Keep kidding yourself.
You think euro banks are in better shapethen US?
You think Chinese, Japenese banks are in better shape then US?
Two articles follow:
Ring Fences, Rustlers and a global bank insolvency
| Sep 12, 2008
In this week which has seen so much speculation on the fate of Lehman Brothers, it seems only sensible to review how an international insolvency of a major bank works and what it might mean for international creditors. The insolvency treatment of international banks has remained one of the stubbornly difficult areas of law to harmonise and huge uncertainty and complexity remains. For excellent background, see Cross-border bank insolvency by Rosa Maria Lastra of Queen Mary, University of London.
Although markets are global, and Lehman Brothers operations span the globe, all insolvency is local. The basic premise is that each jurisdiction buries its own dead and keeps whatever treasure or garbage it finds with the corpse. Local creditors get to recover their claims out of the locally available assets. If, and only if, there are any assets left over will international creditors be invited to make a claim for the rest. Europe has managed to harmonise cross-border insolvency for banks under directives and local law to embody principles of universality and unity within the EU, but that only works equitably if enough assets are in the EU when the bank fails, and local insolvency law still applies in all its divergent complexity.
Claims against a bank are deemed located wherever the contract creating the claim is undertaken. If it is under US law then the claimant must look to the liquidator in the United States and assets under his control for recovery. If the claim is in Hong Kong, then the claimant looks to the Hong Kong receiver and assets.
The key to having a happy insolvency, if such a thing exists, lies in ensuring that when a globalised bank goes bust, all the best assets are inside your borders and subject to seizure by your liquidators on behalf of your creditors. Everyone else outside your borders is on their own. As the US dollar is the reserve currency of banking and US Treasuries, Agencies and other assets are the highest preferred asset class, the US is almost always in a good position in an international bank failure.
The principle of using local assets for local recovery is known as the “ring fence” – the idea being that insolvency drops an invisible “ring fence” around any valuable assets at the borders to meet claims arising within the borders. No country is more assiduous in weaving the ring fence than the United States of America. It is a very successful strategy for US creditors. US creditors of failed international banks tend to recover disproportionately relative to creditors anywhere else. The ring fence contains all these choicest assets for US creditors, and all the international creditors are forced to pick among the dross of foreign assets to eke out a recovery, only receiving any residual US assets remaining after US creditors get 100 percent recovery.
Lehman has been deeply troubled and subject to speculation since the early spring. That was just about the time that we started to see a marked sell off in foreign markets where Lehman has long been a major player. Recently, along with intensification of that sell off, we have seen a strengthening of the US dollar and US asset markets.
If one were cynical, and one believed that Lehman was going to be allowed to fail pour encouragement les autres one might wonder if Lehman was quietly bidden – or even explicitly ordered – to sell off its foreign holdings and repatriate the proceeds to asset classes within the US ring fence. This would ensure that US creditors of Lehman received a satisfactory recovery at the expense of foreign creditors. It would also contribute to a nice pre-election illusion of a “flight to quality” as US dollar and assets strengthened on the direction of flow.
If one were really cynical, one might even think that a wily bank supervisor might arrange to ensure 100 percent recovery for its creditors with a bit of creative misappropriation thrown in the mix. Broker dealers normally hold securities and other assets in nominee name on behalf of their investor clients. Under modern market regulation, these nominee assets are supposed to be held separately from a firm’s own assets so that they can be protected in an insolvency and restored to the clients with minimal loss and inconvenience. Liberalisations and financial innovations have undermined the segregation principle by promoting much more intensive use of client assets for leverage (prime brokerage and margin lending) and alternative income streams (securities lending). As a result, it is often very difficult to discern in a failed broker who has the better claim to assets which were held to a client account but reused for finance and/or trading purposes. The main source of evidence is the books of the failed broker.
On the wholesale side, margin and collateralisation in connection with derivatives and securities finance arrangements mean that creditors under these arrangements should have good delivery and secure legal claims to assets provided under market standard agreements. As a result, preferred wholesale creditors could have been streamed the choicest assets under arrangements that will look above suspicion on review as being consistent with market best practice.
If Lehman were to go into insolvency, I will be interested to discover whether US creditors achieve a much higher proportion of recovery than their global peers in other locations where Lehman did business. If so, it will likely be because of the US ring fence and the months of repatriation of assets and funds back into the confines of the ring fence before the failure was finally orchestrated. It will also be because the choicest assets were preferentially delivered to preferred US creditors under market standard margin and collateral arrangements.
Unfortunately, the pace of an international insolvency means that any retrospective evaluation will be so far down the road that I will likely be almost alone in looking backwards to see what the final distribution effects are and what they mean for equitable principles of international banking practice.
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Can China Weather a Downturn?
by: J. Amberger posted on: October 12, 2008
seekingalpha.com
As Iceland’s banking industry is melting down, the pundits have started to look expectantly at China to put some of their $1.6 trillion dollars into play, taking stakes in distressed Western banks.
After all, Chinese banks appear to have dodged the U.S. subprime mortgage crisis. Barron’s wrote last month:
Chinese lenders accumulated large amounts of that bad debt. But bankers have assured investors they are within manageable levels that won’t greatly affect their profit, fattened by a domestic economy that is growing at double-digit rates.
But China will not escape unscathed. In fact, we are now seeing signs of yet another credit crisis that could rock global markets.
Remember, since 2007, every quiver in the global stock markets has been blamed on increasing default rates in U.S. mortgages. Given $700 billion bailout plans and collapsing investment banks all over the world, comsider this: The risky segment of the mortgage market we now know as “subprime” accounts for just about 10% of the U.S. mortgage market. That means that less than 1% of total mortgages are in subprime foreclosure.
But if a few billion in shaky loans can trigger a global financial crisis, how about another bit of a crisis brewing that makes subprime look like the broadway version of American Pie.
Here’s what’s going on with China: After decades of double-digit growth… an incredible stock market boom…. and an even bigger real estate and building boom… the big four, government-run banks are now sitting on record non-performing loans (NPLs).
That’s banker’s talk for "bad loans". Not debt. Not deficits. But loans that will never, ever be repaid.
The Chinese NPL market is one of the largest in the world… The last more or less reliable data about the total of outstanding balances dates from 2007. Back than, it was over a trillion dollars. That’s about 40% of China’s gross domestic product! Almost half of what the entire Chinese economy — one billion hard-working people! — produce in a year. In the past, Beijing has spent the equivalent of 25%-30% of GDP in bank bailouts.
Accounting firm Ernst & Young calls the main reason for why these bad loans were generated in the first place "political". Remember, China is a corrupt one-party state. And that one party is still Mao’s old Communist Party.
The party appoints 80% of the chief executives in state-owned enterprises and 56% of all senior corporate executives. All are under pressure to hit fixed growth targets quickly, no matter how. Consider this:
* Politically directed lending accounted for 60% of loans in 2000-2001.
* And in a 2002 survey, over 80% of polled bank employees said corruption in their branches was either prevalent or took place quite often.
* New loan growth had been running at 15% in 2007.
* At least 2% of loans made since 2000 have been reported as nonperforming. The proportion was as high as 60% for older lending. And a substantial portion of the loans that went out were issued to keep bad loans floating.
There was a bank bailout in the late 1990s and early 2000s that, according to the World Bank, cost China about 55% of GDP.
Bad loans for the major commercial banks (the big five plus the 12 joint-stock banks) stood at 6.63% of total loans at the end of September 2007, and rose to 6.74% by the end of December. This may seem like a small increase. But remember that this occurred during optimal times:
The economy grew at well over 11% in the 4th quarter of 2007. China was flooded with new money. Inflation increased faster than interest rates (which causes debt payments to decline relative to revenues and asset values). And loans expanded rapidly — which should push the NPL ratio down.
But that was last year.
In 2008, inflation was soaring! Energy costs went through the roof — squeezing the tiny margins of export-oriented manufacturers to nothing. Thousands of factories were forced to close their doors for good all over the country. And all the money corporate officers borrowed to play the stock market?
It’s gone! Evaporated! Gone up in smoke as the Chinese stock indexes fell 70% from their 2007 highs. And Chinese real estate speculation?
Real estate makes up about 25% of China’s fixed asset investment, which is in turn a major driver of economic growth. Land sales account for about 30% of local government revenues — and senior officials’ bonuses depend on economic growth indicators.
The increase in house prices in China’s 70 biggest cities fell from an average of 11% in early 2008 to 5.3% in August, only 0.4% above the inflation rate.
So developers have started to cut prices. This already has sparked protests — including some ransacking of offices — in parts of China from owners who have recently bought flats at a higher price. Most Chinese home owners have had no experience of price cycles… and have never seen prices fall before!
Now tie up the loose ends: Chinese investors pulled billions from personal savings and lost 70% of that money in the stock market… factories are going bust… and now real estate prices are seizing up.
In 2009, that trillion dollars of NPLs will hit the fan. People keep assuring themselves that the difference between Chinese banks and other banks is that Chinese banks are state-owned, and that fact makes a banking crisis in China nearly impossible.
They’re wrong.
Governments have had to bail out state-owned banks with taxpayers’ money. The Chinese did just that ten years ago. But if a state-owned bank were to go under, the consequences could be disastrous for the whole economy.
And China, at this point, is in no position to weather a downturn. |
