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Credit crunch and economic recession
Financial turmoil spreads worldwide
Martin Khor
Volatility in financial markets has spread across the world. The turmoil is hitting more sectors, having moved from the United States' mortgage market, to stock markets around the world, and to investment funds operated by banks.
Central banks in Europe, the United States and Asia took action by pumping a total of over US$200 billion into their banking systems, in an attempt to prevent the conversion of a liquidity shortage into a full-scale credit crunch and eventually an economic recession.
The week ending 10 August was hit hard with many stock markets having fallen sharply. In Europe, the fall was an average of 3 per cent, with the UK down by 3.7 per cent and France by 3.1 per cent. In Asia, stock market indices fell by 2 per cent in Malaysia, more than 2.5 per cent in Japan, Hong Kong and Australia and 4.3 per cent in South Korea.
In the United States, the Dow Jones index fell 2.8 per cent on 9 August and share prices were further plummeting the following day until the central bank injected US$38 billion into the financial system (in addition to $24 billion the day before). As a result index closed only 31 points down to 13,239.
As the turmoil spread to Europe, the European Central Bank (ECB) injected 95 billion euros on 9 August and another 61 billion euros on 10 August into the European banking system.
The extraordinary moves by the US and European central banks were an attempt to stop the steep rise in shorter-term money-market interest rates that had shot above their target levels, resulting from increased demand for cash. The ECB's target rate is 4 per cent but the short-term interest rate had gone to 4.7 per cent.
The conservative ECB's intervention was so unexpected and stunning that a Financial Times columnist wondered whether "there is something truly nasty lurking out there in relation to credit losses that only the ECB knows about."
The actions showed up the seriousness of the situation, as more financial institutions showed signs of being hit by the crisis that started in the "sub-prime" house mortgage sector in the US. Banks and funds that lent or invested in that sector have suffered losses, and other institutions that are linked to these have also suffered secondary effects.
The week's biggest shock was the announcement on 9 August that the big French bank BNP Paribas had stopped withdrawals from three of its investment funds, which were exposed to the US sub-prime mortgage market.
The crisis has thus now affected the investing public, which is unable to redeem their investments from the affected funds.
The bank said the freeze on the funds was due to the "complete evaporation of liquidity" in certain market segments in the US (meaning that there were no buyers). The combined value of the three funds was 1.6 billion euros, down from 2 billion euros on 27 July.
Other investment funds have also been hit, according to the Financial Times. The North American Equity Opportunities fund run by Goldman Sachs fell 12 per cent in July and another 12 per cent in August so far. The big hedge fund Renaissance Technologies is also reported to be experiencing difficulties.
The Dutch investment bank NIBC on 9 August also reported 2007 first-half losses due to exposure to the sub-prime market. In early May, the Swiss Bank UBS announced its affiliated fund Dillon Read had lost 150 million Swiss franc on US sub-prime investments.
The most publicised European institution hit by the "sub-prime crisis" is the German bank IKB, whose affiliate Rhineland Funding had bought 14 billion euros of bonds in the US, some backed by US subprime mortgages.
Massive losses from its operations led to a German government-organised rescue including a 3.5 billion euro bailout plus 14.6 billion euro in liquidity guarantees, to be shouldered by other German banks. The chief German financial regulator said there was risk of the worst financial crisis since the 1930s.
The irony is that IKB had earned the praise of the rating agency Moody in December 2006, for successfully diversifying its business activities outside Germany.
In the US, the bank Bear Stearns in early July closed two hedge funds after nearly total losses on bets on sub-prime market worth over US$20 billion.
The last three weeks' turmoil has led to uncertainties as to what lies ahead, and how the crisis will play out.
"Investors are finding it hard to deal with two big uncertainties," said a Wall Street Journal column. "No one knows how big the losses from US housing will eventually turn out to be, or who will suffer them."
The economist Paul Krugman in his New York Times column last week gave his view of how the drying up of liquidity can produce a chain reaction of defaults. "Financial institution A can't sell its mortgage-backed securities, so it can't raise enough cash to make the payment it owes to institution B, which then doesn't have the cash to pay institution C - and those who do have cash sit on it, because they don't trust anyone else to repay a loan, which makes things even worse."
The most scary thing about liquidity crises, said Krugman, is that it is very hard for policy makers to do anything about them. The Central Banks can respond by cutting interest rates or lending money to banks that are short of cash.
"But when liquidity dries up, the normal tools of policy lose much of their effectiveness," said Krugman. "Reducing the cost of money doesn't do much for borrowers if nobody is willing to make loans. Ensuring that banks have plenty of cash doesn't do much if the cash stays in the banks' vaults."
Meanwhile, calls are being made to the financial authorities not only to act to stem the crisis but to investigate the parties responsible and to punish them.
Danny Schechter, editor of MediaChannel.org, and director of the new film "In Debt We Trust: America Before The Bubble Bursts", said it is a matter of time before the "subprime" credit crunch is seen for what it is: "a sub-crime ponzi scheme in which millions of people are losing their homes because of criminal and fraudulent tactics used by financial institutions that pose as respectable players in a highly rigged casino-like market system."
According to Schechter, companies suspended their usual 'standards' and 'rules' and self-styled 'due diligence' and knowingly sucked money out of people with poor credit records. These companies are themselves imploding and collapsing worldwide.
"This was done deliberately, with forethought and malice, a well orchestrated plan to create armies of 'suckers' and steal-yes, I said it-their monies to leverage even bigger deals. Their greed had no limits, until the scheme collapsed.
"Behind it all were the so-called 'Masters of the Universe', the wise men of Wall Street who worked behind the scenes to turn mortgage brokers and small lenders into part of what will one day be seen as a criminal network worthy of prosecution under the conspiracy laws."
"We should demand criminal penalties for the profiteers who started out to enrich themselves and seem to have ended up destroying the very system they misused."
-- Third World Network Features
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Taking advantage of an emotionally
driven stock market
Share Shah
With the continuing exuberance in the stock bubble of financial sector stocks and the memory of the crash of the late 1996 still fresh in some investors' memories, adherents of the behaviorist school are finding it easier than ever to spread the belief that markets can be something less than efficient in immediately distilling new information and that investors, driven by emotion, can indeed lead markets awry. Some behaviorists would even assert that stock markets lead lives of their own, detached from economic growth and business profitability. Other people have argued that stock markets are not efficient, that is, that they do not necessarily reflect economic fundamentals. According to this point of view, significant and lasting deviations from the intrinsic value of a company's share price occur in market valuations.
I agree that behavioral finance offers some valuable insights-chief among them the idea that markets are not always right, since rational investors cannot always correct over pricing by irrational ones. But for the astute, the critical question is how often these deviations arise and whether they are so frequent and significant that they should affect the process of financial decision making. In fact, significant deviations from intrinsic value are rare, and markets usually revert rapidly to share prices commensurate with economic fundamentals. Therefore, investors should continue to use the tried and true analysis of a company's discounted cash flow to make their valuation decisions.
Behavioral-finance theory holds that markets might fail to reflect economic fundamentals under three conditions. When all three apply, the theory predicts that pricing biases in financial markets can be both significant and persistent. Firstly, investors behave irrationally when they do not correctly process all the available information while forming their expectations of a company's future performance. Some investors, for example, attach too much importance to recent events and results, an error that leads them to overprice companies with strong recent performance. Others are excessively conservative and under price stocks of companies that have released positive news. Presently we are seeking investors who only see a positive side of any information released by the company. But then again there are those who correctly evaluate the information and sell.
Secondly, even if individual investors decided to buy or sell without consulting economic fundamentals, the impact on share prices would still be limited. Only when their irrational behavior is also systematic, that is, when large groups of investors share particular patterns of behavior, should persistent price deviations occur. Hence behavioral-finance theory argues that patterns of overconfidence, overreaction, and overrepresentation are common to many investors and that such groups can be large enough to prevent a company's share price from reflecting underlying economic fundamentals-at least for some stocks, some of the time. One can never be sure how long this time would last. But the most important fact to remember some of these ingredients start disappear, surely that is the time to get out.
Finally, when investors assume that a company's recent strong performance alone is an indication of future performance, they may start bidding for shares and drive up the price. Some investors might expect a company that surprises the market by the disclosure in the half yearly report to go on exceeding expectations. This asking for too much! But as long as enough other investors notice this myopic overpricing and respond by taking positions, the share price will fall in line with its underlying indicators.
I feel that any market deviation makes it even more important for the investors to understand the intrinsic value of shares. This knowledge should allow one to exploit any deviations, if and when they occur, to time the implementation of strategic decisions more successfully. One has to watch out that issuers do not take advantage of market deviations. They usually do! Usually there is the great opportunity to issuing additional share capital through right issue when the stock market attaches too high a value to the company's shares relative to their intrinsic value.
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IMF reforms won't benefit
developing countries
Celine Tan
The current proposals for reform at the International Monetary Fund (IMF) will not bring about benefits for the majority of its developing-country members, nor will they restore the Fund's credibility or improve its efficacy as a multilateral financial institution, according to a leading developing-country representative at the IMF.
In an article published in the upcoming issue of the Journal for International Economic Law, Mr. Hector Torres, an Alternate Executive Director of the IMF, and an important representative of the Group of 24 (G24), said that the "quota and voice" reform process launched at the IMF in September 2006 is unlikely to redress the dysfunctional nature of the Fund's governance structure or correct the power imbalances which lead to its ineffectiveness in both its regulatory as well as lending roles.
The reform process launched in Singapore in September 2006 is not likely to help the Fund to recover credibility or improve efficiency, writes Torres. Referring to the discussions to revise the quotas allocated to IMF members, Torres commented: "At the Board, we are just tinkering with the variables used in the current flawed quota formula and preparing ourselves to horse-trade on the weight that should be given to those that better accommodate narrow national interests.
Financial support
"At most, it will result in giving some more votes to a few successful emerging economies, already weaned off the Fund's financial support, at the expense of other less successful developing countries that remain to be potential borrowers. This will not bring additional effectiveness or credibility to the Fund."
As Alternate Executive Director on the IMF Board, Torres, an Argentinean, represents six Latin American countries (Argentina, Bolivia, Chile, Paraguay, Peru and Uruguay). As Argentina is currently the Chair of the G24 (which is the most representative grouping of developing countries at the IMF), Torres is also responsible for the day-to-day coordination of the G24.
The article, "Reforming the IMF - Why its Legitimacy is at Stake", is written in Torres' personal capacity. The journal is published by Oxford University Press. Most of the article dwells on why the IMF lacks legitimacy, with a section on the topical issue of the current reform process.
The article is an important contribution to the on-going discussions on the current state of the Fund and especially on the reform process and its effects on developing countries' voice and participation in the IMF.
"The Fund's capacity to influence its key members' policies through its advice, and to give confidence to potential borrowers by offering opportune and meaningful financial assistance in case of trouble, has been seriously put into question," says a summary of the article.
"Its governance structure is inconsistent with its multilateral nature and is dysfunctional to its purpose. There is also an ideological bias in its policy advice that prevents the Fund from being responsive to citizens' concerns and challenges posed by globalisation. The ongoing reform process is tinkering on the margins and if not redressed will fail to bring additional credibility and effectiveness to the Fund."
More noise than nuts
In his section on the IMF's reform process, which he subtitles "More Noise Than Nuts", Torres remarks that the IMF Managing Director Mr Rodrigo de Rato launched a "strategic" reform "in implicit recognition that the Fund either changes or fades away into irrelevance."
The first result of that reform process, supposedly to give developing countries more "quotas and voice" in the IMF, was seen in the IMF's 2006 Annual Meetings in Singapore.
The Fund's Governors decided to grant four countries (China, Korea, Turkey and Mexico) the right to modestly increase their quotas by a total of 1.8 per cent in the overall capital of the Fund.
With such a modest increase, "the start has not been bright and many developing countries voted against the reform or supported it only after strong lobbying from the Fund's management," writes Torres.
As for the basic votes, the IMF Board decided that they would "at a minimum" be doubled and thereby the "existing voting share of low income countries as a group" should be protected. The 2006 meeting did not decide on the actual amount of increases in basic votes nor on the second round of quota increases. It was agreed that both issues would be defined together no later than by the 2008 annual meetings.
Torres reveals that many developing countries initially opposed the modalities for the current two-stage reform process adopted by the IMF Board of Governors.
A significant number of developing countries (23 in total, including Argentina, Brazil, Chile, Colombia, Ecuador, Egypt, India, Iran, Peru, Qatar, Sri Lanka, Trinidad and Tobago, Uruguay, and Venezuela) voted against the reform and other developing countries supported it only after the IMF management strongly lobbied them.
This was confirmed to Torres by several of his colleagues on the Board who found that "against their own advice, their governors had been lobbied to vote in favour of the resolution."
Article XII
"The actual implementation of both the increase in basic votes and the aforementioned second round of quota increases will, however, take some time," writes Torres. Increasing basic votes will require an amendment to the Articles of Agreement of the Fund and a second stage of more meaningful quota increases will only come after the adoption of a new quota formula.
This is compounded by the fact that the increase in basic votes will depend on a successful amendment to Article XII, Section 5(a) of the IMF's Articles of Agreement.
Since such a constitutional amendment requires 85 per cent of the total voting power, it will be the national legislatures in the current majority shareholding countries which ultimately decide whether the reforms are implemented or not.
"As the US holds more than 15 per cent of the total voting power, this means that ultimately, the US Congress holds the key of the reform initiated at Singapore," notes Torres.
Quota formula
According to Torres, the reservations that several developing countries had with the Singapore decision on the reform process were two-fold. Firstly, "the reform foreshadowed in that Decision may result in more, not less, quotas and voting power for the most advanced economies", with developed countries already dominating the discussions for a revision of the quota formula.
Developed countries have already put forward GDP and openness to external trade as two variables that should bear more weight (in considering the new quota system).
"This was a bad start, as including reference to other variables which better capture likeliness to borrow would have presented a more promising reform for the majority of developing countries," says Torres.
"However, front-running GDP and openness is made even worse by the insistence of the most advanced economies in using market exchange rates to calculate GDP (rather than Purchasing Power Parity) and that of EU members of factoring in their intra-Euro trade as part of their 'openness' to the world."
According to Torres, the US indicated that it wanted only to restore the voting power it had before the token quota increase approved in Singapore; the Europeans did not join the US in its pledge; while Japan made clear that it would not forgo any increase in quotas which it may be entitled to under a new quota formula.
Torres remarks that reform on quotas and voice on this basis "that would further deteriorate the already minority position that developing economies hold in the Fund's aggregate voting would be clearly at odds with the objective of giving additional legitimacy to the Fund and reinforcing multilateralism".
Multilateralism
The second and more important reason behind developing countries' opposition or reservations about the Singapore decision is that the "drafting of that Decision creates a very high risk that even if advanced economies were not to increase their current share in quotas and votes, the end result of the reform could allow for the increase of the quotas of a handful of successful emerging economies at the expense of middle-income countries", says Torres.
He said that an increase in the quotas for the most dynamic emerging economies will not come at the expense of advanced economies "because they have the necessary voting power to prevent it" and it will not come at the expense of the low-income countries as the Singapore Decision guarantees against an erosion in their basic votes.
Potential borrowers
Thus, it would necessarily come at the expense of middle-income developing countries.
This is ironic, because it is the middle-income developing countries that are most likely to remain as the Fund's potential borrowers, since many emerging markets (such as China, Korea and some ASEAN countries) seem to be graduating from the potential use of Fund resources, thanks to their persistent current account surpluses.
As quotas also determine borrowing entitlements as well as voting power at the IMF, Torres argues that it would be "self-defeating" for the Fund to reduce the relative weight of middle-income countries' quotas.
"Indeed, this would encourage this large group of countries to set up policies of self-insurance, shoot for depressed exchange rates that allow them to accumulate more reserves and build up new (or reinforce existing) regional reserve pooling arrangements."
Torres further argues that while he was not against such arrangements in principle, he was "wary of a world that resorts to bilateralism or regionalism as an alternative to inefficient and unreliable multilateral institutions".
He says that the current governance structure of the Fund is not just inconsistent with the multilateral nature of the institution but it also prevents the institution from carrying out both its regulatory and lending roles effectively and with legitimacy.
Blow whistle
"A promoter of international monetary and financial stability requires the capacity to perform and put forward un-compromised arms-length assessments of the economies of its members and blow the whistle (loud and clear) when domestic policies are systematically disruptive," argues Torres.
"The fact that its decision-making process is dominated by its largest and most powerful members, precisely those whose domestic policies have systemic implications, attempts against the independence of the Fund's assessment and its capacity to police compliance with its obligations. This handicap is compounded by the fact that two of its members, the US and the EU, can veto its most important decisions," he adds.
The article by Torres is a valuable contribution to the on-going discussion on the IMF reform process, especially as it carries the views of an important representative and coordinator of the G24.
The reform process will be intensifying in the months ahead, as the IMF Executive Board is scheduled to come up with a revised quota formula by the IMF's Spring meetings in April 2008, and a decision will have to be made on the second round of quota increases plus the increase in basic votes no later than the Annual Meetings in the autumn of 2008.
- Third World Network Features
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Toshiba to participate in uranium
project in Kazakhstan
Holiday Desk
Toshiba Corporation announced on Aug. 20 that the company would participate in the Kharassan Uranium Mines Project, a new development project in southern Kazakhstan promoted by Kazatomprom (KAP), a state-owned enterprise of Kazakhstan, says a press release. Toshiba's participation is in line with its policy of enhancing its nuclear energy business.
The Kharassan project is being promoted by two KAP-related companies, Kyzylkum LLP and Baiken-U LLP. Test excavation of uranium ore is due to start this year, and output is expected to reach approximately 5,000MTU (metric tons of uranium) a year by 2014. Japanese companies have acquired indirect ownership interests in Kyzylkum and Baiken-U and will have the right to obtain up to an aggregate annual quantity of 2,000MTU.
Toshiba will acquire an indirect ownership interest in Kyzylkum and Baiken-U by taking a 22.5 per cent stake in a holding company that has part ownership and control of Kyzylkum and Baiken-U. This move will give Toshiba the right to a maximum of 600MTU from the Kharassan each year.
The holding company is currently jointly owned by Marubeni Corporation, The Tokyo Electric Power Company, Chubu Electric Power Co., Inc. and Tohoku Electric Power Co., Inc. Toshiba will be the first power systems manufacturer to participate in the project, which will allow the company to contribute to the stable supply of uranium concentrate for nuclear power plants in Japan.
Japan and Kazakhstan signed a memorandum of cooperation in nuclear power in August last year. In April this year, a Japanese government-private sector mission, led by Mr. Akira Amari, Minister of the Ministry of Economy, Trade and Industry, visited Kazakhstan and confirmed to deepen the cooperative relations between the two countries, including securing uranium resources for Japan and technical cooperation. Toshiba participated in the delegation, and signed a memorandum on mutual cooperation with KAP at that time.
By cultivating cooperative relationships with other key players, Toshiba aims to complete its transition to become a world leader in the nuclear power industry.
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