Swine Flu - Update

The markets are pricing in a 40% chance of 5000 or more cases of Swine Flu be end June.

Irish EU Commissioner McCreevy proposes new Directors Pay Guidelines

These are new guidelines but the Commissioner will propose they be enshrined in law soon. 

The guidelines apply to all financial undertakings having their registered office or head office in an EU state. 

The main elements of the bankers' guidelines include:

-- payment of the major part of the bonus should be deferred to take into account risks linked to the underlying performance through the business cycle;

-- performance measurement criteria should privilege longer-term performance of a company;

-- financial institutions should be able to claim back already paid bonuses where data has been proven to be manifestly misstated;

-- a company's board should have responsibility for oversight of remuneration policy throughout the bank;

-- board members and other staff involved in the design and operation of remuneration policies should be independent;

-- remuneration policy should be adequately disclosed to stakeholders;

-- supervisors should ensure that financial institutions apply the principles on sound remuneration.

-- severance pay in cases of failure ot be banned

-- a minimum vesting period of at least three years on stock options and shares with some retained until employment ends.

-- Companies should also be allowed to reclaim the variable component of a director's pay

-- non-executive directors should not receive share options as part of their remuneration to avoid conflicts of interest. 

Ireland to Shrink Most of Any Economy Since 1930’s

Ireland’s economy may suffer the biggest decline of any industrialized country since the Great Depression of the 1930s, according to the Irish Economic & Social Research Institute.

Here are a few of the dreadful projections…

·          GDP is set to decline 8.3 percent this year they believe.

·          Ireland's economy is expected to shrink by 11.6 percent 2008-2009.

·          Ireland’s economy will contract by 14 percent 2008-2010.

·          Unemployment is set to increase to 13.2% this year-17% in 2010.

·          Our budget deficit will hit 12% of GDP.

Remember that Ireland was once the fastest growing economy in the euro region.  While Ireland is an open economy (3rd most open in the world behind Hong Kong and Singapore) and therefore exposed to the global situation the driver of the Irish problem is construction, the same sector that drove the boom.

Also a 10 percent contraction from its peak crosses the line that is often used to distinguish between a recession and a depression. 

Due to our particular predicament our Government needed to increase taxes recently, and will increase them further in the October budget, and at the same time reduce spending. However they got the balance wrong. Increasing taxes reduces the chances that employers can achieve the pay-cuts that are needed to make Ireland competitive again. We desperately need to increase our competitiveness if we are to avail of an export-led recovery if and when the rest of the world bounces back.

But as Paul Krugman recently noted the “troubles of the Irish banks are largely responsible for putting the Irish government in the policy straitjacket they are in”.

In September the government offered to guarantee deposits at Irish banks which equates to a notional liability equal to twice our G.D.P. The combination of deficits and exposure to bank losses raised doubts about Ireland’s long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies.

Earlier this month the government simultaneously announced a plan to set up a bad-bank to buy the bad assets from our banks while raising taxes and cutting spending, to reassure our lenders.

So what can we do?

1.       Reduce our spending and increase our competitiveness. This requires severe government spending cuts alas.   

2.       Remember that like the boom, this bust will not last forever. It will be painful while it does. Our standard of living will reduce by 20% perhaps. 

3.    Don’t let the negative news get us down. Our morale and spirit is our most important resource now to get us out of the mess.

$50 to $46,562 in 2 years on Intrade.

I was reminded this morning of a member (lets call her “Mrs. Midas” for this note) who made one deposit of $50 on 1st March 2007. As of 31st March, Mrs. Midas has an account balance of $46,562.30.

Mrs. Midas has made no other deposits, nor has she made any withdrawals. She has paid the exchange $4,463.66 in trading fees during this time.

During the two years since the initial deposit she has traded against 1,061 of other traders. The successful member traded on 516 separate markets covering economic, financial, political, entertainment, legal and current event categories on Intrade.

While this member was unprofitable on 38% of markets traded, a demonstrably disciplined cash and investment management approach contributed to the superb performance of her account.

The growth in her account balance and the dispersion of profitable markets to unprofitable markets traded are depicted below.

Deflation Most Likely, But What (and When) about Inflation?

Most (as do we) believe that the risks of deflation are far greater than inflation currently. However, if the vastness of the quantitative easing and other “unconventional measures” being taken by central banks cause to much money to be printed then inflation expectations might and I mean might just ignite.

There are of course many other reasons why expectations of inflation may ignite, e.g. people start believing that the global role of the US dollar is undermined.

So while we predict that deflationary pressures will be with us for quite a while when will inflation raise its head and what types of markets would you like us to list on these topics?

Please let us know here.

Source: Google Trends

We and Others Know How To Get Credit Flowing Again - We Think!

Now that governments around the world have declared they won’t let banks fail, at least certain banks that is, credit should start flowing between these banks naturally at national and international levels. But the credit is not flowing yet and this is due to lack of confidence between the banks.

This lack of confidence is due to lack of timely and accurate financial information (aka transparency) relating to the quality of the balance sheets of banks. Bank A will not do business with Bank B because of fear that B may be unable to honor its obligations due to toxic assets (aka bad loans or derivative positions) or go out of business even though Bank B’s government has bailed it out before.

But if governments (central bank’s, treasury’s, etc) are already acting as an insurer of banks through bailouts what is needed is to go one step further. This need not cost more per se. That step is moving bank to bank lending and borrowing onto a central market place where all transactions are guaranteed by a clearing house. In financial speak, move bilateral over-the-counter interbank trading onto an exchange with a central clearing house and clearing members.

Sure, there would be implementation issues like who would manage the exchange (While Intrade is happy to help ;-) perhaps the G20 could establish), who would be the clearing members and what banks would get trading rights. Also the thorny problems like would or should Ireland be able to join with our current precarious (albeit exaggerated) position? It should also be a pre-requisite for any bank to get approval of their guarantor Government before they can trade on the interbank platform to provide the very best financial information about its assets and liabilities.

Access to the market would create massive incentives for governments and banks to “come clean”. The incentives are access to credit and comfort when giving credit. If Japanese banks had such an incentive in the 90’s would they have recognized their debts earlier and would this have shortened their lost decade?

So, if what is needed is more transparency and trust then use an exchange with a clearing house. They work elsewhere. They have a big role to play here now we think.

What do you think?

European Banking & Deposit Guarantees

There is justifiable discussion surrounding the Irish (and other EU members) banking industry and the government guarantees supporting customer deposits. 

This is a very important issue for Intrade.  It is one that we monitor closely on a daily basis. We do not take risks with customer funds.  We have diversified the institutions where we hold segregated customer funds and the underlying government guarantees are not all from Ireland. 

In the unlikely event of a single bank where we maintain funds defaulting and the government (Irish, Danish, UK or wherever) who has guaranteed those funds being unable to honor its guarantees (including an inability to access national reserve fund assets, support from the markets, from fellow members of the EU or the ECB itself etc) it is theoretically possible that all funds we have placed on deposit would not be easily accessible. In such a remote eventuality then the company from its own capital base (held at various institutions) would cover any theoretical shortfall. 

While I appreciate the above is hypothetical, and I believe highly remote, on a far more practical level let me make a very respectful suggestion, one that I do not make facetiously or glibly. For anyone who is seriously worried about the full recoverability of their funds at any institution, Intrade included, they should periodically test the institution in question by seeking a withdrawal in whole or part. 

Perhaps the above comment may be taken and reported on as a recommendation to withdrawal funds from Intrade or other institution, but my motivation is not to cause withdrawals but to encourage the people who have understandable concerns to remove those concerns by considering risk reduction actions. 

As additional information becomes available I will post it here. 

Personal note:  I personally bank at the retail level the same banks where Intrade segregated customer funds are maintained at the corporate level. I do not believe the banks where Intrade segregated customer funds are maintained have any material default risk although I do believe further recapitalizations will be required. Furthermore I do not believe the Irish government will be unable to access additional funds to finance our growing deficit but I am aware that Irish credit default swaps.  

The following article from Bloomberg this morning is insightful. 

Germany and France may be forced to contemplate the bailout of entire nations rather than just individual banks as European government budgets buckle under the weight of recession.

German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic this week, saying some of the 16 euro nations are “getting into difficulties” and may need help. French officials are also concerned about market tensions as the cost of insuring Irish, Greek and Spanish debt against default rises to records and bond spreads widen.

The nightmare for Angela Merkel and Nicolas Sarkozy is that widening deficits will prompt investors to shun the debt of some countries, sparking a region-wide crisis. While few investors are yet forecasting any defaults, the mere risk of it may prompt the bloc’s two richest economies to ignore the European Central Bank and announce their willingness to come to the rescue.

“When push comes to shove Germany, France, the larger players will bail out those smaller peripheral players,” said Alex Allen, chief investment officer of Eddington Capital Management. “You can’t let one part of the system fail because it leads to failure of the whole system.”

Allen’s betting that the risk at least one nation will leave the bloc is higher than the market currently expects.

Swelling Deficits

European deficits have ballooned as governments from Berlin to Dublin committed more than 1.2 trillion euros ($1.5 trillion) to save their banking systems from collapse. The situation will be underscored by the European Commission today, when it publishes a progress report on budget policies at 11.15 a.m. in Brussels.

The European Union’s executive arm forecasts a deficit of 11 percent in Ireland, 6.2 percent in Spain and 4.6 percent in Portugal this year. The euro region’s average budget gap was just 0.6 percent in 2007.

European officials have already expressed concern that their bond market could potentially face a crisis similar to that unleashed by the collapse of Lehman Brothers Holdings Inc. in September. ECB board member Lorenzo Bini Smaghi said Feb. 12 there’s a “risk that the mistrust that there is today in financial markets” is “transformed into mistrust in states.”

“I would be very reluctant to say: ‘O.K., let Ireland or Greece default, the market will sort it out, punish them for their irresponsibility of the past,’” said Thomas Mayer, co-head of global economics at Deutsche Bank AG in London. “They tried it with Lehman and realized that was not a good idea.”

Bond Spreads

The gap between the interest rates Greece, Austria and Spain must pay investors to borrow for 10 years and the rate charged Germany yesterday rose to the widest since before they adopted the euro. Credit-default swaps on Ireland rose to a record on Feb. 16, climbing to 378.4 points.

Greek credit-default swaps, 270 points on Feb. 16, show a 4.5 percent chance that the country will default in the next 12 months, according to ING Bank NV.

Eddington Capital’s Allen, who runs a fund of hedge funds, says the market currently “vastly underestimates” the risks and expects credit-default swaps for Greece, Italy, Spain and Portugal to double in the next 12 months.

Any state-funded rescues may meet with opposition from the ECB, which has repeatedly said the Maastricht Treaty forbids bailouts.

“The no bailout rule is an important pillar on which the European Union was founded,” says ECB Executive Board Juergen Stark, who helped draw up the fiscal rules underpinning the euro.

No Bailout?

At the same time, the treaty says that EU nations can grant financial assistance to a member state if a country is “threatened with severe difficulties” caused by “exceptional occurrences beyond its control.”

“The member countries are working hard on a ‘pre-emptive de facto bailout’ to prevent the test of the ‘‘no bailout’’ clause,” said Juergen Michels, an economist at Citigroup Inc. in London.

Part of the problem policy makers now face stems from the fact the currency union does not have a single treasury and relies on the Stability and Growth Pact, which has been breached in the past, to keep budgets in check. Billionaire investor George Soros said yesterday the region’s economy must confront the problem posed by the lack of a Europe-wide finance ministry.

For now, finance officials say that market concerns are not justified. ECB President Jean-Claude Trichet said in Rome on Feb. 14 he’s confident countries will work towards sustainable public finances.

State Rescue

Greek Finance Minister Ioannis Papathanasiou said three days earlier the extra interest rates on his country’s debt were unjustified. Spain’s Deputy Finance Minister Carlos Ocana categorically ruled out a default on Feb. 16, and the Irish Finance Ministry warned yesterday against drawing conclusions about public finances from the CDS market.

Steinbrueck’s comments nevertheless suggest that views in Berlin are shifting as the financial crisis worsens.

“In reality the other states would have to rescue those running into difficulties,” he said Feb. 16. Steinbrueck said that Ireland was in a “very difficult situation.”

“There will have to be some kind of support package for some of the smaller economies to avoid the tension and speculation about breakup,” said Ken Wattret, senior economist at BNP Paribas SA in London. “The bigger national governments will say this isn’t our problem. But when push comes to shove they might need to provide some kind of financial support.”

To contact the reporter on this story: Emma Ross-Thomas in Madrid aterossthomas@bloomberg.net