mandag den 22. december 2008

IMF awakening to fight the Weapons of Financial Mass Destruction

(Picture: Icelandic SUV's parked after the crisis - source: IMF)

According to a number of speeches from high level officers within the IMF these last few days, IMF has finally realized the magnitude of the financial crises, and at a meeting in Madrid on December 15, the managing director of the Fund, Dominique Strauss-Kahn was cited to have said that the international community would have to come up with at least 2% of the Worlds’ expected total GDP in order to combat the crisis.

A few days before this speech, his first deputy director, John Lipsky, addressed a conference in Steigenberger Hotel, Frankfurt via a Videoconference link from Washington D.C. He stressed the severity and depth of the crisis, loss of consumer confidence and the impact on the emerging economies. He said:

“In November, the IMF revised down its forecast for global growth, less than a month after the publication of its October World Economic Outlook. Based on current policies, the world economy is projected to grow by 2¼ percent in 2009, down from about 5 percent in 2007, before picking up in 2010. The major advanced economies are in recession, and activity is expected to contract by ¼ percent on an annual basis in 2009, marking the first annual contraction in the post-war period for this group of countries.”

The most interesting part of his pitch was the underpinning of the need for what he called a reform of the financial architecture:

These include the design of financial regulation; the assessment of systemic risk; and creating mechanisms for more effective international action to reduce the risk of crises, and to address them when they occur.

Financial innovation and integration also have increased the speed and extent to which shocks are beingtransmitted across asset classes and countries, and have blurred boundaries, including between systemicnon-systemic institutions. Regulation and supervision, however, remain geared at individual financialadequately consider the systemic and international aspects ofdomestic institutions' actions. ...

The challenge, therefore, is to design new rules and institutions that reduce systemic risks, improve financial intermediation, and properly adjust the perimeter of regulation and supervision, but without imposing unnecessary burdens.”

What John Lipsky is pointing at is that one of the most important powers beyond the speed of of the crisis are the so-called financial derivatives combined with a lack of international assessment of the real risk of these ‘inventions’. He stated that the crisis has underscored the tension between globally active financial institutions and nationally bounded regulators and supervisors.

And his final sentence was:

“Enhanced information provision will also be important for improving the assessment of any build up of systemic risks. This will require reviewing transparency, disclosure and reporting rules. Information requirements will also need to cover a larger set of institutions, from insurance companies to hedge funds and to off-balance sheet entities.”

This very much reflects my own earlier remarks on the need for a complete restructuring and possible combination of IMF, G20 and the World Bank with equal voting rights also for the BRICcountries.

Dominique Strauss-Kahn’s speech in Madrid on December 15 had similar and maybe even more stressing points; the purpose of the meeting was to celebrate Spain’s 50th anniversary as member of IMF. Dominique Strauss-Kahn said that action is needed on three fronts to prevent the current recession turning into a global depression:

• Coordinated government intervention in financial markets to get credit flowing and support bank recapitalization

• Fiscal measures to offset the abrupt fall in private demand

• Liquidity support for emerging market countries to reduce the adverse effects of the widespread capital outflows triggered by the financial crisis.

In some of the starkest language he has used since the crisis erupted, Strauss-Kahn said governments around the world have endorsed this agenda, most recently at the November meeting of the Group of 20 (G-20) industrialized and emerging market countries in Washington. "Many have begun to implement it. But the actions taken so far are not enough. We need more," he said, according to the text of remarks as prepared for delivery.

According to the most recent IMF forecast, the major advanced economies are expected to contract by ¼ percent on an annual basis in 2009, marking the first annual contraction in the post-war period for this group of countries. But with the effects of the crisis spreading rapidly, IMF First Deputy Managing Director John Lipsky has said that the Fund is likely to revise downward its global forecast when it announces new numbers next month.

"We are facing an unprecedented decline in output, we have evidence of substantial uncertainty limiting the effectiveness of some fiscal policy measures, and we anticipate that the negative growth effects will last for some time. For all of these reasons we are calling for stimulus measures that are large and diversified, and that will last longer than one or two quarters," said Strauss-Kahn.

His main points were that a lot of fiscal measures can be effectively applied to maximize the multiplier effect of different fiscal measures. Actions could include support to housing and finance; transfers to low-income families, greater provision of unemployment benefits, improved tax benefits for low-wage earners, and expansion of benefits and spending on major projects—particularly those that are already planned and could be implemented quickly, as time is everything.
But the IMF would not recommend reduction in corporate tax rates, dividends and capital gains taxes, or special incentives for businesses. "These are likely to be ineffective and difficult to reverse," Strauss-Kahn said. This is quite remarkable considering the pressure on Washington to help the troubled car makers in US. Let us look at the indications from IMF that the real problem behind the crisis might be the so-called derivatives.

Looking into the history of derivatives we find some real horrors – not least in the reason for why they were created in the first place. Of course neither IMF nor any of the heavy weights in the Financial Sector had warned (sufficiently) or earlier against these derivatives, except a few remarkable persons, which I will come back to.

But these days the papers and blogs are filled of stories like this one:

The 58 Trillion $ Elephant in a room

Jesse Essinger has a fine description of what compared to these 58 Trillions $ elephant in a room:

“The history behind the derivatives seems to be an invention by a team of JP Morgan’s top economists around 1995 at a time when Morgan’s books were under pressure; they had reached the practical maximum of guarantees to private companies, and if they extended these credit lines, they would very soon run the risk of crossing the line of solvency according to standard regulation terms.

So the idea that the team came up with was derivatives”

The idea behind the construction is that if you can sell somebody a lottery ticket that the guarantees you issue to a third party company and that other wise should have been shown on your books, now gives you the opportunity to keep your guarantees and credit lines to lenders out of the books, and in this way leverage your equity way beyond what the normal national financial rules would allow. And as you sell these lottery tickets all over the World in a global sweepstake, other financial institutions can make additional lotteries out of the original lottery making it completely impossible to estimate the real risk. The 58 Trillion Dollars is probably on the low side.

Jesse Essinger collected this interesting timeline of the derivatives and what created a need for them: (View an interactive timeline of derivatives.)

What is interesting to note is that it was far down the road before the real poison of the derivatives finally dawned on Wall Street. And Paulson, Treasury Secretary, didn’t recognize it even if the system was collapsing around him. The deal makers continued selling derivatives during the melt down. But somebody did notice the problem behind the derivatives.

As early as in 1998 Long Term Capital Management (“LTCM”) encountered financial difficulties that required a bailout by banks, orchestrated by the Federal Bank of New York. LTCM is now forgotten and the lessons were forgotten surprisingly quickly.

Also this link contains the story of Amaranth: (Edited by Satyajit Das, the author of ‘Traders, Guns & Money’ Buy his book here:

“Amaranth was a multi-strategy hedge fund. Amaranth Advisors started life as a convertible arbitrage fund (a relatively low risk trading activity). The fund was a recent entrant into energy trading – an infinitely more volatile activity. Just before it blew up, the hedge fund had assets of $9.2 billion. Amaranth's investor base is believed to include funds of funds at major investors such as Goldman Sachs, Morgan Stanley, Credit Suisse, Bank of New York, Deutsche Bank and Man Group. Amusingly, Amaranth claimed to have “best-practice” risk management.

Risk Models – Nick Maounis after the losses surfaced, noted: “Although the size of our natural gas exposure was large, we believed, based on input from both our trading desk and the stress testing performed by our energy risk team, that the risk capital ascribed to the natural gas portfolio was sufficient”. It is questionable that the risk models used were appropriate. For example, correlation risk (one of the main risks in relative value trading) is not generally well captured in traditional risk models. A cursory review of the events shows the inherent limitations of the risk models used. Amaranth took approximately 80 trading days to make $ 2 billion through the end of April and approximately 20 trading days to lose $ 1 billion in May 2006. Amaranth also took twelve trading days to lose a reported $4.44 billion through September 18th or a daily average of close to $ 370 million. Further, when the sale of the energy book was announced on Wednesday, 20 September, the losses were approximately $6 billion and the average daily loss for September expanded to $ 420 million per trading day.”

The story of derivatives also contains other names of interest – Robert Reoch and Blythe Masters seem to be the most notorious:

Robert Reoch

Blythe Masters Called: 'The woman that invented the Weapon of financial Mass Destruction'

As the story goes: “In 1997, she and a team developed many of the credit derivatives that were intended to remove risk from companies' balance sheets. The idea was to separate the default risk on loans from the loans themselves. The risk would be moved into an off-balance sheet vehicle. The product was called Bistro, otherwise known as broad index secured trust offering.

In a guide to understanding the instruments she had created, Masters sung their praises: "In bypassing barriers between different classes, maturities, rating categories, debt seniority levels and so on, credit derivatives are creating enormous opportunities to exploit and profit from associated discontinuities in the pricing of credit risk."

The banks argued that by trading credit derivatives of the kind pioneered by Masters, they had spread their risk elsewhere and therefore needed lower reserves to protect against loan defaults. Regulators rolled over and the banks loaned ever more. It was a huge success and the market for credit derivatives grew rapidly.”

Follow this link and read Elana Centors article on Blythe Masters: On the game plan for derivatives:

It is fantastic to read Blythe Masters comment on her invention: “By enhancing liquidity, credit derivatives achieve the financial equivalent of a free lunch, whereby both buyers and sellers of risk benefit from the associated efficiency gains.

But she wasn’t alone – read about: Bill Demchak – co-inventor of derivatives . And learn about Bill Demchak’s status since 2002: See Bill Demchak Forbes notes

Already in 2002 the Market for derivatives was exploding:

At stake is the unfathomable $56 trillion notional value of derivatives contracts between U.S. commercial banks and counterparties, measured by the Office of the Comptroller of the Currency at the end of 2002. The entire market, around the world, is estimated at over $100 trillion. But such notional amounts--the face amount of the underlying security--are rarely realized

But also Alan Greenspan: did what he could to let the derivatives go on the run: In 1994, a bi-partisan bill was introduced in Congress to tighten the supervision of the complex and growing derivatives in the banking industry. The bill would have had the regulatory agencies establish standards for capital requirements, disclosure, accounting and examinations and audits. As expected, the banks argued that no new laws were needed. Greenspan sealed the legislation's defeat by testifying that the Fed had the powers it needed and that a taxpayer bailout caused by derivatives was remote.
Read the comments on Forbes here. (“The great Derivatives Melt down”)

As a closing conclusion on these ‘Weapons of Mass Destruction’ (More real than some other WMD) – a PDF from the originator, JP Morgan’s Guide:

JP Morgans Guide to credit derivatives

Where you can read as their conclusion:

“The use of credit derivatives has grown exponentially since the beginning of the decade. Transaction volumes have picked up from the occasional tens of millions of dollars to regular weekly volumes measured in hundreds of millions, if not billions, of dollars. Banks remain among the most active participants, but the end-user base is expanding rapidly to include a broad range of broker-dealers, institutional investors, money managers, hedge funds, insurers, and re-insurers, as well as corporates. Growth in participation and market volume is likely to continue at its current rapid pace, based on the unequivocal contribution credit derivatives are making to efficient risk management, rational credit pricing, and ultimately systemic liquidity. Credit derivatives can offer both the buyer and seller of risk considerable advantages over traditional alternatives and, both as an asset class and a risk management tool, represent an important innovation for global financial markets with the potential to revolutionise the way that credit risk is originated, distributed, measured, and managed.”

mandag den 15. december 2008

Greenland - icy Path to Independence

On November 25. Greenland held a referendum on 'Namminersorneq' – self rule. Many international observers seemed to be slightly misled by this and commented as if the Greenland community won it's independence from Denmark over night.
The purpose of the referendum was to obtain the Greenland Peoples acceptance of a new treaty between the home rule of Greenland and the Danish Government that will replace the current law of home rule from 1978. The content of the new treaty is to define the areas where Greenland step by step could take over the regulatory and administrative areas from Denmark, that is currently not covered by a treaty, which costs that Greenland will have to carry for each of these areas and which economic impact exploitation of oil (believed to be in plenty supply in North-East Greenland) will have on the Danish annual contribution to the Greenland Economy.
It also clarifies that Greenland will have the right to explore natural mineral resources.
But total independence is in no way just around the corner – the realities are too harsh.
The annual Danish contribution is 3.5 billions Dkr – about 590 Mio $, or one third of the Greenland GDP, 2/3 of the Home Rule income. Next year the Greenland fiscal plan has a deficit of 300 Mio Dkr, mainly allocated to investment in infrastructure , new water driven power plants, harbours and other items needed to attract mining industry. (Read Lars Emil Johansen’s comments to the fiscal law for Greenland for 2009 (In Danish))
So there is really not so much available to start financing new areas for many years to come – Police and Legal autonomy is estimated to cost at least 300 Mio Dkr, but the real problem is – as in many sectors – lack of skilled Greenland speaking trained policemen, judges, lawyers, administrators.
What was expected to improve this position has now been postponed for several years: The mines that would contribute to the Greenland economy by taxes on workers and spin off from investments, are faced with ice cold outlook: The Bloomberg metal ad mining index is down to 1/3 compared to spring time, the only working goldmine is closing down because of heavy deficit, and the Alcoa aluminum company that still has a LOI to start building an Aluminum plant once a couple of more power plants are installed, is faced with adverse trends, stopping new investments, closing down some facilities.
So there is not much hope for the Greenland self rule quickly to undertake new areas and being able to pay for it. Even if 75% votes yes.

So the referendum may be only little more than a political victory for the parties in Greenland that advocated for increased self rule. But as such it will be helpful for a more equal partnership with Denmark. The Greenland language will be the national language, Danish and English 2nd
and 3rd. Language. The People of Greenland will be recognized as a separate people according to the International Law. Even many resident Danes in Greenland voted for the acceptance of the treaty, and one of the stated that 'Now the handle is on the inside of the door, they are free to open it at any time!'. Some even expect the requests for support from Denmark from now on will be more realistic.

The strategic importance of Greenland has been clear since 2. World War – the Thule Radar is an important part of the US defense system ever since the Cold War and particularly since Ronald Reagan's 'star wars' project was launched. The latest treaty is dated 2004. A Greenland with substantial oil reserves would of course be even more interesting for US, and there is no doubt that the Greenland politicians are very much aware of their favorable position, particularly the more socialistic IA party would probably have hoped for a faster way to independence – but also very much aware of the risk of ending with a heavy embrace by the American neighbour.
But Greenland is also a symbol of the global warming – Al Gore was early to visit the melting glaciers, the Danish Climate Minister, Conny Hedegaard, enjoys showing her colleagues the glaciers at the Icefjord, now moving at a speed 20 times the speed in 1980'is.
It suddenly dawned on the Greenland political leaders that a part of the new treaty and earlier treaties with Denmark on the climate issues demanded that Greenland stuck to the Danish scheme of reducing the CO2 emissions. This however, may be completely impossible. Where could the savings come from once Alcoa's aluminum plant starts producing CO2 in a volume 20-40 times the current Greenland emission? As the Greenland Industry Association points out, Greenland has not yet become industrialized and should be allowed special treatment. This conflict is going to be interesting with an Obama administration in US and with Denmark hosting the UN climate conference in November in Copenhagen. From both sides the demand for CO2 reduction will be difficult to neglect.

And again, if the aluminum plants are postponed, and mines will be delayed for decades, the financing of increased independence is non-existing, and the best the Greenland Self rule Government can do right now is to invest heavily in education and try to become independent of Danish and other experts in key areas like mining, IT, transportation, construction – and administration.

The current financial crisis has not yet hit Greenland with any strength – I participated in a seminar for the ICT key players in Greenland, Nuuk last week and presented the overall problems with a particular twist on Greenland strategic options that are still open for discussion. The investment in infrastructure has called for the installation of a sea cable, and TeleGreenland expects to open this almost 1 billion Dkr. investment in March 2009. Still the radio stations transmitting the signals along the coast needs additional investments – probably around 100 – 200 Mio Dkr. during the next 5 years. This is a lot for a country of less than 60.000 inhabitants, and the political pressure from the Greenland Government to keep investing is enormous; during the last few years a GPS system for sheep farmers have been built up at a cost of 65.000 Dkr. pr. Sheep farmer. And still Tele Greenland has managed to deliver a surplus to the Home Rule – it’s only owner.

It is ironic to note that at the same time as the educational system and telemedicine suddenly becomes possibilities within reach, the politicians are trying to step in and open broadband connections to everybody as a low priced flat rate. It seems to be a recurring problem in Greenland where political participation in the major industries has been – to put it best – a very close alliance. In this case it would result in drowning the capacity and taking any sort of control out of a professional company management team. The price parameters could in stead be used as a budget support to education and health sector while TeleGreenland build up its capacity - and then eventually adjust rates downwards. Compare with the Tele Company in North West Canada that has been a heavy receiver of subsidies for decades.

But so far TeleGreenland has got its financing in place – next in line may not be so lucky – whether it is Royal Greenland, Umiaq Line, the construction sector, AirGreenland. Tourism will probably soon begin to drop slightly housing is still in short supply in the bigger cities.
In the short run the lower price of oil will benefit the fishing industry, but demand for fish is also likely to drop.
There is no doubt that even if Greenland so far is hiding behind Denmark, the global crisis will be felt. And the first victim will be the mines - and with the mines the hope of early independence.

But the Greenland people will undoubtedly struggle to protect their culture, language. If you have never really encountered this people, listen to this beautiful christmas carol performed by a choir of Greenland women in their traditional dress: Guuterput on Facebook.
Merry Christmas – Santa Claus is highly needed everywhere this year. But remember: He lives in Greenland! I met him at his home last Saturday!

tirsdag den 2. december 2008

Eurocities Annual General Meeting - Den Hague

Last week I had the pleasure to participate in Eurocities annual general meeting, this year in den Hague. Eurocities is an EU-partnership between 130+ major cities in Europe, and I have for some years had the honour to represent IBM as a coordinator, as IBM is one of 6 sponsors for a sub-orgasation, formerly Telecities now Knowledge Society Forum. Eurocities as an organization has the objective to support cities’ role in EU as one of the most important focus areas for developing high standards of living, dwelling, working.

To this end the Eurocities a year ago adopted the ‘Leipzig Charter’. This charter states that cities should be seen as cornerstones for development of well-being and a sustainable Europe. It calls for integrated approaches to development (breaking down silos between different parts of the public sector and between the public and private organizations and enterprises). It also calls for new governance principles, democratic participation in policy making and supporting citizen entrepreneurship.

To support these objectives the Eurocities conference started by an award ceremony where 3 cities where awarded for their innovative ways to solve some of these challenges:

The Finnish city Espoo won the award for their practice to bring senior citizens in contact with the cities many cultural organizations: music schools performing for elderly, sports facilities with instructors for elderly etc. a very inclusive and heart warming initiative.

The Belgian city of Gent was awarded for a very comprehensive and all-inclusive solution called ‘Gentinfo’ covering all aspects of services and information for citizens from booking books in the library, reserving day care for children, parking spaces, handling complaints and proposals etc.

Newcastle, UK won the third award for a project called ‘Udecide’ – an interesting project to involve citizens in prioritizing the budget and selecting, actually voting, between alternative ways to spend the cities money. There is a detailed study of this project available her: (Case study Udecide)

The ceremony took place in the Haag City Hall, a completely white and beautiful building created in 1995 by the US architect Richard Meier.

The official opening of the AGM took place on Thursday in the old and beautiful Steigenberger Kurhaus in Scheveningen. Mr. Jozias van Aartsen, the mayor of Hague and the next president for Eurocities welcomed the several hundred delegates, followed by Mr. Gerard Collomb, mayor of Lyon, current president and a person that has succeeded in placing the Eurocities agenda very high on the priority list in the EU Parliament and Commission. Also the Dutch Prime Minister, Jan Peter Balkenende, addressed the audience and surprised by describing his first political experiences from a small town close to Amsterdam. Finally, the newly appointed Secretary General, Paul Bevan introduced himself to the audience. He has an exciting career both in EU organizations and in setting up a successful planning cooperation organization in South East England, which he ran for 8 years.

Among other interesting speakers, The EU Commissioner for Competition, Ms. Neelie Kroes, made an interesting speech in the midst of the Financial Crisis, which of course has put a lot of pressure on her and her staff. She stressed that the wise fathers of EU and Jean Monnet in particular already from the outset put into the declaration that State Aid of private companies were forbidden, and could only be tolerated temporarily in case of an identified fault in the market. This has also been a guiding principle in the current support for the European Banks, and it is mandatory, that the EU aid and support MUST be followed by a restructuring. At the end of her speech, the representative from Newcastle rose and praised her flexibility and personal assistance to save the Northern Rock Bank, which would otherwise have put thousand of citizens in Newcastle on the street.

As the conference unfold, the 4 key areas were handled separately in a very intelligent way, as each of the working areas: Living in cities, Well-being, Environment and Health, and Working in cities were treated in break-out sessions, where each group was taken to a part of Den Hague that illustrated the problems in question, showed how this was being addressed by Den Hague, and then finishing off in meeting halls around the city.

The ‘Living’ working group was sent on a sightseeing to see the program ‘New Approach to priority Neighborhood the Hague Zuidwest’, and together with the speakers from Belfast and Rotterdam they discussed the problems of creating balanced residential areas.

The workshop on ‘Well Being’ discussed how diverse ethnical and cultural background could be seen as cohesive rather than a diverting factor in creating global cities with multi ethnical inhabitants. Den Hague has a large number of immigrants representing more than 52 countries, and together with Bristol UK and Barcelona Spain, this topic was discussed intensely.

The ‘Environment and Health’ workgroup, where I participated, drove through an area that was at a point becoming a ghetto – the Transvaal district – but where a lot of initiatives to tear down debris and build new sustainable houses with far less heat consumption and with a nice and attractive design had helped to bring up the standard. The meeting ended in a former church founded by the late queen Juliane. As the inhabitants were now mostly muslims or hindus, this was now a city service center, and the chapels have been transformed into special offices and information desks for citizens. Also the president for Knowledge Society Forum, Dr. Giuseppe Paolo presented – a case of how to avoid problems when allocation mobile sending stations, and the city of Sheffield’s representative presented a very interesting case showing the key influential factors in people’s health, unemployment being one of the major sources of diseases and health care related costs.

The strategic plan for Sheffield seems interesting for many other cities.

The working group on ‘Work’ also passed Transvaal, and the topics of the discussion were how to leverage public-private partnership to create enough jobs also for the unskilled workers and immigrants. This also included having a number of jobs to secure clean and nice local and dwelling areas, even if the jobs were subsidized, this could be shown to pay off in less crime, better quality of living. From Budapest a description on how an Office for Equal Opportunities were created , and how the cooperation between local officials, high quality social services, NGO’s and private participant could help the underprivileged to get jobs, education and housing.

From Poznan a presentation of the Barka-Kofoed Social Integration Centre (Based partly on funding from the Danish Velux Foundation) showed how this benefited unemployed and socially excluded people in the city.

Finally a Working Group on Innovations in Local Government stayed at the centre and discussed the 3 key topics of developing local community participation, how to develop integrated approaches (breaking down silos between departments and institutions) and how to develop multilevel governance. Among the speakers was the representative from Berlin that described the Quartiersmanagement project. Also Istanbul presented My Project Istanbul, a runner-up for the award on cooperation initiatives.

The last day of the conference was among topics devoted to work on an updated version of the Leipzig Declaration, and the next – Den Hague Declaration – will be published shortly, so I will come back to this in a later blog.

The Conference finished by the mayor of Den Hague, now the President of Eurocities, who thanked the participants and the chairs for the various committees/For a that had developed a status of the results from the last year.

I will look forward to the next meetings in Telecities/Knowledge Society Forum, where the more politically oriented topics will be left out and the focus will be on the practical adaptation of IT technology in the key areas of urban life. This is very much in line with IBM’s initiative called ‘A Smarter Planet’, where cities are in focus for a lot of the development during the next decade.

This is a practical way of transforming the IBM vision from ‘Government 2020’.