Are buybacks suitable gifts for investors and acceptable choice for decision makers?

Everything is fine say whose agree with the new tax regimes imposed to balance sovereign debts. However, those who disagree may find buybacks policies as alternative solutions to satisfy expectations of long term investors. So, are the buybacks appropriate means to ensure markets’ financial stability, suitable to attract investors and acceptable choice for decision makers?

The shares’ buyback policy may be advantageous for long term investors compared to paid dividends if taxes on dividends are higher than taxes on capital gains. The buyback policies may be favourable as well for the postponement effect. Shareholders may keep shares for long term and pay taxes on capital gains only once shares are profitably sold. These trends may sustain equity markets as notices in respect with buyback policies usually lift share prices. But will the buyback of debs has similar effect?

New programme to support Greece was discussed by the Troika during last several weeks. According to the press release of Hellenic Republic announced on 3 December, 2012, the bond holders were invited to exchange Greek debt securities for up to 10 billion euro aggregate principal amount of six-month notes issued by the European Financial Stability Facility. It was reported by Reuters on 3 December, 2012 that the offered prices were higher than Greek bonds eligible under the buyback closed at on 23 November, 2012. So, is such buyback of Greece’s public debt a gift for investors?

The invitation to buyback Greece bonds followed the Eurogoup Statement on Greece released on 27 November, 2012, which set considerations regarding an updated programme of further actions between the Troika and Greece. The goals of the IMF assistance programme till 2016 involve the reduction of Greece debt-to-GDP ratio to 175% in 2016, 124% of GDP in 2020 and lower than 110% of GDP in 2022.  It is expected that graduate buyback of Greece’s public debt will return it to the market financing.  So, Greece was encouraged to reduce debt in exchange of lower interest rates on the loans available from the Greek Loan Facility, lower guarantee fees on the EFSF loans, extended maturities of the bilateral and EFSF loans by 15 years, deferred interest payments of EFSF loans by 10 years and transferred amounts from the national central banks of the euro area Member States to Greece’s segregated account equivalent to the income on the portfolio of the Securities Market Programme used to absorb liquidity. Moreover, after the Member States’ approval of the next EFSF disbursement which amounts 43.7 billion euro, the 23.8 billion euro will be paid for banks recapitalisation in December.

 

Buyback of Greece sovereign bonds is an attempt to absorb risky assets from the markets. However, once favourable buyback conditions are created for investors, what capital structure of decision makers’ balance sheets remains? Only generators of constant revenues may afford such decisions.

 

Will Dodd-Frank Wall Street Reform and Consumer Protection Act save the markets from the collapse?

Thanksgiving Day in the US last Friday, 23 November, opened the Christmas shopping season.  Massive purchase brought confidence in the retail sector’s stocks. However, was the last Friday also the final rally? Historically, December is a weak month for stocks’ performance. Moreover, the ongoing US officials’ talks about the tighter fiscal discipline most likely will lead to the reduced consumption and decreased economic growth.  Going further, the US Securities and Exchange Commission’s statement, published on Monday, 26 November, surprised with Mary Schapiro’s decision to leave the agency on the 14^th of December. So, does it mean that the Chairman of the SEC abandoned started reforms? Then, who will safeguard the markets?

The Dodd- Frank Wall Street Reform and Consumer Protection Act which entered into force in July of 2010, was a response to the financial crisis in 2008. The legislative changes were approved as an economic foundation for job creation through increased investors’ confidence. Mary Schapiro, the former chairman and chief executive officer of the Financial Industry Regulatory Authority and chairman of the Commodity Futures Trading Commission, was appointed to lead the reforms at the SEC by President Barack Obama in January of 2009. The main changes according to the Dodd-Frank Wall Street Reform and Consumer Protection Act involved introduction of a new independent watchdog housed at the Federal Reserve; prevention measures those end bailouts of financial institutions and liquidate failed financial firms; establishment of a council for identification of systemic risks; increased transparency and accountability measures for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders; improvements in corporate governance and enhanced voting rights for executive compensation; improved transparency and accountability requirements of credit rating agencies; strengthened oversight on financial fraud, conflicts of interest and manipulation of accountancy books.

It was expected that imposed consumer protection measures will prevent from another financial crisis, but do the reforms include prevention measures from contracting economy? It may appear that shrinking economic growth will undermine stability of financial institutions and commitments to end the bailouts may lead to the increase of interest rates or the liquidation of an array of systemically failed financial firms.

Isn’t it too late to concern about the financial stability of the US banks?

2013 is going to be a challenging year for the global economy. Set US obligations to reduce the growth of budget deficit during 2013 and 2021 years and termination of the reduced taxes from 2013 may weaken consumption and cause double dip recession in the US with the contingency effect on global economy. Moreover, isn’t it too late to concern about the financial stability of the US banks due to approaching fiscal cliff?

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 which was passed by the US Congress and signed by President Barack Obama on December in 2010 terminates a two year extension of reduced income taxes known as the “Bush tax cut” in 2013. It also terminates extension of several other measures such as unemployment benefits and reduction of social security and medical care taxes. Moreover, according to the approved Budget Control Act of 2011, US was able to increase debt ceiling to $16.4 trillion in exchange for mandatory $1.2 trillion cuts of budget expenditures during the period from 2013 till 2021.

According to the analysis of the Congressional Budget Office – Fiscal Tightening in 2013 and Its Economic Consequences, published on August 22, 2012, a sharp reduction in the federal budget deficit will cause economy to contract but also put federal debt on more sustainable way. If current laws remain unchanged those lead to the tax increase and spending cuts the federal budget deficit will be reduced by $487 billion in 2013 and federal budget deficit will be $ 641 billion in 2013. According to this scenario it is expected that economic growth will contract to -0.5 % in the 4^th quarter of 2013 compared to the 4^th quarter of 2012. In case the lawmakers extend most tax cuts and other forms of tax relief and prevent automatic certain spending reductions, the federal budget deficit may be reduced by $91 billion in 2013 and federal budget deficit is projected to be $1,037 billion in 2013. According to the alternative fiscal scenario, it is expected the economy to growth by 1.7% in the 4^th quarter of 2013 compared to the 4^th quarter of 2012.
 

It is likely that in the anticipation of the worst case scenario and sharp economic contraction in 2013, the Federal Open Market Committee (FOMC) of the US Federal Reserve decided to continue monetary stimulus with third round of large-scale asset purchases. According to the statement of the FOMC meeting released in September 13, 2012 the Committee agreed to purchase additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also decided to continue through the end of the year its programme to extend the average maturity of its holdings of securities and to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. It was expected to increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year and put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The continued monetary stimulus programme lifted equity markets; however, will capital gains from the equity price increase be substantial to meet investors’ in the US markets expectations related to the increased taxes on capital gains in 2013. Additionally, will the future economic environment promise more business growth opportunities and policies of higher dividends, so that gains from the dividends were substantial to meet investors’ expectations including increased taxes on dividends in 2013? Moreover, the fiscal policy of higher taxes creates more incentives for corporations to fund development through borrowing due to tax shield which leads to more lending opportunities for banks and increased financial risks related to higher leverage of corporations.

Sold gold reserves held in the IMF may realise frozen capital for economic development

The annual meetings of the World Bank Group and the International Monetary Fund hosted in Tokyo, October 9-14, once again engaged high level representatives from financial organizations and academic communities into the economic growth and financial stability issues. The events started with a brief presentation of the World Economic Outlook (WEO) which emphasised threats of high debts and sluggish economic growth mainly due to weaker demands in advanced economies. Similarly, the press briefing on Global Financial Stability Report (GFSR) highlighted actions restoring market confidence through monetary interventions and financial system reforms related to financial buffers, high-quality capital and sufficient liquidity in advanced economies as well as fiscal discipline in Europe, Japan and the United States. So are there particular circumstances those affect the future economic outlook?

Several events during the last and upcoming month have set more challenges and uncertainties regarding the future economic development. Slowing global economic growth and upcoming leadership changes encourage aggressive economic growth strategies and implementation of short term financial stability measures such as monetary easing measures to relieve credit crunch and market pressure. Approaching the US presidential elections in November 6 may change public debt management policies and measures for reduction of fiscal cliff, set new economy growth and employment programmes, and even affect monetary decisions. China’s slowing economic growth and territorial dispute with Japan, which may weaken economic cooperation between Asian countries, also coincide with the date of the 18th Party Congress on November 8, the date of formal unveiling of China’s new leaders and development policies. Moreover, despite of the measures prepared by European leaders to provide necessary financial support, Europe’s peripheral countries faces internal unrest due to exercised austerity measures, high unemployment and weak economic recovery.

Investment in gold products are seen as a save heaven in the environment of high uncertainties. So could growing gold prices create economic distortions? Expectations of investors that gold may rise to $2,000 an ounce could encourage investment in gold and may freeze capital for economic development.

Even the role of the gold has been reduced in the international monetary system, the IMF remains one of the largest official holders of gold in the world. According to the factsheet on Gold in the IMF published on 24 August, 2012, the IMF held 90.5 million ounces (2,814.1 metric tons) of gold at designated depositories at mid-August 2012. The IMF’s total gold holdings are valued on its balance sheet at SDR 3.2 billion (about $4.8 billion) on the basis of historical cost. As of August 17, 2012, the IMF's holdings amounted to $146.1 billion at current market prices. So, sold gold reserves held in the IMF at market prices could realize frozen capital for economic development.

The Eurosystem’s Outright Monetary Transactions – the ECB’s intervention in management of sovereign debt

Mario Draghi, a president of the European Central Bank introduced the technical features of the Eurosystem’s Outright Monetary Transactions in secondary sovereign bond markets during the press conference on the 6^th of September. The ECB’s approved conditions of programmes allow intervening in the financial markets and absorbing high yield sovereign debt securities.  The special programmes could relief borrowing cost of issued sovereign bonds through the ECB’s purchase of securities those are not accepted by investors. Considerations regarding the monetary and fiscal policies interactions intensified during the period of financial instability. However, interventions of central banks in the management of the sovereign debt are still assessed contrary.

According to the “Interactions Between Sovereign Debt Management and Monetary Policy Under Fiscal Dominance and Financial Instability” (No. 3 of OECD Working Papers on Sovereign Borrowing and Public Debt Management), published by Blommestein, H. J. and P. Turner (2012), it is difficult to separate monetary and public debt management as both policies are involved in the sales of sovereign debt to private sector, though in different forms. New issuance of sovereign debt securities or regulation of the supply and demand of sovereign debt affects investment decisions of firms and households, and impacts on macroeconomic development. Moreover, monetary and fiscal policy interactions, mandates, accountability and potential conflicts of policies were reviewed in the ECB’s article “Monetary and Fiscal Policy Interactions in a Monetary Union” published in July’s Monthly Bulletin, 2012. So, the ECB’s decision on the Eurosystem’s Outright Monetary Transactions could not be judged as urgent and reckless.

A necessary condition for Outright Monetary Transactions approved by the Governing Council of the ECB is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The transactions will be focused on the sovereign bonds with a maturity of between one and three years with no ex ante quantitative limits in the size of the OMTs. The same pari passu treatment will be accepted for private and other creditors regarding the issued bonds by euro area countries and purchased through the OMTs. Moreover, the liquidity created through the OMTs will be fully sterilised and information about the OMTs holdings will be publicly available. It is also expected that the IMF will be involved into the design of the country-specific conditionality as well as the monitoring of such programmes. 

If we assume that according to the borrowing demand and high costs of Italy and Spain, those two countries will enter the OMTs programmes, what are the high quality securities the ECB is going to sell in order to offset increased liquidity?

How stable and liquid is physical gold?

The World Gold Council is an association comprised of 23 members of the world’s leading gold mining companies those represent approximately 60% of global corporate gold production.  The main goal of the organization is to develop gold market by stimulating and sustaining demand for gold.  Historically, gold is used as a hedge against inflation and deteriorating currencies thus, according to the prolonged financial crisis, the World Gold Council suggested that added gold to the high-quality liquidity buffers could bring stability to the banking system. Additionally, due to gold’s characteristics the World Gold Council expressed believe that gold could be included in banks’ reserve asset portfolios and be used as collateral for liquidity financing.  So could gold be acknowledged as a stable and liquid global currency which is equivalent to high-quality capital?

The physical gold may be purchased from mine producers those refine gold according to the London Good Delivery – the internationally acceptable standards and in the global OTC market.  The reference gold prices are fixed in London twice during the day and either the morning (AM) or the afternoon (PM) fixed price is used for pricing long term contracts. According to the international standards, the bars must be at least 995 parts gold of 1000 and weight between 350 and 430 fine ounces. The physical gold is mainly stored at the Federal Reserve Bank of New York and the Bank of England – the largest custodians safeguarding other central banks’ gold reserves. However, investors may choose a broad array of financial products such as Exchange Traded Funds, Futures and Options, Warrants, Gold Mining Stocks, Gold oriented funds and others those provide opportunities without a purchase of physical gold to gain from the movements of gold price.  

According to the Gold Demand Trends, a report for second quarter 2012 which was prepared by the World Gold Council in August 2012, the total amount of the gold purchased by official sector institutions was 157.5 tonnes and accounted for 16% of overall Q2 gold demand. During the first quarter of 2012, official sector purchased 254.2 tonnes of gold which reflects a 25% increase compared to the 203.2 tonnes of gold purchased during the first quarter of 2011. The biggest buyers were the National Bank of Kazakhstan, the central bank of Philippines, the central bank of Russia, the National Bank of Ukraine, the central bank of Turkey and South Korea’s central bank.

Going back to the World Gold Council’s suggestions, the advantage of established gold as banks’ reserve asset is elimination of credit risk; however, market and liquidity risks may be even severe for financial stability.

The main goal of central banks is to maintain price stability. Moreover, deteriorating exchange rates of domestic currencies reflect the worse economic state of the country.  Reduced purchase power of domestic currency forces governments to reconsider economic policy. Debts of governments and corporations are covered by collateral assets and guarantees. So creditors have legal obligations to repay debts. Market value of equity depends on the asset allocation decisions. In all these cases the responsibility is assigned for managing uncertainties and made decisions.

So will the World Gold Council take responsibility to maintain stable gold price and even more will it emerge as a key authority responsible for the stable global financial system?

Value creation should be a priority of stability policy, shoulddn't it?

US Treasury Secretary Timothy Geithner held private talks with German Finance Minister Wolfgang Schaeuble and ECB’s President Mario Draghi this week. The other confidential meeting was carried between ECB’s President Mario Draghi and Bundesbank Chief Jens Weidmann before the ECB’s monetary policy vote on Thursday, 2 August. Last week M. Draghi’s publicly announced to do whatever it takes in order the Spain’s and Italy’s borrowing costs were reduced and euro stability was maintained. However, Germany’s position remained against resuming the ECB’s government bond buying programme and issuing Eurobonds. Broadcasted the US Treasury Secretary’s interview with Bloomberg on Wednesday, 1 August revealed T Geithner’s concerns about market stability and desires to sustain investors’ confidence, though usage of the euro zone's rescue funds is not clear. Does it mean that €500bn funds of European Stability Mechanism could be used to implement reforms not necessary related to the recapitalization of European banks and sovereign bonds purchase programme?

The slowing down global economy growth was captured with different statistics. However, World Trade Organization’s observations may reveal some new aspects of slowing growth. According to the World Trade 2011, Prospects for 2012, WTO’s press release on 12 April 2012, the world trade expended in 2011 by 5.0%, which is a sharp deceleration from the 2010 rebound of 13.8%. Moreover, it was predicted that the growth would slow further to 3.7% in 2012. On World Trade Report 2012 released on 16 July, 2012, WTO focused on new international trade challenges – increased use of non-tariff measures. These measures reflect regulatory standards for manufactured and agricultural goods. So, political concerns about the health, safety, environmental quality and other social aspects may affect international trade even more than tariffs.

Consequently, value creation should be a priority of stability policy, shouldn't it?

Are negative interest rates a signal of excessive liquidity?

International Monetary Fund warned on increased risks to financial stability in the Global Financial Stability Report released on 16 July, 2012. Excessive European sovereign debts and concerns about the quality of banks assets were mentioned as the main threat to financial stability alongside with the uncertainties on the fiscal outlook and federal debt ceiling in the United States. Financial risks are understood as possibility of losing assets. So, shouldn’t quality of assets remain the main focus and concern?

It could be mentioned that prominent features of June and the first part of July involved further easing of global monetary policies. According to the Monetary Policy Meeting held in June 15, Bank of Japan will encourage the uncollateralized overnight call rate at around 0 to 0.1 percent. The US Federal Open Market Committee decided to continue purchasing Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. The news about the expended operational twist by $269 billion through 2012 was announced on 20 June. The key ECB interest rates were cut by 25 basis points to 0.75% on 5 July. Monetary Policy Committee of Bank of England decided to increase size of Asset Purchase Programme by £50 billion to £375 billion on 5 July. The People’s Bank of China decided to cut one year RMB benchmark deposit and loan rates by 0.25 and 0.31 percentage points to 3% and 6% respectively on 6 July.

Similar remarks could be addressed to the quality of decisions in financial sector. Single supervisory mechanism for euro area banks and the concept to recapitalize banks directly through the European Stability Mechanism (ESM) may fail if banks’ business models are dysfunctional and they cannot sustain financial shocks. Banks’ insolvency arose due to inaccurate assets management and failed estimations. So, additional banks capitalization and facilitated access to attractive borrowing costs will hardly improve the assessment of viability of business plans/investment opportunities.

Moreover, could negative interest rates signal that liquidity is enough in the markets? Investors demand for credibility allowed Germany, Denmark, Finland, Belgium and France to borrow at negative interest rates. When investors chose sovereign bonds with negative interest rates they sink their savings. So, maybe liquidity is already enough and the main concern is to employ existing capital efficiently.

Could leaders of highly regulated institutions be easily replaced?

The FSA has announced about the misleading sales of interest rate hedging products to some SMEs on 29 June and confirmed that it reached agreement with Barclays, HSBC, Lloyds and RBS to provide appropriate redress where mis-selling has occurred. Barclays was fined £290m by authorities in the UK and the US following an investigation into the submission of various interbank offered rates. Chairman of Barclays, Marcus Agius resigned on 2 July, Chief Executive Bob Diamond and Chief Operating Officer Jerry del Missier resigned on 3 July. So, is it difficult to replace leaders of highly regulated and self–running business?

According to the FSA sold interest rate protection products involved “caps” those fix the upper limit to the interest rate on a loan and more complex derivatives such as “structured collars” which fixed interest rates within a band but introduced a degree of interest rate speculation. The investigation at Barclays revealed that some interest rates submissions reflected individual traders’ positions instead of the cost of interbank borrowing. However, its LIBOR submissions were relatively higher than in other banks during the credit crisis period which reflected appropriate management of structural risk, the risk that it may not be possible to decrease administered savings rates in line with decreases in money market (LIBOR) rates, resulting in a margin squeeze where lending is LIBOR-based.

So, is it difficult to find candidates those could prevent mistakes in the future, candidates with integrated knowledge of financial products, business operations and risk management expertise and maybe the most important feature – clear understanding of the role of financial institutions in economy?

Lack of capital or capabilities?

After the massive warnings from credit rating agencies about the deteriorating creditworthiness of financial institutions and new suggestions for better capitalization and additional injections of liquidity to sustain stability, an open question remains whether additional capital can restore self-sustainability of financial sector. Moreover, during the past several years financial system became more vulnerable and less significant for recovery of economy.  Further shortages of funds simply remind that currently held capital is not enough to fulfil all desires.

Spain's credit rating was downgraded by Fitch from A to BBB in 7 June and 28 Spanish banks’ credit ratings were downgraded by Moody in 25 June. The yield on 10 year Spanish government bonds increased above 6.5% and independent auditors revealed that Spain’s banks need 62bn euro support. Worsen situation caused Spain to ask officially support on Monday. The next country which possibly will need bailout is Cyprus. Fitch downgraded the country's credit rating to BB+ from BBB- and it could potentially require 4bn euro to recapitalize its banks, heavily exposed to the Greek economy.

As a response to the prevailing negative outlook, a proposal Towards a Genuine Economic and Monetary Union was introduced by President of the European Council, Herman Van Rompuy on Tuesday, 26 June. The plans for further banking, fiscal, and economic union could meet a tough opposition at EU summit on Thursday and Friday, 28-29 June. Angela Merkel refused to accept common liability and to introduce eurobonds.

So, could political union be sustained by sharing and implementing the best practices those strengthen banking system, enhance fiscal discipline and develop economic potential? Moreover, will EU’s leaders stick to the additional capital needs and common  debt of euro zone countries - eurobonds; or will the debate turn towards measures those enhance capabilities to contract in at least painful way and enforce recovery with a new strength.

How easily euro could be broken?

Central banks of the world’s major economies prepared contingency plans to stabilise markets in case anti-austerity parties won elections in Greece on Sunday, June 17. Moreover, leaders of the G20 meet in Mexico on Monday, June 18 to discuss Europe’s debt crisis and clarify contributions to the pledged IMF‘s fund worth of $430 billion US.  It is expected that additional cash injections into the financial system may calm public panic; however, could euro, the second largest reserve currency, be broken easily?

Prolonged political tensions in Greece intensified considerations whether it is able to meet bailout obligations. Moreover, it was announced that in the middle of May the ECB stopped providing liquidity to some Greek banks because of insufficient capitalization, overseas banks reduced reserves holdings in euro and Greeks rushed to withdraw money from domestic banks or transfer deposits to more stable ones. Euro deterioration to 1.24 against US Dollar last week and international mistrust in European currency strengthen the worst scenario – the end of euro.

It could be interesting to observe how European banks follow the news of deteriorating assets. Euro might collapse if European banks hurry to stabilize deteriorating assets by ridding of devaluated euro. However, the other scenario is also possible. Self market regulation mechanism may come into force and European currency may survive as long as European goods are traded in euro.

Goodbye to volatility, hello to arbitrage!

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The US Securities and Exchange Commission approved two proposals those are designed to curb volatility in individual securities and the broader US stock market on 31 May, 2012. The national securities exchanges and the Financial Industry Regulatory Authority will implement the approved proposals by 4 February, 2013, for a one-year pilot period, during which the assessment regarding any additional modifications will be made. So, what are the chosen market control measures and how will be the effect estimated during the pilot period?

One of the approved initiatives establishes a “limit up-limit down” mechanism that prevents trades in individual stocks with a specified price band, which would be set at a percentage level above and below the average price of the security over the immediately preceding five-minute period. According to the news released by the US SEC on 1 June, 2012, for more liquid securities — those in the S&P 500 Index, Russell 1000 Index, and certain exchange-traded products — the level will be 5 percent, and for other listed securities the level will be 10 percent. The percentages will be doubled during the opening and closing periods and broader price bands will apply to securities priced $3 per share or less. This new mechanism will replace the existing single-stock circuit breakers that the Commission approved on a pilot basis after the market events of May 6, 2010.

The other initiative updates existing market-wide circuit breakers those halt trading in all exchange-listed securities throughout the U.S. markets. The existing market-wide circuit breakers were adopted in October 1988 and have been triggered only once, in 1997. The new requirements according to the US SEC involve a reduction of the market decline percentage thresholds needed to trigger a circuit breaker to 7, 13, and 20 percent from the prior day’s closing price, rather than declines of 10, 20, or 30 percent; a shortened duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60, or 120 minutes; a simplified structure of the circuit breakers so that there are only two relevant trigger time periods instead of six, those that occur before 3:25 p.m. and those that occur on or after 3:25 p.m.; a usage of broader S&P 500 Index, rather than the Dow Jones Industrial Average, as the pricing reference to measure a market decline and a requirement to recalculate the trigger thresholds daily rather than quarterly.

However, I wonder how the authorities will measure the effect of attempts to protect domestic markets from excessive volatility. Imposed trading halts those close domestic markets creates an arbitrage opportunities for the companies’ securities traded in other opened stock exchanges. So, these efforts to control volatility may deepen market distortions and could be welcomed as risk free opportunities.

How is Greece going to resolve debt burden with exit from euro zone?

The approaching 17^th of June is remarkable for Greek elections. After the failure to form a coalition government for the third time Karolos Papoulias, a president of Greece dissolved a newly elected parliament with a strong opposition for bailout policies. The political party Syriza led by Alexis Tsipras obtained the second largest amount of seats in the 300-member parliament with pledges to overturn the austerity measures. So what are Greek solutions to resolve debt burden?

Opened debates about Greece exit from euro zone prompted euro zone’s experts to prepare contingency plans even though European leaders at the informal EC dinner held on 23 May, 2012 declared their desire to keep Greece in euro area and respect for its commitments. Moreover, it was ensured that growth and job creation in Greece would be supported through mobilised European structural funds and other instruments.

However, if Greek political leaders decide to leave euro zone, how Greece will exchange euro to drachma? Do Greeks really believe that if, according to the statistical data of Aggregated Balance Sheet of Monetary Financial Institutions (MFIs) of Greece for the end of March 2012[1], the €23,233 million banknotes and coins in circulation as well as the €179,668 million domestic deposits and repos of non Monetary financial institutions had been exchanged to drachma, Greece would has been able to repay €145,637 million outstanding liabilities to Credit Institutions of euro area and other countries, and cover remaining liabilities worth of  €95,178 million?

[1] Bank of Greece. Monetary and Banking Statistics http://www.bankofgreece.gr/Pages/en/Statistics/monetary/default.aspx

What is missing in management of portfolio of credits?

The JPMorgan Chase & Co. announced $2 billion trading loss on credit derivatives on Thursday, 10 May. Financial institutions use sophisticated financial modelling methodologies those involve estimation of the market price of the derivatives, the derivatives impact on the institutions’ balance sheet and macroeconomic indicators to forecast trends and values of financial products. So what is still missing in management of portfolio of credits?

Credit derivatives are used in risk management to mitigate pressure on institutions' balance sheets. Derivatives help to manage differences in asset classes, maturities, rating categories and debt seniority levels. Thus, it might seem that once credit derivatives separate ownership of assets from the management of credit risk, the clients’ relationship management become more significant than due diligence and estimation of credit risk. However, derivatives transfer but not eliminate risks.

So if risks are determined through probability distributions the following consideration might be quite important. Widely used risk management systems or attempts to find a universal solution - standardized risk management methodologies narrow selection of possible decisions and transform firm specific risks associated with company’s unique decision making into the systematic risks those affect the overall industry.

Systematic risks are created once the majority uses the same risk management techniques – similar credit derivatives solutions, thus further losses are coming up.

Is current macroeconomic data above the future growth expectations?

The joint meeting of the World Bank and the IMF Development Committee was accomplished with the IMF’s members pledge to contribute over $430 billion to an anti-crisis firewall which is aimed to restore market confidence and support the recovery of global economy growth, the news released at the IMF Survey Magazine on Saturday, 21 April. However, even successfully mobilized global fund ought to strengthen safety net, markets pressure on Monday, 23 April suggested that current macroeconomic data and contraction in Europe is above the future promises. So, are there any surprises for Friday, 27 April 2012?

The 25 EU governments signed agreements to tighten budget discipline in March. Moreover, 17 eurozone finance ministers agreed on the permanent European Stability Mechanism worth of €500 billion which is combined with the remaining temporary European Financial Stability Facility comprise €700 billion. In spite of this, Spain and Italy are on the closest watch in Europe. The Spanish and Italy government bond auctions evoke yield spikes. The yield on 10 year Spanish government bonds reached 6.05% and the yield on Italy government 10 year bond increased to 5.77% on Tuesday, 24 April. Though on the other hand, according to the data provided in the consolidated financial statement of the Eurosystem as at 20 April 2012 which was released by the ECB on Wednesday, 25 April, liabilities to general government declined by €3.5 billion to €155.3 billion and the Eurosystem’s net lending to credit institutions fell by €38.8 billion to €152 billion compared to the previous week. Similarly, the European Commission released the draft budget for 2013 with the investment objectives in growth and jobs on Wednesday, 25 April, which represents €137,9 billion of payments with dedicated €9,0 billion (28,1% increase on 2012) to the Research framework Programmes,  €546,4 million (47,8 % increase) set for the Competitiveness and Innovation Programme, €49 billion (11,7 % increase) allocated for structural and cohesion funds as well as €1,2 billion (15,8 % increase) for lifelong learning. 

However, growth is not only the Europeans objective. Get economy back to normal levels within 2-3 years is the goal of the G20 members announced at the IMF-World Bank Spring Meeting in April 21, 2012. Moreover, the governance reforms of the IMF are on the way. The quota formula which reflects members’ relative positions in the world economy will be reviewed by October 2012 and changes most likely will give greater influence for emerging markets and developing economies. Some of changes may be radical associated with the BRICS’ Delhi Declaration, 29 March 2012. The BRICS initiative to form South South Development Bank with mobilised resources for infrastructure and sustainable development projects in BRICS and other developing countries may spur growth in emerging regions, diminish dollar usage in global transactions and entrench BRICS’ currencies as global reserve currencies.

So, are there any surprises for Friday, 27 April 2012? Let it be released GDP for the United States. The annualized first quarter’s estimated growth is 2.5% which is less than the previous period - 3% growth.

The US giants’ earnings – reflection of believe and disappointment

The first quarter’s earnings of the dominating US companies will be released this week and investors’ sentiments will determine further trends of the markets. Will the earnings be strong enough to feed public – public investors, and support the new heights of Americas Stock Indexes? Or will the indexes sag down reflecting investors’ disappointments along with new reproaches on insufficient stimulus?

The Dow Jones Industrial Average, the S&P 500 Index and the NASDAQ Composite Index reached new heights in March and the beginning of April. The highest value of the Dow Jones Industrial Average was 13297.11, the S&P 500 Index reached 1422.38 and the NASDAQ Composite Index reached 3123.03, reflecting the best performances since the financial meltdown in 2009. However, the last week showed weakness of optimism; therefore investors’ disappointment may send ripples through the markets.

According to the Reuters, the Citigroup will disclose the first quarter results on Monday, the performance of the Goldman Sachs, the Intel, the Yahoo, the IBM will be released on Tuesday, data of the eBay and industrial companies such as Halliburton and Textron will be presented on Wednesday, the Bank of America, the Morgan Stanley, the Microsoft will provide their financial statements on Thursday and Friday will reveal the GE and the Honeywell results.

So, what will triumph: believe in bright perspective of the companies or disappointment of the current economy state?

Does infinite growth exist and is sustainable development possible?

Investment rules of pension funds and savings schemes those provide tax shields and encourage chasing assets growth in long term are coincident with the believes of perpetual growth, the concept which is based on sustainable development and assumption that a comfortable retirement is in the interest of all people. However, does infinite growth really exist and is sustainable development possible?

According to the survey of the retirement-income systems in OECD and G20 countries [1], OECD pension fund assets reached USD 16.8 trillion in 2009. The US pension funds’ assets were worth of USD 9.6 trillion in 2009 those represented 57.1% of the total pension funds assets in OECD, the UK pension funds’ assets were worth USD 1.6 trillion, a 9.5% of the total. The other largest pension funds belonged to Japan with estimated assets worth of USD 1 trillion, the Netherlands - USD 1 trillion, Australia - USD 0.8 trillion and Canada - USD 0.8 trillion. The survey disclosed that in 2008 OECD pension funds experienced on average a negative return of 22.5% in real terms, equivalent to USD 3.5 trillion. Losses made in 2008 were recovered by around USD 1.5 trillion during 2009. More information about the investment performance of pension funds and public pension reserve funds in selected OECD countries during the period of 2008-2009 is available in the Picture 1 and Picture 2.

Pension funds' real net investment return in selected OECD countries, 2008-2009 (%)

Picture 1. Pension funds’ real net investment return in selected OECD countries, 2008-2009 (%)[2]

PPRFs’ real net investment return in selected OECD countries, 2008-2009 (%)

1. There are five Swedish National Pension Funds (AP1-AP4 and AP6).
2. 2009 data refer to fiscal year 2010 ending March 31, 2010.
3. AGIRC and ARRCO are unfunded mandatory supplementary plans for white-collar and blue-collar workers respectively, with reserves. More information on these plans can be found in the OECD Private Pensions Outlook 2008.
4. Data refer to June of each year.
5. 2009 data refer to the period January-March 2010.
Source: OECD Global Pension Statistics.

 Picture 2. PPRFs’ real net investment return in selected OECD countries, 2008-2009 (%)[3]

The research also revealed the information about the allocation of pension funds’ and public pension reserve funds’ assets in selected OECD countries in 2009. According to the survey bonds and equities remained the two most important asset classes, accounted for over 80% of total pension funds’ portfolio in nine OECD countries at the end of 2009. The proportions of different asset classes allocated by pension funds in selected OECD countries provided in Picture 3 and Picture 4.

Pension funds' asset allocation for selected investment categories in selected OECD countries, 2009 (As a % of total investment)

Note: The GPS database provides information about investments in mutual funds and the look-through mutual fund investments in cash and deposits, bills and bonds, shares and other. When the look-through was not provided by the countries, estimates were made based on asset allocation data for open-end companies (mutual funds) from the OECD Institutional Investors' database. Therefore, asset allocation data in this Figure include both direct investment in shares, bills and bonds and cash and indirect investment through mutual funds.

1. The "Other" category includes loans, land and buildings, unallocated insurance contracts, private investment funds, other mutual funds (i.e. not invested in cash, bills and bonds or shares) and other investments.
2. Data refer to 2008.
3. The high value for the "Other" category is mainly driven by land and buildings (11%) and other mutual funds (8%).
4. The high value for the "Other" category is mainly driven by outward investments in securities (26%), for which the split between various securities is not available.
5. The high value of the "Other" catoegory is mainly driven by unallocated insurance contracts (22%).
6. The "Shares" category includes all mutual funds' investments, as the split between various securities is not available.
7. The high value for the "Other" category is mainly driven by loans (30%) and other mutual funds (16%).
8. The high value for the "Other" category is mainly driven by private investment funds (46%).
Source: OECD Global Pension Statistics.

Picture 3. Pension funds' asset allocation for selected investment categories in selected OECD countries, 2009[4]

Public pension reserve funds' asset allocation for selected investment categories in selected OECD countries, 2009 (As a % of total investment)

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1. The "Other" category includes structured products, land and buildings, private investment funds, loans, unallocated insurance contracts, and other investments.

2. The high value for the "Other" category is mainly driven by private investment funds (17%).

3. Data refer to June 2009. The high value for the "Other" category is mainly driven by private investment funds (27%).

Source: OECD Global Pension Statistics.

Picture 4. OECD Pensions at a Glance, Retirenment-income Systems in OECD and G20 Countries, 17 March 2011[5]

Analyzing assets allocation portfolios, the survey of investment regulation of pension funds [6] which contains information about quantitative portfolio restrictions applied to pension funds in OECD and selected non-OECD countries as of December 2010, revealed that Belgium, Germany Pensionsfonds, Luxembourg’s savings companies with variable capital (SEPCAVs) and pension savings associations (ASSEPs), Netherlands had the most flexible rules to select assets for the investment portfolio. Countries mentioned above do not have portfolio limits on pension funds in equity, real estate, bonds, retail investment funds, private investment funds, loans or bank deposits and only some restrictions are applied in Australia, Canada, Ireland, United Kingdom and United States.

Even though everyone has got the same objectives to preserve savings and grow portfolio of assets, the assets allocated in pension funds and returns during the period of 2008 - 2009 are a clear illustration how much savings for the future comfort depend on the market conditions. If returns from liability matching assets, id est bonds, credit, swaps and cash collaterals are below the inflation rates and gains are equally expected as losses from the investment in equities and high yield debts those value related to the markets state, and furthermore, if perfect diversification is equal to zero, how effective is management of savings and how practical pension funds’ reliance on markets’ growth?

The answer regarding the growth of closed financial systems may be the following – the growth of the system is possible as much as it could be inflated until it burst, as long as we keep on persuading that the financial system with a constant amount of money is the system without limits.

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[1] OECD Pensions at a Glance, Retirenment-income Systems in OECD and G20 Countries, 17 March 2011

http://www.oecd-ilibrary.org/finance-and-investment/pensions-at-a-glance-2011_pension_glance-2011-en

[2] OECD Pensions at a Glance, Retirenment-income Systems in OECD and G20 Countries, 17 March 2011

http://dx.doi.org/10.1787/888932371234

[3] OECD Pensions at a Glance, Retirenment-income Systems in OECD and G20 Countries, 17 March 2011

http://dx.doi.org/10.1787/888932371234

[4] OECD Pensions at a Glance, Retirenment-income Systems in OECD and G20 Countries, 17 March 2011 http://dx.doi.org/10.1787/888932371215

[5] OECD Pensions at a Glance, Retirenment-income Systems in OECD and G20 Countries, 17 March 2011 http://dx.doi.org/10.1787/888932371215

[6] OECD Survey of Investment Regulation of Pension Funds, June 2011

www.oecd.org/dataoecd/9/1/48094890.pdf