Pow Wow at Fake Lake – the G8/G20 Meetings

Dateline 25th, June 2010,  Fake Lake, Ontario, Canada

Eat your heart out South Africa!! You might have the FIFA Word Cup to celebrate, but Canada has the “Max Carbon Footprint Lollapalooza Rolling Caravan and Econo Extravaganza” in town; otherwise known as the G8/G20 Meetings. Featuring a cast of tens of thousands; a security budget of $1 Billion; and your favourite World Leaders; never before has Toronto the Good hosted an event which promises to generate so much hot air. Apart from the security lockdown, the cost, and the fumes; what does it all mean?

We’ll get to that later in this piece. In the meantime we turn our attention to a related matter that appears to us to be of more pressing importance, namely, the unfolding Sovereign Debt crisis.

The markets have hailed the UK’s post-election budget and similar moves on the Continent as evidence that the Sovereign Debt crisis is receding and the appropriate solutions have been identified and are being applied. Simple Simon. The reality is that these types of financial reform operations have a very poor track record of success, as we have discussed at length elsewhere. There are only a handful of success stories among the more than 140 attempts at fiscal consolidation in the last few decades. Importantly, there has never been a successful effort mounted in a situation where numerous countries are attempting to achieve the same thing in the aftermath of a Global Financial Crisis (GFC). [For more detail on this topic you can view a BNN G8/G20 Special Panel discussion on Sovereign Debt in our Newsroom section.)

What the authorities will never acknowledge and what the Mainstream Media has either ignored or failed to understand, is that the Sovereign Debt crisis is itself the result of Policy Failure and years of Government cronyism, inefficiency and waste that took root and spread throughout a number of economies. This made the authorities in those places very reluctant to upset the balance of political and economic interests that hold sway; and encouraged policymakers to apply fixes that protect those interests at the expense of more appropriate, durable and cost effective solutions (but those happened to be options that promised to do financial damage to their supporters and paymasters).

 Thus, the reality is that the second-order effects of the Fed-mandated QE include significant erosion of market confidence in a number of economies who participated in the program of aggressive fiscal expansion to support activity. Many Governments it now turns out did not possess finances and institutions robust enough to sustain the policy – it should never have been followed by those countries in other words.

Hence we witness that within 18 months, the Euro-zone and other economies are largely abandoning what will ultimately be recognized as a massive failed experiment based on the idea of Keynesian pump-priming, and have moved instead to exercise restraint and austerity in an attempt to rein in ballooning deficits and deteriorating finances. Only the US and to some extent Canada, are continuing to advocate further fiscal expansion, unwilling to admit that this policy move, while having stopped a potentially deeper recession, has brought with it an array of more serious problems to deal with; including the risk of sovereign default(s), geopolitical instability and a renewed downturn in the key economies.

 Apart from the political dimension, this policy failure is also related to the fact that key government agencies around the globe, most importantly the Fed and Treasury, did not recognize that what was and is occurring is a Solvency Crisis and not a Liquidity Crisis. The distinction is important. In the first instance, this means that you cannot solve this problem with either monetary or fiscal policy. There must be a reckoning and write-down of bad debts.  This is the only cure.

However, as a consequence of the policy-driven efforts to prop up the many and various zombies, not only has there been a massive risk transfer to national balance sheets (leaving taxpayers on the hook); the needed liquidation of bad debts has been pushed into the future causing solvent banks to shy away from lending, creditworthy borrowers to restrain their activity and savers to hoard as opposed to investing. This promises to stretch out the period of adjustment until the needed liquidation has run its course. If Japan’s experience since the early 1990’s  is any guide, and the authorities remain slaves to mis-guided Keynesian policy prescriptions, then this adjustment will likely take many decades; assuming that we do not experience a worse crash, extreme social dislocation, and/or geopolitical conflict  in the interim.

 For these and other reasons we believe that the G8/G20 roadshow is unlikely to produce any major policy agreements and will instead serve to highlight key policy differences between countries participating in this shindig. Outside of the many potential areas of disagreement, we list five key issues that will fail to find resolution at these meetings:

•  The key area of policy difference was alluded to above. The US and Canada are clearly advocates of continued pump priming while the key euro-zone countries are embracing fiscal restraint. Inscrutable as always, Japan is sitting on the fence while hinting at wanting to rein in its deficit but taking no steps to do so.
•  The second most important area of disagreement concerns the Chinese exchange rate. As we know there is significant potential here for tensions to flare up despite the soothing announcements by Chinese policy authorities ahead of the meetings, suggesting that they were relaxing the Yuan/US peg. We are more likely going to see the Chinese continue to keep their options open while seeking to extract more concessions in return for agreement to the Western demands that the Yuan should appreciate.
• The third bone of contention is the relevance of the G8 itself and whether this forum should continue. The attack on the hegemony of the large Western Economies is rooted in regional differences and the failure of the G8 to deliver on commitments it has made at its previous meetings.
• Fourth is the issue of Global Warming which, quite apart from the science which remains unsettled, cuts straight across North South Divide as regards the apportionment of the fiscal burden.
• Finally, the bank tax and supervisory reform is another area of friction where Canada has led the charge against a bank levy, and is supported by the Japanese and others whose banking systems held up during the crisis; while the countries in the  euro-zone and the US are in favour of new taxes on banks and more stringent supervision.

G ZERO?

 G8, G20 it doesn’t matter. In an environment of instability and financial stress, the policy flips of the past 18 months and the growing rifts between various countries in key areas of economic management are extremely worrying. In our view therefore, the best and safest thing to hope for coming out of these meetings is that our fearless leaders do not make things yet worse.

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

The Road to Zombieville

“Any thoughts that participants in the financial community might have had that conditions were returning to normal should by now be shattered…We are left with some very large questions: questions of understanding what happened, questions of what to do about it, and ultimately questions of political possibilities.”

 Former Federal Reserve Chairman Paul Volcker, May 19 (Bloomberg)

Never one to mince words, the revered ex-Fed Chairman is calling attention to what many of us have been saying for some time – the economy is in worse shape that we have been led to believe; significant problems remain; and it is not all clear that the fixes that have been applied so far are doing, or will do the job.  In short Mr Volcker was saying that the usual “re-flate and wait” strategy is not working (and quite possibly may not work this time around!).

Shortly following Mr Volcker’s speech at Stanford University last week,  Pinehurst Bank of St. Paul, Minnesota, was shuttered by the Minnesota Department of Commerce, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. According to the press release issued by the FDIC. the cost to the taxpayer is expected to be a relatively modest $6.0 million. The failure of Pinehurst makes that bank the 77^th bank to go down in 2010 and the 241^st bank to fail since the onset of the Global Financial Crisis (GFC) in late 2007. 

At Recovery Partners we have examined the failure data published on the FDIC’s website and have compared recent activity to the failure experience extending back to 1990. What this research reveals is that losses to the deposit insurance funds are far higher than at any time in the last twenty years – including the S&L debacle. The table below shows that at around $73 billion not only have  losses for 2008 to date vastly exceeded the losses experienced by the Fund in the prior period, on a “per bank” basis, the current debacle shows that at 26%, losses are about 2 ½ times larger as a percentage of recorded assets at the time of failure than in the previous period. And, at around a cost of $300 MM per failed institution, the actual dollar amounts involved are around six and half times higher per institution than in the period between 1990 and 2007.

What doesn’t add up here is the fact that we are being told that the failure rate is only a third of what it was in the previous bank failure cycle, when all of the information we have, including the fact that loss severity as a percentage of recorded assets is vastly higher, suggest that the failure rate should be much higher.

 The risk of financial institution failure is high when the following conditions are present:

• Rapid growth in assets is occurring;
• Marginal loans are being made without adequate spreads built in to compensate for the underlying risk
• Balance sheet leverage is high and possibly increasing
• Loss Reserves are not maintained at levels reflecting the risk of loss in the underlying portfolio

 All of these conditions were in place in the run-up to the GFC.

During the run up to the crash, Consumer and Corporate credit growth was booming, growing far faster than nominal GDP. Now credit growth in the US is negative. This will hamper the efforts of banks to restore balance sheet strength and rebuild earnings.

Skyrocketing loan losses in the recent cycle are far higher in aggregate than at any time since this data started to become available. This is because much of the business being written towards the end of the last cycle was mis-priced and did  not reflect the risk of the borrower. This is why….

…..Bank profits are at record lows. As David Rosenberg reports the current recovery in the US is one of the weakest on record and many risks remain, suggesting growth will remain muted, likely accompanied by deflation in prices. This is not good news for bankers or the Federal Government, both of whom are hoping for a recovery in secondary market asset prices

In previous cycles the Fed eased, the yield curve steepened and banks were able to replenish capital resources by capturing the spread between the short end of the curve and term dates. Today Net Interest Margins are only about where they were when the latest Fed easing cycle started. Note also that the present spreads are far below the levels recorded in the previous bank failure cycle.

 Some commentators suggest that because the FDIC has already gone to the Government for a top-up on its Deposit Insurance Fund and jacked up the levy in order to accumulate reserves more quickly, that there should be concerns that the Fund could go bankrupt.

 The issue is not whether the insurance fund can go broke. Not only is this not possible under the existing set of arrangements, it is beside the point. Part of the issue is that from the beginning the US authorities have minimized and downplayed the significance and impacts of the crisis.

 Note that in the late summer of 2008 the FDIC reported that number of banks on its watchlist stood at 117. A year later, the FDIC reported that it had 416 banks on its watchlist. More recently, the Federal agency announced that its watchlist had grown to include 775 banks. Adjusting for changes in the number of banks since the early 1990’s our view is that the failure rate should be at least 2 ½ to 3 times higher than what is being reported; meaning that the number of zombie banks in the US is on the order of 1800-2000 at-risk institutions. Multiplying the average loss figure of $300 MM per bank by that total yields a contingent liability of around $500-700 billion for the FDIC – in short, a pretty scary number.

 The real  issue is thus whether the weakness of the banking system represents another multi-hundred billion dollar black hole that the Feds would need to fill relatively quickly if the true scale of the zombie bank problem were to be revealed to the markets. The reluctance to come clean might be because the authorities themselves realize that markets are currently fragile and the disclosure of another large fiscal requirement might cause a loss of confidence and renewed risk of meltdown; it may be that the US financial managers have been told by key creditor nations that their willingness to underwrite vast new US deficit spending programs for whatever reason is near a breaking point; it might be that yet another “bankers’ bailout”  is deemed politically unpalatable; or it may be a combination of the three issues.

The zombies are out there, problems are not being dealt with expeditiously, the banks know it and this is influencing their behaviour; and these weak financial underpinnings vastly increase the chances of a “double-dip or worse” type of scenario unfolding in the US in the not too distant future. What adds to the worry is that not only is the US  the bellweather economy for the developed world,  but that this same general set of  issues (zombie institutions, authorities in denial, severe fiscal pressure) prevails in a number of other countries - with the obvious potential for ill-timed strains to affect sovereign credit profiles and economic renewal prospects in those places as well…….

Paramedic #1 : You have no pulse, your blood pressure’s zero-over-zero, you have no pupillary response, no reflexes and your temperature is 70 degrees.

Freddy : Well, what does that mean?

Paramedic #1 : Well, it’s a puzzle because, technically, you’re not alive. Except you’re conscious, so we don’t know what it means.

Freddy : Are you saying we’re dead?

Paramedic #1 : Obviously I didn’t mean you were really dead. Dead people don’t move around and talk.

 Return of the Living Dead 1985

Posted in Bankruptcy, Banks, Crisis, Economy, Fed Policy, Loan Losses | No Comments »

A Dead-Beat World

We can easily forgive a child who is afraid of the dark; the real tragedy of life is when men are afraid of the light.”        Plato

Well, it seems the unfolding Greek Tragedy was averted, but the patch that was applied does not mitigate the risk of a much larger debacle a short way down the road from here. The Greek Government, whose approach to Government Debt Management appears to have consisted of borrowing more than they could afford to pay back and simultaneously lying about it to each other, their neighbours in the EU, the ratings agencies and their investors, has been bailed out using a combination of masking tape and binder twine. The ECB is not impressed. The Germans and French are holding their noses. And the rest of the EU is waiting for the next shoe to drop.

In the end this “solution” merely papers over the problem, sets a dangerous precedent and waters down the European Monetary Union. That being said, the Greek Crisis is but a symptom of the problems facing financial markets as we move into the second decade of the 21st Century.

Greece is but one economy out of many that are facing serious financial risks centering on the financability of their deficits and their ability to manage this process in a low risk way and with regard to the impact of debt servicing on Government budgets. The second order effects of the Fed-led rescue plan has exposed serious financial stresses in a number of economies who are having difficulty bearing the strain of funding large deficits.

By way of example, the UK is running a budget deficit of over 12%. In Spain, debt arrears are running as long as 500 days. In the US, personal incomes are still falling and over 50% of homeowners who have had their home loans restructured are defaulting again a mere 9 months later on average. In Mongolia, recent estimates place the ratio of non-performing loans to total bank assets at around 19%. Portugal has just been downgraded. The continued financability of Japan’s public debt is now being thrown into question by shifting demographics. The Eurozone is running a combined deficit of 6% of GDP.

We could go on (and on).

Source: OECD

Suffice it to say that the historical record shows that following banking crises the years following the initial shock usually feature a spate of sovereign defaults. For this reason, we expect that rapidly escalating debt levels are likely to force several countries to default and many, including the US to ultimately cut spending in order to rein in ballooning deficits and debt ratios. Based on the numbers that we are seeing, some of which are reproduced in the chart above courtesy of the OECD, we have no doubt that renewed, and significant financial stress, is in store.

The gross borrowing needs of OECD countries are expected surpass $13 Trn. in 2010 and remain elevated for some time. Much of this incremental issuance will be in short term markets. This is because issuance conditions remain unsettled featuring weak demand at long term debt auctions. Moreover, both primary and secondary market fundamentals have been negatively impacted by the disappearance of some primary dealers and the generally weaker balance sheets among the survivors. In the US for example the number of primary dealers has dropped from 46 firms in 1998 to only 17 today. In addition the demise of numerous banks has also removed liquidity from the primary and secondary markets

Together with the decline in liquidity referred to above, issuance conditions have become tougher in general due to the larger financing needs of governments. The demand for funding has intensified at the same time that investors have become more conservative in their allocations. Lower rated borrowers are increasingly being forced into the shorter-term markets with a consequent increase in coupon reset risk, rollover risk and liquidity risk in their debt portfolios. Many debt managers are now organising road show events, changing issuance methodologies and beefing up capacity and capability in order to cope with the grim conditions.

The implication for government financial management is obvious: don’t borrow if you don’t have to; use your domestic sources of funds and avoid the international markets and offshore debt capital as much as you can; develop debt management expertise, policies, systems and procedures if you do not have them; and improve them if you do. The “gales of destruction” are only just beginning to blow again.

The last line was a homage to Joseph Schumpeter. A friend at Carleton University in Ottawa sent us this homage to JM Keynes and FA Hayek. Please have a look. We are all “in the test tube now” and are sure that you will find that this little video proves to be six minutes of your time well spent.

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

Why Iceland Must Vote “No”

“The policy of collecting debts by gunboats is unrighteous, unworkable and outdated”

President Woodrow Wilson in 1919

Iceland is heading toward a referendum on a deal to refund some $5.5 billion to Britain and the Netherlands for money lost by depositors in these two countries. This puts the country on the threshold of perhaps the most important national question since its independence was formalized in 1944.

 Background

Between 2002 and 2003 three Icelandic banks Glitnir, Landsbanki, and Kaupthing, were privatized and expanded aggressively into offshore markets raising money from private citizens directly and through Internet websites. Asset footings expanded enormously, and in proportion to the Iceland economy at one point reached a ratio of more than 10 to 1. Then came the global financial crash in mid-2007 and the revelation that the asset quality of all three banks was very poor, leading to insolvency, the loss of depositors funds, a currency collapse and a severe economic contraction.

The British and Dutch Governments, under political pressure in the aftermath of the banks’ collapse, and in the midst of the crisis affecting their own domestic financial institutions, agreed to make good their depositors’ losses. For this reason the British and Dutch are of the opinion that the taxpayers of Iceland have a duty to refund this total loss to them. To force the issue, Britain froze the accounts of all its Icelandic bank branches. This prevented them from remitting funds out of the country, forcing the banks into insolvency. Britain branded Iceland as a terrorist country in order to invoke these measures because the only law at hand enabling this financial grab was emergency anti-terrorist legislation.

 A deal was subsequently hammered out with the help of the IMF whereby Iceland would get a $10 Billion rescue package (more than half of which was earmarked for repayment to the UK and the Netherlands) which included some funding to assist with the crisis and structural adjustments. When this plan was presented to Iceland’s President, Olafur Ragnar Grimsson, he chose not to ratify the legislation to repay the lost bank deposits to Britain and the Netherlands. Under the parliamentary procedure a national referendum on this issue must now be held and will take place on March 6^th.

Britain and the Netherlands have railed against Grimsson’s  intervention and issued thinly veiled threats that collapse of the deal would throw into doubt Iceland’s bid to join the European Union and its eligibility to qulaify for a $10bn economic rescue program that has had the participation of the International Monetary Fund.

Do the Math

We have set out a table which list some of the key variables to consider is assessing the relative merits of a “Yes” or “No” vote in relation to the bailout package that is being pushed onto the country by the UK and the Netherlands. In the discussion following we look at each of the considerations in more detail. 

*Recovery Partners’ estimates. Wide ranges due to uncertainty owing to steep GDP decline and currency depreciation

 Historical Precedent

 If the bailout plan goes ahead it would be the first peacetime circumstance where a borrower’s debt burden has actually been adjusted significantly higher following a crisis and the subsequent restructuring. The proposal, as rejected by President Grimmson does not make any sense in the historical context whatsoever. He was right to refuse to aquiesce on this basis alone.

Legal Precedent

We operate in a limited liability legal system.

There is absolutely no legal (or moral) obligation to pay off the claims lodged by the UK and the Netherlands. Insolvency law states that recourse can only be made to the estate of the bankrupt and not to unrelated parties. If the Deposit Insurance Fund set up to guard the claims of the depositors is bankrupt, there is no case law that states recourse to the taxpayers is a legitimate avenue for resolving unsatisfied claims in the absence of explicit sovereign guarantees. We are not aware of any such guarantees. As a case in point, do we have any evidence of US depositors seeking redress for their claims against failed UK financial institutions from the UK Government? Have International creditors of Lehman Brothers or Bear Stearns approached the US Government for restitution? It is not hard to imagine how far Europe’s leaders would have gotten in their discussions with the US Treasury if they had dared to make this approach.

Hello Iceland, Meet your new EU Neighbors

The currency crisis, collapse of the financial system, and pressure from Britain and the Netherlands has led to a major shift in opinion within Iceland in favor of joining the EU and adopting the euro. Despite this, there is significant confusion within Iceland as to what “joining Europe” would mean in practice. Moreover there appears to be only minimal understanding of how the EU is now being torn apart by unstable, heavily indebted post-Soviet economies and other states (e.g. Greece) that have no clear means of financing ballooning structural deficits.

Central and Eastern European members of the former Soviet Union voted to join the EU in the 1990s under the impression that the EU would help them put in place a modernized Western-style industrial capitalism that would lead to rising living standards. Instead, the EU leadership looked at these post- Soviet economies as outlets for their exports, and greenfield opportunities for its banks. The EU looked the other way when the privatization process in these countries became corrupted; and again looked the other way when locals mortgaged their properties with FX loans which fueled an unstable real estate bubble. Crises in a variety of these economies is presently severely undermining the EU and the European Monetary Union and could lead to its demise.

The foregoing describes the exact the situation that Iceland finds itself in today. The added danger is that Iceland might surrender to the pressure to join the EU, when this will likely result in outside interests appropriating its fishing rights, energy resources, obtain unfettered access to the banking markets, and maintain the program of keeping the Government in thrall by lending to it in order to bail out their citizens and companies who speculated and lost with the now-defunct Icelandic banks. The EU entry would also take place at an extremely disadvantageous exchange rate, effectively undervaluing the entire country in euro terms.

We say leave the EU to itself, entry now creates problems for Iceland and does not solve anything.

Debt Paralysis

If the package were to be adopted the share of debt servicing out of total government revenues would top 16%. At those levels this statistic is more usually associated with extreme sovereign default risk.  Iceland’s current Debt to GDP ratio stands between 80 and 100%. This is already very dangerous territory. However, if the USD 10 Bn. package were adopted this ratio would soar to around 140-160%, an extreme danger zone as regard defualt risk. In that case the Debt to Government Revenue ratio would rise from around 160% to almost 300%. The World Bank defines Heavily Indebted Poor Countries (HIPC) as those where this ratio exceeds 280%. The HIPC’s are all basket cases where social dislocation, starvation and corruption are a daily fact of life.

Why “restructure” in order to inevitably slide into that state of affairs?

Credit Ratings

Fitch, the credit ratings agency, downgraded Iceland’s main sovereign rating to “junk” status recently. This is not surprising. What is also not in question is that it would be extremely unlikely that Iceland’s rating would move higher if it adopted the bailout proposals. The country would likely remain a basket case for the foreseeable future.

Alternatively, if Iceland were to embark on a comprehensive reform program, retrenching and relying on its natural resource base and strong exporter status to backstop fresh money from different sources, a move upwards in the credit rankings can become a reality within a relatively short period of time.  

 Structural Reform

Iceland must free up parts of its economy and make increased revenues available to the Government as part of the attempt to did itself out of this hole. For example Iceland’s Treasury currently receives no recurring revenue from the domestic fishery. Fishing Licenses have become a “rentier” instrument whose benefits accrue to a narrow slice of the populace This needs to be changed to the benefit of the entire country rather than the few insiders who now control the licenses.

Among the other issues to address is the free lunch given to financial firms through debt indexation which places the burden of adjustment primarily on households and has led to a rash of mortgage defaults.

International Pariah?

The UK has warned that Iceland faces economic isolation if they do not approve the package as negotiated. The sub text here is: “If you do not do as we say we will try and make this happen to you.” The reality is that the UK has massive problems of its own, is effectively bankrupt and in need of outside assistance itself. Iceland has abundant natural endowments, exports that the world wants and earns significant revenues from the tourism business. Are the Brits going to interdict fly fisherman and nature lovers when they try to visit Iceland? Are they going to stop shipments of fish from landing in the local  supermarket in Oslo? We think not. Iceland is perhaps the best placed economy to push ahead on its own. It can feed itself, build and heat its own homes and earns enough net export revenues to buy the little fossil fuels that it needs.

Durability of the Fix

Public-sector borrowing to bail out bad private-sector debts involves expropriating money from the workforce through higher taxation ultimately rendering the economy uncompetitive. This leads to a self reinforcing death spiral in which the liability grows and debt servicing costs eventually cannot be met resulting another bust. This is exactly what the UK and Netherlands sponsored bailout package will deliver. (It is of note that the Latvian bailout stipulates that the Government there only use the bailout money to pay off foreign creditors and not for structural adjustment or job creation. Nothing good is coming from that situation as we are seeing.)

Vote “NO” on March 6th!!

In reviewing the forgoing it is hard to identify any upside in the ”Yes” scenario..

The facts reveal the bailout plan cobbled together under significant UK and Dutch pressure to be nothing more than a 21st Century version of Gunboat Diplomacy and should be rejected by the population of Iceland out of hand. It would consign the population to de facto slavery and remove whatever degrees of freedom are left regarding the country’s flexibility to dig itself out of this hole and to chart its own course as an independent nation.

The “No” vote has history, the law and economic reality on its side. Icelanders should vote “No” in favor of a better future for themselves and their countryfolk and not allow themselves to be bullied into a bad deal by other countries whose disingenious politicians are following the “Somebody Else Must Pay” maxim.

 It is important to note that voting “No” means that Iceland needs to negotiate shrewdly and launch a comprehensive restructuring that targets key areas of its economy, its financial management and its regulatory oversight practices. Properly managed, a restructuring backed by the natural resource and export earning potential of Iceland could restore incomes and economic activity to pre-crisis levels within 3 to 7 years.

 [If you would like additional detail about any aspect of the forgoing, then please do not hesitate to give us a call here at Recovery Partners.]

Posted in Bankruptcy, Banks, EU, IMF, Restructuring, Sovereign Debt | No Comments »

Bread and Circuses

A nation ignorant of the equal benefits of liberty and law must be awed by the flashes of arbitrary power: the cruelty of a despot will assume the character of justice; his profusion, of liberality; his obstinacy, of firmness. 

Edward Gibbon, The Decline and Fall of the Roman Empire

 Yesterday, the markets learned that the rumors of a new tax on US financial institutions imposed to “pay” for the bailout were in fact about to be realized. The White House issued a press release concurrent with the announcement of the tax by President Obama while flanked by his economic advisors. In making this announcement, the Obam-ites appear to have stolen a march on George Washington Plunkett and his devious vote-getting practices.

 The US public is being led to believe that the impact of the financial crisis on household finances will be lessened by this new levy on the big, bad financial institutions. Interviewed after the President’s announcement, the venerable ex-Fed Chairman, Paul Volcker did nothing to dispel this impression even if he believed otherwise. Nothing, in fact, could be further from the truth.

 According to the White House press statement the parameters of the “Financial Crisis Responsibility Fee” are designed to “require the largest and most highly levered Wall Street firms to pay back taxpayers for the extraordinary assistance provided so that the TARP program does not add to the deficit”. It is expected to stay in place for 10 years or longer. By imposing this tax on the banks (at the same time that the US Congress was grilling the heads of the largest US financial institutions in front of the Financial Crisis Inquiry Committee) the Obama administration is seeking to deflect responsibility for the financial crisis from the Democrats and Government agencies that supported various risky schemes to expand homeownership, to rest squarely onto the shoulders of the banks. In a  month which features a critical Senate race, and a year where it looks like the Democratic Party is on the back foot heading into mid-term elections following a variety of gaffes and mistakes that has sent the President’s and the party’s popularity plummeting, this amounts to blatant pandering to the electorate.

In fact Mr. Volcker was probably privately shaking his head with dismay, but clinging to the party line as the better of two very bad alternatives – the other one being to resign in the face of this populist fakery. We are sure that the respected ex-Chairman felt it better to stay inside the tent and remain in a position to counsel against the next mis-step rather than to quit.

 Anyone remotely familiar with the nature of banking will recognize that the ones paying for the tax will be bank customers i.e. businesses and individual taxpayers. Banks are simply intermediators of risk. In order to function efficiently they must earn an after-tax, after-cost return on capital that is commensurate with the risk they are taking. This means that in the absence of any changes to the risk profile of their balance sheets, that the tax will be paid for by a rise in lending spreads and bank fees to customers in order to preserve the banks’ required risk adjusted returns. This is no different to a utility that will pass on increases in input costs to its installed base of customers in order to ensure that it maintain a return on capital sufficient to maintain services, replace depreciated equipment and expand capacity to meet future demand growth.

 As such, the new tax promises to be a drag on growth, because it will reduce incomes and profits of consumers and businesses that do business with the banks. The fact that smaller banks are exempt and that ten of the largest banks are expected to have to pay around two-thirds of the expected receipts does not change this fact. US growth prospects are reduced because of it and households will retain less spending power.

 The bottom line is that the Administration is betting that the electorate is stupid and does not realize the fact that they will be the ones largely funding the new tax. The measure is thus a cynical ploy to appear righteous and strong in championing the cause of the “little guy” against the big evil banks when in fact the “little guy” is being soaked for new cash and the only real objective of value for the Obama Administration is to gain his vote by whatever means.

Posted in Bank Loans, Bankruptcy, Crisis, Fed Policy, Restructuring, Sovereign Debt | No Comments »

Non-Farm Payrolls Drop Again: Is the US checking in to the Roach Motel?

 “The recession isn’t over”

Martin Feldstein interviewed on Bloomberg Radio 17/12/2009

In our opinion, there was nothing in today’s US Labor Department statistical release to cause the esteemed Harvard Professor to change his views. Moreover, the statistics offered little cheer to those pundits in the recovery camp who have been predicting a swift V-shaped upturn in response to the Fed and Treasury’s unprecedented Monetary and Fiscal stimulus. Indeed, the drop in  payrolls of 85,000 and the record-setting decline in consumer credit also reported today, only served to reinforce the calls of unrepentant Keynesians such as Paul Krugman who have been calling for another vast round of fiscal stimulus. Does this advice make any sense when there is no evidence whatsoever that monetary expansion and government spending programs can cure the ill effects of past financial excesses?

Instead, we have to ask ourselves is whether, by applying massive stimulus, the Fed and Treasury have built a “Roach Motel” (i.e. you can get in, but you cannot get out!) for themselves in terms of the vulnerability of the US economy to new shocks and their future policy flexibility; rather than setting the stage for a durable and reasonably robust recovery.

 Chief among our concerns is that the vast increase in the Fed’s balance sheet has seriously compromised the independence of the central bank. In this regard we note that every hyperinflation in history has featured situations where (a) the central bank has meddled with private sector financing decisions (beyond the setting of the policy rate) and (b) the government ran budget deficits that the political system could not remediate. We note that the entire raison d’ètre of the Fed’s new lending facilities is to redirect capital to specific perceived priorities under the general suggestion that unelected Fed officials are better able to make such decisions than the private sector. This does not square with the generally accepted view of how the world should work (unless you are living in the USSR of 1955). We also observe that  in the U.S. today, with over 100 million voters dependant on handouts from the government (food stamps, welfare, unemployment benefits and the like) there is little question that repaying the projected deficits with tax increases or spending cuts will be extremely difficult, if not impossible, politically.

 The “Super-sized” Fed balance sheet has also handicapped the Fed’s ability to fulfill its primary mission, which is promoting a stable and predictable low rate of inflation. It is easy to foresee that special interests and political pressures may make it harder to terminate the ad hoc programs in a timely manner, thus making it difficult to shrink the Fed’s balance sheet and avoid policy error.

We note further that despite the well known solvency issues at the aggregate level, in the US, banks there have been keen to pay off TARP liabilities. What seems to have escaped the attention of the mainstream media is that many of these banks are still far from having marked all of their crappy assets to market and that in the event of another shock to the system, that they may be ultimately forced to reveal the illiquid and insolvent state of their balance sheets and then turn to Fed for help yet again. We note in addition that there is now no further room to cut rates, only to inflate the money supply more.

 Back when the Fed held $900 billion in Treasuries, these were a liability of the Treasury and an asset of the Fed. In effect, the Treasury’s liability would never cost taxpayers a cent. In the present situation, the Fed has taken on significant private sector risk for which the taxpayers are potentially on the line,  distracts the Fed from its primary mission and subjects it to even more political pressures than it usually has to bear.

 Moreover, should the markets begin to suspect that because of the policy gridlock as relates to the unwinding of fiscal stimulus and the needed shrinkage of the Fed’s balance sheet, that the US will attempt to inflate itself of its debt and deficit problems, then term rates will rise very fast and very sharply. This would further complicate debt management generally for households, businesses and governments.

 Typically Sovereign debt crises are triggered when debt servicing costs as a proportion of total budget expenditures reach levels around 15-25%. By this measure the US appears OK, but that is only if one ignores the Off Balance Sheet obligations of the US Government, as the markets have been doing for some years. However numerous other nations are not currently so fortunate. We are already seeing the effects of the raids by bond vigilantes in the Baltics, the PIIGS, and central Asian countries. In these economies the “going-in” position to the GFC was far weaker than that of the more developed economies, China and the Asian Tigers. Multiple debt crises are looming, accompanied by social dislocation and political strife.

 The risks associated with Chairman Bernanke’s strategy are thus significant. Should Bernanke’s bet go wrong, the nexus of finance and politics suggests that preeminence of the US and the role of the dollar as the key international reserve currency could unravel far more quickly than anyone in the mainstream currently thinks possible. In this scenario the US could end up facing significant and more immediate challenges to its hegemony from China and its rapidly growing roster of client states as well as others. Volatility and carnage would likely follow in many investment markets throwing the Global Economy into another severe down-leg. This outcome might also very well be accompanied by military adventurism in a variety of places and an emboldened array of terrorist plotters for the US Globo-Cop to contend with simultaneously.

 In the meantime, we expect the unfolding Sovereign Debt Crisis story to remain prominent in the headlines for 2010 and beyond. PIMCO and other large scale investors recently announced that they are trimming bond exposures to the US Treasury and other government bond markets. We expect this trend to continue, pressuring rates in the belly of the US Treasury curve and beyond. For this reason we expect equity markets in most economies to experience a downward adjustment in 2010. Equities will also be pressured generally in response to downwardly revised expectations for economic growth,  top-line revenues and profits. Finally, the continuing weak economic profile and rising term rate environment will not allow banks to recapture, or begin to limit, loan loss provisions as many of them have been expecting. Our view is that most banks will likely experience even greater distress ratios in their asset portfolios and pressure on their capital cushions and efficiency ratios.

Posted in Banks, Crisis, Economy, Fed Policy | No Comments »

Hubris in Abundant Supply

We examine two very hot and timely themes in this blog: Global Warming and the Dubai Meltdown

The Empire Strikes Back

“Hotel guests should have their electricity monitored; hefty aviation taxes should be introduced to deter people from flying; and iced water in restaurants should be curtailed”

Rajendra Pachauri, Railroad Engineer and chair of the Intergovernmental Panel on Climate Change (IPCC)

Dr Pachauri’s admonitions coming shortly before the commencement of the Global climate change conference did not deter the cricket aficionado from flying from New York to Delhi in order to participate in a one day match and then flying back again. In fact, until a few weeks ago the die seemed cast: the IPCC and the climate change proponents and their assorted hangers on seemed on the verge of a major breakthrough in securing global cooperation for limiting CO2 emissions, a massive wealth transfer to developing countries from the developed world, and approval of a cap and trade system for the carbon credits. They had “won”.

 Not even the disclosure that a large chunk of the key research underpinning recent policies had been seriously compromised and that scientists not in agreement with the Anthropogenic Global Warming theory were routinely prevented from conducting appropriate due diligence on AGW research papers and contributing their own research and input to the peer review process seemed to make any difference to the IPCC and its supporters. The icing on the cake seemed to be President Obama’s recent commitment to GHG reductions and yesterday’s announcement by the Environmental Protection Agency of the US that CO2 (i.e. plant food) is henceforth to be considered a pollutant and within its regulatory ambit.

 This hubris was reflected in an editorial run by 56 newspapers in 45 countries (note: there are over 5000 regularly issued major news publications and over 190 countries on the face of the planet) on the eve of the Copenhagen summit. One such paper which counts itself in the cheering section, early this morning proclaimed that “Hope for Emissions Deal Surges in Copenhagen”.

 Unfortunately for the believers, a short time later the UK Guardian newspaper reported that “the  UN Copenhagen climate talks are in disarray today after developing countries reacted furiously to leaked documents that show world leaders will next week be asked to sign an agreement that hands more power to rich countries, abandons the Kyoto protocol and sidelines the UN’s role in all future climate change negotiations.”

 For now it looks to us as though a much needed “Time-Out” in the climate debate is in the offing at “Carbon-hagen”, at a minimum this will reduce the GHG emissions associated with the hot air surrounding this issue.

Castles in the Sand

 “When things go sour, you can’t have some banks in the West going to Dubai and saying ‘oops’ and crying wolf and saying, ‘You should have guaranteed those loans.’”

 Saudi Prince Alwaleed bin Talal

 In the mid-1990’s the Abu Dhabi government had drawn up similarly grandiose plans for a development called the Saadiyat Free Trade Zone (FTZ) and was actively courting investors for the development. Following a few due diligence visits, I and a few others on our investment banking team had developed misgivings about our firm’s potential involvement with the proposed transaction. Then, back in London and after some rather intense internal debates, our Chairman, a venerable British peer and former Permanent Secretary of the UK Treasury, shot down the deal in a Credit Review meeting with the words “Mr R. you are describing a 19^th century concept – we are about to enter the 21^st. Are you utterly, barking mad !!?”

 Luckily for us that was it. Sir D had nailed it.

 Also, and fortunately for them, and their eventual investors, the Abu Dhabi leadership had independantly, and wisely, scaled back the early development plans before the FTZ project was launched some years later and with delivery dates into 2014.

 It is now obvious to everyone that the Dubai project could not sustain its own footprint and fell apart from the weight of financial obligations that could not be met by recurring revenues. Luxury hotel rooms for example, are changing hands at $100 per night or less. This does not make sense when engineering, construction, and maintenance costs are significantly higher than in New York or London. There are numerous other examples of misallocated investment dollars in this tale.

 Hence the fallout. The “foreigner blogs” in Dubai have been buzzing recently with hard luck stories of expats being thrown out of work and unable to pay back $100,000 ++ “rental loans” from local banks (which had on their earlier arrival been  quickly supplemented with further credits enabling the expats to buy cars and other goodies in order to make life more comfortable in C 38 degree heat), that there are daily queues of bank customers lining up to withdraw funds, and that literally hundreds of building sites have been abandoned because the expat engineering and construction companies (some of which hadn’t been paid in many months) have picked up sticks and moved on.

 The Saadiyat FTZ development appears to be still proceeding but its viability has been thrown into question by a number of issues, including the simple fact that many of the banks heavily involved with Dubai are also lending money to the Abu Dhabi project and other regional schemes. They include Standard Chartered, ADCB Bank, Mashreq and others. Contrary to early media reports, it is fairly easy to imagine that this contagion could affect the entire area and beyond….and…Oh….did we mention that the Dubai World meltdown would be the first “acid test” of Islamic finance-based claims placed under the duress of a bankruptcy? This could be a real roller coaster…….

 Apart from the Islamic finance angle, a close analog to this snafu is the Development Finance Corporation of New Zealand debacle which played out between late 1988 and 1991. In that situation, similar claims of sub rosa state guarantees were made by disgruntled investors, following which, in 1989, a coalition of banks almost brought the country to its knees by boycotting a crucial rollover financing operation in retribution for the government’s refusal to acknowledge what the banks considered were its implied obligations. Eventually the Crown was forced to compromise its early negotiating position and give in, in some important ways, to the offshore creditors.

 In other similarities to the DFC, the Dubai debacle is far from being resolved; there are basic questions of how large the debt is, the lender security position, the possible workout scenarios and the role of the local government and that of the larger UAE that must find clarification – not to mention the fact that political relationships within the UAE are likely under significant strain.

 ….And of course today’s foreclosure of the New York ‘W” hotel by Dubai World’s creditors and its tumbling bond prices are undoubtedly giving the Dubai leadership some pause.

 Our view is that we are only at the “beginning of the beginning” of this one, particularly, if what now appears to be a containable liquidity crisis deteriorates into a government solvency crisis.

[For art and history buffs, and possibly some banking types, an exhibition entitled “Disorientation II: The Rise and Fall of Arab Cities” was recently unveiled at the Manarat Al Saadiayat for display until 20th February 2010 ]

Posted in Bankruptcy, Global Warming, Middle East, Restructuring, Sovereign Debt | No Comments »

Credit Growth Drives off of Cliff

“From a technical perspective, the recession is very likely over at this point, but it’s still going to feel like a very weak economy for some time.” Ben Bernanke, September 2009

 Green shoots. What green shoots? Even Chairman Bernanke admits that signs that the North American economy has resumed growing are modest at best. And in the US, the bleak jobs picture shows that job hunters now outnumber openings six to one, the worst ratio since the government began tracking open job postings.

 A key feature of the Postwar North American economy has been the intimate relationship between credit growth and economic activity. It takes money to finance economic growth. Indeed, by late 2006 the available statistics showed that approximately six dollars of debt was needed to finance every one dollar of expansion in the US GNP. The lesson is this:  without  growth in private sector credit demand, sustainable growth in the real economy cannot be maintained.

The reality so far in 2009 is that no one is borrowing and the banks are not lending. The chart above shows that the amount of consumer credit outstanding in the US economy nosedived in 2009, dropping at an annual rate of over 7%. Not only is this a fairly torrid pace of decline, it is the first time this has occurred since the data began being recorded in the late 1940’s. However, this retrenchment is necessary for households to replenish savings and restructure stretched balance sheets

Similarly, US corporate loan growth has stalled and gone into reverse, in part because businesses are working off inventories and are not investing in new capacity, but also because bankers are becoming more tightfisted and discerning as to who they choose to lend their money to. More creditworthy borrowers (representing less than 0.5% of all businesses) have also been tapping the bond markets feverishly to lock in low rates. Quarterly Loan growth in the US was tumbling at an annualized rate of 12%% in the latest reporting period.

US banks are increasingly concerned with mounting loan losses and the implications that these will have for earnings, capital and their future ability to fund new activity. Loan losses are at the highest levels since these series were first compiled and the pace of deterioration shows no signs of slackening.

In Canada the situation seems much the same. Credit growth has faltered. Bank loans at weekly reporting Chartered Banks were falling at an annualized quaterly rate of around 10% in the late summer, and consumer credit growth has been leveling off. Loan loss provisions at all of the banks are up sharply, reflecting restraint in lending practices and a focus on managing their way out of existing problems.

 The bottom line is that the North American “recovery” is largely technical. Balance sheets need to be rebuilt, jobs are very scarce, many problems remain, not in the least the “re-entry” issues that the Fed is facing after the massive injections of high powered money and fiscal expansion of the past year, and what appears to be a growing mutiny against the continued use of the US Dollar as the global currency of account. The decline in credit this year portends anemic real activity next year.

 Through all of this the modus operandi of the US authorities has been to attempt a slow, controlled deflation of what is left of the “bad asset balloon”, allowing zombie banks and businesses to continue operating on the one hand, while attempting to re-flate markets such that asset positions that were underwater can be re-priced at higher levels;  balance sheet problems can be cured, and access to capital markets can be restored for public companies whose shares were only a short time ago trading in the bargain aisles. This effort has been accompanied by an aggressive campaign of moral suasion (”spin” some might call it) aimed a fostering a rosy view of present policy and of future developments.

 We see many risks with this approach as we have stated in the past. At this juncture one of the key risks we see is that developments in the US stock market are significantly out of step with developments in the real economy, prospects for corporate profits going forward, and the massive reversal in credit growth (without new credit formation the “recovery” will go nowhere).  We have three observations here:

•  Without a meaningful and strongly-based recovery in the US, the Canadian economy will also face significant and growing headwinds. There is no “magical” de-coupling in store. In combination with a resurgent Loonie, this portends continued tough times for domestic manufacturers, exporters, and growers. The Bank of Canada faces a daunting task.
•  We are again approaching an inflexion point where outsized downside risks in the US sharemarket have accumulated and there is a growing likelihood of another painful rout. What the spark will be is unclear, but with so much dry tinder around it does not take much imagination to see this rally ending in flames in the not too distant future. This would put the Fed in a smaller box.
• Once the realization that times are going to remain tough sets in, many banks will be forced to deal with their zombie borrowers. If banks are not proactive in dealing with the rot in their portfolios now, they will face a much more complicated and expensive task in the near future.

Posted in Bank Loans, Banks, Crisis, Fed Policy, Loan Losses | No Comments »

20th Century Political Reality Meets 21st Century Economic Reality

“It no longer makes sense for global economic policy to be the concern of just a small group of countries” Dominique Strauss-Kahn in Istanbul

Coming off of a largely incident-free and positive G20 meeting recently concluded in Pittsburgh and with a blazing US stock market rally as the backdrop, the mood at the Annual IMF/IBRD confab should have been more upbeat than it was. The reality that participants from the 186 countries in attendance were for the most part eager to proclaim was that the Postwar system of international financial machinery had broken down, was no longer up to the task and needed to be urgently re-structured.

The United States was clearly not among those cheering for change.

This is because the sub-text of this year’s meetings was that the days of the US as a financial hegemon and shot-caller were clearly numbered in a world where it’s banks are broken, its economy still languishes, and where it is beholden to foreign sources of capital and therefore can no longer credibly anchor a global financial system with the US dollar as the currency of account.

Moreover, a number of prominent delegates and invitees renewed calls for even more comprehensive changes to the IMF and its sister institution the IBRD (World Bank) than had been agreed between G20 participants only a short time ago. The proposals that were put on the table were significant: an end to the US veto at the Fund, more frequent adjustment of member voting powers to reflect changing output shares and, a reduction in the number of European directors on the board from eight to no more than four.

Criticisms that were leveled at the IBRD included misguided lending policies, discrimination against HIPC’s (Heavily Indebted Poor Countries) and shortfalls in its governance practices. It was noted that the actual amount pledged and disbursed to low income countries since the onset of the crisis is three hundred and sixty times less than the $18 trillion that richer governments have found to bail out or guarantee their private financial institutions. According to the IBRD itself, the crisis is causing a financial shortfall for developing countries of between $350 and $635 billion in this year alone. Furthermore it projects that most developing country economies will recover more slowly than those of richer countries.

The Financial Times’ coverage of the meetings points out that the IBRD’s business model fails in a fundamental way in that its two main sources of revenue, interest payments on loans from borrowing governments and contributions from wealthy member governments, both stand in conflict with its anti-poverty mission because they encourage large individual loans to borrowers most able to pay while ignoring the smallest and poorest nations.

What the Financial Times did not say, and what most officials are loath to acknowledge, is that the IBRD and the IMF are in serious danger of losing relevance in a world where China and certain other states can write billion dollar checks without the conditionality and other red tape demanded by the Washington twins.

Also relevant here is the fact that China again easily rebuffed renewed calls from senior IBRD and IMF  bureaucrats to revalue its currency…….Who’s in charge now?

Snippets from the Banking Arena

We read recently that analysts at Goldman have upgraded their ratings on Large US banks to “attractive “ from “neutral”. We haven’t had a close look at this report but note in this connection that while the latest disclosures by the FDIC place 417 institutions on its watchlist, the picture may in fact be far, far worse. Chris Whalen analyses the US banking universe  which consists of  8133 banks. He assesses them on a ratings scale of A+ (3518 banks) through A,B,C,D and F.. Recently Chris calculated that around 2300 banks in the US are at risk of bankruptcy and are rated F (28% of the total). His expectation is that the FDIC will need between $400B and $800B by the end of 2010 to backstop the banks, and that is after healthy banks have absorbed some the “best of the worst”. 

Our analysis of the TARP program last fall expressed serious misgivings as did our analysis of the Stress Tests that were conducted this spring. Earlier this week and following an investigation, Neil Barofsky, the Treasury Special Inspector General for the Troubled Asset Relief Program reported that, “By stating expressly that the ‘healthy’ institutions would be able to increase overall lending the Treasury may have created unrealistic expectations about the institutions’ condition and their ability to increase lending”.  We will not comment further.

Posted in Bank Loans, Banks, Crisis, EU, Economy, Fed Policy, Loan Losses, Sovereign Debt | No Comments »

Smurfs on Ice

 “For the most part, and with the possible exception of me, I don’t think anybody goes out to try and hurt somebody”           Jeremy Roenick,  former NHL forward

With all of the wailing and howls of protest regarding increased regulation, salary caps and bonus eliminations coming out of certain sectors of the North American economy, it is (perhaps to some) refreshing to see corporate executives in at least one industry marching in total lock step with the US Government’s attempts to fight economic reality. The current debacle in Phoenix regarding the fate of the Coyotes hockey franchise there has opened the window wide on the leadership approach and decision-making style that holds sway in the NHL today.

The mindset appears to be not too dissimilar to the mentality that holds that debt problems can be fixed with more debt, that the Fed can expand credit without limit or ill effect, and the requirement that the consumer sector retrench and shore up its finances can be successfully challenged with “Cash for Clunkers”, outright handouts and other blandishments that will theoretically be paid for not by today’s beneficiaries but by tomorrow’s taxpayers.

Faced with a soft economy, a significant proportion of  NHL clubs (not only Phoenix) are in distress; if it is looking ahead at all, the NHL is probably seeing lower attendance figures, lower corporate marketing spend and lower revenues generally. Some of the owners may be looking “over the next rise” in this fashion. Unfortunately and more to the point, the Phoenix debacle however shows that the current NHL leadership has chosen to divert attention from more pressing commercial concerns, to spurn the injection of fresh outside investment capital into its business, and to effectively act in defense of toxic investment decisions that it itself promoted to itself.

That the NHL leadership has chosen to allow this situation to deterorate to the point where it must participate in a courtroom display centering on the efficacy of its business plans has to be counted as a “first” in business history.

But there are Principles at stake.!!

Yes Petunia, there are principles, and there are principles that you don’t want to risk losing. When they didn’t have to, Mr Bettman and the NHL leadership decided to bet the house on defending the principle that the NHL should have the right to determine where its franchises are located. Instead of principles Mr Bettman should possibly have focused his attention on “cats and how to skin them”. Mr. Balsillie’s support of the NHL is arguably the best thing to potentially have happened to the league since Walter Gretzky decided to flood his backyard in the 1960’s. “How to do a deal” should have been the priority, not “how to stop a deal”. Mr Balsillie is real, he is interested, he is successful, he is connected and he has some good ideas that promise to enrich the game for all the participants – fans, players and owners.

 We do not know of any points of agreement that may have emerged from the recent mediation that was imposed on the Chapter 11 process by Judge Baum last week.

What we do know is that NHL has had negative control of this situation and over the course of the discussions with the Phoenix ownership and latterly with Mr Balsillie for several years now. Given that this process has become very expensive, and given that Mr. Bettman has chosen to lead the League into a fight, which in the context of the negative control position, referred to above is unnecessary, it must be asked of the Commissioner why a solution still hangs up in the air on the cusp of the new Hockey Season? Why has Mr Balsillie’s interest not been turned into the huge positive that it could be for the league?

Mr Bettman has chosen to defend opacity, arbitrariness of decision-making and confused governance in rejecting Mr Balsillie and in not working hard to come to an accommodation with him.

Is the league more profitable since the Southern expansion started? Is the game more popular in the Southwestern US States? Are the endorsement and marketing contracts bigger? Surely by referring to these simple metrics and a few others a normal businessman would be able to determine that a particular expansion strategy was sound and should continue to be pursued.

Clearly, the foregoing considerations dictate that, at a minimum,  the NHL should consider its position on these matters. However, the Phoenix bankruptcy saga is but a symptom of the problem that is afflicting the NHL, it is not the “The Problem”. Whether or not the Bettman – Balsillie fight drags out, the NHL is already encumbered with  reputational and financial challenges. Aside from this aspect, “The Problem” has many dimensions, among them are: 

• Almost one-third of the NHL Clubs are in financial difficulty and/or on the block. The economy and the Coyotes saga are making them less valuable.
• The NHL is Missing Opportunities, for example, the various TV deals, when measured against a team roster show that TV revenues “per player-per game-per team” in the NFL are 26 times higher in that league than in the NHL.
• The NHL does not have a Coherent Marketing Strategy. It has fallen short in embracing internationalization, and the marketing of and investing in opportunities in hockey-mad countries, choosing instead to waste resources on folks that would rather be watching NASCAR and playing golf year-round.
• The NHL Governance Model is out-moded and is exceedingly non-transparent, which provides an open invitation to hucksters of many stripes – Del Biaggio, Samueli and McNall to name a few.
• As evidenced by Mr Moyes’ de facto indenture which has so far cost him almost $300 MM and other situations of this nature, the NHL has continually fallen back on the “somebody else must pay” revenue model.
• Mr Bettman’s tenure has been punctuated by various missteps, gaffes andoutright  mistakes, the like of which any one or two would have been sufficient to cause a normal CEO-type to be led straightaway to the Gibbet. Somehow he has survived all of this value destruction despite also being an obvious impediment to positive change.

At a time when the league is in difficulty, serious questions must be asked of someone who chooses to marshal scarce financial and professional resources to fight this fight and “bid” for the Coyotes when other more pressing items (see above) should precede it on the agenda – especially since Mr Balsillie promises to bring fresh capital to the table.

Mr Balsillie’s expression of confidence in the NHL should not be undervalued in any way, shape or form since the current financial debacle has dried up sources of capital for numerous industries. Banks are stingy with lending cash. This is not a credit-friendly environment.

Enema Now…Rah ….. Enema Now… Rah Rah!!!

If the NHL continues on this path, our prediction is that within a short period of time, within say twelve to twenty four months, it could find itself in serious financial difficulty – maybe even Chapter 11. It does not to us seem sensible that in this economy, any enterprise could withstand the various incompetencies and goofs that are piling up in increasing amounts on the NHL’s doorstep. Therefore our message to the Fans, Governors and the Players Association is that the NHL needs a “Corporate Enema” now. Consider the following:

• Your business is valuable, but it is a long, long distance from being as valuable as it could be. Your revenue model is in fact now under threat.
• Your Leadership must change. Mr Bettman seems to have surrounded himself with like-minded individuals who are not commercially orientated and who view matters through a narrow, legalistic lens. The League Front Office has ossified, yet seems to have the Board of Governors in its back pocket. The NHL needs Vision, Ingenuity and Execution; not Cronyism, Legalism and Confrontation. Investigating the processes for removing the Commissioner must proceed without delay. (Is he a Stalin or an Italian Prime Minister?) The findings here will determine in large measure how high the Mountain is that needs to be scaled. However, if Judge Baum makes a ruling detrimental to the League, even modestly so, this could simplify matters greatly in this area.
• Your Opaque Governance Structures must change. The recent vote, for example, by 26 NHL Governors against Mr Balsillie, accompanied by some abstentions (most notably from the Leafs) AND the contemporaneous NHL bid proposal for the Coyotes, smacks of thinly-veiled self-dealing and does not pass the smell test.
• You must understand that these changes are not going to be palatable to everyone. Some Clubs will need to be put down or reorganized. Players might lose jobs.
• You must seek Trusted Advisors Now to help you make those changes

The Puck Stops Here

For his part Mr Balsillie must answer for his confrontational behavior. He has chosen to crash the net repeatedly and this has raised the ire of the NHL leadership. This behavior has clearly risked having him lose the “prize”. We will all have to wait and see on that one. However, if he is to claim the prize, a prerequisite step will likely be that he rapidly and personally repair bruised relationships and  establish sufficiently collegial relations with the ownership groups and at the Board of Governors level. An accommodation must obviously be reached with affected Clubs if he is to move the team.

As for the Glendale City Leadership and their Jobing.com albatross – Too Bad!! This is a bankruptcy and you need to carry the can for your lousy decisions. Under any conceivable outcome to this process, their $500 MM claim will be shredded by what is, by definition, a bankruptcy estate limited to far below that fantasy number and accompanied by a defined waterfall as relates to the distribution of valid outgoings. Sorry, but you might not get re-elected.

Whatever Mr Bettman, Mr Melnyk or the other owners might think of Mr Balsillie, in our opinion he has  done a great service to Professional Hockey. He is knowledgeable and passionate about the Game, and seems to have an instinct as to where this league needs to go in order to maximize the experience for the Fans, Players and Owners. His quest has cost him significant sums of money and his personal reputation to a degree, but assuming that the NHL’s problems meet solutions as discussed above, we all stand to benefit from the sacrifice he has made in exposing the serious weaknesses in the current stewardship of the Game.

For his efforts and perseverance,  Jim Balsillie merits appreciation and high regard whatever the outcome of the Coyotes saga. Here at Recovery Partners we wish him all good fortune in his quest to turn around the Coyotes and exert a positive influence in the NHL.

Posted in Bankruptcy, Crisis, Hockey, Loan Losses, Restructuring | No Comments »