Keep your bank deposits safe
Document Sample
Financial Literature Reading USST 2011-2012 I
Keep your bank deposits safe
Tips to keep your savings protected by FDIC insurance
By Andrea Coombes,
The raucous debate in Washington over raising the U.S. debt limit has
raised fears about a possible shock to the financial system. That makes
it a good time to review your savings accounts and other bank deposits
to make sure the cash stashed there is as protected as possible.
If lawmakers fail to hike the debt ceiling, and the U.S. defaults on its
debt, you may need to start worrying about the safety of your bank deposits
— eventually.
“If the government defaults and it’s not just a brief default but one that drags on, financial markets
will be in turmoil, credit markets will seize up, and the economy will roll over,” said Greg
McBride, senior financial analyst with Bankrate.com.
If a default dragged on for many weeks, the question becomes: Is the government that’s backing
the insurance on your deposits good for the cash? (The Federal Deposit Insurance Corp. collects
fees from banks to insure deposits, but it says it’s backed by the full faith and credit of the U.S.
government.)
“There’d be no government backstop,” McBride said. While bank failures have slowed — 61
through July 30 this year versus 108 from January through July 31 last year — a debt default
suggests an economy in turmoil and thus, perhaps, a rise in bank failures. If the FDIC insurance
fund were depleted, you’d have a scary scenario.
Luckily, a drawn-out U.S. debt default is “highly, highly unlikely,” McBride said. Plus, “that
doomsday scenario would have to be in effect for a while before we’d have to worry about deposit
insurance.”
Another concern now is a credit-rating agency downgrade of U.S. government debt. For savers,
that’s not as worrisome. “If there’s a downgrade but no default, bank deposits would likely
become the safe haven, particularly for consumers,” McBride said. The bad news there is that the
current low interest rates on deposits would not improve any time soon.
FDIC insurance
The financial-armageddon scenario is unlikely, but you should still make sure your deposits are
properly insured.
1
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
For the 380 bank failures from January 2008 through July 22, 2011, a total of about $218 million
of customer deposits was uninsured, according to the FDIC.
Of that amount, more than $66 million has been reimbursed to depositors, and more could be on
its way. “As the FDIC sells more of the assets from these failed banks, additional money may be
distributed,” said David Barr, an FDIC spokesman, in an email, adding that, “To put this in
perspective, the 380 failed banks had total deposits of $471,450,749,000.”
Still, that leaves those uninsured customers out a total of about $152 million, for now.
FDIC insurance now covers $250,000 of your deposits per bank, up from the $100,000 limit in
effect when the financial crisis hit in 2008 (that higher limit is retroactive to Jan. 1, 2008). If you
want to insure more than that, you can open up accounts at different banks, but there are ways to
get more than $250,000 insured at just one bank — if you understand the FDIC’s categories for
insuring various types of accounts.
Say you have a checking and savings account in your name alone at one bank. Those are counted
together for the purposes of FDIC insurance; add up that money and any amount over $250,000 is
not insured.
But say you also have a joint account with your spouse. Joint accounts are a separate category for
FDIC insurance purposes, so as a co-owner on that account, you’re separately insured up to
$250,000 in that account, too. Your spouse is also insured up to $250,000 in that account. And if
you also have a revocable-trust account — another FDIC category — that account is insured up to
$250,000, per beneficiary.
Thus, a married couple, each with an individual savings account (insured up to $250,000 each), a
joint checking account (up to $250,000 per co-owner), and a revocable trust in both their names
naming their daughter and son as beneficiaries ($250,000 each spouse, per beneficiary), would
enjoy a total of $2 million in FDIC insurance (remember: a maximum $250,000 applies per
category).
Another category for FDIC insurance: retirement accounts. Thus, a bank certificate of deposit held
in an individual retirement account (IRA) enjoys insurance up to $250,000. Remember, though,
that investment products, such as annuities and mutual funds, are not FDIC insured — even if you
bought it at a bank.
But don’t set up accounts solely to ramp up your insurance coverage, said Kathy Nagle, associate
director for consumer protection at the FDIC.
“People trying to get additional coverage, they’ll do joint accounts and put their children on there,
[but] they don’t want the kids to have any access to the money,” she said. “If you don’t have equal
withdrawal rights, that’s not a joint account.”
Similarly, some people create trust accounts naming various relatives as beneficiaries just to get
2
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
added insurance coverage. But keep in mind that if you die unexpectedly, that money will go to
those relatives.
More tips
Here are more tips to keep your money safe.
If you’re a sole proprietor, the money in your business account may get counted together with
personal funds. “If the business was incorporated or is a partnership or some other kind of separate
legal entity, then the business funds and the personal funds would be separately insured,” Nagle
said.
If you buy a CD through a broker, check whether it’s from the same bank where your other
accounts are. “If the brokered CD of $250,000 is parked at the same bank where you have another
account for $200,000,” McBride said, “you have an exposure.”
Got an Internet bank account? Make sure that bank is not a subsidiary of a brick-and-mortar bank
where you have other accounts. Same goes for a bank that might use a different trade name in
different parts of the country. Ask for the banks’ FDIC certificate number. If both banks are
insured under the same number, your money in those accounts may be pooled together for FDIC
insurance purposes.
Money deposited at a federal credit union is generally insured up to $250,000 by the National
Credit Union Share Insurance Fund, which works under the same account-category rules as FDIC
insurance, said Bill Hampel, chief economist for the Credit Union National Association. Most, but
not all, state-chartered credit unions are also covered by the NCUSIF, he said. If you’re not sure,
ask your credit union. Also, there’s a deposit-insurance calculator on the National Credit Union
Administration site. http://webapps.ncua.gov/ins/calculator.html
To keep millions of dollars in CDs insured at just one bank, look for a bank that participates in the
Certificate of Deposit Account Registry Service. CDARS works with financial institutions to
spread out your holdings across different banks, though you work with only one.
Still confused? The FDIC offers the “electronic deposit insurance estimator,” or Edie, to help you
assess whether your money is insured. Go to FDIC.gov/edie. Or call 877-ASK-FDIC.
3
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Reappraising Beijing policy favors
for Hong Kong
Is it getting a raw deal?
By Craig Stephen
As the Hang Seng Index last week decisively breached the key 20,000 points level, it further
dented confidence in a city-state where the stock and property markets remain so central to its
prosperity.
Even the promise of new concessions to boost yuan trade in Hong Kong by China’s visiting vice
premier Li Keqiang — widely tipped to succeed Wen Jiabao next year as prime minister — did
little to stem the slide.
In such times of uncertainty Hong Kong leaders have tended to look north for assurances that its
role as the mainland’s de facto international capital market will remain. Surprisingly for a
city-state so imbued in free market capitalism and self-reliance its leaders have developed a
troubling dependency habit of repeatedly lobbying Beijing for policy favors. It almost appears as
if Beijing’s leaders are believed to possess some kind of wizard of Oz powers that can direct
capital flows, markets and prosperity at will.
One possible explanation is mistaking the power of the mainland authorities with simple price
arbitrage.
For instance, if we go back to 2007, then euphoria over the “investment through train” that Beijing
was expected to green light sent the Hang Seng Index briefly above 30,000 points. Stocks were
re-rated higher as an avalanche of mainland money — until then ring fenced inside China with its
capital controls — was now expected to land in Hong Kong.
This phenomenon helped cement the impression that Beijing had the ability to channel capital at
will.
And this was not the first time Hong Kong experienced the impact of a shift in policy from Beijing.
Back in 2004, when Hong Kong was mired in post SARS gloom, a relaxation of mainland tourist
visas triggered a surge in visitors that lifted not just retailers and hotels, but the whole economy.
Impressive perhaps, but much of this was down to relative prices as items from cosmetics, luxury
clothes and jewelry bought duty free in Hong Kong were considerably cheaper than over the
border.
HSI 19,219.65, -181.68, -0.94%
4
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
In 2007 the leap in stocks was arguably just another case of price arbitrage. Back then many
Shanghai stocks traded at a premium of over 100% to their Hong Kong counterparts so buying for
mainlanders looked like another bargain. Ultimately, the move upwards was in anticipation of long
flagged policy that never actually materialized.
Now, however, many of these dual listings trade in Shanghai at the same price or even cheaper
than Hong Kong. It looks most unlikely, even if Beijing permitted another through train there
would be a similar stampede for Hong Kong equities.
Vice premier Keqiang did at least announce a further series of initiatives to extend Hong Kong’s
position as an offshore yuan-trading hub. Hong Kong holders of yuan can invest that money in the
mainland through qualified foreign institutional investor scheme QFII although the initial quota
was set at just 20 billion yuan. Instead of a through train there will be an exchange traded-fund
linked to Hong Kong stocks that will be listed in Shanghai.
Despite this there was little reaction due to the small and limited scale of these measures.
Perhaps less attention should be paid to these supposed policy favors and more to some of the
unintended consequences of how Beijing policy impacts Hong Kong.
Take initiatives to clamp down on property prices and bank lending for on the mainland for
instance, which have had the opposite effect on Hong Kong. As purchases of multiple homes were
restricted in China, buyers turned to Hong Kong helping stoke further price rises.
Similarly, lending curbs in China have coincided with an unprecedented surge in borrowing by
mainland companies in Hong Kong — having risen four fold to 1.6 trillion yuan ($250 billion)
since mid-2009 to the end of May according to the Hong Kong Monetary Authority. Some
estimates put the exposure to the mainland running at 20% of Hong Kong bank assets.
One reason for this is again a difference in price — borrowing is much cheaper in Hong Kong,
especially in a depreciating currency. This is one consequence of Beijing’s efforts to
internationalize the yuan while allowing it to steadily appreciate. Last week this picked up pace as
the yuan rose 0.8% and is now up 6.2% year on year. The preference in this situation is to keep
5
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
yuan as assets and not as a loan.
The scale of this lending is also beginning to raise questions on how well these loans are
collateralized, which often come from the Hong Kong branches of mainland banks.
Overall, it looks about time Hong Kong examined just how benign the sum of Beijing policy
really is.
One reason repeatedly rolled out for keeping the increasingly contentious Hong Kong dollar peg is
any change must wait for Beijing to be ready for the yuan to achieve full convertibility. This state
of affairs certainly looks advantageous for mainlanders, who can enjoy ever cheaper shopping and
bank loans in Hong Kong.
Meanwhile the direct inflationary consequences and potential risk to Hong Kong’s banking system
are rarely mentioned, never mind debated. Perhaps this is why, this time round, a mainland leader
bearing gifts did little to lift the gloom.
China's currency
Stranger than fiction
The plot thickens on the rise of the “redback”
Jan 20th 2011
IN HIS new book “Super Sad True Love Story”, the novelist Gary Shteyngart depicts a future in
which an overstretched America depends on the forbearance of its Asian creditors. That scenario is
not, sadly, a great test of the author’s imagination. In this fictional world, America’s currency and
China’s are still closely linked. But nervous Americans peg their greenbacks to the yuan (worth
about $4.9), not the other way around.
America presents a “grave risk to the international system of corporate governance and exchange
mechanisms,” says a Chinese central banker after a trip to New York. That is from the novel. The
“international currency system is the product of the past,” says China’s president before a trip to
Washington, DC. That is from real life. In response to a question posed by the Wall Street Journal
and the Washington Post, Hu Jintao echoed a complaint made by the (real) governor of China’s
central bank, Zhou Xiaochuan, in 2009. The financial crisis, Mr Zhon said back then, reflects the
“inherent vulnerabilities and systemic risks in the existing international monetary system.”
These observations are partly political, of course. America has long complained about China’s
cheap currency, raising the issue at multilateral forums like the IMF and the G20. China has taken
to responding in kind. If America is going to gripe about the yuan’s rate, then China will complain
about the dollar’s role.
6
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
What is that role? The dollar is more than just a reserve currency. For many countries, it is a “key”
currency. Their exchange rates revolve around the dollar, just as the notes on a scale centre on a
musical key. Their governments fear that if their currency falls too far against the dollar, inflation
will take hold or the country’s dollar debts will become too heavy to bear. If their currencies rise
too far against the greenback, their exporters will lose out wherever customers pay in dollars.
But the dollar is not always perfectly pitched. Mr Zhou and President Hu worry that America is
printing too much money to try to revive its own economy, regardless of the consequences abroad.
To stay in tune with a falling dollar, other central banks will have to print more of their own
currency, risking inflation and asset-price bubbles. “The monetary policy of the United States has
a major impact on global liquidity and capital flows,” Mr Hu told the Journal and the Post,
“therefore, the liquidity of the dollar should be kept at a reasonable and stable level.”
Mr Hu admitted that making the yuan “an international currency will be a fairly long process.”
Still, that process has begun. His government now seems keen to promote the yuan in international
trade. In June it allowed most of the country to pay for imports in yuan and 365 Chinese
companies to sell exports for the currency. Last month, it expanded the number to 67,359. By the
end of November, trade worth 385 billion yuan ($58 billion) had been settled in China’s currency
(see chart).
About 80% of these transactions involved exports to China not imports from it. Foreigners seem
keener to sell stuff for yuan, rather than buy stuff with them. As a result, a stream of yuan has
flowed beyond China’s borders, most of it collecting in deposits in Hong Kong. This offshore pool
of “redbacks” is still small but is becoming deeper and more liquid. In Hong Kong, yuan deposits
probably reached 300 billion by the end of 2010 (see chart).
Once offshore, these redbacks can frolic in Hong Kong’s free markets. They can be bought, sold,
borrowed, lent, swapped and hedged. A growing list of issuers, from McDonald’s to the World
Bank, have sold so-called “dim sum” bonds in Hong Kong in order to borrow these offshore yuan.
But the mainland remains enclosed by a levee of regulatory controls. Yuan can leave the mainland
7
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
in payment for an export to China; they can return in exchange for an import from China. But all
other routes in and out are tightly controlled.
In August the government said that certain lucky banks could invest some of their offshore yuan in
the interbank bond market on the mainland. This month it said that companies making direct
investments abroad—acquiring foreign firms or building foreign factories—could pay in yuan.
Likewise, it permits companies that have raised yuan offshore to invest the proceeds on the
mainland, but only in their own operations or other direct investments. The process is
unpredictable and can take weeks or even months, says Donna Kwok of HSBC, which is partly
why so few mainland companies have borrowed offshore, despite the cheap rates on offer.
China seems happier to allow capital to flow in the opposite direction. Its banks are pushing yuan
loans and trade credits, especially to customers in emerging economies. But lending in yuan is not
as easy as China might wish. When India’s Reliance Power ordered equipment from Shanghai
Electric, three Chinese banks offered the Indian firm a loan of $1.1 billion over more than 13 years.
The deal demonstrates China’s manufacturing prowess and its prodigious ability to lend. But it
also reveals how far the yuan has to go. Less than 0.5% of the loan was in yuan. The rise of the
redback will be a super, true story. But as Mr Hu cautioned, it will also be a long one.
China's currency
The rise of the redback
China will have to open its financial market if it wants the yuan to rival
the dollar
Jan 20th 2011
IN 1965 Valéry Giscard d’Estaing, then France’s finance minister, complained that America, as the
issuer of the world’s reserve currency, enjoyed “an exorbitant privilege”. China’s president, Hu
Jintao, does not have quite the same way with words. But on the eve of his visit to America this
week he told two of the country’s newspapers that the international currency system was a
8
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
“product of the past”. Something can be a product of the past without being a thing of the past.
But his implication was clear: the dollar’s role reflects America’s historical clout, not its present
stature.
Mr Hu is right that America’s currency punches above its economy’s diminished weight in the
world. America’s share of global output (20%), trade (only 11%) and even financial assets (about
30%) is shrinking, as emerging economies flourish. But many of those economies, such as South
Korea, still sell their exports for dollars; many, including China, still peg their currencies to the
greenback, however loosely; and about 60% of the world’s foreign-exchange reserves remain in
dollars.
This allows America to borrow cheaply from the rest of the world. Its government has been able to
overspend, secure in the knowledge that its IOUs will be bought by foreign central banks, which
are not too fussy about price. America would show more self-discipline, many Chinese believe, if
the dollar had a little bit more competition.
Could the yuan become a rival? China’s economy will probably surpass America’s in outright size
within 20 years. It is already a bigger exporter. It is prodding firms to settle trade and even acquire
foreign companies in its own currency. That is adding to a pool of “redbacks” outside its borders.
These offshore yuan are, in turn, being tapped by borrowers, issuing “dim sum” bonds in Hong
Kong
But as the dollar’s history shows, economic clout is not enough without financial sophistication. If
foreigners are to store their wealth in yuan, they will need financial instruments that are safe,
stable and easily sold. Dim sum makes for a tasty appetiser. But the main feast of China’s financial
assets is onshore and off-limits, thanks to its strict capital controls. The government remains
deeply reluctant to let foreigners hold, buy and sell these assets, except under tight limits. Indeed,
it is barely ready to give its own people financial freedom: interest on bank deposits is capped;
shares are largely owned by state entities; and bonds are chiefly held by the banks—which are, in
turn, mostly owned by the state.
Over time China will relax its financial grip. But even if it could usurp the dollar’s role as the
world’s currency, it will not replicate the American set-up. The United States takes advantage of
the dollar’s position to borrow cheaply from the rest of the world, selling its assets in return for
goods. China is a mirror image of this. It runs a trade surplus, selling goods in return for financial
claims on foreigners. Its firms, households and government save more than they can invest at
home.
A different kind of perk
Rather than seeking to borrow in its own currency, China may harbour the opposite ambition: to
lend in its own currency. The exorbitant privilege it may covet is a lower foreign-exchange risk on
its savings. On top of the trillions China has lent to America’s treasury, it also holds stakes in
Australian mines, African farms and Swedish car companies. But because none of these assets is
in yuan, China suffers a capital loss whenever its currency strengthens. It would no doubt like to
9
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
share some of this risk with the rest of the world. The model is not America, but Germany, an
international creditor which holds 70% of its foreign assets in euros.
There is a catch, though. No one will want to borrow in a currency that is only ever going to
strengthen, increasing the value of their debts. So if China wants to “yuanify” some of its claims
on the rest of the world, it will need a currency that can go down as well as up. To make people
believe the yuan can fall tomorrow, China will have to loosen its currency’s peg and let it rise
faster today. China is different from America: it is a rising economic power and a thrifty one. But
one rule still holds: China will have to open its financial system to the world if the yuan is to be
the dominant currency.
China’s currency
Redback and forth
The yuan is flowing beyond China’s borders—and back again
Aug 20th 2011
THE helicopter buzzed to and fro, hour after hour, high above Hong Kong’s shining harbour and
glistening skyscrapers, a bright red advertising banner trailing behind. What unmissable
opportunity was it selling? Government bonds, that’s what, yielding as little as 0.6%.
The bonds were issued on August 17th by China’s Ministry of Finance in its own currency, the
yuan. That would not normally be a banner-waving event. But what made this sale notable was its
size—20 billion yuan ($3.1 billion)—and its buyers: offshore investors in Hong Kong. It
represents by far the biggest issue of “dim sum” bonds, securities denominated in the currency of
mainland China, but sold in Hong Kong, where people like to eat dumplings, pork buns and other
tasty morsels known as dim sum. It therefore marks another step in the globalisation of the
redback.
The first such bond was sold by China Development Bank in 2007. The bank has since been
followed by more than 80 other issuers, including the World Bank, a Russian bank, McDonald’s,
Volkswagen and a casino operator.
Despite these headline-grabbing offerings, the dim-sum market has remained true to its name:
“delicious but limited”, as Tony Wang of Bank of China put it at a conference organised by the
Centre for Financial Regulation and Economic Development (CFRED). Bond sales have remained
bite-sized and quick to digest, with a typical maturity of two or three years. By the end of June,
there were 4.7 yuan in Hong Kong deposits for every one yuan of dim-sum debt (valued at its
10
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
issue price). That is why the finance ministry’s 20 billion yuan offering got everybody’s rotors
beating.
No way home
This week’s bond issue will not be the government’s last, according to Li Keqiang, a Chinese
vice-premier destined to succeed Wen Jiabao next year as prime minister. In a speech in Hong
Kong on the day of the sale, he said that non-financial Chinese firms would be allowed to raise
yuan offshore, a privilege previously reserved for mainland banks.
That will expand the menu somewhat. But the biggest deterrent to offshore borrowing is the
difficulty of getting the money back onshore again. China’s government remains deeply
ambivalent about the redback’s role in cross-border investment. Chinese companies can now buy
foreign ones with yuan; foreign firms can invest yuan raised offshore in their operations on the
mainland. But both transactions are subject to government approval.
In the early days of dim-sum issuance, approval took only a month or two, a sign the government
wanted the market to succeed. But because China’s authorities now worry that capital inflows will
stoke an overheated economy, they have tightened up: one company that raised yuan in Hong
Kong at the start of this year is still waiting to bring them across the border.
Mr Li’s speech may signal a softening of attitude. China already allows some “qualified” foreign
investors to buy mainland securities, subject to a quota. These investments are settled in dollars.
Now, Mr Li said, it will allow such investors to sink up to 20 billion of offshore yuan into China’s
stockmarket too. That will give foreigners another reason to hold redbacks.
China’s government has no such ambivalence about the redback’s role in international trade. In
2009 it allowed firms in China’s most dynamic provinces to trade goods in yuan; this week Mr Li
extended this right to the whole country. The currency was used to settle 600 billion yuan-worth of
11
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
cross-border commerce in the second quarter of this year, up from less than 50 billion a year
before (see chart 1). But that still represents only 7% of China’s total trade and 2% of the world’s.
Its role also remains lopsided. Of the trade settled in yuan in the first quarter of this year, 94% was
foreign goods sold to China, not Chinese goods sold abroad. In other words, yuan flow out not in.
Yu Yongding, of the China Society of World Economics, argues that this outflow of redbacks is
paradoxically tying China ever more tightly to the dollar. In the past, Chinese importers settled
more of their trade in dollars. This dollar outflow relieved some of the upward pressure on the
yuan’s exchange rate. Insofar as yuan settlement replaces this dollar outflow with a yuan outflow,
it erodes one of China’s few channels for easing the pressure on its currency. To keep the yuan
down, the central bank will end up adding more dollars to its stockpile, not fewer.
Foreigners will be keen to acquire yuan, and reluctant to part with it, for as long as they think it is
artificially cheap. That perception was only reinforced by China’s external surplus of $69.6 billion
in the second quarter, a big jump from the previous three months. That may have prompted
China’s central bank to let the yuan rise to a rate of 6.4 redbacks to one green (see chart 2).
The government is also making diplomatic efforts on behalf of the redback. It is nudging countries
such as Venezuela to pay in yuan. Indeed, in June yuan payments from the mainland to Hong
Kong fell short of payments in the other direction, contributing to a conspicuous slowdown in
offshore deposits. But that may reflect the Chinese regulator’s decision to tighten up on triangular
trade transactions, in which Chinese importers paid yuan to an intermediary, who then paid the
foreign supplier in dollars.
A pause in the breakneck growth of yuan deposits may be a relief to some. These deposits are not
particularly profitable for Hong Kong banks, because they are struggling to find anyone to lend
them to. In June, outstanding loans amounted to only 11 billion yuan, giving banks a yuan
loan-to-deposit ratio of just 2%.
12
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Hong Kong is keen to embrace its role as China’s offshore financial laboratory. But the
experiment is not without side-effects. The helicopter buzzing back and forth across the skyline
represents the financial centre’s more yuan-denominated future. But it was a relief when a
rainstorm forced it to take a break.
America’s downgrade
Substandard & Poor
The messenger may be flawed, but the United States should take heed of
the message
Aug 13th 2011
IT WAS a humbling moment for America, and the decision by Standard & Poor’s to strip the
country of its triple-A credit rating on August 5th came at a particularly sensitive time. Furious
Obama administration officials immediately attacked the ratings agency—and the criticisms
increased on August 8th, the first trading day following S&P’s announcement, when the Dow
Jones Industrial Average plummeted by 5.5%.
Was S&P justified? This matters for the downgrader as well as the downgraded. The reputations of
the ratings agencies are still stained by their gross overstating of the quality of mortgage-backed
bonds before the credit crisis.
The most extreme criticism is that S&P and its peers should not really be in the business of rating
the American government anyway. A credit rating is far less relevant to Treasury bonds than it is to,
say, a corporate bond. The United States government has ample taxing power to repay its bonds,
and its central bank, like that of any country that controls its own currency, can as a last resort
simply print the money needed, albeit at the risk of inflation. As if to underline the point, yields on
US Treasury bonds actually fell in the days after the downgrade, as investors fled to them as a
haven.
All true, but the basic fact is that credit ratings are useful for investors: if the likes of S&P did not
exist, the market would invent them. No matter how much Barack Obama huffs and puffs, a
13
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
ratings agency’s job is to rate bonds, including government ones, and to speak out when it thinks
the least risky asset in the world has become riskier. So did S&P get it right?
The gravity of its announcement was not helped by some dodgy analysis. Before releasing its
report, S&P notified the Treasury Department, which soon discovered that the firm had overstated
cumulative deficits by some $2 trillion, inflating the debt by 8% of GDP in 2021. S&P corrected
the error but went ahead with the downgrade, revamping the announcement to elevate politics as a
main rationale for the move. Critics say the timing was odd too. Under the deal between Mr
Obama and Congress to raise America’s debt ceiling, a panel has to come up with deficit-reduction
plans which Congress must accept or reject by December 23rd; if the panel fails to agree or
Congress rejects its proposal, automatic spending cuts are triggered in 2013. Moody’s and Fitch,
the two main rival agencies, have for now given America the benefit of the doubt.
AAAaaargh
Yet as flawed a messenger as S&P is, its message should still be heeded. Even after cleaning up its
maths, it concluded that America’s debt was rising unsustainably as a share of GDP, in contrast to
other AAA-rated countries such as Britain and Germany that have put in place plans to stabilise
that ratio. (A similar rationale explains why Moody’s has a negative outlook on America’s rating.)
As for the timing, the debt deal in Congress just before the downgrade was plainly inadequate. It
focuses its cuts on discretionary spending, which future legislatures can too easily override. More
durable deficit reduction means reforming both the tax system and entitlements such as pensions
and health care for the elderly. And there is no guarantee that Congress will allow the deal’s
spending cuts to occur.
Above all, S&P’s verdict is based on the uselessness of America’s politicians: both their inability
to deal with the budget and their vividly displayed political brinkmanship. S&P argues that
America’s policymaking has become less predictable and its finances less manageable. The threat
of default, previously unthinkable, is now a bargaining chip in Washington. This is not how an
AAA-rated country behaves. S&P did America a favour by pointing this out.
Currency pegs
Poor dollar standard
Has the downgrade shaken loyalty to the greenback?
Aug 13th 2011
“THE United States can pay any debt it has because we can always print money to do that,” said
Alan Greenspan, a former chairman of the Federal Reserve, after Standard & Poor’s cut America’s
credit rating. Whenever this point is made, people usually respond by invoking Zimbabwe. As the
hapless African republic demonstrated, there is a limit to how much money a government can print
before its economy plunges into hyperinflation.
14
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
But Zimbabwe no longer has hyperinflation. According to the Economist Intelligence Unit, a sister
company of The Economist, inflation will average only 5.5% this year. How did it achieve this
miracle? By adopting the American dollar as its principal currency. America may have lost its
triple-A rating, but the dollars it issues will “remain the key international reserve currency under
any plausible scenario,” says John Chambers of Standard & Poor’s.
Zimbabwe is one of 66 countries beside America itself that, by the IMF’s last count, either adopt
the dollar as legal tender, peg their currency to it or manage their exchange rate against it. Its only
present rival, the euro, has a much smaller circle of influence, counting 25 devotees, beyond the
17 members of the euro zone itself (see chart).
The 66 members of the dollar block have a collective GDP of almost $9 trillion, or about 14% of
the world economy. The list includes some minnows like St Kitts and Nevis, some populous
countries like Bangladesh and some middle-ranking economic powers like Saudi Arabia. The
group comprises allies such as Qatar, and rebels such as Venezuela, which expresses disdain for
American imperialism even as it surrenders its monetary sovereignty to America’s central bank.
Alas, all is not well in the dollar block. Last year, inflation averaged 5.6% across its members
(without weighting for GDP). This year it will probably rise to almost 8%.
The biggest member of the dollar block by far is China, which keeps tight tabs on the yuan’s
movements against the greenback. It has aspirations to create its own reserve currency. Many
countries already keep an eye on the yuan because they cannot afford to lose competitiveness
against a formidable exporter. An analysis by three economists at the National Institute of Public
Finance and Policy in Delhi shows that the yuan already has a discernible influence on as many as
33 currencies.
One economy sandwiched between the dollar block and a potential yuan block is Hong Kong. Its
dollar peg, backed by a currency board, made perfect sense when the yuan was also tied to the
greenback. But as the yuan parts company with the dollar, Hong Kong feels pulled in two
directions. Some have called for the yuan to be recognised as legal tender alongside the Hong
Kong dollar. But Hong Kong officials tend to keep quiet about the whole issue. They fret that to
discuss alternatives to the dollar peg is to undermine confidence in it. The link to the dollar has
15
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
“served Hong Kong very well as the anchor for monetary and financial stability since 1983,” said
Norman Chan, head of the Hong Kong Monetary Authority, after the S&P downgrade.
That loyalty to the dollar cannot be assumed, even in the places where it is most deserved. On
August 10th Newsday, a Zimbabwean newspaper, wondered whether it was time for Zimbabwe to
“ditch” the dollar, lest it import America’s macroeconomic recklessness. Some think the South
African rand would provide a better alternative. The dollar remains the world’s key currency, but it
cannot be a good sign that even some Zimbabweans are now considering alternatives.
Financial markets
Hit me baby one more time
Markets will take any help they can
get
Aug 13th 2011
ADDICTS always crave one more hit. With stockmarkets slumping over the past two weeks
investors hoped that the Federal Reserve would unveil a third round of “quantitative easing” (QE),
the creation of money to bolster asset prices, on August 9th. The second round, announced in
August last year, had triggered an equity rally in late 2010.
Instead of pure heroin, investors got methadone in the form of a commitment from the Fed to keep
rates at their current low levels for another two years. While Wall Street managed a late rally on
the day (the Dow gained almost 430 points, or 4%), the Fed’s hit gave only a brief rush. Share
prices resumed their fall on August 10th.
There was a more sustained reaction to the actions of the European Central Bank, which started
buying Italian and Spanish government bonds on August 8th. Though the size of the buying
programme was unknown, the effect on the bond markets was dramatic. The Spanish ten-year
yield fell from more than 6% to 5% within two days.
At least the central banks are having a positive effect, however temporary. Politicians, meanwhile,
have left investors with serious doubts about their ability to handle the crisis. European leaders
have moved from an initial stance of denial about the seriousness of the region’s debt problems
through a series of sticking-plaster solutions as the rot spread. American leaders, for their part,
flirted with the prospect of a default before reaching a deal that neither helped the economy in the
short term nor did enough to improve the government’s finances in the long term.
16
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Worse still, their approach has seemed chaotic. “Investors have ended up betting on the political
outcome as opposed to making decisions on the basis of the fundamentals,” says Ian Harnett of
Absolute Strategy Research, a consultancy.
There has been an inevitable effect on confidence. According to The Economist/FT global
business barometer, a survey of business confidence, political risk is the second-biggest concern
(after the economy) for executives. Between May and July, the proportion of businesspeople
expecting global conditions to improve over the next six months fell from 38.3% to 23.2%; those
expecting a deterioration rose from 19% to 33.7%.
Moreover, the Fed’s low-rate commitment is a sign of its concern about the health of the
economy—hardly a bullish signal for stockmarkets. By the time it had reached its high for the
year on April 29th, the S&P 500 had doubled from its March 2009 low. A setback was only to be
expected, especially since government-bond yields (outside the euro-zone periphery) have been
falling in recent months, marking concern about the economic outlook.
Bad omens
Risk aversion has also shown up in the price of gold (see chart 1), which has hit repeated highs,
and in the strength of the Swiss franc, which reached a record against the dollar on August 9th
despite the efforts of the Swiss National Bank to let it weaken.
In contrast, other commodity prices have fallen by 12% since April 26th. That is a potential silver
lining for developed economies, since higher raw-materials prices have acted as a tax on
consumers.
17
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Less positive was the slide in bank shares, which have underperformed the broad market this year
(see chart 2). On August 8th alone, Citigroup and Bank of America fell by 16% and 20%
respectively. Further declines in bank shares on August 10th took Bank of America’s fall this year
to 49% amid concerns it needs more capital.
Meanwhile American money-market funds are ever less willing to buy European bank debt. In a
further sign of concern, shares in Société Générale, a French bank, fell by 15% on August 10th
(see article); those of Intesa Sanpaolo, an Italian bank, fell by 14%; and the cost of insuring
against European bank defaults rose sharply. There has also been a modest rise in the spread
between the borrowing costs of European banks and of governments, though nothing like the gap
in 2008, when banks were almost frozen out of markets.
In corporate-bond markets, the spreads over government bonds paid by investment-grade and
speculative borrowers reached their highest this year. They have been driven by falling
government-bond yields (see chart 3) more than by rising corporate rates.
18
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Indeed, with the Fed committed to keeping rates close to zero, Treasury-bond yields are
astonishingly low by historic standards. The American government is paying just 0.9% to borrow
money for five years. Those rates are eerily reminiscent of Japan, where bond yields have been at
rock-bottom levels for the past decade in the face of sluggish growth.
Such rates chime with the “ice age” thesis of Albert Edwards, a Société Générale strategist who
has long predicted a Japanese-style crunch for the developed world. “Unsustainable private-sector
debt mountains were transferred to the public sector in 2008 to prevent the adjustment to the
Depression-era reality that the debt unwind would undoubtedly have brought about,” Mr Edwards
wrote in his latest research note. “Yet, those debts are as unsustainable in the hands of the public
sector as they were in the private.” Mr Edwards expects ten-year Treasury-bond yields to fall to
1.5% (they are currently 2.1%) before the “ice age” is over.
If the economic slowdown continues, the Fed may have to dole out the hard stuff, in the form of
more QE, later this year. But many observers think that, as with the last round, it will have only a
temporary impact. “QE helped to push up equity prices but those increases were based on the hope
of a vigorous economic recovery that didn’t happen,” says Stephen King, chief economist of
HSBC. Eventually, the markets will have to kick the habit.
The Federal Reserve
Take that, Congress
In the face of intensifying political assault, the Fed eases
again
Sep 24th 2011
IN THEORY central banks need independence to insulate them from meddling politicians’
demands for easy money. It is a sign of how strange the times are that the Federal Reserve is now
fending off the opposite demand.
On September 20th, as its officials sat down to a two-day policy-setting meeting, they got an
unusual letter from the four top Republicans in Congress urging them to “resist further
extraordinary intervention in the US economy…[We] have seen no evidence that further monetary
stimulus will create jobs.”
If the politicians had hoped to stay the Fed’s hand, they failed. The next day it announced it would
purchase $400 billion of Treasury securities maturing in six to 30 years by next June, while selling
an equivalent amount with maturities of three years or less. It also said it would maintain its
mortgage-related holdings at current levels to support the housing market. Three of the ten voting
19
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
officials dissented, as they did in August when the Fed said it expected to keep short-term rates
near zero at least until mid-2013.
Buying long-term bonds by selling shorter-term issues is less aggressive than the Fed’s previous
two rounds of “quantitative easing” (QE), in which it bought bonds with newly printed money.
But the impact is similar. Lengthening the average maturity of the Fed’s $2.65 trillion portfolio
reduces the supply of long-term bonds, nudging down yields.
Politicians have long bashed central bankers. In the 1970s and 1980s Congressmen regularly
threatened to impeach the Fed chairman. In 1981 one Republican senator told Paul Volcker, the
then chairman: “You’re high on the hit parade for lynching.” Democrats, too, have tried to bar
hawkish regional reserve-bank presidents from voting on monetary policy.
But the latest assault differs in several respects. One is that politicians, especially those from Texas,
have historically wanted easier policy from the Fed. By contrast, when Rick Perry, the Texas
governor and a Republican presidential candidate, recently threatened Ben Bernanke, the current
chairman, with rough justice, it was for providing just that. This is partly politics: if monetary
stimulus worked, the principal political beneficiary would be Barack Obama. But many
Republicans genuinely equate Fed bond-buying with reckless government activism leading to
rampant inflation.
The second difference is that past critics had a point: Mr Volcker’s tight monetary policy did tank
the economy. This time, the hysteria over inflation has no obvious factual basis. Overall inflation
has gyrated with petrol prices but is an unremarkable 2% when food and energy costs are excluded.
Wage growth and inflation expectations are docile; nominal demand is barely growing.
Third, and most important, historically the Fed’s antagonists came from the fringes of their
(usually Democratic) party. Now Republican leaders and presidential candidates are flouting the
idea of central-bank independence. That has troubling implications. Mr Bernanke’s term ends in
early 2014 and in the unlikely event he wanted another, a Republican president would not grant it.
A new chairman in sync with his (or her) philosophy would presumably tighten monetary policy
forthwith, the last thing the economy is likely to need.
Bank of America
Strife of Brian
A battered bank tries to hack and sack its way back to prosperity
20
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Sep 17th 2011
FIVE out of six of Bank of America’s divisions are doing well, said Brian Moynihan, the
company’s chief executive in a closely scrutinised presentation on September 12th. In other
circumstances that might be a source of cheer—in the second quarter alone the quintet collectively
earned almost $6 billion. Sadly for Mr Moynihan and his beleaguered bank, that one problem
division packs quite a wallop.
The losses from the bank’s mortgage operations are not just vast, they are literally incalculable.
Since the start of the fourth quarter of last year the bank has written off more than $30 billion in
future provisions, legal settlements and other losses relating to their mortgage exposures,
according to a tally by CLSA, a broker. Were that the full extent of the damage, Mr Moynihan’s
words would now be received with the bored nods that accompany success. Instead, Bank of
America’s shares trade at one-third of book value, reflecting concern that total losses are a long
way from being recognised. A brief pop in its share price following the announcement of a $5
billion investment by Warren Buffett on August 25th has quickly dissipated.
The bank’s big problem is litigation stemming from America’s mortgage fiasco. This risk is not
unique to BofA but it is unusually severe. The lawsuits fester in three different categories. The first
of these, responsible for $12 billion in paid claims and another $18 billion in specific reserves,
covers litigation in state courts over mortgages sold to investors with allegedly faulty
representations as to their quality. An $8.5 billion settlement announced in June with various
investors was supposed to have stanched the bleeding in this area, but the deal has recently
appeared to unravel. A second category involves alleged violations of federal underwriting laws
that are expected to grind through the courts over many years. The final category, tied to
irregularities in foreclosure processes, is currently the subject of negotiations with a number of
state attorneys-general.
Based on the total volume of securities involved, BofA could potentially be on the hook for
hundreds of billions of dollars, says Chris Whalen of Institutional Risk Analytics, a research firm.
Although that kind of havoc will surely not come to pass, the litigation (and the accompanying
uncertainty) will certainly weigh on the bank’s performance, draining resources and managerial
attention. And the distractions come on top of two other worries: the general slowing of the
American economy (which is bad for credit, loan growth and interest-rate spreads) and regulatory
changes that will force the bank to increase its equity base.
Fat or muscle
Enhancing returns in this kind of environment will not be easy. Mr Moynihan announced plans to
cut $5 billion in ongoing annual costs and the bank subsequently confirmed this will involve the
elimination of 30,000 employees, 10% of its staff. These reductions will be in addition to the loss
of tens of thousands of other temporary jobs created to process dud mortgages.
21
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
Some of the cuts are long overdue. A string of acquisitions inflated the bank’s balance-sheet (see
chart) but saddled it with three separate systems for handling deposits and 63 data centres,
according to Mr Moynihan. Outsiders contend that Mr Moynihan’s famously acquisitive
predecessors, Hugh McColl and Mr Lewis, were far more interested in buying than integrating
operations. Mr Moynihan promised this week that these sorts of inefficiencies would be
eliminated, a strategy that would perhaps have resonated more had not his audience heard similar
pledges repeatedly before.
The announcement of redundancies seemed to provoke little enthusiasm among investors. Bank of
America’s share price barely budged after Mr Moynihan’s presentation. A possible reason is
concern that any benefits from reduced expenses could be offset by damage to the bank’s
operations. The ubiquity of Bank of America’s heavily staffed nationwide branch network is what
enables it to retain customers despite charging high fees and offering depositors low interest. It
retains a vast credit-card and mortgage-origination business, both of which are gold mines in less
desperate environments but which require lots of committed staff.
Keeping the troops happy is even more important at Merrill Lynch, whose “thundering herd” of
16,000 brokers underpins the firm’s wealth-management business. Here, Mr Moynihan has used
the scalpel rather than the cleaver, getting rid of Sallie Krawcheck, the head of the division, earlier
this month but sparing Merrill in the bigger round of cuts. But the broker may be in line for
harsher treatment in the months to come. Swarms of aggressive competitors surround Bank of
America, alive to the possibility that cuts could prompt affluent clients or staff to desert.
That has prompted some to wonder whether a more decisive move is needed. The mortgage
lawsuits come from three sources, of which the smallest by far is the pre-crisis Bank of America
franchise at under $10 billion in claims, according to Institutional Risk Analytics. Perhaps two to
three times that amount came with the costly 2009 purchase of Merrill Lynch. But the largest
chunk of claims by far, about $60 billion, came along with what may ultimately prove to be the
single worst acquisition since Paris grabbed Helen, the 2008 purchase of Countrywide.
22
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
The most provocative question during Mr Moynihan’s presentation this week was whether he
would put Countrywide into bankruptcy. He declined to answer, leaving the door to that
possibility slightly ajar. Mr Whalen contends that BofA is, in essence, a healthy operating bank
buried by obligations tied to Countrywide. Shedding those obligations would, in theory, create a
vast and profitable bank, with all the residual benefits that might bring to the listing American
economy.
Whether the courts would allow BofA to make a clean getaway from Countrywide is far from
clear, however. The consequence might be nothing more than yet another round of litigation. As a
lawyer himself, and the bank’s general counsel at the time of the Countrywide purchase, Mr
Moynihan is in a good position to judge. The alternative course, and the one he put forward this
week, is to slog it out. That may be realistic but it also suggests a siege that could outlast Troy’s.
Emerging markets
One more such victory
The emerging economies are winning the currency war. No one is celebrating
Oct 1st 2011
A YEAR ago Brazil’s finance minister, Guido Mantega, declared that the world had entered into a
“currency war”. He worried that in a depressed global economy, without enough spending to go
around, countries would sally forth and grab a bit of extra demand for themselves by weakening
their currencies. The dollar, for example, fell by 11% against Brazil’s real in the year to August
2011, much to the chagrin of Brazil’s manufacturers. Like other emerging economies it fought
back by imposing taxes and other restrictions on foreign purchases of local securities.
23
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
But the invasion of foreign capital that so worried Mr Mantega has now turned into a shambolic
retreat. The outflows have dragged down the exchange rates of almost every emerging economy
since the beginning of August (see chart 1). Having spent much of the past year fretting about their
currencies’ rise, central banks across the emerging world have now intervened in the markets to
slow their currencies’ fall. In a currency war, where each side fights to gain competitiveness
against the others, these tumbling exchange rates presumably count as victories. But they are
Pyrrhic.
That term originates with the Greeks—Pyrrhus was a Hellenistic general whose victories against
Rome came at a grievous cost to his own side. The Greeks are also partly responsible for more
recent reversals. As the government in Athens teeters on the brink of default, investors have begun
to doubt the creditworthiness of other euro-zone governments, as well as the banks that lent to
them. The gathering unease has left global investors less willing to tolerate the risks associated
with volatile emerging economies.
Indeed, some are unwilling to tolerate risks of any kind (see Buttonwood). They are accumulating
cash by selling other assets, from gold to Thai equities, more or less indiscriminately. An index of
emerging stockmarkets prepared by MSCI has fallen by over 20% since August 1st, despite a rally
on September 27th. The worry now is that bonds will follow suit. Foreign investors hold a third of
the local-currency debt issued by Indonesia, Korea, Malaysia, Mexico, Poland and Turkey. In a
conference call, Bhanu Baweja of UBS worried that the stomach-churning developments in
Europe and America might prompt these investors to “puke” up their bondholdings.
A cheaper real, zloty and rupee will help emerging economies win a bigger share of global
spending. But that is small consolation if global spending declines. The volume of exports from
Latin America and Asia did not surpass its pre-crisis peak until the first quarter of this year,
according to the Netherlands Bureau for Economic Policy Analysis. And foreign sales are bound
to fall again as America stagnates and a two-speed Europe converges on a single, slower pace.
Falling export orders was one of the complaints voiced by Chinese manufacturers in a preliminary
survey of purchasing managers published by HSBC last week. The survey showed manufacturing
shrinking from the month before (see chart 2), adding to the gloom on world markets. But HSBC’s
China economist, Qu Hongbin, believes GDP will still grow at an annual pace of 8.5-9% in the
second half of this year. China’s economy is not as dependent on exports as it was, he points out.
International trade (exports minus imports) contributed a little less than nothing to the country’s
growth in the first half of this year. And imports have remained strong: in the traumatic month of
August, China imported 30% more (in dollar terms) than it bought a year before.
24
Success is 99% attitude and 1% aptitude
Financial Literature Reading USST 2011-2012 I
These imports included iron ore and other materials destined ultimately for China’s construction
industry, which has become a mainstay of the economy’s growth, but also a headache for its
policymakers. To quell property prices, the government is trying to starve real-estate developers of
financing. First, it restricted bank lending; now it is removing trust-company financing from the
menu. But even as it curbs the top end of the property market, the government is urging local
authorities to build affordable housing. Bricks are still being laid, even if less profit is being made.
Homebuilding is surprisingly buoyant (housing starts increased by 32% in the year to August),
even as home builders take a battering on markets.
If the world economy were to collapse, emerging economies have scope to ease policy. Michael
Buchanan and his colleagues at Goldman Sachs calculate that emerging Asia could offset a growth
shock of up to 5.1 percentage points, if they allowed their interest and exchange rates to fall to
their lowest points in the crisis, and their budget balances to deteriorate as far as they did in 2009.
In Israel, where inflation expectations have fallen, and Brazil, where they have not, central banks
have already started cutting rates, even though inflation in both countries remains above the
official target. Thailand’s new government is beginning a fiscal splurge, including generous
purchases of rice from the country’s farmers, that may prove better timed than it seemed when it
was promised.
But other emerging economies will be more reluctant to stimulate, precisely because they have
done so before. India’s central bank is still preoccupied with the inflation that quickly ensued after
the financial crisis abated. As recently as September 16th, it raised interest rates for the 12th time
in 18 months. And China is only now coming to terms with the bad debts amassed by local
governments during the stimulus lending of 2009 and 2010. Loans worth perhaps 2 trillion-3
trillion yuan ($310 billion-630 billion) may have already turned sour, according to China’s
banking regulator. It is now scolding banks for the recklessness that was urged upon them during
the crisis. If the central government decides that another stimulus onslaught is necessary, it may
find the banks are less willing footsoldiers. Even successful battles leave casualties in their wake.
25
Success is 99% attitude and 1% aptitude
