Economic Recovery: Are Happy Days Here Again?

Wall Street has just seen a two-month rally that included a whopping 39% rise from the recent rock-bottom prices on the Standard & Poor's 500. In addition, during several consecutive weeks, new U.S. jobless claims have dropped. Even quarterly reports from the battered banking sector have given investors some optimism that the worst-case scenarios will not happen. So does that mean that the band can strike up “Happy Days Are Here Again” to herald the arrival of an economic recovery, and the end of America's longest recession -- now 18 months and counting - since the Great Depression of the 1930s? Most financial experts insist that the much talked about recovery is not here yet, despite some of the first hopeful data in months - and they remain concerned that the recovery will be weaker and take longer to gain momentum than past slowdowns.

Indeed, a June 10 "Beige Book" report from the Federal Reserve Board said that economic conditions remained weak during mid-April through May. Conditions deteriorated in many regions of the country, the survey found, as commercial real estate and labor markets continued to struggle.

Several experts express fairly pessimistic views about the recovery - predicting that positive growth may not be here yet, and that even when it does arrive, it will probably take several years for employment rates to return to so-called normal levels. Even if the U.S. gross domestic product turns positive by the end of 2009, they note, the American economy will remain close to the bottom of the large trough that began in late 2007, with a long way to climb for jobs, home prices and other key economic indicators just to get back to where they were.

One indicator that economists find problematic is unemployment. The U.S. jobless rate for May has reached 9.4%, the highest in a generation, and experts say that hiring typically lags well behind the earliest rumblings of a recovery, such as an increase in consumer confidence. That is because some companies are still reluctant to lay off people during the depths of the downturn.

Despite these worrisome trends, some economists - even those who predicted financial gloom a couple of years ago - are seeing a few early signs of optimism. A recent survey of 45 professional forecasters released by the National Association of Business Economists showed that three-quarters of them predicted that the economic recovery would be underway by the late summer or early fall, and none expects the recession to last later than the early months of 2010. Princeton's economist and recent Nobel laureate Paul Krugman says the world economy "averted utter catastrophe" but that the road to recovery will be slow and laced with lingering pain.

Are Consumers Confident?

Of course, the ongoing signs of economic distress and gloomy forecasts from economists create another problem, which is that the real recovery cannot happen unless both rank-and-file consumers and business executives regain confidence to spend money again. Indeed, consumer confidence did rise sharply in May: The Conference Board says its index jumped to 54.9 from 40.8 in April. Experts say that both confidence and gloom about the economy among consumers will affect spending habits.

The problem, according to some economic experts, is that while consumers and business leaders are anxious for any hopeful signs of a recovery, the upbeat psychology will not last if banks are not lending money or if consumers continue their recent focus on paying down debts and saving rather than on shopping. Experts say that economic downturns that are triggered not by the conventional business cycle but by a financial crisis - as was also the case in the Great Depression of the 1930s - tend to have much slower and more shallow recoveries.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

Hedge Funds likely to increase its presence in India

Very few hedge funds are currently registered as FIIs in India. Some of these funds were allowed registration after a scrutiny of the track record of fund managers and were perceived as more of an exception to the rule.

Cayman islands, the Caribbean offshore financial centre and a favourite tax haven of money managers, is one of the most popular offshore fund jurisdiction for funds. Cayman, with its investor-friendly laws, has emerged as the most-favoured jurisdiction for fund formation, and is currently the fifth-largest banking centre in the world.

Cayman, has been admitted as a member of the International Organization of Securities Commissions (IOSCO), the global standard setter for securities markets. The move could encourage SEBI to give hedge funds - most of which are registered with Cayman - direct access to the Indian market.

Some countries either do not allow investment vehicles from non-IOSCO member countries to be sold in their jurisdictions or will require greatly-enhanced due diligence which makes it more difficult to do business with those jurisdictions. The IOSCO membership will remove these impediments and expected to open up markets for Cayman-domiciled securities providers.
As CIMA gets an ordinary member recognition from IOSCO, it may open up an opportunity for several hedge funds and investment funds to seek direct registration with SEBI as an FII rather than use other indirect access routes like third party FIIsThe development comes at a time when emerging markets are competing with each other to attract the huge liquidity created through money infusion by central banks across markets. So far in 2009, India has seen net FII inflows of little over $5 billion.

Contributed By:
Prof. J. N. Mukhpadhyay
(Globsyn Business School)

Source : Economic Times

Potential to become India’s largest M&A

India’s largest mobile phone company Bharti Airtel is in talks to acquire a 49% stake in Africa’s largest telco MTN to create an entity with revenues of about $20 billion and over 200 million subscribers. The combined entity will be amongst the top five operators globally. MTN will get a 36% economic interest in Bharti in return for offloading the minority stake. The deal size is estimated to be worth over $23 billion.

The Indian telco said the deal would be achieved through a scheme of arrangement. As per the talks, MTN would acquire about a 25% post-transaction economic interest in Bharti for an effective consideration of approximately $2.9 billion in cash and newly issued shares of MTN equal to approximately 25% of the currently issued share capital of MTN.

• MTN would acquire approximately a 25% post-transaction economic interest in Bharti for an effective consideration of approximately USD 2.9 billion in cash and newly issued shares of MTN equal to approximately 25% of the currently issued share capital of MTN.
  
• Bharti would acquire approximately 36% of the currently issued share capital of MTN from MTN shareholders for a consideration of ZAR 86.00 in cash and 0.5 newly issued Bharti shares in the form of Global Depository Receipts ("GDRs") for every MTN share acquired which, in combination with MTN shares issued in part settlement of MTN’s acquisition of approximately a 25% post-transaction economic interest in Bharti, would take Bharti’s stake to 49% of the enlarged capital of MTN. Each GDR would be equivalent to one share in Bharti and would be listed on the securities exchange operated by JSE Limited.

The broader strategic objective would be to achieve a full merger of MTN and Bharti as soon as it’s practicable to create a leading emerging telecom operator which today would have combined revenues of over $20 billion and a combined customer base of over 200 million customers.

Contributed By:
Prof. J. N. Mukhopadhyay
(Globsyn Business School)

Source: The Economic Times

Hope, Greed & Fear - The Psychology Behind the Financial Crisis

To explain the current economic crisis, the world of finance has a particular lexicon -- including, for example, Credit Default Swaps, Mark-To-Market and Securitized Subprime Mortgages. Psychologists, on the other hand, might use very different terms: Hope, Greed and Fear.

The language of psychology helps to address the fact that behind every cut-and-dried statistic about falling home prices and other indicators of economic decline, lies an ever-shifting horde of homeowners, bankers, business owners, unwitting investors -- in short, people. And people often pay no heed to fine-tuned economic models by doing things that are not rational, are not in their best interest, and are justified not by numbers -- but by emotion.

Emotion, it can be argued, not only helped to lead America into the current economic crisis but may also be helping to keep it there. At a recent conference called, "Crisis of Confidence: The Recession and the Economy of Fear," sponsored by the University of Pennsylvania's Department of Psychiatry and the Psychoanalytic Center of Philadelphia, an interdisciplinary panel explored the psychological elements behind today's economy. Psychological factors are at work behind the crisis, the panel agreed, although each focused on a different element: mania and over-optimism behind the housing bubble, a lack of self-control by consumers hooked on debt, and the shock and feelings of betrayal of many Americans who thought they were making safe investments, but now find themselves facing a frightening and uncertain future.

Like so many others in history, today's economic crisis began with a bubble, Bubbles occur when people are willing to buy something simply because they believe they can sell it for a higher price. Bubbles often have an aspect of mania.

Real estate booms and busts happen in very long cycles -- on average about every 20 years. Consequently, when housing prices are going up, few remember that they ever went down. This was certainly the case in the recent crisis, since housing prices only went up between 1975 and 2006. According to Herring, property markets are especially prone to booms and busts because of their nature: They have no central clearinghouse of information about prices, transaction costs are high and trading is infrequent, and the supply of property is relatively fixed in the short term. Because the cycles are decades long, it is difficult to tell what a piece of property should be worth in the long run.

Housing booms and busts are almost always linked to the banking system. When something good happens in an economy, it tends to drive up real estate prices, and banks tend to lend to support that, because people now have collateral. Optimism about rising prices feeds the frenzy, and as an increasing number of novice investors enter the market, prices and enthusiasm also increase. Again, emotion plays heavily into the cycle. People suffer "disaster myopia," either because they simply can't imagine a downturn happening, or they assume the probability of it happening is so low that it really isn't worth worrying about.

In the recent bubble, both buyers and lenders were overly optimistic about what the future would bring. Buyers ignored the possibility that they might not be able to keep up on payments because they assumed the prices of homes would go up and they would be able to sell or refinance. Likewise, lenders ignored the possibility of default because rising home prices had made it easy to get bad loans off the books. In the case of the housing bubble, homebuyers failed to exercise self-control when they bought larger homes than they knew they could afford. Lenders failed to exercise self-control when they chose to write shaky mortgages in order to bank short-term profits. When the bubble breaks, as it inevitably does, the pendulum swings back to the other extreme. People find it all too easy to imagine that bad things can happen to the market and they withdraw& tend to overshoot. They will act very, very risk averse for quite a long time until they are persuaded that [real estate] is once again a safe asset to hold.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

Are 'Mark-to-market' Accounting Rules on the Mark?

On April 2, the Financial Accounting Standards Board (FASB) is expected to vote on a proposal to relax an accounting standard at the heart of the financial crisis -- or at least the accounting of it. Many big banks say the crisis has been made worse -- perhaps created -- by mark-to-market accounting rules, which require toxic assets to be carried on their books at fire-sale prices, based on recent trades of similar assets for far less than they would command in normal times. Those bankers prefer looser accounting rules allowing higher values calculated by in-house mathematical systems.

But not everyone agrees that mark-to-market rules have been as damaging as the banks claim. Changing accounting rules to accommodate the banks would be like changing the scoring system for tennis. In March, John A. Courson, President of The Mortgage Bankers Association, told a congressional committee discussing the issue that mark-to-market rules had never been tested in an "inactive or illiquid market environment," and that they were improperly forcing banks to report big losses due to temporary conditions. Rules should be changed to require write-downs only when conditions were judged to be permanent, he said.

If the FASB, which sets accounting rules in collaboration with the Securities and Exchange Commission, approves the rule change tomorrow, banks would be free to carry troubled assets on their books at higher prices, avoiding requirements to shore up balance sheets with new capital they cannot get now.

But potential buyers of toxic assets will make their own valuation assessments regardless of what the accounting rules allow the banks to claim.

Mark-to-market defenders say that using market prices is the best way to derive honest values. Allowing banks too much latitude would paper over the problem, making banks look healthier than they are, they say. Those rules, "FAS 157," set by the Financial Accounting Standards Board, took effect in November 2007. They were intended to clear up confusion about the circumstances under which different valuation measures could be used, and they made it harder for financial institutions to use their own systems.

Under FAS 157, accounting should be based on market data, such as prices in recent sales, when it is available. Many banks and other mortgage-market players, such as Freddie Mac, the government-authorized mortgage company, have argued that the new rules spurred a downward spiral: Listing mortgage-backed securities on financial statements at low prices discouraged buyers, making prices fall even further and leaving the market illiquid.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

$ 1 trillion Toxic Assets – Will the recovery plan work ?

The term "toxic asset" is a nontechnical term used to describe certain financial assets when their value has fallen significantly and when there is no longer a functioning market for these assets, so that they cannot reasonably be sold. This term became common during the financial crisis that began in August 2007. Toxic assets played a major role in that crisis. When the market for such assets ceases to function, it is described as "frozen".

Markets for some toxic assets froze in 2007, and the problem grew significantly worse in the second half of 2008. Several factors contributed to the freezing of toxic-asset markets. The values of the assets were very sensitive to economic conditions, and increased uncertainty in these conditions made it difficult to estimate the value of the assets. Banks and other, major financial-institutions were unwilling to sell the assets at significantly reduced prices, since lower prices would force them to significantly reduce their stated assets, making them appear insolvent.

US Treasury Secretary Timothy Geithner has unveiled a plan aimed at persuading private investors to help rid banks up to $1 trillion in toxic assets that that are seen as a roadblock to economic recovery.

The US treasury has invited private entities and individuals to buy some of the toxic assets in the bank books at rock-bottom prices. The banks have partially marked these assets to the market and booked huge losses in recent quarters. There are additional incentives for investors to buy these assets at heavily marked-down prices.

The private investor is being asked to bring in less than 10% of the acquisition cost and the treasury is willing to fund the remaining 90% or more. Also, the government is ensuring private investors could walk away if the value of these assets falls further. So there is no further downside for the private investor.

There are many problems with such a scheme. It has been debunked by a Nobel prize winning economist as “cash for trash”. The main flaw in the scheme is that there is no knowing whether banks such as AIG, City and Goldman have fully marked these assets down to their real value. Over 60% of the housing derivatives were traded and acquired outside the exchange in over-the-counter deals. Since there is no liquidity, one cannot ascribe any value to them.

The treasury plan seeks to discover a price with private partnership. But nobody is sure whether any reasonable price will be discovered for these toxic assets. The biggest irony is that the treasury is trying to discover a price by allowing the private investor a nine-fold leverage! Is this sustainable for US citizens, already over-leveraged.

The Fed's Term Asset-Backed Securities Loan Facility, or TALF, received lukewarm response heightening fears private capital will also shun the government's toxic-asset plan amid public outrage over outsized executive bonuses.

A closer examination of the US treasury plan would suggest that the scheme might need a lot more fine-tuning before it is able to provide some succour to the ailing American banking system.

Contributed By:
Prof. J. N. Mukhopadhyay
(Globsyn Business School)

The Other Banking Dream: Those Secret Swiss Accounts

While World Markets are teetering in a global banking melt down, another banking drama is playing out in Switzerland that could end the way private banking has been done there for centuries.

U.S. Tax Authorities have challenged long standing Swiss banking secrecy laws, demanding that UBS AG release the names of 52,000 Americans suspected of opening secret accounts to evade taxes. The bank agreed to release client information on 250 US Citizens and to pay $780 million fine as part of a settlement, but that decision has put the entire Swiss banking system in jeopardy, according to Experts.

Even though UBS has balked at releasing the full 52,000 names, turning over the 250 clients names put a “chink” in the system that will destroy the trust of wealthy people around the world in Swiss bank accounts. The UBS case shakes that foundation of trust that clients had placed in Swiss Banks regarding the secrecy of those accounts.

If the release of individual names triggers a run on UBS, the already fragile global banking system could be further endangered. Secret banking in Switzerland dates back to 1713 when the Council Geneva passed a law preventing banks from showing client information. In the 1930s, after France & Germany tried to negate that ruling in order to prevent capital Flight, the Swiss responded by making the release of banking information a crime. The system was reaffirmed in 1984 when 73% of Swiss Voters agreed to preserve secret banking.

The combination of its secret banking laws & a stable Government gave Switzerland a competitive advantage in private banking, allowing it to attract capital from overseas. Today, one third of the world’s total offshore assets of $ 7 Trillion are in Swiss Banks, according to Reuters.

The current dispute pits US tax law against Swiss law, which still makes the release of banking client’s name a crime – unless there is a specific client suspected of evasion and the client has the opportunity to answer to Swiss Authorities. The U.S. Internal Revenue Service (IRS) has filed a civil law suit in U.S. District Court in Miami to force UBS to disclose the identities of U.S customers who have secret Swiss bank accounts holding cash & securities valued at almost $ 15 billion as of the middle of the decade.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)