Friday, December 18, 2009

Sovereign Debt Default Scare - Is Dubai Too Big To Fail?

Just a year back big banks and financial institutions had defaulted big time in many developed nations, specially in US. Declaring themselves bankrupt overnight, these big financial institutions reported losses in billions of dollars on what we now know as sub prime crisis. So huge were the losses that US Govt alone injected more than $700 bn to resuscitate these dying financial institutions. Honest tax payers' money has been squandered to revive failed private US banks in one of the most aggressively capitalist nations of the world. Reason - these banks were too big to be allowed to fail. On the other hand, in 2009 alone 106 US banks had to close down, but they were not bailed out by US Fed. Reason - they were not big enough to be saved.

So what is the lesson to be learnt from here? Lesson is that as a business institution you have to bungle big time, show billions of dollars as debt in your books, borrow or leverage indiscriminately and then sit back and relax after blowing the whistle. You will face no problem because your government will bail you out since your bungling is too big. And once bailed out, you can then go about using the bailout money to enrich yourself with astronomically high bonuses. You can justify large bonuses by showing existence of big money in your books. So what if now the money in your books is honest taxpayers' money loaned to you by your government?You can be squatting smug on your haunches with the knowledge that, do what you may - you just cannot fail. You are too big to be allowed to fail!!

That is how investment bankers are using the bailout money in many countries. In fact in UK the public outrage has been such that Govt has now slapped 50% tax on bonuses that banks pay to their employees. As a result, Barclays recently announced a pay hike of 150% for 22000 of its investment bankers with retrospective effect from June 2009!! Take that - if you tax our bonuses then we have other means of looting tax payers' money.

Well so far so good. Big business institutions have been bailed out of thick financial soups by their respective governments. But in doing so these governments have become susceptible to credit crisis themselves. Governments, I agree, are again too big to be allowed to fail. And that is how we found Dubai getting bailed out by its neighbour, Abu Dhabi. For more details on Dubai bailout click this link here -

Abu Dhabi has given temporary reprieve to Dubai so as to maintain investor confidence in the region. But such actions of saving nations from becoming bankrupt will be possible only when there are only few and far between instances of sovereign default. What happens when most nations fall into a debt trap from which they cannot extricate themselves? Many developed European nations are on the brink of sovereign default. Greece, Spain, Ireland are some such names. Then there are a host of East European nations which are tottering under the burden of massive debt. Who will ultimately bail out whom?

The way even rich European nations are falling into debt trap, I wouldn't be surprised if lenders, as a species, totally vanish from the face of this earth. Germany is the richest nation in European Union and it also has spiraling debt in excess of 70% of its GDP. But wait a second! The biggest debt defaulter can be US in times to come. It is estimated that for the next 30 years US national debt will keep on increasing every year. Presently US Treasury has calculated the National Debt at $ 12.135 trillion. White House estimates a record $ 1.5 trillion deficit this year alone, and next 5-year deficit total of $ 4.97 trillion.

Now imagine a scenario in future when US defaults on its public debt. What will then happen to this global economy, which shook like an aspen leaf with the prospect of tiny Dubai defaulting? The total debt of Dubai, including all its state sponsored entities, is not more than $ 100 billion. Compare it with the present day US debt of $ 12135 billion. It is agreed that US is really too big to be allowed to fail. But tell me, who on this planet will be capable of bailing out US, in case it defaults??

Thursday, December 17, 2009

Did Fed Go Wrong In Last FOMC Meet 2009?

US Central Bank concluded its two day meet on 16 Dec 2009, that being the last FOMC meet of year 2009. The Federal Reserve, specially its Chairman Ben Bernanke, was very careful in not ruffling any feathers, so to say. It took utmost care that the statements it issued should not unnerve market participants. It not only left the rates unchanged , but also retained its key phrase "exceptionally low rate for an extended period of time".

That's right. Fed wants to retain an exceptionally low rate for an extended period of time. And yet the US markets gave a thumbs down to this benign act of Fed. The moment the decision on rate was announced yesterday, the US markets sold off. Dow Jones which had made an intra-day high of 10553 before the announcement, swung into negative territory to make an intra-day low of 10402 after the announcement. By pressing the sell button US markets signaled to Ben Bernanke that he had not done enough.

But what more could Bernanke have done? He went overboard painting a rosy picture and not stepping on any toes, keeping rates at zero for an extended period of time. Time magazine also splashed him across newsstands on the same day as its Person of the Year 2009. Every bit of positioning helps. Time's managing editor showered accolades on Bernanke. Sample this piece from the article - "Bernanke didn't just learn from history; he wrote it himself and was damned if he was going to repeat it,".Such manoeuvres can surely give Bernanke that extra push when Senate Banking Committee votes this Thursday on Bernanke's second four year term.With a little help from my friend - reminds one of an old song by Beatles!

But alas! Markets will be markets!! Ben Bernanke's friendly and conciliatory overtures were given a total cold shoulder. The promptness with which the market sold off after the Fed announcement of keeping rates unchanged suggested that this was a premeditated move of the market. It could well be that irrespective of Fed decision market participants had preplanned to sell off after the announcement. Are they trying to express their displeasure before Bernanke gets the votes for a second term? Time will only tell. I would rather like to pin the sell off down to fears of sovereign default by Greece. More of that later.

Debt Laden Dubai - When Will The Woes End?

Fortnight ago Dubai World's request to its creditors for debt repayment restructuring plan had sent sentiments of global investors into a tizzy. In taking precautionary stance, global investors had exhibited an urgency to take cover at this slight bit of adverse news in global financial ecosystem. That amply indicates that risk taking appetite of global investors is surely on the wane. Otherwise, how do you explain a puny $ 26 bn expected default scaring the wits out of investors in South East Asia, across Indian Ocean to Europe and across Atlantic to the Americas?That's pandemic contagion, if you may!!

But why is the global investor getting spoofed so easily. Could it be that Dubai World episode portends destabilizing happenings in global financial ecosystem in days to come? Does Dubai World indicate that the cup of global financial woes is finally spilling over? Does Dubai epitomize the surreal world of tall dreams with borrowed money, whose nemesis is in offing? To get an answer to all that let us first understand the nuts and bolts of Dubai and Dubai World.

Dubai is one of the seven Emirates under the federal governance of UAE. It started off as a trade based oil-reliant economy but presently has turned itself on its head as a service and tourism oriented economy. This has been necessitated because of the belief that its oil reserve will last only twenty more years.

Dubai World is a state-owned conglomerate which deals in real estate, financial instruments and various other business ventures . Its real estate arm, Nakheel has to its credit the Palm Trilogy, three palm tree shaped man made islands, as also Burj Dubai, the tallest free standing 818m high man made structure being built. 'The World' is another extravagant real estate development project which aims at creating 300 islands off the coast of Dubai resembling the continents of the world. All such projects come at an exorbitant price and are insanely expensive for all parties connected with such projects.

It is estimated that the actual debt burden of Dubai's government-related-entities is 116% of emirate's GDP. That's what has prompted economist to put the tag of 'debt laden' to Dubai. Such a tag is also being put on fancied European countries like Greece and Spain. Many East European countries have also earned this sobriquet. So the global investor was spoofed not by the size of expected Dubai default, but that one sovereign default may trigger an avalanche of other sovereign defaults.

But now for some good news. Last Monday was pay time for Nakheel's bonds which had matured and the creditors could be paid off $4.1 bn. A bond default was avoided at the very last moment when Dubai's oil rich neighbouring emirate Abu Dhabi came to its rescue with $10 bn dole, like a knight in shining armour. This total sum of $10 bn will see off debt servicing requirements of Dubai World till April 2010. What after that! Will Dubai have to periodically stick out the begging bowl for servicing debt of its state owned entities?

To get an answer to that and more, do watch this space in coming days.

Friday, November 27, 2009

Dollar Carry Trade - Easy Money in Difficult Times

What is driving asset prices to scale newer heights in year 2009? Answer is simple - weak dollar and near zero interest rates in US. It is very simple for global investors to make quick and easy money. Borrow at near zero interest rate in US, short dollar and invest that money in any asset in the country whose currency you have bought. Lets examine all the options available to global investors to make easy money :-
  • Scenario #1. Borrow dollars in US. It is almost free to borrow since you have to pay near zero interest on the dollar borrowed. Put this money to work in US itself by buying any high yielding asset like stocks, commodities, gold etc. As these assets appreciate you will be making money from capital given to you almost free of cost by US Govt. Isn't this a simple equation for making easy money?
  • Scenario #2. Borrow dollars in US. Then sell dollars to buy another currency of a country where interest rate is higher, say India. This arbitrage situation if tapped in India can fetch a global investor about 5% profit through interest differential for doing next to nothing.
  • Scenario #3. Borrow dollars in US. Sell dollars and buy currencies of different emerging markets especially the BRIC countries. Then employ this money in various high yielding risky assets and enjoy rapid appreciation.
Well global investors are doing all the above and maybe more. Dollar has become the international currency for carry trade, a position that yen and Swiss franc used to enjoy till some time back. This drives dollar to depreciate as there is massive supply of dollar for buying various other assets. And that is how we are witnessing this spike in prices of all assets, from stocks to commodities to gold, while the dollar is plummeting.

I am certainly not complaining for what is presently happening across all assets because of dollar carry trade. If it is dollar carry trade plus other positive reasons like turn around from recession, then all the more reason to rejoice! Let us enjoy the spike till it lasts. But the question that begs an answer is 'till when?'. Certainly till US Feds keep the interest rates to near zero. Simple as that! But once the interest rates are hiked in US then the following can happen:-
  • Investors who are short in dollar will cover their positions, making the dollar to appreciate with a spike.
  • Massive unwinding of carry trade will take place with tremendous rush to buy back the dollar after exiting all trades like emerging market stocks, commodities, gold, et al.
  • With dollar rallying significantly, prices of all other assets will plummet which will have the effect of bursting of asset bubble.

Tuesday, November 17, 2009

Asian Stock Market Blues - Frequently Looking to the West

This has become a routine for Asian Stock Markets - shake like an aspen leaf at every sneeze in the US. On 17th November almost all major Asian stock markets closed nearly in red, after trading the entire day in red. This was after US markets in last trading session had made a spectacular up-move, closing at a new high of 2009. So the least one expected was a slightly positive mood in Asian markets. But that was not to be! I am told that Asian markets wore such a sullen look on 17th November because Ben Bernanke made some not very rosy comment on US economic recovery. But tell me frankly, don't we already know all that.

Not withstanding the above ramblings, the reasons why markets across the globe are exhibiting high volatility are listed below :-
  • Stock markets moved up from March 2009 lows primarily driven by huge liquidity, which in turn came into existence owing to generous stimulus packages from respective nations. Now there is apprehension that since the recovery in stock markets has been spectacular, there might be a case for withdrawal of stimulus packages by most nations. But the fact is that leaders of G-20 nations have promised to keep the stimulus packages in place for some more time. Premature withdrawal of stimulus can result in a prolonged depression as was witnessed during the Great Depression of 1929.
  • Weakness in Dollar is pushing the commodity prices, oil prices, gold prices and also the stock prices higher. But any short term technical strengthening of dollar from here can send the other asset prices spiraling downwards. The moot question is when and that is creating nervousness in global markets. Lets see who blinks first!
It is certain that there is correction lurking in the dark, and suddenly it will spring a surprise on all of us. I have to admit that this forthcoming correction will be quite serious. In absolute terms I will venture to say that the corrective wave will wipe off about 1500 points from Nifty. If Nifty can climb to about 5500 in the current run up as predicted in my 8th November post (, then the correction can make Nifty trade at 4000 level. That is how serious the anticipated correction can be!! No wonder the market participants are getting so easily spooked by every shred of negative news.

Coming down to brass tacks, we need to apply caution after Dow reaches 10500. Similarly in Indian markets we have to watch out for the selling zone between 5320 and 5580 in Nifty, after Nifty crosses 5182.