Tuesday, December 06, 2011

Migrating Doctors Costly and Harmful to African Countries

Sources:
Daily Monitor: Africa’s Doctor Brain Drain a Home-Made Problem
LA Times: South Africa Loses $1.4 Billion Training Doctors who Emigrated
Medical Express: Doctor Migration to Developed Nations Costs Sub-Saharan Africa Billions of Dollars

A recent trend of emigration to developed nations by medical doctors from underdeveloped African nations has created a big economic and social problem in Africa. The majority of the doctors leave countries with some of the highest HIV infection rates in Africa, (Ethiopia, Kenya, Malawi, Nigeria, South Africa, Tanzania, Zambia, and Zimbabwe, for example). The migrations negatively impact these countries’ economies and healthcare systems.

Though the countries are training about 600 doctors per 10,000 people (at a cost of $21,000 to $59,000 per doctor), they still only have about 8 doctors for every 10,000 people. The United States alone has hired about six percent (5,334 doctors) of the doctors trained in Sub-Saharan Africa. This means that there are only about 90,000 doctors left in the Sub-Saharan countries’ healthcare systems for a population of about 800 million people, drastically lowering the ratio of patients to medical staff.

In response, international organizations have stepped up to address the problem. The World Health Assembly published the “Code of Practice on the International Recruitment of Health Personnel” in 2010 to provide guidelines for the international recruitment of medical doctors by developed nations. The guidelines aim to reduce the number of doctors developed countries hire away from developing countries. The World Health Organization (WHO) also released a report proposing that developed countries hiring African doctors compensate the African countries for their investments in the doctors’ training. In addition, the WHO believes that the developed countries have an obligation to help finance and improve developing countries’ healthcare systems. Still other groups believe developed countries should somehow be held criminally liable for recruiting African doctors.

Scholars blame many different factors for the migrations, including inadequate wages and poor promotion opportunities. Studies conducted by one group of scholars show a 40-year trend of abuse towards doctors who are forced to work long hours, treat too many patients to provide adequate care to each, and lack the necessary medical materials and facilities. In the face of such poor conditions, the doctors seek countries that will provide them with better opportunities, and developed nations are more than willing to welcome the cheaply-trained doctors. The healthcare systems in these countries will continue to diminish and will become increasingly inadequate to treat the respective populations if something is not done to stop the migrations.

Can South Africa Meet its Development Goals?

Sources:

AllAfrica: South Africa: Partnerships and Implementation Capacity Are Pre-Requisites to a Successful South African Development Path
BusinessDay: SA Needs to Raise Growth to 10% to Create 5-Million Jobs, Says DBSA
IOL: Political Leaders Key to Success, Says Bank

The Development Bank of South Africa (DBSA) released a report recently to provide South Africa a perspective on what steps it needs to take to achieve its proposed development goals. The goals aim to positively affect areas like reindustrialization, climate change, and skill development. The report found that the most difficult goal to achieve would be lowering the unemployment rate from 25% to 15% by the end of 2020. The South African government hopes to meet the goal by increasing employment by 7% each year through investing in development projects (possibly infrastructure) that require the most workers.

The steady economic growth the country has experienced in recent years is not sufficient to sustain an annual 7% increase in employment. The DBSA report states that the country will need 10% annual gross domestic product (GDP) growth to support the spending necessary to meet the goal of 7% employment growth. However, the report stresses that the South African government must resist the temptation to dismiss the goal as a failure—as it has done with past development goals—and suggests lowering the 7% target to a more feasible level. The report also contains suggestions on how to bolster employment, which mainly consist of seeking more labor-intensive government investments that will create a need for more workers.

If South Africa can successfully reduce unemployment, it stands to become a more stable country economically. Economic stability will encourage investment by reducing the risk of loss due to dramatic changes in the economic climate. It will also show that the government is committed to realizing its development goals. This commitment should entice foreign investors to provide capital investments for the development goals because they would no longer fear losing government support prior to completing a project.

Friday, December 02, 2011

Myanmar Leaders Meet with Hillary Clinton to Discuss Reform

Sources:

On November 30th, Secretary of State Hillary Clinton arrived in Myanmar (also known as Burma) to discuss the country’s reform efforts and to assess whether these efforts warrant a change in U.S. policy toward the country. This visit marks the first time a U.S. Secretary of State has visited Myanmar since 1955, and potentially signals the first step toward improved relations between the countries.

In the 1980s and 1990s, relations between the countries soured due to the Myanmar military government’s numerous human rights violations against political dissidents and ethnic minorities. As a consequence, the U.S. and European countries imposed strict economic sanctions that prohibited new investment in Myanmar, blocked its exports to Western markets, and restricted financial transactions between the countries. Together, the military government’s economic mismanagement (it did not institute a capitalist economic system until the 1990s) and economic sanctions have resulted in Myanmar having the second-lowest gross domestic product (GDP) per capita in Asia.

In March, Than Shwe, the former President and top general, stepped down and Mr. Thein Sein (another former general, but a civilian as of April 2010) was elected President in Myanmar’s first election in over twenty years. The election was considered a sham in the U.S. and Europe, and although Myanmar is nominally a civilian government led by President Sein, it is still comprised primarily of military leaders. Since his election, President Sein’s government has released over 200 political prisoners, eased media censorship, and engaged in dialogue with Ms. Aung San Suu Kyi, the leader of Myanmar’s democracy movement who was under house arrest for most of the last twenty years before being released in November of 2010.

Although Clinton supports the reforms that President Barack Obama has called “flickers of progress,” she insists that Myanmar release the remaining 1,000 political prisoners, end ongoing violence between the Myanmar military and ethnic minorities, and cease illicit nuclear-missile-technology trade with North Korea before the U.S. will consider ending its economic sanctions on Myanmar. Clinton did, however, pledge to support International Monetary Fund (IMF) and World Bank efforts to determine whether Myanmar should receive international aid, and also suggested that the Obama administration would consider sending an ambassador to the country in the near future.

Economically, Myanmar suffers from an ineffective banking system, inadequate infrastructure, regular power outages, and extreme poverty. Despite these weaknesses, foreign investors are carefully watching Myanmar’s reform efforts because the country has vast amounts of oil, gas, timber, and gems, the availability of which would make it easy for foreign investors to earn a profit. Furthermore, wages are lower in Myanmar than its neighbors, many of its citizens speak English thanks to former British rule, and the legal system is derived from the British system, making it familiar to many potential Western investors. To attract more foreign investment, Myanmar needs to undergo more meaningful political reform to give companies the public support they believe is needed to set up business in the impoverished country. More foreign investment could promote strong economic growth and improved living conditions, much in the same way it has in other Asian countries.

Although President Sein has made progress, many analysts believe the country needs more economic results quickly. There is still a hard-line contingent in Myanmar’s military-dominated government and its patience with President Sein’s administration may run out if there are not concrete changes, such as the lifting of economic sanctions or improved economic activity. To produce these concrete changes, President Sein needs to convince the West that Myanmar has made meaningful political reform. The hard-line contingent, however, is reluctant to push political reform too quickly. Therefore, President Sein is in a difficult bind. If political reform moves too slowly, the West will not change its economic policies and there will be no concrete economic changes in Myanmar, but if political reform moves too quickly, President Sein will lose favor with the military leaders. Unless President Sein manages to find the appropriate balance, his tenure may be short and the hard-line government may return to power, potentially erasing what little progress has been made.

The IMF’s Assessment of the Chinese Financial Sector

Sources:
Bloomberg: IMF Sees 'Buildup' of China Bank Risk Needing More Oversight
Hindustan Times: China's Financial System Vulnerable, Warns IMF
The Independent: IMF Alert on Banks Adds to Fears About Dangers in China
Irish Times: IMF Warns China Must Relax Grip on Banks and Rates
NYT: IMF Warns China on State Control of Banking
Xinhau Net: IMF Reports on China's Financial System "Generally Objective": PCOB

The International Monetary Fund (IMF) recently completed its inaugural evaluation of the Chinese financial sector as part of the IMF’s periodic look at the twenty-five most important economies in the world. While the report found that China’s financial sector is sound, it also noted several vulnerabilities that need to be addressed and reforms that need to occur.

The report identified many things the Chinese financial sector is doing well, including a trend towards policies the IMF favors. Among these strengths is the Chinese Government’s trend away from state-controlled economic decisions towards a regime where market forces have a greater effect on the economy’s direction. The IMF also applauded China’s increased legal regulation and additional safeguards placed on the financial market, such as interest and exchange rate reforms. Despite the positive movements, the IMF warned that additional regulations are still required.

Chief among IMF concerns is the lack of risk management and regulation in the financial sector, which makes the country vulnerable to asset bubbles, especially within the housing market. Adding to this problem is the artificially low interest rate set by the Chinese Government through the People’s Bank of China. The artificially low interest rates have resulted in increased loans to Chinese citizens giving them more access to money. The increased availability of capital has increased consumer demand, which leads to higher prices in many markets, especially the housing market. This bubble will likely burst when interest rates for consumer loans increase because fewer people will be able to afford the higher loan payments associated with higher interest. Demand for houses will then decrease based on a reduction of potential buyers, and ultimately the price of houses will fall. The IMF is also concerned that extending credit to Chinese consumers will result in loans to less credit-worthy individuals who have a higher chance of default.

The Chinese financial sector also suffers from “shadow banking,” which is unregulated and lightly supervised distributions of capital that occur outside the formal financial market. These transactions, which the Chinese Government cannot adequately track or tax, can lead to financially risky investment decisions that the Government is not aware of and, therefore, cannot prevent or later correct. China also needs to improve its financial accounting oversight system to recognize and proactively stop accounting scandals. Finally, the IMF is concerned that China’s banking system favors state-owned companies over private and foreign corporations by giving Chinese companies easier access to capital—often at lower interest rates. The sum of the above problems has led to inefficiencies in the Chinese financial market.

According to the IMF, China should address these issues by first increasing privatization of the banking system, which the IMF believes will allow the financial sector to react to market trends faster and make more efficient capital allocation decisions. China is likely to retain more state control than the IMF would prefer, however, as state control is the basis of the Chinese financial model. This belief is furthered by China’s relatively successful past operation of state-run companies.

China’s response to the IMF report stated that it believes the report is objective and generally positive, but that the suggested timelines and priorities of certain projects do not reflect the reality of the Chinese economy. As China’s economy continues to move forward, many investors and countries will be following whether China implements the IMF’s recommendations.

IMF Seeks Latin American Support to End the European Financial Crisis

Sources:
Bloomberg: IMF’s Lagarde Seeks Latin America Help for Europe in “Historic About-Turn”
IMFdirect: Latin America-Taking the Helm
La Rep├║blica: Las dos posibles razones de la visita de Lagarde
Washington Post: Lagarde Suggests Latin America Safeguards Against Europe Crisis

Christine Lagarde, the Managing Director of the International Monetary Fund (IMF), is visiting three countries in Latin America this week, Peru, Mexico, and Brazil. Analysts believe that Ms. Lagarde has strategically chosen to visit these countries in particular to gain financial support to help Europe emerge from its debt crisis. Brazil is one of the foremost emerging economies in the world; Mexico will chair the Group of 20 (G-20) for 2012 (a group of finance ministers and central bank governors from the world’s 20 major economies); and Peru boasts one of the strongest emerging economies in Latin America. Experts think that Ms. Lagarde is travelling to Latin America and other countries holding large international reserves to secure bilateral loans to the IMF to fund loans to Europe during the crisis. Brazil, for example, has more than $350 billion in international reserves. The IMF alone, which has approximately $390 billion available for lending, may not be able to finance loans to Europe if the crisis continues.

Ms. Lagarde has emphasized that there are many ways beyond providing funds in which Latin America can help Europe, including through information sharing. Latin America’s experience in recovering from the debt crisis that led to many countries defaulting on their debt during the 1980s could serve as a model for Europe. In the past decade, Latin America has reaped financial and social benefits from becoming a model economic region that has grown because of reasonable fiscal policies implemented in the wake of its debt crisis. This year, the region experienced 4.5 percent economic growth, compared to 1.6 percent for developed nations. Although they have expressed a willingness to help Europe, Latin Americans have made it clear that Europeans should take responsibility for a problem they created and come up with specific solutions to end the debt crisis and keep it from spreading to other countries. Furthermore, Latin Americans are hesitant to help Europe and the IMF without receiving some benefit in return. Brazil, for instance, hopes that the IMF decides on a formula for calculating voting quotas that gives greater voting power to the world’s strongest emerging economies, even though the IMF already agreed to increase their voting power earlier this year.

Analysts also believe that Ms. Lagarde intends to warn Latin American countries during her visit that, despite their current economic success and stability, they may be vulnerable to the effects of the European crisis. Prior to her visit to Latin America, Ms. Lagarde suggested that Latin America could also be affected by the European financial crisis. Thus, while the crisis is currently Europe’s problem, it could become Latin America’s as well. She argued that Latin American countries must, therefore, implement preventive measures to strengthen and further stabilize their economies, such as continuing to increase domestic savings and protecting the banking sector, to guard against the effects of an economic slowdown if the financial crisis worsens.

Thursday, December 01, 2011

Standard and Poor’s Changes Rating Criteria – Downgrades 15 Banking Companies

Sources:

NPR: S&P Downgrades Top U.S. Banks' Credit Ratings

Reuters: S&P Cuts Ratings on Big Banks After Criteria Change

S&P: Standard & Poor's Applies its Revised Bank Criteria to 37 of the Largest Rated Banks and Certain Subsidiaries

WSJ: S&P's New Criteria Prompt Downgrades of BofA, Barclays, Citi


Standard & Poor’s (S&P), one of the ‘big three’ New York City-based credit rating agencies (Fitch and Moody’s round out the trio), announced new rating criteria for banks on November 9, 2011. This week, S&P applied the new criteria to 37 of the world’s largest financial institutions, which resulted in the downgrading of 15 major institutions including Goldman Sachs, Bank of America, UBS, JP Morgan Chase, Citigroup, Morgan Stanley, and The Royal Bank of Scotland.


S&P’s new criteria consist of two key steps. First, S&P evaluates a bank’s financial health and ability to withstand severe or extreme economic stress without reliance on external support and assigns each bank a “stand-alone credit profile.” Second, S&P assesses the degree of extraordinary government or institutional support available to a given bank. These two conclusions are then factored into the broader credit rating methodology, which includes complex risk analysis and assumptions and an overall financial evaluation.


By taking into consideration the degree of external support a bank may have available from central banks or due to its association with a parent group, S&P attempts to create a more accurate credit profile by evaluating the bank not only as an independent financial entity, but also as to the position of the bank within the financial industry as a whole. The new criteria appear promising; however, it may also extend the reach of credit rating agencies and prove controversial. The new criteria allow S&P to consider a bank’s position within the broader context of global finance, governmental support, political climate and economic conditions and to reflect that information in the credit rating. The recent bank downgrades are largely a result of the industry’s susceptibility to such factors and increasing reliance on governments and central banks worldwide.


The new criteria were designed to allow the rating agency more flexibility to respond to rapidly changing market conditions and adjust credit ratings accordingly. Prior to implementing the new criteria, S&P detailed its underlying assumptions and methodologies for rating banks in a series of reports on January 6, February 16, November 1, and November 9, 2011. According to the November 9, 2011 report, “the criteria are designed to improve transparency of bank ratings globally.”

Eurozone Crisis Worsens as Unemployment Rises in the Region

Sources:
Eurostat: Euro Area Unemployment Rate
FT: Eurozone Unemployment Hits Euro-era High
Spiegel: The High Price of Abandoning the Euro
WSJ: Europe’s Crisis Gets Real as Unemployment Soars

The European debt crisis continues to worsen as borrowing costs increase, governments’ credit ratings are downgraded, and investor confidence continues to diminish. To make matters worse, the European Union’s statistical office, Eurostat, released its latest report last Wednesday on the unemployment rate in the region. The data highlights the rapidly depreciating economic outlook for the European Union (EU) and Eurozone, which many economists already say may be in a recession.

According to the report, the seasonally-adjusted unemployment rate (a rate that is adjusted to eliminate influences of predictable seasonal employment patterns) in the Eurozone was 10.3% in October 2011, compared with 10.2% just the previous month. This constitutes an increase of 126,000 unemployed workers, bringing the total to 16.3 million—the highest number since the statistical office started compiling such data in 1995. Compared with October 2010, unemployment rose by 367,000 in the region.

Among the member states, Greece and Spain saw the most significant increases in unemployment: Spain had a rate increase in one year from 20.5% to 22.8% and Greece from 12.9% to 18.3%. The lowest unemployment rates were recorded in Austria (4.1%), Luxembourg (4.7%), and the Netherlands (4.8%). Moreover, the economic crisis has especially affected the ability of young adults (under 25 years old) to find jobs. As the report highlights, as of October 2011, there were 3,338,000 youths unemployed in the Eurozone—an increase of 141,000 from the previous year. The youth unemployment rate is now 21.4% for the Eurozone. However, in countries such as Spain and Greece youth unemployment is even higher at 48.9% in Spain and 45.1% in Greece.

The rise in unemployment in the Eurozone is of particular concern for EU leaders who are trying to keep the region afloat. In addition to the suffering of the individuals who have lost their jobs and the growing discontent of the unemployed, the rise in unemployment puts an additional burden on governments trying to end the debt crisis. More unemployment means higher social security payments and lower tax revenues. These already cash-strapped governments will likely have to borrow more to support those out of work, which would only worsen the debt crisis. Also, the economic growth of the country suffers as individuals (now with lower or no income) cut back on spending, which lowers profits for businesses, which then have to lay off more workers. Thus, the increase in unemployment comes as a sign that perhaps the worst is yet to come in the European debt crisis if governments do not start taking more drastic actions.

Monday, November 21, 2011

Afghan Leaders Meet to Discuss Afghanistan’s Future

Sources:
International Business Times: Is Afghanistan Moving in the Wrong Direction?

At the invitation of President Hamid Karzai, over two thousand Afghan leaders gathered in Kabul on November 16th for a four-day meeting—or loya jirga—to discuss the future of Afghanistan, particularly regarding its relationship with the United States and the Taliban.

Among the attendees at the loya jirga were elected politicians of the national assembly and district councils, along with tribal and religious leaders. In all, there are only 250 elected officials and over 1800 non-elected tribal and religious leaders. Although the loya jirga has no official legal capacity and all its proposals must be approved by the parliament, some politicians have protested or boycotted the meeting. These politicians believe the meeting subverts the democratic political process in Afghanistan because many Afghans remain loyal to the judgment and guidance of their religious and political leaders, and many of these leaders remain loyal to Karzai. Therefore, any decision made by the loya jirga could influence Afghanis into pressuring their representatives in parliament, giving Karzai the necessary leverage to push through his plan.

In his opening remarks, Karzai stressed the need for a prolonged strategic partnership with the United States after the planned exit of foreign troops in 2014. Such a partnership could lead to the U.S. establishing temporary military bases throughout Afghanistan during the next decade, which would assist the government in fighting Taliban insurgents. Although Karzai acknowledged the need for international assistance after 2014, he stated that any long-term partnership between Afghanistan and the U.S. should not threaten Afghanistan’s national sovereignty. Specifically, he stated that such a partnership must be conditioned on foreign troops ending night time raids of Afghan homes. The U.S. contends these raids are the most effective way to kill or capture Taliban insurgents, but Karzai believes too many of these raids end up treating civilians as if they were insurgents and violating Afghans’ cherished privacy rights. The loya jirga will also discuss possible reconciliation with the Taliban. Since the U.S.-led raid in 2001, violence in Afghanistan has never been higher, and Afghans are growing weary of the persistent threat of violence. A recent poll conducted by The Asia Foundation, a non-profit, non-governmental organization, revealed that 35% of Afghanis believe their country is moving in the wrong direction—the highest level of dissatisfaction since 2004—and many Afghanis cited security and conflict as their main concerns.

Despite continued violence, political tension between elected officials and traditional Afghan leaders, and the uncertainty looming from a potential U.S. exit, there are some positive signs in Afghanistan. Afghanis are generally more satisfied with their access to education, drinking water, health services, and the role of public institutions than they were a year ago. Afghanis also are more united in their stance against the Taliban. In 2010, 40% of Afghanis sympathized with the Taliban, but only 29% of Afghans sympathize with the Taliban today. In recent years, Afghanistan has also seen a dramatic increase in the production of its agricultural sector and is close to reaching its goal of becoming a net exporter of agricultural products. This is important because the country now has enough food to feed its people, and also because this sustained growth in a key industry may convince foreigners to invest money into Afghanistan which would spur additional economic development. To sustain these perceived and real gains in economic development, it might be necessary for the loya jirga to pave a way for continued United States presence in Afghanistan. However, such a recommendation is not without risk. A continued United States presence may galvanize Taliban insurgents and lead to prolonged violence, threatening the stability of the country. Perhaps most importantly for Afghanistan’s elected leaders, a continued U.S. presence will beholden them to a foreign government and delay the true independence of the country.

Thursday, November 17, 2011

Libya’s Post-Conflict Future

Sources:

NYT: Western Companies See Prospects for Business in Libya
Reuters: Update 2- Libya’s Oil Exports to Jump 350,000 bpd in Nov- Sources

Libya recently rid itself of Muammar Qaddafi’s four-decade-long dictatorship, but still faces a difficult task. Months of fighting have left the country’s infrastructure in need of repair. Fortunately, Libya has Africa’s largest oil reserves, which it can use to pay for the repairs. The potential for new investment opportunities in the oil industry also have western countries seeing Libya in a new light.

Countries like France and Britain are vying for a chance to invest in Libya’s oil development and reconstruction. Surprisingly, the United States has not yet shown the same enthusiasm. The hesitation stems from the fear that corruption from the Qaddafi era still lingers in oil contracts. Currently the issue is irrelevant since Libya’s interim government, the Transitional National Council, has said that it will not sign long-term contracts—a task it thinks is better left to a future, elected government. However, the reconstruction process has been slow because of the lack of a permanent government.

The absence of a permanent government is not the only source of instability in Libya. A large number of youths are unemployed, the oil industry is not producing at maximum capacity, and the country’s infrastructure was heavily damaged during the armed conflict. The infrastructure is of particular concern to foreign investors—a potentially large source of money and jobs. Building a good infrastructure will reduce production costs and raise profits, which will attract foreign investors. The future permanent government will have to address these issues quickly to restore stability. It will also have to work on strengthening international ties that eroded under the Qaddafi regime, but which could serve as an important source of reconstruction financing. If Libya cannot stabilize its economy, it may soon face more backlash from its citizens.

Zimbabwe’s Diamond Industry Can Boost its Economy

Sources:
News 24: Zimbabwe to Get Diamond Boost
NewsDay: Is Zim any Better with Diamonds?
RadioVoP: Marange Diamonds to Generate $2 Billion Annually: Mpofu
The Zimbabwe Guardian: Zimbabwe, a New Economic Giant: Mpofu

The Kimberley Process Certification Scheme (KPCS), an organization that certifies that rough diamonds were not acquired through human rights violations, recently gave Zimbabwe permission to sell diamonds mined in the Marange district in the eastern part of the country. The KPCS’s decision lifts an international, years-long ban on exports from a portion of the country’s largest profit making industry to western countries.

The ban on Marange district diamonds started after a group of small-scale miners discovered diamonds in the region at the end of 2008. Police and military security forces forcibly removed, beat, and killed the miners to take over mining in the region. The takeover resulted in the evacuation of thousands of families who were promised, but never received, compensation.

Even with the KPCS’s ban limitation on western buyers, the mining industry in Zimbabwe has earned around $300 million by selling diamonds to Asian countries. Mines and Mining Development Minister Obert Mpofu stated that Zimbabwe stands to earn more than $2 billion without the ban. These profits would make up more than fifty percent of the nation’s total yearly earnings. The increase would drive Zimbabwe to produce more than twenty-five percent of the world’s diamonds. Many government officials believe that the increased income will allow the country to pay for its own development needs without needing foreign aid. However, analysts are concerned that the president, Robert Mugabe, will use the funds for political gain instead of to address development needs.

Experts also question whether the end of the ban will really be as lucrative as government officials claim it will be. The $2 billion in earnings depends on the industry’s growth rate and on how high-quality the diamonds are after processing in the country. Currently, Zimbabwe sells raw diamonds for less than what those diamonds would be worth if they were processed and cut. Zimbabwe currently does not refine the diamonds because there is a lack of skilled workers who could properly refine diamonds. Zimbabwe must further implement a system to track the profits it stands to make to ensure the government uses them in a productive manner. If it can manage these profits successfully, Zimbabwe could become one of the most developed African nations.

Tuesday, November 15, 2011

The Italian Debt Crisis and the International Monetary Fund

Sources:
Reuters: Analysis: Losing Credibility, EU Seeks IMF's Embrace
Traders Magazine: G20 Summit Roundup
WSJ: UPDATE: UK: G-20 Withheld IMF Commitments, Want Euro-Zone Action

As the European sovereign debt crisis continues to worsen and many countries and investors are questioning the EU leadership’s ability to remedy the crisis, many investors are looking to the International Monetary Fund (“IMF”) to help stabilize and restore market confidence in the region. Market confidence is of upmost importance because the market’s perception of the troubled economies (Italy, for example) will significantly affect the interest rates the countries have to pay on bonds. In the case of Italy, market confidence is of extreme importance because Italy may be able to pay its debts if it is able to receive bonds at low interest rates, but if market confidence falls and Italy appears more risky investors will demand a higher risk premium on their investment in Italian bonds, which will increase Italy’s cost to borrow money and may cause the country to default.

Italy, the third-largest economy in the EU and eighth-largest in the world, is the most recent EU member to find itself in financial trouble. Because of the importance of market confidence in Italy, EU leadership recently forced the country to accept tighter oversight of the country’s economy from the IMF and European Central Bank (ECB). While the EU hoped the move would increase market confidence, some investors believe the move shows that the EU cannot maintain market confidence without outside assistance.

A large factor in market confidence is the ability and willingness of the IMF to offer a bailout to Italy, and potentially the entire EU, if the need arises. At a recent G-20 Summit in France on November 3rd and 4th, the group discussed potentially increasing the IMF’s funding to make a European bailout more plausible. However, before the G-20 will commit to additional funding it first wants to see the EU take more internal actions to control their debt. The G-20 also has specific concerns about the EU’s political structure, which makes quick or firm action almost impossible. Some developing countries that are also members of the G-20 (Brazil, China, and India) stated that they are willing to increase IMF funding if the EU can first show that it has adequate leadership, a clear vision, and the ability to respond to problems rapidly.

While at the current time it seems unlikely that the IMF will make a large loan to the EU, and will instead be involved in more intense economic monitoring, the EU is hoping the IMF’s presence will increase market confidence. However, if EU leadership cannot take concrete steps to confront the growing debt problem and market confidence continues to deteriorate, it may be necessary for the IMF and ECB to play a much more direct role to avert an economic collapse.

Italy’s Political Unrest Puts Markets on Edge

Sources:

NYT: Interest Rates on Italian Bonds Pushed to New Levels
WSJ: Ailing Italy Accepts IMF Monitoring
Spiegel: Italy Becomes Next Euro Battleground
Spiegel: Why Berlusconi's Departure Is Making Markets Nervous

On Tuesday, Italian Prime Minister, Silvio Berlusconi, announced that he would resign from office once the Italian parliament passed a package of austerity measures European Union (EU) leaders demanded to reduce Italy’s vast debt and restore investor confidence in the country. The move came after a humiliating budget vote where parliament approved a plan to increase taxes and raise the retirement age, during which it became clear that the Prime Minister no longer had support from the majority of parliament.

Following the announcement, the interest rate on Italy’s 10-year bonds (which is viewed as a measure of investor anxiety) increased to 7.45%, from 6.63% just the previous day. There are also fears that the higher rates may force clearing houses (the intermediaries between buyers and sellers of bonds) to demand higher collateral payments from traders of Italian bonds to protect the clearinghouses from default, which would push interest rates even higher. Although by some measures the Italian economy is in better shape than the economies of Greece and Portugal, the economy cannot sustain paying such high rates on debt. If the interest rate rises so high that investors stop buying Italian bonds, the country will be unable to raise sufficient money on the bond market to continue paying its current debts and will have to seek a bailout like Greece and Portugal.

The developing crisis in Italy is of particular concern to European Union leaders. The Italian economy is the third-largest in the 27-member bloc and the current Eurozone bailout fund, the European Financial Stability Facility (EFSF), does not have enough money to bail out Italy. Italy’s debt is currently €1.9 trillion and accounts for 25% of all the sovereign debt in the Eurozone.

In an effort to restore market confidence in the country’s economy, the Italian parliament passed another package of austerity measures on Saturday. The austerity package includes an increase in the value-added-tax (a form of sales tax) from 20% to 21%, a freeze on public sector salaries until 2014, and an increase in the retirement age from 60 to 65 by 2026. Also, a new special tax will be imposed on the energy sector along with tougher measures to fight tax evasion. The austerity measures are expected to produce €59.8 billion in savings by the year 2014. Following the passage of such measures, Prime Minister Berlusconi stepped down, as he had promised earlier in the week, and a new Prime Minister, Mario Monti, has been appointed. The new appointment has been welcomed by EU leaders as a signal of the Italian authorities’ determination to overcome the current crisis. However, Italy is still not out of the danger zone as the country will continue to be monitored while it implements the austerity measures.

Sunday, November 13, 2011

Asset Valuation: A Numbers Game?

Sources:

Reuters: Goldman, Morgan Stanley Mull Reducing Mark-to-Market Accounting

TIME: Will Mark-to-Market Fix Help Save the Banks?

WSJ: Bank Quandry-Valuing the Assets


Continuing uncertainty in the global markets has led some major financial institutions to reconsider how they account for and report certain assets. This week both Morgan Stanley and Goldman Sachs announced that they are considering whether to reduce their use of “mark-to-market” accounting in favor of “historical-cost” accounting. This process, called “asset valuation,” impacts a bank’s ability to meet capital requirements, fund operational spending, and implement lending programs.


Investment banks and commercial banks are subject to different accounting requirements for different assets. As investment banks, Goldman and Morgan were required to price most assets using “fair-value accounting,” currently defined as mark-to-market accounting which requires institutions to price assets on their balance sheets according to the price they could be sold at on the open market—not the price they paid for them. However, to receive emergency federal funds during the subprime crisis, Morgan and Goldman converted to bank-holding companies which are subject to different accounting regulations. Banks are able to record certain assets based on historical-costs which means these assets are reported at their original value or purchase price. In short, Morgan and Goldman now have more flexibility in reporting certain asset values and the use of historical costs could substantially increase asset values.


Mark-to-market accounting became problematic after the 2008 U.S. financial crisis as the market for some securities collapsed and buyers disappeared. Mark-to-market accounting requirements magnified the impact of the crisis by forcing banks to show massive losses on their balance sheets, which reduced their ability to lend since banks are only allowed to lend an amount equal to a certain percentage of the total value of their assets. As a result, many banks were left holding (and still are) billions of dollars worth of toxic assets, which they have to report at very low values ranging from zero to sixty percent of their original price. Thus, some banks argue that the accounting requirements are making an already bad situation worse.


Since 2008, the financial industry has lobbied regulators to ease the mark-to-market requirement, which it argues would bolster their bottom-line, prevent additional bank failures, and help stabilize the economy. In April of 2009, the Financial Accounting Standards Board (FASB) adopted changes to accounting rules to allow banks more discretion in the use of mark-to-market accounting for “distressed” assets. Generally, distressed assets refer to securities that can only be sold by greatly reducing the price or for which there is no market at all. Critics argue that easing mark-to-market requirements allows banks to hide losses and reduces transparency.


Morgan Stanley’s and Goldman Sachs’s decisions to move away from mark-to-market valuations could dramatically affect financial results for both firms. Under historical-cost accounting rules, assets are generally reported at their original value or purchase price, a shift that would increase asset values on the firms’ balance sheets. Given the continued market volatility and sluggish economy, such balance sheet reorganizations will likely be met with a certain degree of skepticism. The accounting shifts could be viewed as an effort to disguise significant losses that belie greater financial concerns, or they may reflect prudent management decisions enabling the banks to recapitalize internally by retaining earnings or increasing capital ratios by reducing losses, which will allow them to loan more money and potentially earn more profits.