MF Global’s bankruptcy – a fail or a mirage?

A mission of MF Global to bring superior market access as well as to provide the powerful trading and hedging solutions to its clients came to the end with the authorization of the board of directors to file for Chapter 11 Bankruptcy Petition on October 31, 2011. According to the quarterly report, MF Global experienced a $191.6 million net loss and Moody’s Investors Service and Fitch Ratings cut the firm’s credit rating to the junk. MF Global announced that regarding to the Europe’s debt crisis, its $6.3 billion worth Short-Term European Sovereign Portfolio deteriorated and the company failed to raise additional capital. However, making loss in derivatives’ trade is almost impossible.

Strike price and date of expiry matter in derivatives’ trading as long as puts, calls and forwards are related through the put-call parity. This relationship gives flexibility to transform derivatives and gain from whatever the circumstances in the markets are. Moreover, according to the balance sheet for the second quarter of 2011, Revenues, Net of Interest and Transaction-Based Expenses comprised $205.9 million which shows that performance from its main activities was profitable. Additionally, the $133.5 million worth Employee Compensation and Benefits made up more than a half of net revenues, the $6.3 billion short-term European Sovereign Portfolio comprised 15% of the $41.05 billion total assets while the $1.2 billion total equity accounted for 2.9% of the total assets.

Bloomberg reported that MF Global performance is under investigation by U.S. regulators after it filed for bankruptcy protection. The news that the company violated requirements to keep clients’ collateral separate from its own accounts was published on the 1th of November and more mismatches regarding publicly available information and reality may be discovered.

The aspects of money supply policies

A message delivered on the 27th of October that the firepower of the Europe’s rescue fund will be increased to 1 trillion euros, the bondholders will accept a 50 percent loss on their holdings of Greek government debt, the European banks will be recapitalized to meet the target of the core Tier 1 capital equal to 9 percentage of assets, the bond purchase of distressed European countries will be maintained by the ECB and the EFSF as well as expectations that the IMF and countries those possess excessive foreign exchange reserves will support the European leaders plan revitalized financial markets. It also revealed how political decisions are flexible according to the external threats and prevailing demand to keep stability. As long as the intermediation role of the financial institutions in macroeconomic development is incontrovertible, different aspects of money supply policies should be considered.


A pool of traditional deposit funding might be increased by the securitization of various types of debt including the banks’ debts those are sold to the investors. However, increased money supply through market based funding can limit investors’ ability to estimate risks. Off-balance sheet treatment for securitization as well as guarantees those are provided from the issuer may hide the leverage of the securitizing firm, accordingly encourage risky capital structures. Moreover, debt securities depend on the market valuations, thus investors, including financial institutions, may experience significant losses those could have contagious effect.

In general, the money supply depends on the requirement to keep percentage of deposits that banks required to hold as reserves. The higher the reserve requirements, the tighter the money supply which may result to the decrease in lending and restrictions for business development if banks are not able to raise required capital in the markets. Moreover, considering the context of international businesses, the multipliers’ principle in one region may not have impact on its domestic economy growth; consequently increased capital requirements could mainly be associated with the strengthening banks' solvency.

The steering short-term money market interest rates and responding to the demand for the money is the other mode of money supply. Central banks buying government securities or other financial instruments through open market operations increase liquidity in the markets. However, such measures may create conditions for passive governance when central banks respond to the demand of money supply instead of being proactive and generating monetary policies those could relieve current economic circumstances and shift trends to the desirable outcomes.

Proposals of the G20 Finance Ministers’ meeting - temporary solutions to avoid default

The G20 official website provides only the calendar of the G20 meetings and therefore leaving the rest of the public only with expectations regarding the agenda. Moreover, reports about discussed issues and reviews of official statements are also primarily released by public media. However, the main idea of this article is not to criticize the publicly available information. The most important is the objectives of the meetings and the content of proposals discussed.

According to the public media, the G20 Finance Ministers mainly discussed the Europe’s plan to handle sovereign debts and banks stability in the meeting held on the 14th-15th of October in Paris. The solution for European banks to write down Greek debt was discussed alongside with the proposals to support capitalization of the banks those need to be protected against banks' exposures to other bad European countries sovereign debts. It was proposed to enhance the European Financial Stability Facility and leverage the fund for the insurance purposes to protect investors against European debt losses. The considerations regarding the write down of Greek debt ranged from a 21% to 50% were taken and additional options such as exchange of Greek bonds for new debt at a lower face value collateralized by the euro area’s AAA-rated rescue fund, or to set up an European-level backstop capitalized by the rescue fund were discussed. According to the final option the established entity would have the power to take direct equity stakes in banks and provide guarantees on bank liabilities. The IMF officials estimated that additional €100 billion to €200 billion in extra capital is needed to recapitalize banks.

Equilibrium is required to sustain well functioning systems. However, the transfer of possible default from sovereigns to banks and the transfer of banks losses to the European level backstop entity is just a temporary solution to avoid the announcement of the default until clear proposals to boost competitiveness of the region by improved conditions for the capital inflows through stimulation of investment in new technologies and optimization of processes are not accepted.

Financial transactions are zero NPV and do not have direct effect on the GDP growth

The released Federal Reserve’s decision on the 21th of September to purchase $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell the same amount of Treasury securities with remaining maturities of 3 years or less by the end of June 2012, called as operational twist shrank equity markets, dropped market value of corporations and slashed wealth of investors. The Federal Open Market Committee intended to support stronger economy growth by pushing down long term interest rates those could stimulate borrowing. In the judgement of the stock markets, the Committee approved economic recession. However, do slumped stocks markets equivalent to the state of economy?


A yield curve which is a benchmark for banks to determine interest rates on loans is a prime indicator in financial decisions. If it is expected that the term structure of the US interest rates become more flat and long term interest rates fall in the future companies will not be willing to take long term loans at the present. Borrowers would better choose a short term loans and take new loans only after the long term rates fall down. Moreover, yields of the US Treasury securities are already relatively low.

In general financial transactions are zero NPV and additional value is created by the choice of assets’ allocation but not by the choice of financial recourses or financial securities. Thus, the decision to change the portfolio of the Federal Reserves’ assets and the meltdown of the stock markets do not have direct effect on the GDP growth.

Coordinated quantitative easing – will intended actions lead to expected outcomes?

Coordinated actions were agreed by the European Central Bank, the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to save the European banking system from the US dollar liquidity crisis on Thursday, September 15. Three fixed rate tenders to repurchase eligible collateral with a maturity of approximately three months will be organized to provide dollar liquidity. Is this decision a strong signal to stop lending in the US dollars, or otherwise – incentive to provide more loans denominated in the US dollars?

European banks need the US dollars to fund dollar-denominated loans and other obligations. So, here we come to the QE3, the monetary policy to stimulate economy by additional injection of money. In this particular case, the agreement is achieved by the five major central banks. The coordinative actions to increase the US dollar liquidity in the markets set the depreciation trend of the US dollar. Moreover, this fact combined with the US Federal Reserve’s promises to keep low interest rates until 2013 creates a huge stimulus for investors to borrow further in the US dollars. According to that demand, banks may have great incentives to provide loans denominated by the US dollars and a closed cycle when more and more liquidity is required to sustain stability of the banking system may be established.

However, how much those decisions stimulate domestic economies? The depreciated US dollar should ease the US export while domestic economies of the rest parties are driven by domestic businesses conducted in their own domestic currencies. So, most likely provided the US dollar liquidity will not stimulate the other parties’ domestic economies.

Hence, once the US dollar liquidity issue is solved by the quantitative easing decision mentioned above, shouldn’t it be imposed restrictions to engage in new obligations denominated by the US dollars in the rest parties at the same time so, that the intended actions led to expected outcomes?

Stagnation in the financial markets is a cure for experienced recession

Economic growth is supported by well functioning financial markets. So, coordinated measures to restore the stability of the international financial markets remains the main subject for the G7 finance ministers and central bank governors to discuss on the annual summit in September 9-11, Marseille. However, could the current economic climate be recovered in recent turmoil in financial markets and insufficient liquidity? I guess that it is possible and is already underway.

Market values are driven by public expectations. So, according to the recent excessive volatility, market self regulation mechanism come into play.  Investors those consider that market value does not reflect the true value of assets, avoid possible lost by investing in mistrusted financial markets.  It follows that the crash of stock markets should encourage investors to seek investment opportunities those are independent from market valuations. Consequently, investments in private equities should increase.  

Even though, investment in private companies is illiquid, direct investment in business development, participation in business management and control of business performance might be an attractive option. Investors may expect reliable and steady returns related to cash flows generated from invested capital and avoid market risks due to undervaluation of assets.

As a result, stagnation in the financial markets might become a cure for current economy recession when the attention of investors is focused on direct control and improved management of attractive investment opportunities.
 

Banks recapitalization – market value matters

The recent financial markets' volatility forced Greece, Belgium, France, Italy and Spain to extend bans on short-selling. The updated news regarding the measures taken by EU competent authorities to prohibit market abuse were published on the European Securities and Market Authority’s website on August 25, 2011. The other warning to shield financial institutions was reported by Christine Lagarde. The Managing Director of the IMF encouraged speeding European banks’ recapitalization at the Federal Reserve Bank of Kansas City’s annual conference in Jackson Hole on August 27, 2011. So, are the fears of the financial system’s collapse reliable and are protective actions reasonable?

One of the main ratios to capture the value of a public company is the price-earnings ratio (P/E), which is equal to the market capitalization divided by the net income. If a company generates steady cash flows and its share price falls it may seem that undervalued stocks are an attractive investment opportunity. However, danger may lie in its leverage. A company defaults once the market value of its liabilities exceeds its assets. Such being the case retained earnings may be used to increase capital, or the firm can issue new shares if it has access to the capital markets. Thus, the market value of debt-equity ratio is very important as it reflects a company’s solvency.

An inaccurate measure of a bank’s solvency may arise according to the leverage ratio which is introduced by the Basel Committee on Banking Supervision in the Basel III: A global regulatory framework for more resilient banks and banking systems. A measure of the minimum Tier 1 leverage ratio of 3% is based on banks' accounting balance sheets these do not reflect the performance of the market.

Market value matters for public companies. Banks recapitalization should not be ignored.