopes to publish the proposed amendments later in the year.
1- The October 2nd meeting is unprecedented. What does the fact that the IASB is holding a "special meeting" tell us about the extent to which the credit crisis has affected the international business community?
2- The choice between preserving fair-value accounting in IFRS 7 and replacing it with hold to maturity values seems to be the choice between what is convenient for investors and what is convenient for banks. Which interest do you think will dominate during the October 2nd meeting?
3- What is so important about reporting a subsidiary company's activities in a parent company's balance sheet? Does transparency in business really lead to more stability, or is there such a thing as "too much information"?
Wednesday, September 24, 2008
Globe and Mail (Toronto) - Canada Could Face Housing Woes, Merrill Warns
Bloomberg - Canada Stocks Fall
Canada's housing and mortgage markets have remained relatively stable despite the United States' financial crisis. Nevertheless, the Canadian stock market continues to fall because of the continuing global credit crunch as well as expectations of slower U.S. economic growth. The U.S. is Canada's biggest trading partner.
Canada's housing and mortgage markets are more stable than those in the U.S. Canadian lenders have not issued subprime mortgages to the extent of U.S. lenders, and Canadian residential property does not appear to be significantly overvalued. Canada's banks are also currently more stable than their U.S. counterparts. Although Canadian banks have had writedowns due to exposure to the U.S. subprime market, Canadian banks have a stable base of domestic deposits.
However, some experts such as Merrill Lynch Canada have warned that Canada may go through a period of financial turmoil in the near future, citing the high average level of debt in Canada. Household debt in Canada currently averages six percent of income, putting it near the record-high U.S. level in 2005 before the mortgage crisis. Others argue that lenders have been considerably more conservative in Canada than in the U.S., and that current Canadian household debt is not "risky."
Canada's stock market index fell for a third straight day, mainly on news of the U.S. government's announced financial bailout. The Canadian stock index has declined more than nine percent in September, the most in a month since 2001.
1. How has Canada, a large and integrated trading partner of the U.S., been able to avoid the economic meltdown occurring among U.S. banks and investment firms?
2. What is the relationship between a falling Canadian stock market and the health of its financial sector, including banks and mortgage lenders?
Tuesday, September 23, 2008
Goldman and Morgan Shift Marks End of Era in Finance, New York Times
The era of huge, unregulated Investment Banks and their domination of the Wall Street culture has, at least for now, come to an end. On Monday, the Federal Reserve announced that, as part of their efforts to stay afloat in the increasingly tumultuous financial climate, the two remaining large investment banks (Morgan Stanley and Goldman Sachs) would officially become "bank holding companies."
As bank holding companies, Morgan Stanley and Goldman Sachs will be subject to full regulation by the Federal Reserve, just as major commercial banks have been for years. The deal struck with the Federal Reserve will require the investment banks will surrender their rights to make aggressive use of their own capital--and debt--to make major deals and transactions with little or no government oversight.
The loss of certain financial freedom does not, however, come without substantial benefits to these banks. In exchange for opening themselves to increased regulation, Morgan Stanley and Goldman Sachs will avail themselves of the substantial loans that the Federal Reserve is allowed to make to commercial banks. Such loans and the liquidity they provide may prove essential to the two banks' survival as the consequences of the worsening credit crisis come to fruition over the next weeks and months.
1) Was the Federal Reserve correct to allow Morgan Stanley and Goldman Sachs to change their classification thereby availing them of billions of dollars in Federal Reserve loans? What role will this new financial relationship have on the immediate future of these companies? Of Wall Street?
2) How substantially will the new regulations affect the business activities of Morgan Stanley and Goldman Sachs? Of Wall Street as a whole?
3) What will be the long term effects of the removal of investment banks (in the traditional sense of the term) from the Wall Street scheme?
Monday, September 22, 2008
Financial Times 1
Financial Times 2
Financial Times 3
According to a report entitled “Comprehensive Economic Recovery in Zimbabwe” published by the United Nations Development Programme (UNDP), Zimbabwe is in bad shape financially and could need billions of dollars in foreign aid. Five Zimbabwean economist were responsible for the 239 page report often calls for drastic and potentially painful policy measures to get Zimbabwe’s economy back on track.
The report says it could take at least 12 years for Zimbabwe to recover to peak levels of per capita income recorded in 1991. A 5% annual growth rate of the economy of 12 years would be necessary to return to 1991 levels of income. The authors warn that 4% annual growth is much more likely to occur. And while Zimbabwe has been experiencing devastating inflation and a shrinking economy, other countries in sub-Saharan Africa have seen large economic gains. Zimbabwe is losing millions of skilled workers to South Africa and the UK and wide-spread AIDS has dropped the average life expectancy by 20 years.
It seems that a minimum of $5 billion of foreign aid will be necessary over the next 5 years in order to get Zimbabwe back on its feet. Most of the money will go to plug up large budget deficits and to beat back the hyper-inflation that has crippled the economy. The report also suggests that action must be taken immediately in order to ensure swift change and that the initiatives do not get bogged down by internal conflict.
As a previous post discussed, the recent presidential election in Zimbabwe was marred with conflict. The leaders of the two rival parties are in the process of negotiating an agreement to share power in a way that reflects the will of the Zimbabwean people. These negotiations have been mediated by South Africa’s president, Thabo Mbeki, who has recently resigned amid his own political controversy. Many worry that the rival parties will use this to their advantage and slow real progress.
The UK, US, and the European Union are all worried that no real political stability will emerge, thus making it difficult to imagine that they will be giving large sums of aid-money in the near future. The US has recently given Zimbabwe an ultimatum that it must quickly settle its government problems and insure that aid money will be available to all citizens regardless of political affiliations otherwise the US will not give more aid money. Ultimately the economic situation in Zimbabwe will continue to be unclear until the government can provide much need stability.
1) After a heated election this summer that resulted in many deaths, how likely is it that the rival parties will be able to settle its differences and focus on the severely damaged economy?
2) Will the strain that the credit crisis is causing in the US and the recent announcement of the $700 billion bailout funded by taxpayers affect the US’s ability to offer substantial aid to Zimbabwe?
Sunday, September 21, 2008
Although the credit crisis has proven that the Middle East is not detached from the world economy, Middle Eastern banks adhering to principles of Islamic finance remain virtually unscathed. In fact, the credit crisis has provided Islamic banks with a chance to play up the contrast between them and conventional banks.
The basic principle of Islamic banking is the prohibition of riba, or interest. In addition to discouraging interest-based banking, Islam also prohibits investments in sectors like liquor, pork, gambling, pornography and anything else that Islamic law deems haram, or unlawful.
Investors traumatized by the credit crisis could seek comfort from the stricter rules imposed on lending by Islamic law, which effectually bans some of the financing methods that proved unworkable during the U.S. mortgage crisis. Specifically, Islamic law requires transactions to be linked to assets, thus deterring the kind of complexities prevalent in conventional financing operations.
However, while the virtues of Islamic financing have recently been increasingly noticed, analysts say market commentators and intermediaries may be too zealous in promoting the merits of Islamic finance as a safe product.
Thus, while there is some debate on whether Islamic finance really provides a safer bet, most agree that the industry should make the most of the attention it is now receiving. The virtue of Islamic finance is currently drawing the interest of companies outside the Middle East. Accordingly, David Testa, chief executive of Gatehouse Bank (an Islamic bank in Britain) claims that “the current market condition has given Islamic finance a great opportunity to show what it can do—help to fill the liquidity gap. If Islamic banks step up to the mark, then they will gain attraction.”
Discussion: Do you think that companies affected by the credit crisis will consider pursuing principles of Islamic finance? Do you believe that Islamic banking is really less risky than conventional banking? Would the credit crisis have happened if Islamic finance principles were used in the United States? Even if it is less risky, does Islamic banking inhibit growth?
In advance of the forthcoming publication of its highly anticipated yearly economic analyses-the World Economic Outlook and the Global Financial Stability Report-IMF First Deputy Managing Director John Lipsky gave a first look at the Fund’s impressions of the current global economy this week. He expressed “cautious optimism” about the prospects for avoiding a global recession, but emphasized the need for “clear and coherent” policy responses from governments around the world.
Citing three shocks to the global economy: high energy and commodity prices, the housing market crisis in the US and other advanced economies, and the recent, and ongoing, financial turmoil, he laid out their potential effects and his reasons for optimism that a “gradual recovery” will continue.
First on the list of encouraging developments was the recent decrease in oil prices, which should lead to increased consumer consumption with a potentially greater effect in the US than the income tax rebates given earlier this year. Second was what he characterized as the “plausible” anticipation that the US housing market will bottom out in 2009, reducing that market’s current drag on GDP. He also highlighted relatively robust growth in emerging markets, resulting in increased exports to those countries, which has supported US growth as the relatively low value of the US dollar further encourages export growth. Last, and perhaps most importantly, he cited recent research by the IMF indicating that a credit crunch does not necessarily foreclose overall economic recovery, particularly given the strength of American corporate finances and productivity.
In the speech, which was delivered at the Center for Strategic and International Studies in Washington DC, Mr. Lipsky praised the American government’s decision to bail out mortgage giants Fannie Mae and Freddie Mac, but said that a “more systematic” approach might be warranted. This suggestion turned out to be quite prescient as it was given just one day before the American government announced its plan to systematically buy “toxic” assets from troubled institutions.
Despite the global challenges and the increased risks from this past week’s financial meltdown, the IMF projects that global growth will be around four percent for 2008 and just under four percent in 2009, a relatively small decrease from the 4 and three quarters increase seen in 2007.
Do you think the IMF is overly optimistic about the state of the global economy? What are some possible global implications of the current instability in the financial world?
Saturday, September 20, 2008
On Friday, September 19th, the Inter-American Development Bank ("IDB") approved the creation of the Aquafund, a project that will disburse funds to Latin American governments that wish to improve their water and sanitation services. The Aquafund is designed in large part to help finance the early stages of water and sanitation projects. Once it starts to operate, the Aquafund will be able to quickly disburse funds to elligible governments. By 2011, IDB officials hope to reach out to 100 Latin American cities and 3000 Latin American rural communities.
The Aquafund will be a multi-faceted financing project. Starting now, the Aquafund will be able to disburse up to $15 million in grants drawn from the IDB's internal sources. In 2009, the IDB will also begin to match contributions that other countries make to water and sanitation projects. IDB officials predict that they will be able to provide up to $35 million in grants over the 2009 calendar year through the Aquafund. The project will also provide flexibility to governments who seek support from more than one lender, since it will allow governments who have secured Aquafund loans to seek additional loans from private parties.
Loans received through the Aquafund project will go to different components of water and sanitation projects. For example, governments will be able to use funds to finance preliminary studies to see whether certain projects will be feasible and to provide tecnical training to the individuals participating in the projects. Governments will also be able to use funds to strengthen or change the laws and regulations that deal with sanitation and water systems.
IDB officials hope that the creation of Aquafund will help Latin American governments develop innovative approaches to water and sanitation. Officials also plan to use the Aquafund as an educational tool. Starting in 2009, the Aquafund will finance pilot projects that Latin American governments will be able to use as models. One of the pilot projects that is in the works will focus on improving Latin American households' connection to local sanitation networks. Overall, the goal of the Aquafund will be to turn what have thus far been "proposals" for improved water and sanitation systems into sustainable projects that will improve Latin Americans' quality of life.
1- Many areas of Latin America, particularly rural and urban areas of the Caribbean, do not have access to proper sanitation and water systems. Why has it been so difficult for this region to establish sustainable sanitation systems? Will the new Aquafund project address the obstacles that these governments have had, or should the IDB consider other ways of addressing the water and sanitation issue?
2- Some would argue that improving the health of the Latin American population is a necessary first step to addressing the multiple issues that the region faces. Will developing the water and sanitation systems in Latin America help spur progress in the region's political, economic, and social systems?
Friday, September 19, 2008
Asia battles to shield markets from Wall Street crisis, INQUIRER.net
ADB urges coordination among Asia’s regulators amid financial turmoil, China View
China steps in to prop up stocks, Financial Times
Asia is feeling the crunch as the effects of the U.S. credit crisis spread across the globe. Asian bank stocks tumbled after Lehman Brothers filed for bankruptcy protection on Monday and central banks have had to inject billions of dollars to support weakened money markets. The Asian Development Bank (ADB) has warned that the market is vulnerable in several areas, including asset markets—such as real estate—and is struggling to contain inflation to prevent slowed economic activity. Additionally, analysts have warned that financial integration across Asia is underdeveloped, in spite of growth in regional trade integration, and Asia is too dependent on European and North American markets for handling large-scale savings.
The ADB proposed establishment of an “Asian Financial Stability Dialogue” to coordinate regulatory development and keep a lookout for potential vulnerabilities in the Asian markets. The ADB is looking to develop new and deeper financial markets, promote consistent market standards, and set-up better standards for government transparency to increase domestic and international investment. The ADB hopes that by stepping up regulation and working to improve these different aspects of the Asian markets, policy makers and regulators can shield banks from the financial crises caused by U.S. mortgage defaults--which has caused more than $400 billion in losses and write-downs to Western lenders.
Although Asian stocks surged Friday after announcement of the U.S. bailout plan, analysts say that there hasn’t been enough change in companies and the world markets and warn that Asian financial markets and economies remain at risk.
(1) How will the U.S. bailout plan affect Asian markets and economies?
(2) How can Asia reduce dependency on U.S. and European markets?
(3) What impact might the proposed "Asian Financial Stability Dialogue" have on Asian markets? What is the likelihood Asian markets will cooperate to develop such a dialogue?
Brazil's Real Climbs 5.5% Following US Bailout Plan News FX.com, Sept. 19
Latin America Bonds: Colombia Peso Debt Drops Most in Two Years Bloomberg.com, Sept. 18
Peso colombiano cierra con caida de 2,95 pct Reuters/Yahoo Noticias, Sept. 17
America Latin, ante periodo de vacas flacas tras crisis financiers en EE.UU. Noticias RCN, Sept. 18
News of the U.S. bank bailout, which was announced by U.S. Treasury Secretary Henry Paulson on Friday, came just in time for Latin America. Before the announcement, growing concerns about a domino effect from struggling U.S. markets had lead many foreign investors to leave these emerging markets. Latin American currencies were tumbling. By Thursday, the Mexican peso had slid 9.9 percent against the dollar from its August 4 high. The Colombian peso had fallen 6.3 percent since the Lehman Brothers bankruptcy, hitting its weakest since March, 2007. In Latin American, global market instability affects more than the financial markets. A weakening economy also threatens the demand for raw materials. Raw materials have been the principal driver of the recent economic growth throughout most of Latin America. They make up 65 percent of Brazilian exports, and as prices for commodities like oil and grain surged, so did the Brazilian economy. By Thursday, Latin American economists were recommending a period of "conservatism" and "belt tightening" as fears of a global recession increased.
On Friday, after the U.S. bailout plans were announced, emerging market currencies and bonds rebounded drastically. Bonds rallied the most since 2001. The Brazilian real, Latin America's reference point, led the currency rally. The Colombian peso also climbed an incredible 7.3 percent against the dollar on Friday. That is the biggest jump for the Colombian peso in 13 years. Investors who had recently left the Latin American markets for "safer bets" came running back. "The U.S. government needed to do something as the system was wobbling. The plan seems to have calmed nerves," said Jason Viera, an economist in Sao Paulo.
1) The drastic fluctuations throughout Latin America this week demonstrate how closely the region is tied to the overall global economy. What does this mean for the average citizen of these countries?
2) Before Friday's bailout announcement, economists were recommending that Latin American countries enter a period of greater conservatism, especially when it comes to consumer credit. Many economists continue recommending that strategy. Is this a good recommendation for Latin America? Would it be good for some countries and not others?
3) Most countries are directly impacted by the financial decisions made in the U.S. Is there a way these countries can have a say in those financial decisions? Should they have a say?
Thursday, September 18, 2008
Financial Times, FSA Bands Short-selling of Banks
New York Times, Treasury to Guarantee Money Market Funds
Reuters, SEC Issues Temporary Ban on Short Sales
News of the U.S. government’s rescue plan for troubled financial institutions buoyed markets early Friday, while financial regulators got to work issuing a gaggle of temporary orders to help restore calm amidst a storm of financial uncertainty.
The Securities and Exchange Commission (SEC) has temporarily banned the short-selling of 799 financial stocks, including AIG, Berkshire Hathaway, Loews and Blackstone Group. A short sale occurs when a seller borrows a stock, sells it, and then buys it back at a lower price. The goal of the short sale is to take advantage of price declines. The SEC has put some of the blame for the current financial crisis on short sellers, accusing them of driving down share prices of firms like Lehman Brothers and AIG. Financial regulators across the pond are following suit in banning short sales, including the U.K.’s Financial Services Authority, Ireland’s stock market regulator, and Australia (who banned “naked” short sales – short sales where sellers do not borrow the stock first and then fail to deliver to the buyer).
Hedge funds have warned that the ban on short sellers could make it very difficult for banks to raise new capital, and shares could become more expensive to trade because hedge funds will be unable to provide more liquidity to the market. But regulators maintain that the rules will provide much-needed stability in an otherwise volatile market.
The Treasury Department is [temporarily] guaranteeing monkey market funds, which have traditionally been safe and risk-free investments but have felt the stress of the current market turmoil, up to $50 billion to ensure their solvency. The Federal Reserve is also expanding its emergency lending program to support the $3 trillion in troubled funds. Money market funds are mutual funds, required by law, to invest in low-risk securities, and typically invest in government securities, certificates of deposits, commercial paper of companies, and other highly liquid and low-risk securities. The payments will be guaranteed by the Exchange Stabilization Fund which was set up in the 1930s to intervene in foreign exchange markets.
Questions for discussion:
1) Is market intervention absolutely necessary? Are the hedge funds right in claiming these rules will create artificial prices and hurt banks trying to raise capital?
2) Are these “temporary” rules really temporary, or do you think this is the beginning of an era of nationalization?
New York Times, Fed and Treasury Offer to Work With Congress on Bailout Plan
As the stock market attempted to catch its breath from the roller coaster week after gaining 400 points at close of business on Thursday, U.S. policymakers met to create the structure for what could be the biggest financial bailout in history.
Details remain to be worked out, but the idea is that the U.S. government will have the power and capacity to buy distressed mortgages from banks and other institutions at deep discounts. The Thursday night meeting contemplated a “comprehensive approach to address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and financial markets.” The plan was the brainchild of Sen. Charles Schumer (D – NY) and Department of Treasury and Federal Reserve officials, who were concerned with keeping loan markets alive, even after the Federal Reserve committed almost $380 billion into the markets.
The plan will likely resemble the Resolution Trust Corporation that was set up during the Savings & Loan Crisis in the late 1980’s. U.S. officials had hoped for this plan over the past few days, but wanted to be sure it would pass Congress before they unveiled the plan to preserve what little remains of market confidence.
Several lawmakers have come out in support of the bailout plan, with everyone careful to note that the effort is bipartisan, though tense at times, and in the best interests of taxpayers. Lawmakers hope to have the plan hammered out by next week, when Congress adjourns and goes home to campaign in the homestretch before the November elections.
Questions for Discussion:
1) The Resolution Trust Corporation that helped to alleviate the S&L Crisis in the late 80's and 90's bought troubled assets, not entire institutions. Do you think the government bailout plan, the largest in history, will work in the same way? Will it solve the problem?
2) What do you think this means for taxpayers? What could this mean for the election?
Despite President Medvedev's assurances last weak that the blow to the Russian economy was only temporary and despite repeated liquidity injections, this week did not look good for Russian investors. The stock market showed catastrophic losses Tuesday when falling oil prices combined with poor money market conditions to prompt mass selling on the two major exchanges.
Both the Micex and RTS stock exchanges suspended trading at the urging of state regulators, but already the single-day drop in prices was the greatest for Micex since the August 1998 financial crisis. Traders forced to meet margin calls and brokers pulling their credit lines contributed to the plunge, but perhaps the worst aspect is loss of confidence in the system.
KIT Finance, a mid-sized Moscow brokerage firm, was unable to make payments on short-term loans, and there were rumours that other banks might fail as well. This made banks unwilling to lend to each other, and so a finance ministry injection of $5.8 billion into the banking system did not spread throughout it due to freezes on interbank lending. The interbank money market rates reached 11%, though by Thursday they were back down to 7-8% for the largest banks.
It remains to be seen whether the government will be able to save the situation with both lenders and borrowers afraid to participate in the economy. Alexei Kudrin, Russia's finance minister, insisted that the crisis is not systemic, but at the same time the central bank injected $14.16 billion into the money market in a single day, with its deputy reporting that the bank and the finance ministry could inject a total of $117.6 billion.
Large state-run banks were hardest hit, with stocks in Sberbank losing 21.76% of their value on Tuesday alone. The Micex exchange closed on Tuesday at 17.75% down, and the RTS at 11.47% down. In the past few months, the exchanges have lost nearly $800 billion in value.
With the exchanges planned to re-open on Friday, two more pledges came in – one from President Medvedev promising $20 billion and the other from the finance ministry, announcing a plan to put $59.1 billion in short-term deposits into three state-run banks. Other government measures include reducing oil export taxes to increase companies' cash balances, banning margin selling and short-selling on new accounts, and an order to state banks to open a sixty billion ruble credit line to the largest participants in the market.
1) How does this crisis compare to the August 1998 ruble crisis?
2) Is the country's stronger financial structure enough to keep the crisis from becoming "systemic," as Kudrin suggested, or was this crash the inevitable result of an overheated emerging economy?
On Wednesday, the Spanish government engaged in yet another clash with the Basque community. It jailed 21 Basques for lobbying against the imprisonment of hundreds of fellow separatists deemed terrorist members of the guerilla group ETA. Sentences ranged from 8-10 years.
The Basque people occupy the north-central region of Spain and southwestern France and have long maintained a culture and language distinct from the rest of Spain. The organization ETA (Euskadi Ta Askatasuna or “Basque Homeland and Freedom") was founded in 1959 by a group of radical leftist students advocating independence from Spain and the creation of an autonomous state following brutal repression of the culture during the reign of Francisco Franco. In 1978, the Basque region was established as an “autonomous community” in the Spanish constitution, but was still restricted from the right to self-determination and independence. The past 50 years have been characterized by cycles of violence (the ETA has been responsible for the deaths of over 800 people since the 1960s) and peace talks between ETA and the Spanish government. The EU, including the governments of both Spain and France, and the United States classify the group as a terrorist organization.
However, more than forty years after the death of Franco, freedom of speech and political parties in Spain are still restricted. One can be charged, convicted, and jailed for the verbal offense of “defending terrorism”, as was Arnaldo Otegi, the former leader of the ETA who served a 15 month sentence in 2006 after a speech he gave at the 25th anniversary of a former Basque leader’s death. Other terrorism-related charges include participating in illegal political meetings and marches. The High Court of Spain has also banned the political participation of the Batasuna and ANV parties, believed to be political wings of the ETA.
1. While terrorism and violence should never be tolerated, has the Spanish government gone too far in jailing ETA members for non-violent lobbying? If not, would your answer be different if the protestors were Basques not affiliated with the ETA?
2. Should political parties that are affiliated with terrorist organizations be allowed to function in a democratic state?
3. How does political repression affect the development of a country?
Wednesday, September 17, 2008
Contrary to traditional U.S. economic theory, France has been a huge proponent of prioritizing economic reform over fiscal prudence in recent years. French President Nicolas Sarkozy, especially, has developed the supply side of the economy rather than focusing on balancing the budget. While he planned with EU finance ministers to have a balanced budget by 2010, he recently pushed the date back to 2012. Experts say even this date is unrealistic and predict an actual date of 2014. At $59 billion, the French deficit is estimated to approach 3% of the GDP by the year’s end, making France the biggest spender in the European Union. Such a number is noncompliant with joint EU economic policy, and could lead to France’s dissipated political influence in the region.
Sarkozy’s adopted theory maintains that deficit reduction and budget- cutting inevitably create bitter public interest groups and private investors when funding or proceeds are diminished. Dissatisfied investors lead to less investment and market insecurity, which spirals into the general stifling of economic growth. By temporarily working on the supply-side of the economy, interest groups do not stand to lose, investor confidence and business are not diminished, and as the country’s economy rights itself and makes a surplus, the deficit lessens. Thus, the temporary increase in deficit is worth the public’s confidence and support leading into initial stages of economic reform. This strategy recently proved effective for Sarkozy in the labor market to convince co-opt trade unions and employers to work longer hours.
However, while such a policy has worked for France leading up to the economic crisis, it has been criticized as irrevocably flawed in light of the recent downturn of events. Without the capacity to maneuver the spending and debt of the country, financial crisis is less containable. Meanwhile, other European countries that have prioritized a balanced budget, such as Spain and Germany, have deficit “wiggle room” in times of financial crisis.
Sarkozy is now faced with the choice to amend his fiscal policy, or follow the U.S. economy further down the rabbit hole.
1. In times of financial crisis, do you believe it is ethically wrong for world leaders to purposefully and knowingly increase their countries’ deficits?
2. Are you more inclined to give a break to countries who have maintained fiscally responsible policies in recent years, and who may have planned more prudently for an economic downturn?
3. In the age of globalization, is economic policy a state issue or should other EU countries exert pressure on France to change its policy?
A new African-based fund worth upwards of $150 million is set to launch by the end of the year. The fund is run by GroFin, an African investment group, and is aimed at small to mid-level entrepreneurs throughout the continent. The fund will offer loans between $50,000 and $1 million to African entrepreneurs who have had trouble obtaining loans from risk-averse local banks.
As previous posts have discussed, Africa has experienced record-level private capital investment in the past few years. There are many reasons for this; for instance, emerging markets in Africa have been largely insulated from the world’s credit shock, there has been consistent economic growth, and with the exception of a few countries (most notably Zimbabwe) increased political stability.
However, most of these gains in have gone unnoticed by the “missing middle” – businesses who lack the executive experience and size to attract large capital investors yet are still too big to obtain loans from microfinance investors. GroFin hopes to show that investing in the missing middle can be commercially successful. It plans to offer the loans at interest rates the entrepreneurs could obtain at local banks but are not requiring collateral. GroFin will also offer business advice and technical assistance.
Guido Boysen, the Regional General Manager of GroFin in East Africa, says GroFin helps insure success by “providing hands-on business development assistance” and that the key is that it “maintains a presence locally, on the ground.”
The fund will provide loans to many different sectors; such as, manufacturing, agri-business, tourism and transportation.
1) If this investment strategy proves to be successful do you expect to see more funds trying similar strategies?
2) Many large pension funds invest in emerging markets in Africa because of their insulation from fluctuations in global markets. However, the sheer size and diversity of these funds seem to suggest a hands-off approach. Would large funds be successful investing in the missing middle or do you think that the hand-on approach and local presence of GroFin is what leads to successful investments?
Fed in $85 Billion Rescue of Insurer Near Failure, New York Times
Stocks Dive in Early Trading Despite Fed’s A.I.G. Bailout, New York Times
The Federal Reserve made two major announcements on Tuesday.
The first of these announcements was that the Federal Reserve would not lower the benchmark interest rate, which has held steady at 2% for some time as part of the Federal Reserve's efforts to battle inflation. While, early in the day on Tuesday, U.S. investors had seemed hopeful that the Federal Reserve would choose to lower interest rates, the decision to leave the rates as they were was seen by many as an indication that a Federal bailout of insurance giant AIG was forthcoming.
Indeed, later in the day Tuesday the Federal Reserve and the U.S. Treasury Department announced a massive, $85 billion bailout of AIG. This investment in the failing AIG by the federal government, aimed at preventing a worldwide financial panic, was not only an unprecedented move, it also directly contradicted the Federal Reserve's earlier "line in the sand" proclamation that that accompanied its refusal to bail out Lehman Brothers.
While the Federal Reserve, the Treasury Department, and much of the U.S. and worldwide financial community felt that the AIG bailout was necessary, it has not come without controversy. Many American politicians have called the bail out excessive and have heightened their calls for an aggressive investigation into the regulatory failures which may have contributed to the development of the worsening financial crisis, both in the United States and throughout the global marketplace.
1. Was the Federal Reserve correct in leaving the interest rates unchanged? Should the fight against inflation take priority over the need for greater liquidity in the marketplace?
2. Is the government bailout of AIG appropriate? What, if any, alternatives did the U.S. government have to a bailout of this scale? What would have been the consequences of the collapse of AIG?
Tuesday, September 16, 2008
Wall Street Steady at Open; Fed to Meet, New York Times
As the number of U.S. institution falling prey to the worsening global financial predicament grew in the early week, the financial community’s eyes turned to the world’s central banks. On Monday and Tuesday, central banks in America, Europe, and Asia took aggressive steps (mostly in the form of infusions of cash) to attempt to mitigate the mounting panic and volatility in the marketplace.
In response to increased demand for liquidity by banks, the European Central Bank made available €70 billion in emergency funds. The Bank of England injected £25 billion of cash into the market over the course of the first two days of this week. In a similar move, the Federal Reserve Bank of New York pumped $50 billion into the U.S. market. The Bank of Japan has also let it be known that it stands ready to invest $24 billion to provide needed liquidity.
Unfortunately, these efforts by the central banks have not had a significant impact on the world’s markets. In Europe, London’s FTSE 100, Paris’ CAC 40, and Frankfurt’s DAX were all down sharply on Tuesday, as were Asian indexes including the Nikkei and the Hang Seng.
As central banks’ cash infusions prove, at least in the short term, to be unsuccessful in stopping the market’s decline, the eyes of the financial community have turned to the Federal Reserve. In light of the Federal Reserve’s recent commitment to battling inflation, a cut in the benchmark interest rate has been seen by most as unlikely. However, as circumstances in the marketplace worsen, liquidity becomes more imperative, and the effectiveness cash-infusion strategy employed by central banks early in the week comes into question, a change in the Federal Reserve’s position on interest rates may be forthcoming.
1. Were the Central Banks correct in their cash-infusion approach to the worsening global financial situation? Did they do enough? Do they react with sufficient speed?
2. Is a cut in the Federal Reserve's benchmark interest rate necessary? Is such a cut wise in the long-term?
Monday, September 15, 2008
Los Angeles Times - Dow Jones Index Plummets 500 Points
Wall Street Journal - AIG, Lehman Shock Hits World Markets
Bloomberg - AIG Seeks Funds from JPMorgan, Goldman After Fed Balks at Loan
The Dow Jones Industrial Average fell by the most since 9/11 as fallout from the subprime mortgage crisis crippled some of the United States' most important investment banks. Lehman Brothers filed for bankruptcy protection after a buyout deal fell through with Barclays and Bank of America. Merrill Lynch, another investment firm that was vulnerable to failure, sold itself to Bank of America.
The Dow fell by 500 points, or 4.4 percent. Each of the composite's thirty indicators fell except for Coca-Cola. International stock markets also fell, with most of the European exchanges losing between three and four percent of their value and some Asian indexes losing greater amounts.
Analysts worried that another U.S. company, AIG, might be at a dangerous risk of failing. AIG, which is the U.S.'s largest insurance company, was negotiating for a cash infusion from private companies after the U.S. government showed an unwillingness to further extend taxpayer assistance to U.S. companies caught up in the mortgage crisis. However, the state of New York has taken the step of allowing AIG to transfer money from its subsidiary in an attempt to obtain more capital.
The scramble to sell Merill Lynch and obtain private help for AIG comes after U.S. Treasury Secretary Henry Paulson stated that he never considered giving federal money to help guarantee Lehman Brothers. It is estimated that AIG would need $70-75 billion in loans, possibly with assistance from JPMorgan Chase or Goldman Sachs.
1. How did the U.S. Government-brokered assistance to Bear Stearns affect market expectations? Did it discourage changes for companies expecting a bailout?
2. How is AIG, an insurance company, affected by what began as a mortgage crisis?
Sunday, September 14, 2008
A major drop in stock prices this week spells trouble for the Russian economy. The RTS stock market index fell 7.5% on Tuesday, the biggest one-day drop since June 2006, and fell again 4.4% on Wednesday and 2.7% on Thursday. This adds up to nearly a 50% drop in Russian stock prices since May, though there are differences of opinion on the reason for the decline. Russian Prime Minister Vladimir Putin denies that the conflict in Georgia is responsible, while President Medvedev claims that the conflict was a contributing factor, though a necessary move politically for Russia. He estimates that 75% of the decline is a result of international conditions, rather than the conflict.
The immediate cause of declining stock prices was a combination of political risk highlighted by the Georgia conflict and falling oil prices. Another factor is the liquidity crunch that has finally arrived in Russia, spurred by capital flight estimated by some to be as high as $20 billion. As investors pull their money out of the Russian economy, credit becomes short, exacerbating the stock market crash. Bankers and traders have focused on this element, noting that banks and funds have been forced to sell even attractive assets in order to come up with cash.
The liquidity crisis has also affected a handful of wealthy Russian individuals who used loans to buy shares in Gazprom and Sberbank, the state-owned investment bank. Others bought shares in metals using borrowed money before share and commodity prices fell. The individuals pledged some shares back as collateral in order to qualify for loans, and when the economy began to falter many faced margin calls or sold stock early to avoid greater losses.
Those looking to borrow money, especially in the real estate sector, have found it impossible to do so, and the Russian central bank’s attempt to build confidence in the economy by injecting over $10 billion into commercial banks in a single day does not appear to have had a significant effect. Proposals to use money from the national wealth fund and pension reserves to stabilize the economy have emerged, drawing criticism from those who believe the government should instead use oil revenues to stabilize the economy. Standard & Poor’s also warns that putting public funds at risk would lower Russia’s sovereign rating.
Medvedev continues to talk up the economy to try to draw investors back to Russia, and made a proposal Thursday for a comprehensive economic re-structuring plan. Its components would be considered in the Russian Duma in 2009.
1) Will short-term cash injections have lasting impact on the Russian economy, or is it too late for the central bank to save the situation?
2) Will the Russian economy follow the trends of the rest of the world, or is there a better hope of rebound given unique political and market conditions?
Seoul fears burden of North’s implosion, Financial Times
Seoul Eases Conditions For Aid to North Korea, The New York Times Online
Recent reports of Kim Jong-il suffering from a serious illness have leaked out of North Korea and prompted speculation about what its fate will be when the dictator dies. Kim Jong-il has no known designated successor and it is feared that without a strong leader firmly in place, North Korea will politically and economically implode. If this were to happen, North Koreans would have nowhere to turn to for aid but to their South Korean neighbors.
South Koreans have long hoped for reunification with the North. They provide extensive aid to the resource-poor North and have recently relaxed conditions it has to meet to receive aid, requiring only that the country prove it is facing a crisis and guarantee that rice shipments won’t go to the military. However, the South’s economy has begun to experience trouble of its own. Its stock market has dropped by a fifth this year and inflation is rising. If the North were to collapse in the near future, the South would find it difficult—if not impossible—to provide enough aid to the struggling country to prevent a humanitarian crisis.
A North Korean economy expert claims it would be impossible for the South to absorb the North’s twenty-three million inhabitants, however much South Koreans might wish for reunification. The North’s economy is significantly less developed than the South’s and some economic analysts estimate that the gross domestic product may be as low as $500 per person. Additionally, the North’s infrastructure is dilapidated and in need of renovations, it is isolated from other types of international aid because of its nuclear programs, and there are few links between the two countries. Even their television systems are incompatible.
(1) How is North Korea likely to fare economically upon Kim Jong-il’s death? Are there any possible better outcomes than the one forecasted here?
(2) How should South Korea deal with a North Korean economic collapse? Is absorption of the North Korean population the only option?
(3) What is the international community likely to do in response to a North Korean economic collapse?
Sources: BBC News: End to World Bank’s Chad oil deal
Financial Times: World Bank quits Chad plan
The World Bank announced this week that it would no longer support the $4bn oil pipeline project between Chad and Cameroon. Originally signed in 2001, the loan agreement between Chad and the World Bank gave Chad a total of $140m for the pipeline project, while the Chadian government agreed to use a significant part of its oil revenues to reduce poverty in the central African country.
In a statement issued earlier this week, Michel Wormser, the World Bank’s director of African operations, said that Chad had repeatedly failed to abide by its part of the agreement over the years and that it had become “evident that the arrangements that had underpinned the Bank’s involvement...were not working.” Indeed, almost as soon as the oil started flowing in 2003, Chadian President Idriss Déby funneled large portions of Chad’s estimated $1.4bn yearly oil revenues into arming his security forces, instead of putting it towards infrastructure, health care, education, or agriculture, as the agreement required.
Many at the World Bank considered the agreement with Chad to be a test case for how poverty could be reduced through effective allocation of oil revenues in other oil-rich African countries. Not everyone was convinced, however. Anti-poverty campaigners, against the project from its conception, said that the collapse of the agreement vindicated their assertion that the Bretton Woods Institutions’ support for oil and other natural resource development projects has further cemented autocratic African governments hold on power instead of reducing poverty.
As of September 5, Chad had repaid its outstanding balance of $65.7m, officially ending the nation’s association with the World Bank on the pipeline project. The two former partners parted on good terms however, and both said that relations would continue in other, non-oil, sectors.
What are the pros and cons of World Bank and IMF involvement in natural resource development projects in less-than-democratic African nations? Do the risks of misuse or corruption outweigh the potential benefits to society?
What can be done to convince African governments to channel oil wealth into a development program to reduce poverty?
Financial Times 1
Financial Times 2
New York Times
An ambitious project headed by Greg Wyler, a U.S.-based technology entrepreneur, seeks to offer high-speed internet access to the world’s poorest regions, the majority of which are in Africa. The project is called O3b, which is a reference to the three billion people who still have no internet access, and is backed by Google, Liberty Global cable group, and HSBC’s private equity group. The investors have thus far contributed $65 million of the estimated $750 million needed to complete the project.
The goal of O3b is to launch 16 low-earth orbit satellites that will bring high-speed internet access to places in Africa and other emerging markets. This will be a new type of telecommunication method. The United States and other developed nations use underground fiber-optic cables to provide high-speed internet access, but this method is not commercially viable in Africa. The cost of high-speed access in Africa is almost 20 times more expensive than in the U.S.
O3b’s satellite system will sharply reduce the cost of high speed internet access. Instead of having to lay hundreds of thousands of miles of underground fiber-optic cables in Africa, computer and mobile phone users will send their data to local cell phone towers which will in turn send the data to O3b’s satellites. The satellites will receive the data and then send it to other cell phone towers or to established fiber-optic networks in the developed world. Because it is much cheaper to build cellular towers than it is to lay underground cables, the cost of internet access will be much lower. Additionally, cell phone towers are already being constructed in large numbers in many remote places throughout the world and mobile phone use in Africa is growing at a rate of 60 percent annually.
The O3b satellite system will only serve as an intermediary, however, and will not be the company to actually provide the internet access. Companies in Africa will be the ones to develop the local cellular tower networks and provide the access to the people. This offers opportunities for entrepreneurs to get involved early in an industry that has vast potential. The O3b satellite system is set to be up and running by 2010.
1) Will the advent of inexpensive internet access help provide political stability and increased government transparency to African countries?
2) In many emerging markets, consumers are skipping expensive personal computers and are instead purchasing mobile technology to access the internet. Will the O3b make this trend more likely in Africa? Is this a good trend?
3) Because O3b is not directly providing the high-speed access, the companies who invest in cellular towers will have a more direct impact on the price of the access. Should O3b be worried about the local providers charging high access fees or will competition between local providers help keep prices down?
Saturday, September 13, 2008
The United States announced new sanctions against Iran’s largest shipping company over its alleged support for Tehran’s nuclear program. The U.S. Treasury alleges that the Islamic Republic of Iran Shipping Lines (IRISL) facilitated shipments of military-related cargo to Iran’s Defense Ministry and Armed Forces Logistics, the organization in control of Iran’s ballistic missile research. Washington also alleges that the company falsifies documents and uses deceptive schemes to hide its involvement in illicit commerce.
Previous sanctions from the U.S. were enforced on entities that worked directly on Iran’s nuclear and missile program, but recently Washington and several European countries have taken steps against Iran’s financial sector, notably banning business with Bank Melli, Iran’s largest bank. Although the ban against Bank Melli has increased the cost of financing in Iran, it is unlikely that the sanctions against IRISL will have much practical effect because the company has no dealings with American companies and no bank accounts or assets in the U.S. However, Washington has indicated that it will discourage international companies from doing business with IRISL.
Iran responded to the new round of sanctions by condemning them as “illegal and unjustifiable,” insisting that IRISL had never engaged in any illicit activities and all consignments carried by its ships have been verified by authorities in departing and destination ports. Further, Iran’s Mission to the U.N. said in a statement that the Iranian government now reserves the right to “seek compensation for the damages that may be incurred to its citizens as a result of such unfounded accusations and unlawful unilateral measures.”
Discussion: Do you think that this new round of sanctions will increase the cost of imported refined oil, as Iran ships in to meet more than a third of domestic demand? If so, was this a “smart” sanction by the U.S. government? Do you think that pressure on Iran’s financial sector will serve its purpose of encouraging Tehran to terminate its nuclear program? If the U.S. can convince other nations and international companies to follow suit, how do think Tehran will react?
Friday, September 12, 2008
"Brazil Raises Rate to 13.75%, Highest in Two Years (Update 1)" Bloomberg.com
"Brazil Stocks Rise on Commodities Rebound; Mexico's Bolsa Drops" Bloomberg.com
"Morgan, Goldman, Deutsche Say Brazil Stocks are Cheap (Update 2)" Bloomberg.com
"Lula Achieves Record Approval Rating of 64% in Datafolha Survey" Bloomberg.com
"Mexican Market Has Tried but Still Lags" Wall Street Journal
BM&F Bolvespa Official Site
Brazil's $1.3 trillion dollar economy is one of the few bright spots in the global financial world today. Brazil has been enjoying strong economic growth, despite the current global economic downturn. During the second quarter, Brazil exceeded general growth expectations when its gross domestic product increased 5.9 percent from the previous quarter. Brazil's Central Bank President Meirelles stated, "Brazil lives today a sustained growth cycle, supported by price stability." While other countries cut interest rates to spark growth and investment, Brazil's central bank has recently raised benchmark interest rates to the highest in almost two years, from 13 to 13.75 percent. The bank hopes that higher rates will cool accelerated growth and curb inflation.
Brazil's performance is certainly atypical. For example, six years ago, the Mexican and Brazilian stock markets were roughly the same size. Today, Brazil's market is more than triple the size of Mexico's based on the value of companies listed. Brazil's larges stock exchange, BM&F Bovespa, has become the largest stock exchange in Latin America. Much of the stock market growth is attributed to Brazil's Novo Mercado ("new market"). The Novo Mercado is a listing of shares issued by compaines that voluntarily abide by corporate governance practices and transparency requirements beyond those required under Brazilian law.
Perhaps it is no surprise that Brazilian President Lula currently enjoys record approval ratings, which rose to 64 percent in September from 55 percent in March, according to Datafolha, a Sao Paulo-based polling company. Datafohla explained that this is the first time Lula has won approval from the majority of the population, across all social, economic and geographical sectors.
Of course, the future is not all rosy for Brazil. BM&F Bovespa has dropped nearly 20 percent this year, declining commodity prices threaten Brazil's export revenue, and inflation is a continuing concern. Yet major investment banks, including Morgan Stanley, Deutsche Bank and Goldman Sachs, encourage investment in Brazilian stocks. These banks say Brazilian stock have become cheap after the 20 percent decline this year. Goldman Sachs added that Brazilian stocks are the cheapest in the Americas when comparing estimated earnings for the next twelve months.
Is Brazil's growth sustainable in the face of falling commodity prices?
What lessons does Brazil offer to other Latin American countries?
What should be next in Brazil's economic development strategy?
IMF Press Release, "IMF Executive Board Completes First Review Under Nicaragua's PRGF Arrangement and Approves Increase in Financial Support by US$10 million"
Bloomberg.com, "Nicaraguan Central Bank Warns of Spiraling Inflation"
El Nuevo Diario, "FMI Aprueba Primera Revisión de Programa"
On Thursday, September 11th, IMF Executive Board members conducted their first review of Nicaragua’s performance under the Poverty Reduction and Growth Facility (PRGF) arrangement it established with the IMF in October 2007. Board members expressed their satisfaction with how Nicaragua has performed in the months following the arrangement. They are particularly impressed with the fact that the country has been able to stay within the fiscal standards that the IMF established for it at the outset of the arrangement.
PRGF arrangements are special loan programs that the IMF designs for low-income countries. They typically focus on helping target countries better manage their public resources and establish more accountable governments. They carry annual interest rates of .5% and are repayable over 10 years with a 5 ½ year grace period on principal payments. Governments apply to participate in PRGF arrangements by outlining the economic targets and policy goals that they would like to meet in Poverty Reduction Strategy Papers. The IMF and the World Bank use these Strategy Papers as guides in setting standards for the arrangements, which are funded through trusts that the IMF administers.
Fortunately for Nicaraguan government officials, the IMF is not only providing positive feedback with its review. Executive Board members have also approved a $10 million increase in support provided to Nicaragua, increasing the total value of the arrangement to $120.4 million. Board members also waived two of the requirements that they had expected Nicaragua to meet by the first half of 2008; they have chosen to excuse delays in the approval of the 2008 budget and in the adoption of measures to discourage theft in electricity consumption.
IMF officials recognize that Nicaragua’s economy was particularly affected by Hurricane Felix last October, as the country was forced to import basic foods as a result of the hurricane’s effects on its vegetation. Officials also seem to be concerned with the upcoming national elections because it is likely that the government will spend significant amounts of money in the upcoming months in preparation for that process. Nevertheless, both IMF and Nicaraguan officials are optimistic that the continuing arrangement and the $10 million boost will help Nicaragua continue its progress and perhaps embark in new social and economic projects.
1- One of the purported goals of PRGF programs is to help low-income countries establish more “transparent” governments. What is the relationship between increased external financial aid and accountability in governance? Does a country’s administration become “better” at governing when it receives more money from an organization like the IMF?
2- Given that the IMF is especially concerned with how the Nicaraguan government will respond to the upcoming elections, would IMF officials be wise to send advisors to Nicaragua to aid the government in running the elections? Should the IMF provide “educational” aid as well as financial aid?