Possible Conflict May Arise Over Jamaica’s Stand-by Agreement with IMF Over 5% Tax Cut in Fuel

Sources:
Jamaican Gleaner: IMF Open to New Standby Agreement with Jamaica
Business Content Jamaica: Jamaica Shaves 5% Off Controversial Gas Tax
Business Content Jamaica: 1.2% Decline in Jamaica’s Economic Growth

On April 12, 2011, the Jamaican government successfully avoided protest by opposition party, the Peoples National Party (“PNP”). The PNP, had originally scheduled the protest to oppose the Jamaican government’s implementation of a 15% tax increase on fuel. Consumers had already been hit hard by the international increase of fuel prices and the 15% tax increase would have only increased costs for cash-strapped consumers. Currently Jamaican motorist pay more than $4.40 per gallon for gasoline. The 15% tax increase would have sent the price of gasoline to over $5.00 per gallon, something the PNP was unwilling to accept. In response to the possible protest, the Jamaican government agreed to reduce the tax by 5% and successfully quelled the party’s protest.

Although the Jamaican government avoided the immediate fear of political protest, reducing the fuel tax has only created another imminent fear for the Jamaican government. The 15% increase in tax fuel was one of the conditions negotiated in a medium-term economic stand-by agreement with the International Monetary Fund. This agreement between the Jamaican government and the IMF provides the Jamaican government with a 3-year $1.27 billion dollar loan in order to help the government implement new economic reforms and cope with the global downturn. However, the agreement comes with conditions and clearly states that the Jamaican government must meet certain markers and goals for ensuring greater fiscal discipline. One of these markers included increasing cash supply through increased taxation, which the 15% fuel tax increase was supposed to be a part of. The 5% decrease assented to by the Jamaican government, will now force them to explain an unexpected budgetary cost of 3.5 billion Jamaican dollars (roughly $41 million U.S. dollars) to the IMF. It is clear from the terms of the stand-by agreement with the IMF, that Jamaica faces possible legal sanctions for failing to meet these markers. Already identified as a government with a “terminal point problem,” or a problem with failing to meet financial and structural markers, the Jamaican government is unsure if this decrease in tax fuel will have a legal affect for the country. However, in the February review of the agreement, IMF technocrat Trevor Alleyne said the IMF is working with the Jamaican government to ensure that resort to legal sanctions is avoided.

Although some support the stand-by agreement between the IMF and the Jamaican government, critics point to Jamaica’s 1.2% GDP contraction in the 2010 year as an indicator that the reforms imposed by the terms of the agreement are not stimulating growth. Alleyne contends that increasing GDP was never the major goal of issuing the loan, but providing insurance for banks in case of a sharp demand for loans during a debt exchange shock, or fallout, was. Maintaining the economic confidence of companies is crucial toward the growth of the country, Alleyne stated.
However, when a sharp GDP contraction in Jamaica’s September quarter, did not send companies running to the bank for cash bailouts, critics viewed the loan as an attempt to swindle the Jamaican government into paying interest on a overly excessive loan, since $950 million of the $1.27 billion loaned by the IMF had been allocated for such a shock. Alleyne contends that the loan was created to prepare Jamaican banks against the worst possible scenario, not as a reflection of the IMF’s belief that the worst case scenario would actually happen.

Despite criticisms of the loan, the Jamaican government will continue to work with the IMF to make improvements in their fiscal planning. If nothing else the existence of the loan will encourage much needed cheap budgetary support from the World Bank and the Inter-American Development Bank.

WikiLeaks Founder Says To Expect Major Leak Concerning Big U.S. Bank

Sources:
Forbes: An Interview with Julian Assuage
CNN: Which Bank is WikiLeaks’ Target?
FDIC’s Bair: ‘Ignore’ WikiLeaks Bank Release
CNN Money: Wacky Wiki Won’t Wreck Bank Stocks

The news the last few weeks has been filled with mentions of WikiLeaks, the website that releases confidential and nonpublic documents. Most of that news has been filled with discussion concerning the website’s recent release of thousands of the United States’ State Department’s diplomatic cables. However, there is also some curiosity over information the website may have that could affect the United State’s private sector.

Julian Assuage, the founder of WikiLeaks, sparked this curiosity in a recent interview with Forbes. While discussing the massive nature of the cables leak, Assuage mentioned that the website had enough information for another major leak, and this one would be the website’s first leak concerning the private sector. Assuage stated that about half of the website’s documents concerned the private sector and hinted that the website’s next major release, scheduled for early next year, would target one of the biggest banks in the United States. Assuage said that the information was of such a nature that it would “take down” the bank.

Although evasive on the actual contents of the documents that the website will release, Assuage mentioned that the leaks would detail the inner workings of the bank and likely spark even more investigation and reform within the financial sector. Assuage likened the bank’s atmosphere to “an ecosystem of corruption.” Assuage alluded that there were definite ethical violations occurring within the bank, as well as possible criminal actions, and he predicted that it will cause a scandal of Enron-like proportions.

Assuage’s comments have ignited wide speculation regarding on which bank the WikiLeaks’ has such condemning information. Most commentators think the likely candidates are Wells Fargo, Wachovia, Citibank, JPMorgan Chase, and Bank of America. However, the media has speculated that one bank in particular is the likely subject of the controversy, because of Assuage’s previous comments. Last year, Assuage mentioned to an interviewer from Computerworld that WikiLeaks had five gigabytes of information from a Bank of America executive’s computer. Bank of America’s stock is already suffering from Assuage’s comments. On Tuesday, shares fell more than 3% and ended pennies above their lowest price of the past year.

The head of the FDIC, Sheila Bair, downplayed Assuage’s comments. She suggested consumers simply ignore his remarks and rumors of an upcoming leak. Bair stated that since the financial crisis the transparency of the banking industry has increased. Bair was also skeptical that Wikileaks could have any major information about the financial sector and banking industry that has not already been previously released. Time will tell what kind of impact these WikiLeaks could have on the private sector. If Assuage is to be believed, there will be at least some impact, and we probably won’t have to wait long.

Discussion:
1. Do you think Assuage has the kind of information that could cause another Enron-like scandal or is Bair’s statement that there isn’t any further and unknown information more accurate?
2. If WikiLeaks does have such information, what kinds of reform would you expect?

Tanzania Announces Plans for Large Infrastructure Development

Sources:
Wikipedia: Eurobonds
Investopedia: Eurobonds
All Africa: Tanzania: Poor Infrastructure Dogs Development
Bloomberg: Tanzania May Sell $500 Million of Eurobonds in 2011 – 2012, Central Bank Says
All Africa: Tanzania: Business Confidence High Despite Impending Polls

Last June, the Finance Minster announced that Tanzania would try to borrow around $1.4 billion from lenders in order to finance massive infrastructure projects, such as building roads, expanding ports, and increasing the nation’s power generation. Eurobonds are one avenue for the country to raise these funds. Last week, the Bank of Tanzania announced this week that it was planning on selling around $500 million of Eurobonds within the next two years.

Eurobonds are bonds for an international market. The issuing country issues the bond in a foreign currency, rather than its own local currency. The bond issuer will pay the bond holder interest on the bond over time. An attractive feature of the Eurobond is that the holder does not have to pay a withholding tax on the interest. Eurobonds also draw investors because of their small par value (face value) and high liquidity (investors can easily buy and resell the bonds without affecting their price).

The bonds will help provide Tanzania with the funds to undertake massive infrastructure-building projects. Constructing roads will be one such infrastructure project. Tanzania’s road system is a network of 85,000 kilometers of roadway, but only around 5,000 kilometers are paved. This new infrastructure is important for Tanzania, because poor infrastructure has caused many problems for the county, such as inhibiting both trade and anti-poverty efforts.

Tanzania is currently one of the least developed countries in the country. The national economy relies heavily on agriculture that is not industrialized. Although there are other sectors, such as tourism, mining, construction, and manufacturing, the agriculture sector employs almost 80% of the country’s workforce. If the nation can develop better infrastructure, it will be an important step for the nation’s development and help ease the Tanzanian economy’s reliance on agriculture.

Discussion Questions:
1. What are some of the advantages and disadvantages Eurobonds have over other revenue-raising tools?
2. In what ways, other than helping trade and anti-poverty efforts, might new infrastructure affect Tanzania?

The Cost of the Fannie Mae and Freddie Mac Bailouts

Sources:
The Financial Times: Fannie & Freddie ‘Could Cost US $363bn’
BBC News: Freddie Mac and Fannie Mae Bailout ‘To Double’
The Wall Street Journal: Fannie, Freddie Elicit Grim Forecast
The Wall Street Journal: Regulator for Fannie Set to Get Litigious
Wikipedia: Fannie Mae

Some of the United States public has recently criticized the Federal Government over the bailouts of Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are mortgage finance companies that operate within the United States. Fannie Mae and Freddie Mac provide a secondary market for mortgage loans. They buy mortgages from big U.S. banks, totaling billions of dollars. Fannie and Freddie then repackage the loans and sell them to investors with a guarantee. The majority of investors believe that there is an implicit federal guarantee of both Fannie Mae and Freddie Mac’s securities, and in the event of a default the Federal Government would intervene. Fannie Mae and Freddie Mac were severely affected during the global financial crisis; they sustained massive losses on the delinquent and defaulted mortgages which they had underwritten.

In 2008, in the midst of the financial crisis, the Federal Government set up a conservatorship for the entities, meaning that the Government pledged to subsidize Fannie Mae and Freddie Mac, enabling the entities to whether the crisis. In return, the entities promised to pay 10% dividends on the subsidized funds. The Government subsequently poured around $148 billion into Fannie Mae and Freddie Mac.

Last February, the White House’s Office of Management estimated that the U.S. Treasury would have to provide another $160 billion to Fannie Mae and Freddie Mac in order for them to stay afloat until 2019. The White House noted that in order for this figure to be accurate, the U.S. economy would have to continue to recover from the financial crisis. However, by this August the Congressional Budget Office had already increased the estimate of the needed federal subsidies to around $390 billion. This week, the Federal Housing Finance Agency (FHFA), Fannie and Freddie’s regulator, stated that the lowest amount possible that the entities would need is an additional $221 billion. The FHFA also stated that in the worst-case scenario, Fannie Mae and Freddie Mac would need around $363 billion. The actual amount of funds the entities will need largely depends on the strength of the economy and many other factors, such as interest rates, unemployment rates, and the housing market.

As Fannie Mae and Freddie Mac try to stabilize their operations and regain their independence, there may be repercussions for the banks that caused many of Fannie and Freddie’s problems. The FHFA subpoenaed some of the financial institutions this July, trying to discover exactly how much information the banks had on the mortgages they sold to Fannie and Freddie. The FHFA then selected a well-respected law firm to investigate whether a lawsuit would be successful against the banks for selling toxic loans to Fannie and Freddie. A suit would likely allege that the banks breached promises to Freddie and Fannie about the quality of the mortgages they were selling to the entities. If the FHFA can show that the banks breached their promises to Freddie and Fannie, the court would force the banks to buy back the loans at their original value, leading to the recovery of billions of dollars. If the FHFA is successful in its lawsuit against the major banks, it could open the door for other investors to pursue similar claims.

Discussion:
1. Why do the amounts of funds the Federal Government estimates Fannie Mae and Freddie Mac need greatly vary?
2. Besides opening the door to similar lawsuits, what would be some consequences of Fannie Mae and Freddie Mac bringing a successful lawsuit against major lending financial institutions?
3. Should the U.S. Government continue to provide Fannie and Freddie with funds? What would happen if the Federal Government decided to terminate the funding

Three Major Points of the U.S. Financial Reform Bill

Sources:
Restoring American Financial Stability Act of 2010
Wall St. J.: Senate Passes Sweeping Financial Overhaul
NY Times: 3 Auto Dealer Tactics the Overhaul Missed
Financial Times: A New Era: Key Points of the Senate Bill
CNN: Wall Street Reform: What’s in the Bill?
The Boston Globe: Agency has Teeth, Panelist Says

On Thursday July 15, 2010, the Senate voted 60 to 39 to approve the 2,300 page financial reform bill. The bill marks the most drastic revision of financial regulation since the Great Depression. So, how will the bill affect the financial sector? The bill changed many aspects of financial regulation­­­ ­ (far too many to discuss all of them here), but below are three major points of the bill.

Consumer Financial Protection Agency (CFPA)

The financial reform bill created the CFPA to do exactly what its name implies—protect consumers from abuses of the financial industry. Among these abuses are predatory subprime mortgage lending (a major catalyst of the financial crisis) and mis-selling of credit cards. However, the CFPA will not have power over automobile dealers writing car loans. The CFPA is responsible for writing the rules to protect consumers from abuses, but the bill does not require the CFPA to implement any specific laws.

The CFPA will be housed within the Federal Reserve and will be funded by fees paid by banks. It will operate completely independently from the Fed and have a protected funding stream that will shield the CFPA from congressional and corporate interference.

The rationale for creating the agency is that abuses by some financial institutions helped lead to the financial crisis. Of course, commentators have criticized the CFPA on numerous grounds.

One criticism of the CFPA is that automobile dealers and the loans that they arrange for consumers are not subject to CFPA oversight. Proponents of the automobile dealer exemption believe that “auto dealers are part of Main Street, not Wall Street” and that automobile loans played no part in the financial crisis. In response, those that challenge the exemption are quick to point out “that Wall Street firms bundle into bonds many of the loans that dealers help originate and conveniently forget that lots of dealers are actually owned by publicly traded companies.” Thus, according to the critics of the exemption, auto dealers are actually part of Wall Street.

Another criticism is that the strength of the CFPA is unknown. The bill merely created the CFPA, but does not require the CFPA to implement any specific laws. As a result, these critics believe that the CFPA will be weak if those who write the rules implement weak, loophole-laden laws.

Derivatives

The bill requires that derivatives that trade in over-the-counter (OTC) deals now be traded on exchanges or similar systems and routed through a clearinghouse. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to something else such as stocks, bonds, interest rates, or commodities. Customized swaps can still be traded OTC, but they would have to be reported to central repositories so regulators have a better idea of what is taking place in the market. Put simply, a swap is a simultaneous buying and selling of the same security—such as a bond—to hedge risk, speculate, or reduce funding costs. There will also be new capital, margin, reporting, record keeping, and business conduct rules for derivative dealers.

Before the bill was passed into law, the OTC derivatives market was largely unregulated, disclosure requirements were minimal, and it was made up of highly sophisticated parties (banks and hedge funds). An example of an OTC derivative is a credit default swap, which many believe was a cause of the global financial crisis (and here). A credit default swap is similar to an insurance contract that pays out if, for example, a party defaults on its home mortgage. Previously, counterparties in OTC derivative transaction executed their transactions directly with each other rather than through a clearinghouse. As a result, the counterparties had no assurance that the other would perform. By requiring trades to be executed through a clearinghouse, counterparty risk is minimized—if a counterparty cannot meet its obligations the clearinghouse will cover the loss of the defaulting party. The use of a clearinghouse will decrease counterparty risk and increase transparency.

The bill provides exemptions for non-financial companies using contracts to hedge risk. A company hedges risk to attempt to eliminate the volatility of an underlying asset. Speculation is different than hedging in that the main purpose of speculation is to profit from betting on the direction an asset will move. For example, an airline will buy options in oil to reduce the volatility (hedge) of the price of fuel. On the other hand, a speculator will buy a call option if it believes that the price of oil will increase solely to make a profit.

Volcker Rule

The Volcker rule prevents deposit-taking banks from buying and selling financial products for their “trading account”. The law then defines the trading account as an account meant to profit in the “near term” from “short term” movements in prices. Additionally, it prevents these banks from owning more than a small piece of hedge funds and private equity firms. The bill does provide an exception (government bond exemption) which allows banks to trade in Treasuries, government backed bonds, and municipal bonds.

The Volcker rule attempts to reduce moral hazard for the largest banks which came as a result of the government bank bailouts of 2008-2009. Moral hazard is the idea that when governments bail out financial institutions that have engaged in risky behavior—e.g., risky trades—that threatens the financial system, they send signals to other financial institutions that they too can engage in similarly risky behavior with the expectation that they will be bailed out if they get into trouble. Essentially, the Volcker rule bans banks from using their own funds, which were backed by taxpayer cash, to speculate in the financial markets. For example, in the fourth quarter of 2007, Morgan Stanley took a $7 billion dollar trading loss. Eventually Morgan Stanley took bailout money from the government. Furthermore, Citigroup had significant holdings of mortgage-backed securities and collateralized debt obligations of which it took significant losses. Following these losses, Citigroup received $45 billion in government money and guarantees. Thus, the financial reform bill introduced the Volcker rule to help reduce the number of risky bets that banks make on their own behalf.

The government bond exemption has come under fire. Critics of the government bond exemption believe that there is still a risk of loss in government bonds. Critics point to the European sovereign debt crisis and the poor financial state of some local U.S. governments as evidence that government bonds are in fact risky. Critics argue that using leverage, it is possible for banks to make large speculative bets in exempt bonds which could lead to major losses and therefore, more bailouts.

Proponents of the exception argue that, because banks hold many of these bonds on their balance sheets, disallowing trading in these bonds would cause banks significant hardship. They believe that government bonds are safer than corporate bonds, and therefore should not be treated the same as corporate bonds. Regardless of the risk in government bonds, deposit-taking banks may invest in government bonds for their own benefit.

Discussion:
1) Did the financial reform bill go too far or not far enough?
2) Will the CFPA be effective? What will it take for it to be effective? What is the most important issue that the CFPA needs to tackle?
3) Are government bonds safer than corporate bonds? Should they be exempt from the Volcker rule?

Reformed IMF lending policies address the needs of low-income countries

Sources
Reuters Africa: IMF to boost funds, revamps lending to poor nations
IMF: The IMF Response to the Global Crisis: Meeting the Needs of Low-Income Countries

For the world’s industrialized economies, the worst of the global financial crisis seems to be over. G8 leaders are contemplating recovery strategies, trying to rein in inflation and hoping to reduce the overall severity of the recession. In low-income countries however, the global economic downturn, along with rising food and fuel prices, threatens to erase years of economic progress.

On July 29, the IMF announced a series of new lending policies to combat the effects of the recession in low-income countries. By adopting the new measures, the Fund has “transformed its relations with low-income countries,” and responded directly to an emerging international consensus on how best to respond to global crisis.

The IMF plans to increase concessional lending to low-income countries to $17 billion by 2014. The increased funding will be accompanied by more generous borrowing limits and by new, flexible concessional financing facilities. For example, the new Standby Credit Facility will address short term needs by allowing countries to tap the IMF specifically when they need funding, rather than in the course of an established IMF program. The Fund also plans to place a strong emphasis on poverty alleviation and growth, implementing programs to protect social and other priority spending. The Fund also plans to freeze interest rate payments on outstanding credit for 60 low-income countries over the next two and a half years, until 2011.

Already, in the first six months of 2009, the IMF has lent or committed about $3 billion, more than in the past three years combined. Their new commitment will increase overall lending to four times historical levels and represents an unprecedented transformation of the IMF’s lending policies.

Discussion
1. The IMF is overhauling its lending policies to meet an immense need. However some of those policies were established as safeguards against problematic lending to already debt-burdened countries. What are the potential costs of these new, flexible lending practices?
2. How can the Fund effectively monitor poverty-alleviation spending? Will other member countries be more willing to subsidize low-cost lending if the IMF is able to scrutinize loan spending?