Angela Merkel’s Frankenstein

 “The astonishment which I had first experienced on this discovery soon gave place to delight and rapture. After so much time spent in painful labor, to arrive at once at the summit of my desires, was the most gratifying consummation of my toils. But that this discovery was so great and overwhelming, that all the steps by which I had been progressively led to it were obliterated, and I beheld only the result. What had been the study and desire of the wisest men since the creation of the world was now within my grasp. Not that, like a magic scene, it all opened upon me at once: the information I had obtained was of a nature rather to direct my endeavors so soon as I should point them towards the object of my search, than to exhibit that object already accomplished. I was like the Arabian who had been buried with the dead, and found a passage to life, aided only by one glimmering, and seemingly ineffectual, light.”

Mary Shelley’s  Frankenstein 1818

The passage above could easily have substituted for the press communiqué issued by the EU yesterday which laid down the agreement reached in Brussels regarding the European debt crisis and the measures adopted by lead Ministers to forestall contagion spreading from the PIIGS to other countries.

 Illustration from the “Frankenstein” edition published by Colburn and Bentley, London 1831.  Public Domain.

The nuts and bolts of the bailout package according the that document are as follows:

        – There will be new financing in the amount of EUR109 Billion for Greece;

       – Loan rates on existing debt will be cut to 3.5% from as much 5.5% for Greece, Ireland and Portugal, and maturities will be extended to 15 and as much as 30 years;

       – “Voluntary” private sector contribution to the Greek package would see creditors taking a haircut of 21 per cent. There would be no relief of this kind for Portugal or Ireland;

       – The EFSF and its successor the ESM (The EU bailout funds) will obtain new powers to intervene in national bond markets in Europe and to recapitalize banks, but only with the go-ahead of the ECB;

       – Greece will be given a “Marshall Plan” by the EU to help refloat its economy. Brussels is forming a team to help Greece administer the aid.

       – No mention was made of any need to address issues in any other EU countries or of any plans to increase the size of the bailout mechanism from the present EUR 440 Bn.

The voluntary private sector participation which will result in haircuts amounting to around EUR 37 Billion is expected to result in only a short technical default that therefore will not trigger default clauses in existing CDS contracts, thus averting the nightmare scenario.

Similar to Dr Frankenstein’s violation of every principle of medical ethics and morals involved in his grave-robbing and gruesome experimentation, by reaching this agreement the EU leadership has breached every principle on which the European Union was founded. On the kindest interpretation, this must be regarded as a measure of the desperation the EU leadership must have been feeling in the wake of recent market events and the growing levels of social unrest in a number of southern European countries.

While the intention is to provide this support only until Greece, Ireland and Portugal can re-finance themselves in private markets, the reality is that this new deal effectively gives those countries a commitment of indefinite support. What if other countries fall further into crisis and need to be bailed out? Will they end up with a Carte Blanche as well?

 The deal as announced does little to address the key issues and much of the detail appears not to have been fleshed out. The haircuts apply only to Greece, and even at that, are miles short of what the market has been signaling is really required (we estimate around 70%) and the interest rate subsidies do nothing to address the fact that they apply to mountains of accumulated debt that under the terms of the deal will not go away. How the rate fakery will play in Spain and Italy who are having to pay what the market demands is also not clear. There are now evermore committees involved in trying to operate on the patient. The extension of new powers to the managers of the bailout funds, who on their creation in early 2010 assured the markets that they would “never be used”, make them an easy mark for hedge funds who do not have to trade by committee……Watch this space.

 After the initial euphoria expressed by Dr Frankenstein, we all know how the story ends: the Monster kills a number of people in most horrible ways – including a child and Dr Frankenstein’s bride – causes the death of others, and then ends up committing suicide and dying a most horrible death in the frigid waters of the Arctic Ocean. The immoral abomination is fated to die a grisly death from the moment of its creation.

This monstrous deal will suffer a similar fate, and not too far down the road.

Posted in Bank Loans, Bankruptcy, Bond Market, Crisis, EU, Loan Losses, Restructuring, Sovereign Debt | No Comments »

Now is the Time for Stronger Balance Sheets

Q:Do you know what a banker is?

A: “A banker is someone who happily rents you an umbrella when the sky is clear but quickly demands it back again at the earliest threat of rain”.

Laugh if you will at this cynically humorous description, but having been a Corporate Lender at BMO for over 5 years earlier in my career I know there is more than a nugget of truth in this.

So, in this vein, let me offer a reminder. One which soon may prove timely given the recent build-up of toxic debt on central and commercial bank balance sheets and the growing scarcity of investment-grade opportunities for all the risk capital that’s out looking around for safe-harbours to park boatloads of ‘manufactured’ cash in:

The best time to:

(a) shop for umbrellas is before it rains,

(b) strengthen your dyke is before the spring run-off begins, and

(c) build your ark is before the flood waters come.

Why do I say this now? Well, given the ‘big storm clouds’ that appear to be forming over the global economy, I think there a real risk we’re all going to get ‘really soaked.’ So, if you’re smart you’ll get yourself prepared before ‘all hell’ breaks loose and time runs out for those excessively optimistic (particularly on the business front), for when the market changes, it will do so in a big rush!

Now, beyond the threat of government debt contagion building everywhere these days, many of the informed observers we and Recovery Partners have recently talked to have developed a realtively jaundiced view of the “economic recovery” story. The sense of deepening pessimism relates to a variety of factors: including recent anti-inflation-driven moves in Europe and China to higher interest rates, the realization tha there are many weak economies, demonstrably out of control borrowing by both governments and consumers and the seemingly conspicuous-consumption-led high level of demand for basic economic inputs that clearly is outpacing the global supply of easily-accessible (cheap) resources.

And, with private equity investors and investment and commercial bankers complaining about the lack of good investment opportunities, the globalization and computerization fed growth in corruption and fraud that has occurred in governmental and capital markets over the past 20 years, the high levels of un- and under-employment around the world and the growing realization that our earth better go ‘green’ quick before we all end up killing ourselves, it all makes one wonder just how far beyond sustainability have we been living in recent years.

So, for those with open ears and minds to listen, (and brains that recall the talk two years ago about what type of Great Recession recovery we should expect – ‘V’, ‘W’ or ‘VW’?), I suggest it’s time to pay attention to these ominous ‘rumblings of thunder’ for they portend the high risk that the global economic recovery will get washed out sometime all too soon.

Worse still (and God forbid) is that we might be facing a ‘monsoon beginning’ to a ‘flood of biblical proportions’ if the current ‘US federal debt / borrowing limit crisis’ mushrooms into an actual crisis of confidence in the US economy and downgrades the safe haven status of the US Dollar and US markets in times of global financial and geopolitical stress.

Notwithstanding all of the above, I believe it’s best not to despair (particularly those of you who are mindful and prepared to act). There are constructive things that can yet be done if you act prudently and soon. There are ways still available to cut your risk of getting swept away by the looming economic catastrophe that seems to be almost here.

For those with investable funds, two choices to consider are: (1) parking your money in high quality money equivalents (gold anyone?); and (2) buying Hi-Grade corporate bonds while you wait for (another?) once-in-a-life-time buying opportunity to develop.

And if you or your business are user of third-party capital, I’d say now’s the time to strengthen your balance sheet. And for those corporates with business performance or balance sheet issues, best you opt for as much permanent capital as possible because, should the economic storm I’m concerned about break, accessible capital definitely will be in very short supply, if it’s available at all.

To reitreate the main message, (because it’s always too late to figure out how to keep a leaky boat afloat when the downpour comes) the best time to:

(a) shop for (more third-party capital or) umbrellas is before it rains,

(b) (buttress your defences or) strengthen your dyke is before the spring run-off begins, and

(c) (look for more equity capital or) build your ark is before the flood waters come.

Tony Johnston

President

Compass North Inc.

www.CompassNorthInc.com

Compass North Inc. provides CEO / CRO / CFO transition management, consulting and investment banking transaction advisory services that maximize Client Company:

- revenues, profit & cashflow growth,

- debt & equity capital raised, and

- enterprise market value realized.

Posted in Banks, Bond Market, EU, Economy, Loan Losses | No Comments »

Welcome to the Roach Motel*

“When the blind lead the blind, both will fall in the water”

Old Chinese Proverb

In the last several months a number of politicians have been calling for a “firewall” to be erected between the PIIGS and the rest of Europe and the world that would stand in the way of the spread of financial contagion.

These clarion calls miss the point: Contagion is already here by virtue of the interconnectedness of  financial markets generally, and the central role played by the European Central Bank in backstopping each national banking market in Europe.

Not only are the limitations of the ECB arrangements becoming clear, the reality is now dawning on European bankers, politicians and policymakers that their efforts to contain the Greek, Irish and Portuguese debt problems have to date succeeded in only making the scale of the problems larger and render the probable outcome from this mess far more likely to involve a far more costly meltdown than would otherwise have been the case.

 

In the last year scarcely a month has gone by without the ECB announcing some kind of easement in its collateral rules thus enabling it to continue supplying liquidity to banks in the PIIGS and keep those Governments able to pay bills. Unfortunately this has only come at the cost of polluting its balance sheet with junk rated debt and vastly magnified the consequential risks and damages to its own solvency, and to its credibility as a central bank. [In March 2010 we downloaded the Operations Handbook of the ECB from its website.  It shows that the lowest rated collateral asset accepted by the ECB back then must have been rated at least single "A" by at least two major credit rating agencies. That document is available from us on request. As for the risk protocols today? Please read  Trichet's comments immediately below.]

In a related development, Jean Claude Trichet, the ECB President said that with Portugal now under the umbrella of the IMF and EU bailout, that the ECB would not seek minimum ratings requirements for Portuguese debt “until further notice”. The esteemed M. Trichet said that this was meant to remove “an element of pro-cyclicality on ratings agency announcements.” And in further reaction to the ratings agencies downgrading of Portugal, he stated that “a small oligopolistic ratings structure is probably not what is probably desirable at the level of global finance”  Zut, alors!! Plus ca change!!

We are now awaiting  M. Trichet’s reaction to the Moody’s downgrade of Ireland to “junk” status that was just announced today.

A few days ago, Bloomberg told us, that in an effort to stem deteriorating bond prices and escalating CDS spreads “European lawmakers voted in favor of a ban on short selling of government bonds in the EU unless traders have at least ‘located and reserved’ in advance the securities they intend to sell. The European Union Parliament in Strasbourg, France, also called for restrictions on traders’ use of credit-default swaps to profit from defaults on sovereign debt they don’t own.” The politicians apparently believe that If you don’t like what markets are telling you, then you should simply change the rules and paper over the inconvenient truths.

In the last 10 days revelations that the French plan to “re-profile” Greek debts would not pass the ratings agencies definitions of default provided further evidence that this is a problem that is growing like Topsy, but that is lacking a champion to tackle it. Anyone who has previously been involved in these kind of problem situations will recognize the importance of discussing these types of proposals with all affected parties – especially the ratings agencies – prior to approaching the market with any announcements. Clearly this was not done in this case, illustrating the lack of foresight, planning and communications protocols involved at the very highest levels of the decision-making structure.

Investors in Periperal EU sovereign debt issues, bank shares and short dated European bank paper have been flocking from those markets in droves, fearing the worst. Spanish and Italian CDS spreads have spiked to their highest levels since the creation of the Euro. The remaining PIIGS cannot fund in the open market.

Shares of European banks have dived, particularly in the PIIGS and the market is now fixating on the massive and looming debt rollover profiles of all European countries, but particularly the PIIGS.

These examples of recent developments amply illustrate that the entire debacle has so far featured “problem solving by committee” (and that no one on this “committee” has likely ever had to fund any portfolio or trade any assets – ever). Not surprisingly, the outcomes have been predictable.

The more the ECB compromises its balance sheet and the longer the EU/ECB/IMF Troika continues to insist that its remedies be applied in doctrinaire fashion, then the closer this crisis edges towards the inevitable blow-up and, it seems, towards an unwelcome event that will be far larger than any default may have produced a year ago. As a sidebar to illustrate this point in the case of Greece, whereas a haircut of 20% may have sufficed a year ago, now a write-down of at least 70% is probably required.

And finally, the EFSF is tapped out and its remaining resources are insufficient to fund another country meltdown. The authorities have blown the heavy artillery on a set of smaller problems, have failed to cure or contain them, and do not have sufficient firepower left in terms of Balance Sheet and Credibility to tackle what is now clearly coming down the track.

Leaderless. Aimless. Europe is about to take a dunking.

 ————-

“There is no Plan B to avoid default”

Olli Rehn EU Economic and Monetary Affairs Commissioner

* “Roach Motel” is a trademark of the Black Flag Corporation. Amongst traders, it also denotes a transaction structure that is impossible to get out of without losing a significant amount of money.

Posted in Bank Loans, Banks, Crisis, EU, IMF, Sovereign Debt | No Comments »

FATCA : The Empire Strikes Back

In this blog our friends at US Tax outline a key development in US tax policy as it affects US expatriates. Passed as a “stealth” component of the Hiring Incentives to Restore Employment Act of 2010 (”HIRE”), the Treasury and IRS hope to significantly increase expat tax payments and compliance rates. As Dr Thomas Walford and his colleagues Darlene Hart and Alan Cohen argue in this short note, there is substantial room to increase compliance rates and collections from the almost 7 million US citizens that live outside its borders…..Alex Jurshevski

What is happening?

Just over a year ago, we realized the impact that the new Foreign Account Tax Compliance Act (”FATCA”) legislation in the US  would have on the international community.   This requires all banks, finance houses, investment managers, insurance and trust companies to either:

1. send reports each year to the US IRS on those clients who are, or who have rights to, American Citizenship or are Green Card holders, or
2. suffer a 30% withholding tax on all income, dividends on any US Assets including US Dollars and the gross proceeds of sale of any US investment (equity or bonds).

To opt for the first, the financial institution needs to sign an agreement with the US Government which covers the reporting requirements and obligations necessary.

Why did the US do this?

After 2008/9 the US was left with a substantial deficit following the bail out of the banks and Insurance companies after the Lehman collapse and the sub-prime mortgage disaster.

In 2009, the IRS reported to Congress on the position of Non-resident Americans and their tax affairs.  Currently they are aware of 7,000,000 Americans who live outside the US, and each one needs and always has needed to complete a US tax return every year.  The US taxes on the basis of citizenship or residency.  In 2009 they received only 462,000 tax returns, a figure which represents only seven per cent of the total.  As a result we know that 93% of non-resident Americans are not tax compliant.

So why is it important?

The US taxes its people on Citizenship or Residency.  As a result anyone who has American citizenship (and income over $10,000pa) has to complete a US tax return each year and pay any tax that may be owing. 

If you are an US person, not completing a US Tax return is a criminal offence.

If the individual also lives in a country which has a Double Taxation Treaty with the US, then they can obtain a credit for the tax they have paid and only pay any premium over that amount to the US Government. As a result an employed person with no assets probably owes little in tax as income tax rates are higher in many countries than in the US.  However there are frequently situations where there are US taxes owing.

Is that all that is required?

No.  There are also penalties for anyone who has not completed a tax return form and submitted it within the correct timeframe.  These can amount to a substantial sum of money.  Up until 2009 it was rare for the US to assess penalties – but now in the new economic climate it has become quite regular.

Most non-resident Americans will operate a bank account in the country in which they live; probably more than one.  As part of the annual returns to the US Government American Non Resident individuals need to submit a Foreign Bank Account Form (FBAR).  If this is not submitted there is a minimum penalty of $10,000 per account per year that it has been missed.  If the US can show that the omission was deliberate or willful then the fine rises to $100,000 per account per year or 50% of the maximum balance.

These fines can amount to an extremely large sum.

So who does this apply to?

Anybody who has US Citizenship, a right to US Citizenship or Green Card Holders.  This means that it will include all people who:

• Were born in the US
• Have taken up American Citizenship
• Green Card Holders
• Anyone who has one parent who is American and lived in America for 5 years after the age of 14.

It does not matter if you have dual citizenship or live in another country.

Why is it important to Canada?

Canada has the largest proportion of Americans in the population compared with any other country in the world.

Analysis of number of Non-Resident Americans

                               
Population Stats from http://en.wikipedia.org/wiki/List_of_countries_by_population

Number of Americans from National Taxpayer Advocate 2009 Annual Report to Congress

Is there any way out?

Yes – the US Government has announced a voluntary disclosure Initiative (OVDI). This allows people to come forward who may not be in compliance and, if accepted, pay a fine and with immunity from criminal prosecution.  The fine is calculated as 25% of assets and they need to pay the back tax owed over the last 8 years.  Under certain circumstances the fine can be reduced to 5% for non -resident Americans who are Tax compliant in the country in which they live.

This scheme is only open until 31^st August 2011.  There is a 90 day extension if necessary and once accepted into the scheme, to complete all the tax returns required.

Any one who comes through the OVDI will be fully up-to-date with their tax responsibilities and hopefully will have an easy job in finding financial institutions to represent them.

What has changed?

The tax obligations of US persons has not changed.  What has changed is that the US Government may now receive a report of all US persons who are clients starting on 1^st January 2013 from any financial institution which opts to avoid the 30% withholding tax.  Most financial institutions are expected to do so.

What should US persons do?

They need to get their tax affairs up to date urgently.  Otherwise they risk being a named as a criminal and subjected to possible arrest and detention.

Who can help?

US Tax and Financial has an office in Tel Aviv and provides tax advice and consultancy services to individuals, companies and trusts as well as financial institutions.

US Tax has offices in London, Zurich Geneva and Tel Aviv and as such can help with a wide range of issues.

Please consult

Dr Thomas Walford

Telephone +44 20 7357 8220 or Cell +44 7769 707020

t.walford@ustaxonline.com

www.ustaxonline.com

 

Posted in Economy, Regulatory, USA | No Comments »