Sunday, November 27, 2011

As expected, U.S. Super Committee fails - markets take a hit

As the U.S. congressional “super committee” failed in its objective to identify $1.4 trillion in U.S. budget cuts by its November 23 deadline, politicians pointed fingers at each other and Standard & Poor's and Moody's Investors Service said they would not downgrade the credit rating of the U.S. as long as the planned automatic spending cuts did not change.

MY TAKE: It is broadly understood that addressing the U.S government’s debt crisis requires increases in revenue (more taxes) and decreases in government spending (affecting defense and entitlement budgets). Repeated failures by the U.S. Congress to deal with these issues highlight shortcomings in both Congressional processes and many legislative participants. Regarding the impact on investors, market uncertainty continues to increase and this past week’s negative market action reflects the current investor mood. The global economy is traveling a path where the arrival of unexpected consequences can continue to deliver swift and negative moves. In the short term, positive holiday sales trends may provide market stability.

At Portugal Debt is Downgraded, the Eurozone Drama Continues

This past week, Fitch Ratings cut Portugal’s debt rating to “junk” status, Standard & Poor’s cut Belgium’s rating to AA from AA+ and Moody’s Investors Service lowered Hungary’s debt rating to junk. Additionally, more European countries have their 10-year bond rate over 7%, a level where the probability of a financial bailout significantly increases. On Friday, 10-year bond rates for notable European countries included: Greece 28%, Portugal 12.3%, Ireland 9.5%, Hungary 9.4%, Italy 7.2%, Spain 6.6%, Belgium 5.8%, France 3.6% and Germany 2.2%. In addition, hopes for a Eurozone bond, which would combine some of the $8 trillion in Eurozone debt, faded when the idea was rejected by Germany.

There are no easy solutions to the Eurozone mess. It is understandable that Germany does not want to become further entangled by participation in a Eurobond offering – driven by a fear of lowering its creditworthiness. However, extracting itself from the Eurozone structure would be a painful process. In the meantime as the Eurozone crisis evolves, France, with its significant financial exposure to several of the weaker players, is increasingly at risk of a credit rating downgrade – such an event would be significantly negative.

Sunday, November 20, 2011

Globally connected banking system still seems like risky business

On Wednesday, the Fitch Ratings service said, “unless the Eurozone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen” and “the risks of a negative shock are rising". This news triggered a swift and negative reaction in U.S. markets with the S&P 500 closing down 1.7% for the day. Against this backdrop, senior U.S. financial executives struggle to explain and defend their “limited” exposure to Eurozone
MY TAKE: The global banking system seems to remain a beast that is difficult to analyze and understand. Limiting investor trust are 1) poor disclosure of potential risks, 2) the general complexity of financial structures, 3) the continued use of derivatives and 4) often suspect “off-balance sheet” issues . In addition, MF Global Holding’s ill-fated European sovereign debt bet, along with its attempt to use of hundreds of millions of dollars in customer funds to shield itself from its inevitable bankruptcy, is not reassuring. These dynamics support continued market volatility as investors respond with “sell first, ask questions later” trading.

As U.S. Super Committee deadline approaches, Rep. Gabrielle Giffords shares some thoughts

After traditional U.S. congressional processes were ineffective in determining $1.4 trillion in U.S. budget cuts, the process was “outsourced” to a smaller group of legislators called the “super-committee”. With its November 23 deadline approaching, there is limited evidence that this group has made progress and political bickering continues.

Interesting, Rep. Gabrielle Giffords R-Arizona (still recovering from an assassination attempt), along with 14 Democrats and 11 Republicans submitted a letter to the committee this past Thursday recommending that congressional salaries should be cut by 5% citing that 1) members of Congress have not taken a pay cut since April 1, 1933, 2) U.S. Congressional compensation is among the highest in the world (only exceeded by Japan) and 3) “gold-plated member retirement benefits” should be curbed.

MY TAKE: With low expectations for the committee’s efforts, some investors believe the negative news is priced into the market. However, markets often do not take the negative hit until the news is finally released. Hopefully, the committee delivers some positive
results, otherwise the markets may take control. Note: Eurozone members, having poorly managed their economic problems, are currently learning the lessons of market control.

Sunday, November 13, 2011

More markets swing, during U.S. road trip

Last week, as global markets encountered broad swings - driving initially by concerns and then by progress related to political leadership issues in Greece and Italy, I traveled across the U.S. on a road trip from San Francisco to the western gulf coast of Florida. Phoenix, AZ provided its version of Occupy Wall St. within its downtown sector. Driving through the Midland/Odessa area of Texas provided a chance to hear the local react to Gov. Rick Perry's Oops moment (not supportive), along with exposure to Post-Katrina New Orleans and other southern U.S. locations.

Sunday, November 6, 2011

Reckless CEO Jon Corzine trashes investment firm

In March 2010, Jon Corzine, a former Goldman Sachs CEO and New Jersey U.S. Senator and Governor, joined MF Global as CEO to turn it into a major investment banking force. In an apparent effort to get big fast, he placed a $6.3 billion bet on the recovery of sovereign debt from Belgium, Ireland, Italy, Portugal and Spain. Additionally, the firm was leveraged at a ratio of about 40:1. This week, as investor confidence eroded, the firm’s stock collapsed, bankruptcy was filed, Corzine resigned and up to 2,000 staff members are likely out of work.

Excessive leverage frequently results in economic disaster. As discussed in previous notes, in 2004 the U.S. Securities and Exchange Commission provided an exemption to five investment banks to increase their leverage ratio to 40:1, up from the industry standard of 12:1. The firms were Lehman Brothers, Bear Stearns, Merrill Lynch, Goldman Sachs and Morgan Stanley – each either collapsed or needed significant government bailouts. Corzine’s mix of excessive leverage and speculative bets demonstrated minimal regard for risk management. Hopefully, the investment industry and its varied regulators (in this case, the U.S. Commodity Futures Trading Commission) will learn from this incident.

More travel, but minimal Eurozone progress from G-20 leaders.

As Greek Prime Minister George Papandreou shocked global markets with his suggestion that Greece might not follow through on its bailout plan, G-20 leaders gathered in Cannes, France for yet another summit to discuss Eurozone issues. Comments from summit attendees included 1) Australian Prime Minister Julia Gillard: "Europe needs to get its own house in order", 2) Canadian Prime Minister Stephen Harper: "We see absolutely no reason why Canada, or frankly why any range of other countries, would need to contribute to such a bailout" and 3) Japanese Finance Minister Jun Azumi: "The focus of debate is how to set up a firewall but we consider that the IMF should become one big wall." Additionally, Kenneth Rogoff, a former International Monetary Fund (IMF) chief economist said, “the new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding.”

MY TAKE: It seems that hopes for a resolution of the Eurozone’s problems are turning into policymaker fatigue. With the can being kicked into early 2012 – it is likely that global markets will take matters into their own hands. Heightened unpredictability will continue.