The FC Chronicles

Reasons for the Crisis: Message 10/10

2009-05-29T04:41:00.000+02:00

x) The day after tomorrow, the world will be different.

We may be walking towards a world where governments will have a much larger role in all economies; where financial intermediationwill be a state-controlled "utility"; where "deglobalization" will happen; where societal preferences for consumption will be subdued; and where there will be more than one globalreserve currency. Developing countries will have true autonomy-----they will now have to rely more on their own internal capacity. And the "new USA" will still count on its fundamental advantages (unparalleled rule of law; inside track in science and technology; growing population; unmatched military) but it will be a more frugal place, and no longer the engine of growth for the rest of the world.

Reasons for the Crisis: Message 9/10

2009-05-28T04:40:00.000+02:00

ix) The multilaterals will become bigger before they become fairer.

Enlarging the financing power of multilaterals, especially the IMF, has been the correct move, and more of it may still be necessary. This could be complemented with new liquidity and guarantee facilities, especially for the private sector. Welcome are also the various new or enhanced forums for global policy coordination (like the G20). But there is no illusion that global governance will change much any time soon because, in any grand bargain, the power of European countries will have to be trimmed, something that is not seen as politically feasible.

Reasons for the Crisis: Message 8/10

2009-05-27T04:39:00.000+02:00

viii) Macroeconomics will move towards growth-targeting.

Calls for central banks to go beyond inflation targeting are becoming louder. Those calls range from asking central banks to target credit or asset prices, to plainly asking for targets on short-term aggregate demand or on the so-called "output gap". Behind this, there is an increasing recognition that the state (not just the central bank) can and ought to target short-term growth. This is reinforced by two related factors: financial markets will remain dysfunctional for a while, and fiscal/monetary stimuli have recently been shown to work better when firms are credit constrained. The question is which institution should be in charge of "growth targeting", and with which tools. As central banks begin to lend directly to the private sector ("quantitative easing"), in effect they begin to manage a parallel and unlimited fiscal budget. It is then a matter of time before Congresses lay claim on that budget, and the central banks lose their independence.

Reasons for the Crisis: Message 7/10

2009-05-26T04:38:00.000+02:00

vii) Finance will become simpler.

There is a general recognition that the market cannot keep financial agents in check. At some point, they become so systemically important that they cannot be allowed to fail and have to be bailed out. So a regulatory system is necessary. The question is of whether that system can continue to rely on markets at all. Basle II is all but dead. Its focus on single-bank capital adequacy, internal risk models and credit ratings is seen as grossly inadequate to take care of systemic risk, the procyclicality of marking assets to market, or the intrinsic conflict of interests of credit rating agencies. Technical ideas to fix those problems abound: creating a "systemic risk tax" not unlike carbon emission taxes; shifting capital requirements towards the funding structure (rather than the asset structure) of financial intermediaries; demanding FDA-type of "health certifications" for new financial instruments; focusing on the vulnerabilities of the "financial network" using the same protocols that govern the internet; and so on. But these sound more like attempts to fix the system that failed than to create a new one. More likely, the financial industry will become a "utility", whereby a single or a few private suppliers get a government license to provide a standardized service at a regulated price and under heavy supervision. This will make financial innovation more unusual.

Reasons for the Crisis: Message 6/10

2009-05-25T04:38:00.000+02:00

vi) The poor will suffer less than the middle-class.

In developing countries, the main contact point between people and crisis will be the contraction in labor demand (not a sudden change in relative prices or a sudden loss of wealth, as in the past). This will affect primarily urban formal workers in tradable sectors. That is, it will affect proportionally more the middle classes. The poor were already credit-, demand- and productivity-constrained. So the usual mechanisms to cushion the social impact of the crisis may not suffice. Social assistance may need to be complemented by social insurance.

Reasons for the Crisis: Message 5/10

2009-05-23T04:36:00.000+02:00

v) The export-led development model needs rethinking.

The rich world's absorptive capacity will not come back to its previous level for a while, if ever. Emerging markets will need to rebalance their sources of growth towards domestic and "south-south" demand. The new internal reliance will not apply just to output; it will also apply to inputs, as foreign savings will not be available to fund investment. This will be accompanied by an appreciation of the real exchange rate in developing countries, as the price of tradable goods will be depressed and calls for their subsidization will multiply (directly, through trade protection, undervalued currencies, or financial repression). Completing a new round of trade negotiations will become more difficult. Small economies will suffer the adjustment the most.

Reasons for the Crisis: Message 4/10

2009-05-22T04:35:00.001+02:00

iv) The impact on developing countries will be slow but harsh.

Contagion is happening through four main channels: export demand; remittances; commodity prices; and financing flows. But most emerging markets will be spared the symptoms of past crises----huge devaluations, interest rate increases, inflationary spikes, banking collapses, debt defaults. Instead, the initial impact will come through an interruption of foreign bank finance to the domestic private corporate sector. This will slow down trade and delay investment projects. The early data shows that already. This will be followed by increasing difficulties in rolling over government debts in 2010 (the next iceberg). The availability of external funding will be further impaired by the crowding-out effect of heavy borrowing by rich countries to pay for their stimulus programs. So, less exports, less investment and less fiscal space will bring growth to a halt among developing economies, and may complicate the solvency of those that do not have deep domestic financial markets.

Reasons for the Crisis: Message 3/10

2009-05-21T04:33:00.000+02:00

iii) By now, there is little else policy-makers can do.

After some understandable, initial hesitation, the overall policy response to the crisis has been reasonable. But the contraction in global aggregate demand is likely to be so big that, even with the best of coordination, it cannot be offset by fiscal stimuli and monetary easing. The auction system for trading in toxic assets recently announced by the US is a step in the right direction, but it will take a long time to work, if it works at all. Bank nationalization will not add much; de facto, it already happened. There is no first-best policy responses left (the numbers are just too large and the information too weak).

Reasons for the Crisis: Message 2/10

2009-05-20T04:32:00.000+02:00

ii) Things will get worse or much worse before they get better.

The consequences of the crisis have not yet fully unfolded. On the one hand, the global rebalancing of saving and consumption patterns has barely started. US consumers are said to have lost $13 trillion in wealth, something that should cut their consumption by about half-a-trillion dollars a year. Their "deleveraging" (debt reduction) process has barely begun. On the other hand, the flow of credit will not really restart until the balance sheet of the largest banks is cleared of the bulk of toxic assets. The problem is that we do not have yet a price for those assets which, to make matters worse, continue to lose value as the real economy contracts. Housing prices are still too high compared to their true rental value, so further downward corrections will take place. By now, the toxicity is spreading to asset classes beyond mortgage-backed securities (credit cards and auto loans in particular). And all this assumes that three low-probability-huge-impact risks will not materialize: a "sudden stop" of capital flows to the US (by China among others); a global run away from the dollar; and a spiral of trade protection.

Reasons for the Crisis: Message 1/10

2009-05-19T04:31:00.001+02:00

On April 20 and 21, I attended a special meeting of the "Growth Commission" which took place at Harvard.

It was an impressive, closed-door gathering of some of the best minds in the profession. There were four Nobel laureates (Akerlof, Scholes, Solow, Spence); a line-up of academic luminaries (Acemoglu, Aghion, Banerjee, Calomiris, Cooper, Feldstein, Frankel, Hausmann, Ito, Kenen, Portes, Romer, Rodrik, Sheng); renown current and former policy-makers (Ahluwalia, Boediono, Blejer, Han, Malan, Venner); leading market players (El-Arian, O'Neill, Steer); and international civil servants (Dervis, Watanabe). Ngozi, Danny, Justin, Lars and Otaviano led the Bank's participation.

There were more than 30 presentations in two days, over an agenda that focused on the global crisis. Below are the "Ten Main Messages" I carried from the meeting:

i) The crisis has many culprits. A series of interconnected factors combined to produce the crisis, some causative and some amplifying. First, excess liquidity creation by the US in what appears to be a loss of control by the Fed. Second, a consequent mega imbalance between savings and consumption across the world (roughly, the US consumed while the rest of the world saved). Third, failure of regulation, especially over the segment of the financial industry that was left to operate on its own because it did not technically take deposits but grew so large as to carry massive systemic risk (the "shadow banking" of, among others, hedge funds and special investment vehicles). Fourth, subsidies to housing, from the tax treatment of mortgage interest to the implicit guarantees of Freddie Mac and Fannie Mae. Fifth, pro-cyclical accounting principles that mechanically marked assets at market prices even when there was no longer a market. Sixth, myopic underestimation of tail-end risk ("black swans" events). Seventh, global lack of sound and liquid financial assets, which kept investors pouring money into the US. Eighth, agency problems between shareholders of financial institutions and their celebrity managers ("fake alpha" traders). Ninth, unbridled "animal spirits" in the form of greed and herd-like behavior by investors. And, tenth, securities so complex that only a few traders could tell good from bad ("snake-oil securities").

Reasons for the Crisis

2009-05-19T04:28:00.001+02:00

I normally do not like to use other people’s material on my blog with the exception of some quotes, but for the next few days I think I will make an exception. I recently received an email on the “Growth Commission” which took place in Harvard and I thought it was very interesting. I wish I could’ve attended this meeting, but it seems that I am not a member of the Harvard club. The reports basically explain how we got to where we are and how the ripple effect will continue to affect us.

The person who wrote the essay divided it into “Ten Main Messages”, I will therefore proceed and publish one “message” a day for the next 10 days. Afterwards, I will publish my own thoughts on the matter.

Economists Abound

2009-05-10T20:45:00.001+02:00

Why is it that in times of crises, pretty much everyone becomes an economist of sorts. The most common response to their economics knowledge is usually “Well, I’m not an economist, but I read the newspaper and I know about economics.” Are you kidding me?? Seriously?!?!?

I can’t stand having an argument with these kinds of people. Seriously, if you don’t anything about a topic, than don’t talk about it. It really isn’t that difficult to do.

Don’t get me wrong, I am all about talking to different people about different topics, but if you don't know don’t pretend to know. That simple. You can ask all the questions you want, but don't pretend to know without knowing anything.

Private Equity.... What is so bad about them??

2007-04-05T15:43:00.000+02:00

By Andres D’Alessandro C.

Everywhere I read something about private equity firms it is always something negative. And I don’t really understand why. Yes, private equity firms do tend to cause massive layoffs when they take over a company. But that is only in companies that have way too many employees to begin with. I like to think of private equity as a kind of financial doctor. They come in fix up a company or make it profitable in whatever way be necessary and then sell it. Now I admit, I am being a little naïve, a lot of these private equity firms just borrow massive amounts of money, pay themselves huge dividends, and then sell a worse off company. But sometimes, just sometimes, they really do the right thing. It all depends on how you look at it I guess.

I personally, as you may have noticed, am completely for private equity. I believe to be the purest form of capitalism. They make companies that are not running at their best improve themselves. You see it all around the world, huge corporations shaping up because they are afraid of being taken over. That is a really positive effect they have on companies. I guess, you could say private equity is capitalism’s way of taking out the weakest competitors out there. And in way where every country is obsessed with economic growth and economic growth is dependent on how well companies within that country are doing, than shouldn’t private equity firms be praised and not booed.

But that is just one man’s opinion.

DaimlerChryler sells Chrysler??

2007-04-03T04:29:00.000+02:00

By Andres D’Alessandro

On Valentine’s Day this year, the CEO of DamilerChrysler, Dieter Zetsche, said that he would be looking at all possible solutions to the Chrysler problem. In case you don’t know what the problem is, Chrysler lost 1.5 billion dollars last year. This week marks the deadline for offers to buy Chrysler. Taking this into consideration I have decided to examine three possible scenarios, which I think DaimlerChrysler could use.

Scenario 1: Complete Sale of Chrysler
This definitely is the most talked about scenario and although selling Chrysler might be the most logical solution for most people, I would tend disagree with this opinion. Selling Chrysler would make DaimlerChrysler a much smaller company to begin with. Don’t get me wrong, DaimlerChrysler will remain a huge company, but it will be vastly more susceptible to a takeover. Now, you might think, how can that be possible? BMW and VW are both smaller companies and they are not likely takeover candidates. But DaimlerChrysler differs greatly from those two companies. To begin with the Quandt Family, who own over 50% of the equity and voting rights, controls BMW. This gives BMW vast protection from a private equity takeover. VW on the other hand, had the protection of the VW Law, which vastly constrains the voting rights of any one shareholder, no matter how big his share is. That law is about to be taken out of effect, nevertheless the Porsche/Piech Family controls VW with its 31% stake and together with Lower Saxony (German State, which controls another 21%), VW will be effectively protected against a possible takeover.

There is also the issue of pension and medical payments for Chrysler employees, which are yearly in the billions. If Chrysler were actually sold, the most likely scenario is that DaimlerChrysler would probably have to pay the buyer billions over years to help cover those costs. And that would definitely dig into earnings from other areas like Mercedes-Benz.

Scenario 2: Forget Chrysler focus on Jeep and the Minivans
As long as we are talking about selling, why not consider the option of just getting rid of the Chrysler brand all together. Most analysts say that Chrysler is worth more in parts anyways, so why not just concentrate on those parts that have the potential. In Chrysler these parts would definitely have to be the Jeep brand and the Minivans.

Jeep is a huge brand with great consumer recognition all around the world. In fact, in a lot of countries SUVs are simply referred to as jeeps. Ok, Jeep isn’t as synonymous with quality anymore, like it used to be. But it still brings in a profit and its market goes beyond than just the US, this in fact has always been Chrysler’s biggest problem. Another plus is that its product line compliments rather than competes with Mercedes Benz’s product line, which Chrysler sometimes does (Notice the Chrysler Crossfire).

The other big part is the Minivan. Chrysler invented the minivan and it is one of the few things it has continued to do right over the years. The major problem with keeping them would be to decide under what brand to sell them. You could sell them as Chrysler, but it wouldn’t make much sense in having just one model size, now would it. Another option is integrating it into the Mercedes Benz line, but you could be taking the risk of lowering its brand value (because minivans are really considered sexy!). So by just keeping this part, it would actually be more complicated.

Scenario 3: Keep Chrysler and get rid of Smart
All this time we’ve been talking about selling or closing down Chrysler, but why not sell or close down Smart. In case you do not know, Smart is a car brand made by Mercedes Benz, mostly sold in Europe, which sells tiny cars. If you ask me Smart is a much bigger problem than Chrysler. Smart has lost over 8 billion euros in the last 8 years and there appears to be no end in sight to these losses.

Chrysler and Smart’s problem are very different. Chrysler isn’t selling many cars because it is mainly producing gas guzzling cars and trucks in a world with oil prices in the 60s and 70s dollars per barrel. But most people still like Chrysler cars. Smart’s problem, on the other hand, is not fuel efficiency, but just that most people don’t want to buy a car that feels like you could break it if you gained 50 pounds.

Chrysler also has the problem that there has been no grand effort to integrate the two companies. The sharing of technology has been minimal. On the one hand, because the Mercedes people don’t want their brand cheapened and on the other hand, because the Chrysler people don’t want to make the brand more expensive. Both are valid arguments, but they still should be more integration between the companies. Unfortunately, DaimlerChrysler’s former CEO barely applied any pressure to get this done.

Taking all of these scenarios into consideration, the most likely to happen is scenario 1, but scenario 3 makes the most sense both socially and economically in the long term. Are they really going to let this opportunity pass them by??

David buys Goliath

2007-03-29T02:24:00.000+02:00

By Andres D'Alessandro

I have to say. I am a little bit amazed. I never thought that company with 7 billion euros in sales a year could possible takeover a company with 105 billion euros in sales a year. But it appears that I made the biggest mistake of all, because that is exactly what is happening. Porsche (the sports car maker and probably the smallest independent car company in the world, that still has some importance in the market) now owns about 31% of Volkswagen AG. Volkswagen is known for the Beetle, Jetta and Passat, and it is also the biggest car company in Europe, as well as fourth in the World.

Now you might think that 31% is not exactly ownership. And you would be correct in thinking. But you see in Germany there is a law called the VW Law. This special law basically states that no shareholder, no matter how much of the company he owns, can have more than 20% of the votes. This was created because the German State of Lower Saxony is the second major stockholder in VW and to protect the company from takeovers. This law also states that should a company accumulate 30% of the shares in VW, he must therefore make a tender offer for the remaining 70%. Which is precisely what Porsche has done. Of course they offered a lowball offer of just over €100 a share. Which no one will take, give that the current share price is €115 and rising.

Now you might ask yourself. Why would Porsche, the most profitable car company in the world (yes, even more profitable than Toyota), would want to buy a company that has been losing billions for years. (It actually did turn a profit last year). Well, this is where my explanation divides itself. I am going to try to explain to my best understanding

Reason 1
VW is Porsche’s biggest business partner and in order to insure the future of this highly lucrative business relationship Porsche has become the major stockholder in VW. There is some truth in this argument. I mean, they are currently working on a hybrid engine. But then again Porsche is also working with Toyota on this. So that argument is rather weak. They also developed the framework for the Cayenne, Touraeg and Q7 together, so that works well. This is what they said. I think they are just beating around the bush. See Porsche is a growing company and in the not-so-faraway future, they are going to have capacity shortages and VW has a lot of overcapacity… So that is very complimentary. But I think goes deeper than that. When you think about it, in global term Porsche is a very small company. And it is standing there all alone. Not like Ferrari, which is part of FIAT, or Lamborghini, which is part of VW. The cost of developing new technologies and new cars is becoming increasingly high and it will come to a point where Porsche just cant do it alone anymore. I mean how big can it actually get….. It already made €1.1 billion on a little over €7 billion in sales last year. That is a huge profit margin for a car company. So in that sense, in buying company like VW, it is actually taking out an insurance policy on its future. So that it can remain “independent”.

Reason 2
This is my favourite reason. Porsche is owned by the Porsche/Piech Family. They hold about 50% of the equity and all of the voting rights. The Chairman of the Supervisory Board of VW is Dr. Ferdinand Piech, which just so happens to be the second largest individual shareholder of Porsche holding 12.9%. Isn’t that an amazing coincidence???!?!?! Oh wait, but there's more. You see Porsche was started by Dr. Piech’s grandfather, the ever so famous Dr. Ferdinand Porsche. And in a certain way, Dr. Porsche was the founder of VW, I mean, he designed the first VW, the Beetle. Funny how things kind of turn out……. Still not quite done yet, you see the Porsche/Piech Family owns two companies called Porsche. One is the Porsche, AG, which produces those wonderful sports cars, and Porsche Holding, GmbH, which operates Europe’s largest network of car dealerships. Now which car brand do you think it might represents????? I’ll give you a hint, it ain’t Porsche….. No no no, they sell VW. You see they are VW’s largest distributor in the whole world.

So I would like to leave you with a question. How funny would it be, if one of the largest car companies in the world was a family owned/controlled company? And this would be one tough competitor. If they managed to do with VW what they have done with Porsche, we could easily be seeing a real competitor for Toyota.

Comment and replies are welcomed and appreciated.