The root of European debt crisis

The European debt crisis has been the spotlight in the world. One question we may raise quickly is : what the hell root of this crisis? In order to answer this question, let us take a look at Finland, one of six AAA rated euro countries, which may face a similar fate to junk-graded Portugal in the next decade.

The northernmost euro member grapples with the decline in its two main industries, technology and paper.

Mobile-phone maker Nokia Oyj’s take off in the 1990s to become the world’s largest mobile-phone maker helped pull Finland out of recession. At the peak in 2000, Nokia accounted for 4 percent of Finland’s GDP. But now, the company’s days as the powerhouse of Finnish growth are over. Nokia has announced 1,900 job cuts in Finland since last year, or 10 percent of its local workforce, as its market value plunged almost 50 percent since January.

Europe’s two biggest papermakers, Stora Enso Oyj and UPM-Kymmene Oyj, was built on its forests. Since the 1960s, the country’s pulp industry has languished as emerging markets produce cheaper timber.

As the underlying competitiveness is diminishing, the problem across the Europe has been escalated in Finland: an imbalance in public finances exacerbated by the aging population. The number of workers for every pensioner will drop to three from four by 2015. That’s about five years earlier than in the rest of Europe.

While the government is not able to generate enough capitals to fund the spending, like a company, it must raise debt. In Finland’s case, it is estimated that debt will swell in 2011 to more than 50 percent of gross domestic product from 34.1 percent three years ago.

What happened in Ireland

Ireland had a AAA rating, a lower debt level than Finland and a surplus in its public sector, but then the crisis hit and the situation changed rapidly. Moody’s Investors Service cut Ireland to junk on July 2011, arguing the 85 billion euro ($119 billion) bailout may not be enough to keep it afloat. While Ireland’s plunge was linked to over-leveraged banks, its example remains relevant for economies where growth can’t keep pace with government spending.

Europe’s debt crisis has shown that failure to tackle fiscal weakness in time can force governments to impose severe austerity measures later. If there are no turnaround in the corner, Finland risks having to take emergency action” to fix its finances if the country’s budget drain isn’t fixed promptly.

So who would be the superstar to engine the Finland’s economy if the government is still struggling to find a unity need for cuts? The “Angry Birds”? Is it a lesson that the economy is focused on too few industries which is case similar to the lack of diversification in investment?

Next steps on the road to financial stability

Crises always accelerate the process of change. Two years after the collapse of Lehman Brothers, it is not surprising that the signs of a deep transformation in the financial landscape are very visible. Two main driving forces are at work.

The first is a different perception of risk. For many years an optimistic view that underestimated the level of risk and overestimated its dispersion across participants had become the conventional wisdom; that view has been wiped out by the crisis. A re-pricing of risk of all sorts, higher volatility, reduced valuation of certain assets, more careful examination of credit quality and greater attention to the longer-term sustainability of debt positions – as highlighted by the recent sovereign debt crisis in Europe – are all manifestations of this changed perception. Business models are being reassessed according to their ability to manage risk. Complexity and opacity of financial instruments are no longer rewarded; the demand for transparent, complete and accurate information has increased.

The second source of change is policy driven. After Lehman, any remaining doubts on the need profoundly to reform the financial sector were dispelled. It became clear that a common, internationally co-ordinated approach, involving both advanced and emerging economies, was needed.

At the prompting of the Group of 20 leading economies, and under the co-ordination of the Financial Stability Board, the weaknesses highlighted by the crisis are being tackled. A fundamental step was taken last weekend with the agreement reached by the Basel committee’s governing body on new bank capital and liquidity standards. These standards will markedly increase the resilience of the banking system, including by constraining the build-up of excessive leverage and maturity mismatches that proved the tinder for this crisis.
At the same time, the Lehman case reminds us that other, more deep-seated problems need to be addressed. Lehman was the first global systemically important institution that was allowed to fail during the crisis. It was also the last. The public will not, and should not, accept more such bail-outs. Addressing the problem of “too big to fail” is therefore the next central step in the reform programme.

The work under way in this area has several dimensions. First, systemically important institutions must have loss-absorbing capacity beyond the minimum standards agreed for the banking system in general last weekend. This loss-absorbing capacity could include a combination of equity capital surcharges, contingent convertible capital and mechanisms to “bail in” creditors. The former would increase the resilience of such institutions on an ongoing basis, while the latter instruments would strengthen market discipline.

Second, systemically important institutions will operate with correct incentives only if an effective resolution framework is in place. Many countries lack the powers, the tools and the operational capacity needed in this area. Effective regimes must enable the authorities to resolve financial crises without systemic disruptions and without taxpayer losses. They should include powers that facilitate “going concern” capital and liability restructuring as well as “gone concern” restructuring and wind-down measures, including the establishment of a temporary bridge bank to take over and continue operating certain essential functions. Statutory powers enabling the resolution authority to bail-in senior debt holders would expand the options for going concern resolution.

Third, we need to improve cross-border resolution capacity. Global banks have substantial operations across multiple jurisdictions and thousands of legal entities. In the absence of a global resolution regime, we need not only effective regimes at the national level, but also strong capacity for such regimes to co-ordinate across borders. Assessments of resolvability are part of the recovery and resolution plans being developed by and for the largest international financial institutions. If home and host authorities deem that a bank’s structure is too complex to be resolved in an orderly way, they should demand changes to its legal and operational structure.
Fourth, the effectiveness and intensity of supervision needs to be strengthened both for banks in general, and for systemically important institutions in particular, given the wider damage their failure would cause. Countries need to strengthen supervisory mandates, independence, resources and methods.

Fifth, core financial market infrastructures must be strengthened to reduce contagion risks and to ensure that critical infrastructure is not itself a source of systemic risk. A key source of the risk transmission is the network of major institutions’ exposures to each other; not least in the over-the-counter derivatives and in funding and repo markets. Central clearing arrangements can simplify and greatly reduce the risks associated with this web of counterparty exposures.
The FSB and its members are developing measures in all the above areas and will present their recommendations to the November G20 summit in Seoul.

Last, a central lesson of this crisis was the lack of effective system-wide oversight. One of the blind spots, and an important contributor to the crisis, was the regulatory arbitrage that developed in the shadow banking sector. This sector continues to play an important role in credit intermediation and liquidity transformation, but outside the capital and liquidity regulatory framework that applies to banks. As we strengthen the requirements for banks, we must make sure that we also capture within the regulatory perimeter the sources of systemic risk currently outside it. This will be a priority for the FSB’s work in 2011.

(FT)

Beijing Stimulus Damage

China’s vaunted stimulus package has exacerbated structural imbalances in the economy and may delay the country’s transition to a more sustainable growth model, according to some leading economists.

Most analysts regard the $585bn plan as an appropriate response to the crisis, and say it pulled the economy out of what could have been a much deeper slump.

However, as the effects of the stimulus fade, some now say the response was too aggressive and that the government’s focus on an unprecedented credit exp­ansion and a massive infrastructure boost has aggravated stark economic imbalances.

The economy’s structural problems have been made worse by the stimulus program. While there are resurgent asset bubbles in the stock and property markets and the fact that most of the stimulus had gone to the state sector, smaller private enterprises, which create the most jobs, however had been left largely to fend for themselves.

The stimulus package was a response to a crisis rather than aimed at rebalancing China’s growth model. In the short term, this stimulus and monetary policy are perpetuating the imbalances.

A report published on Friday by the McKinsey Global Institute points out that 89 per cent of the entire stimulus package is devoted to infrastructure investment such as roads and railways, while only 8 per cent is allocated to supporting consumption.

Private consumption in China has declined sharply as a share of overall gross domestic product since the mid-1980s, accounting for only 36 per cent – the lowest ratio of any major economy, reflecting China’s reliance on investment as its main growth driver.

And according to this report, today’s low consumption share is systemic, and China will not be able to tackle this issue without comprehensive reform that includes structural change.

China’s economic growth profile has been very employment-light and there is a need to rebalance investment away from the traditional emphasis on heavy industry and infrastructure towards smaller, private enterprises, especially in the services sector.

World Stock Market Leader - China

China’s stock market has foreshadowed moves in global equities the past two years. It peaked on Oct. 16, 2007, two weeks before the MSCI All-Country World Index. The Shanghai index fell 72 percent from its 2007 high and bottomed on Nov. 4, 2008, four months before the MSCI index. The Chinese measure reached its 2009 high on Aug. 4, seven trading days before the global index.

People are hanging their hopes on China pulling us out of a recession. China’s growth looks great, but things may be a bit overstated. There has been a lot more integration of global markets over the past couple of years.

The focus of global markets is what’s happening in China. But in the current stage, China will have to remove liquidity from the market, and it’s likely that commodities will suffer and it means worse sentiment towards risk in general.

Reversing Stimulus is under consideration

G-8 finance ministers began drawing up contingency plans for rolling back budget deficits and bank bailouts as the economy shows signs of recovery and investors start worrying about inflation.

It’s prudent to consider what exit strategies to deploy once global growth is secured and how to do so without reigniting the two-year crisis. At the same time, it’s premature to rein back more than $2 trillion in stimulus packages.

But some politicians stressed the necessary to continue focusing on the growth now, it is too early to shift toward policy restraint according to the speech by U.S. Treasury Secretary Timothy Geithner.

The dilemma for policy makers is that withdrawing stimulus measures too soon could choke the recovery before it starts, and allowing them to last too long might push up borrowing costs.

Markets aren’t looking for specific exit strategies now, but want governments to start thinking about them. They worry that inflation is going to build up if nothing is done to withdraw the stimulus.

Is “Green Shoots” a sign of recovery?

Many people are suggesting that the recent data from the manufacturing, housing market, labor markets suggest that the ‘green shoots’ of an economic recovery are blossoming. While there do seem to be some signs of improvement, ie that the pace of contraction has slowed, the most recent data may still suggest that the global economic contraction is still in full swing with a very severe, a deep and protracted U-shaped recession.

Although the outlook for global manufacturing and service sectors is still consistent with a significant fall in global GDP, the pace of contraction began to slow towards the end of Q1, even in Europe and Japan which have lagged the U.S. and China. Globally, surveys suggest that the manufacturing outlook has improved from the freefall of the end of Q4 2008 and early 2009. Some emerging economies like China may now be experiencing expansion based on government investment, but those of most advanced economies remain well in contraction territory. In part, inventory adjustment following the sharp destocking could contribute to a revival in demand, but a real increase in end user demand needed for a sustainable fast-paced recovery could be far off.

Another necessary condition for a global recovery is a bottoming in not only the U.S. but also global housing markets. So far in most markets, housing prices seem far from their bottom and the outstanding inventory continues to be very high.

Moreover there is a risk that the increase in commodity prices might choke off a sustainable recovery if it weighs on industrial production and consumption. The recent increase in commodity prices, driven in part by an increase in Chinese demand for crude oil and other commodities, has contributed to an increase in the Baltic Dry shipping index. Yet, given the significant inventory in commodities like oil, prices might suffer renewed declines. Moreover although trade finance is no longer quite as impaired as at the turn of the year, global trade continues to be quite weak as evidenced from recent data from China, the U.S. and other countries.

Accompanied by the rally in stocks starting in March, the wide variety of central banks’ liquidity facilities have finally started to show clear effects in the interbank lending and money markets. Stress indicators such as the 3 month LIBOR-OIS spreads have narrowed significantly as well as the TED spread. The stock market rally extended also to the bond market with spreads receding significantly and junk bonds outperforming all other asset classes in the month of April. It’s not the sign of that the worst is over, maybe markets just have overextended themselves.

ECB Under Pressure to Follow Fed

The US Fed is increasing its balance sheet by another $1 trillion, including $300 of Treasury bonds.

The Euro against USD appreciated after the Fed’s move in more aggressive MBS and Treasury purchase, it put Europe in a disadvantage situation as strong Euro may hurt this export-oriented economy.

The ECB is hemmed in by European Union rules that forbid it from buying bonds directly from governments and any decision to buy debt in the open market may spark a dispute over which country’s securities to purchase. So it is very unlikely that next week the ECB will follow the Fed in deploying traditional quantitative easing measures. Instead ECB may probably cut its main rate, buying more time to figure out how to implement quantitative easing in the more complex euro-zone setup.

As the exchange for Euro against USD can be expected to decline after this possible move by ECB, the resurgent inflation may strike sooner than expected. An over-inflationary monetary or fiscal policy could quickly produce accelerating inflation even while recession persists. And it will cause a big headache for ECB if it really happens.

Hedge fund disappeared 15%

Hedge-fund liquidations rose to an all-time high last year, with about 15 percent of the industry’s offerings disappearing as managers posted record losses, according to Hedge Fund Research Inc.

About 1,471 funds shut down, the closures exceeded by 70 percent the previous record of 848 set in 2005. In the fourth quarter, about 778 funds closed as investors withdrew $150 billion. Those funds that will be around this year are the ones with the right skill set.

Hedge funds lost an average 19 percent last year, the industry’s worst returns since Hedge Fund Research started tracking data in 1990. Client assets fell by 37 percent from the peak in June to $1.2 trillion amid the biggest losses in equity markets since the Great Depression, according to Morgan Stanley.

Among the firms shutting funds were Drake Management LLC, a firm started by former executives from BlackRock Inc.; Peloton Partners LLP, the London-based firm run by former Goldman Sachs Group Inc. partners; and Ospraie Management LLC, run by Dwight Anderson in New York.

The closings represented about 15 percent of 9,284 funds in the industry. The total included more than 275 funds of hedge funds, which allocate money to managers on behalf of clients, shut down.

On the other hand, there were only about 659 openings last year, the lowest since 2000, when 328 funds were set up, the research company said. Fifty-six funds were started in the fourth quarter, compared with 117 in the previous quarter.

Bernanke Says Insurer AIG Operated Like a Hedge Fund

Federal Reserve Chairman Ben S. Bernanke said American International Group Inc. operated like a hedge fund and having to rescue the insurer made him “more angry” than any other episode during the financial crisis.

According to Bloomberg, Bernanke told lawmakers today: “If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG. AIG exploited a huge gap in the regulatory system, there was no oversight of the financial- products division, this was a hedge fund basically that was attached to a large and stable insurance company.”

Bernanke’s comments foreshadow tougher oversight of systemically important financial firms, and come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul. The U.S. government has had to deepen its commitment to prevent AIG’s collapse three times since September as the company accumulated the worst losses of any U.S. company.

Bernanke blamed the company “made huge numbers of irresponsible bets, took huge losses, there was no regulatory oversight because there was a gap in the system. At the same time, officials had no choice but to try and stabilize the system by aiding the firm.

It’s believed that banks relied on AIG’s financial products unit to back about $298 billion of assets through derivative contracts at year-end, making the firm a “systemically significant failing institution” that has to be propped up.

AIG has reduced the number of bets made by the financial products unit that sold credit-default swaps by more than 25 percent since October and cut expenses by “ hundreds of millions” of dollars. But that’s not enough.

Critics including former AIG Chief Executive Officer Maurice “Hank” Greenberg said the strategy of breaking apart the insurer and selling units wouldn’t reap enough to repay AIG loans.

AIG is getting as much as $30 billion in new government capital and relaxed terms on its bailout announced yesterday. The insurer’s first bailout package grew to $150 billion last year. After failing to sell enough subsidiaries to repay the government, the company had to turn to the government again. The company may need more support if financial markets don’t improve.

AIG’s fourth-quarter loss widened to $61.7 billion, the New York-based insurer said yesterday. The results brought its annual loss to almost $100 billion, prompting the U.S. to offer a package of equity, new credit and lower interest rates on existing loans designed to keep it in business and prevent a new shock to the world’s financial system.

The first rescue of the insurer came in September the day after officials couldn’t find a buyer for Lehman Brothers Holdings Inc., leaving the investment bank to file for bankruptcy. AIG also marked a turning point in the relationship between the U.S. Treasury and the Fed, with the central bank pushing then Treasury Secretary Henry Paulson to seek cash from Congress for additional bailouts.

Whether we like it or not, America’s federal policy is now driven by the need to avoid another Lehman.

U.S. Banks Tightened Loan Terms

A majority of U.S. banks made it tougher for consumers and businesses to get credit in the past three months even as lenders received infusions of taxpayer funds. About 65 percent of domestic banks reported having tightened lending standards on commercial and industrial loans to large and middle-market firms. Large fractions of domestic banks continued to report a tightening of policies on both credit-card and other consumer loans.

It may underscore concern among Obama administration officials and some U.S. lawmakers that banks that have received more than $200 billion of taxpayer funds are failing to lend that on to customers.

The U.S. economy continues to be hampered by a financial system that lost more than $1 trillion on housing credits since the mortgage crisis began in 2007.

Treasury Secretary Timothy Geithner is supposed to soon announce a new strategy for reviving our financial system that gets credit flowing to businesses and families. Obama’s goals are to lower mortgage costs and extend loans to small businesses so they can create jobs.

A less favorable or more uncertain economic outlook was cited by all domestic banks as the cause for tighter standards on commercial loans, as well as lower risk tolerance and problems in specific industries.

By contrast, concern about strains on their capital levels were less of a reason for the tightening in lending standards in the period. Only about 25 percent of domestic respondents said a deterioration in their bank’s current or expected capital position had contributed to the change, in comparison with approximately 40 percent in the October survey.

This result maybe is due to distribution of more than $194 billion through Fed program of purchasing stakes in U.S. banks. It has also mounted rescues of Citigroup Inc. and Bank of America Corp., insuring a total of more than $400 billion of illiquid assets on their balance sheets.

Now, Obama’s team is discussing ways to overhaul the bailout fund, called the Troubled Asset Relief Program, in an effort to ensure banks step up lending. Possible strategies include insuring other banks’ hard-to-value investments, and setting up a so-called bad bank that would remove toxic assets from their balance sheets.

But the question is, who borrows? The decline in demand partly reflects the fact that nearly all banks continued to tighten their lending standards and boost the cost of the loans they did extend, making loans unavailable or less economical for many borrowers.

However, it also shows that the recessionary rot has moved deeper into the economy. Even if efforts to spur consumption are successful, businesses may not need to boost capacity or finance large inventories for some time. Other types of borrowers are in similar straits.

“Liquidity trap” is here, and it will keep Obama finger-crossed for a long time.

Banks in storm

No more words are needed. Pay attention to RBS and Citigroupe.

Failed case in FOF

The future of Duff Capital Advisors, a hedge fund launched by former Morgan Stanley CFO Phil Duff, has been cast in doubt after the firm slashed staff even before it began to raise capital to make investments.

Duff has had hedge-fund success in the past. He co-founded hedge fund FrontPoint Partners, which was sold to Morgan Stanley about three years ago. FrontPoint Partners LLC is not a typical hedge fund, but a platform that recruits and sets up hedge fund managers who run their own portfolios under the FrontPoint umbrella. The firm finds capital for new funds and performs back-office, risk control and other services, leaving the managers to focus on investing. Independent funds affiliated with FrontPoint market themselves under its umbrella and use it for back-office and marketing support. Philip Duff worked as a consultant to MS, he started Duff Capital this March, which has similar model to FrontPoint.

Duff, which at its peak employed 100 people, cut nearly 80 percent of its workforce last month, just nine months after opening its doors with some $500 million in seed funding from asset-management firm Lindsay Goldberg founders Robert Lindsay and Alan Goldberg.
According to insiders, Duff's expenses in building out his hedge fund have raised eyebrows and have caused a rift between Duff and Lindsay Goldberg.

This is the late example of the drawbacks of Fund of hedge funds. It’s believed in the hedge fund industry that FoF will be mostly hard hit amid this financial crisis. The cost of running a FoF is comparably high.

Sources said Duff last spring spent approximately $70 million hiring a posse of hedge-fund management teams as well as constructing new office space at 100 West Putnam Ave. in Greenwich, Conn., spurring insiders to criticize Duff for having spent too much money before his firm made even a single investment. In the future, I doubt if FOF model could have any chance to survive and prosper.

Globalization needs reshape

President Obama, most of his fellow citizens and much of the rest of the world agree that the US broke the world economy and now has the duty to fix it. But the crisis is a product of the global economy. It cannot be cured by the US alone. Fortunately, Mr Obama has the authority needed to lead the world towards a resolution. It is in the interest of his country and the world that the world economy be put on a sounder footing. Should this effort fail, I fear a resurgence of protectionism will be the outcome.

The world has divided into two economic camps: in one are countries with elastic systems of consumer finance and high consumption; in the other are countries with high savings and investment. The US is the most important example of the former. China is the most significant example of the latter. Spain, the UK and Australia were mini versions of the US; Germany and Japan are mature versions of contemporary China.

The biggest point about the world economy today is that the credit-fuelled household borrowing that supported the excess demand in deficit countries has come to a sudden stop. Unless this is reversed, excess supply of surplus countries must also collapse. This statement follows as a matter of logic: at world level, supply must equal demand. The question is only how the adjustment occurs.

Someone have argued that the driving force behind these “imbalances” has been the policies of surplus countries and particularly of China, whose surpluses have grown particularly quickly. A managed exchange rate, huge accumulations of foreign currency reserves and sterilization of their monetary consequences have generated national savings rates of well over 50 per cent of gross domestic product and current account surpluses of more than 10 per cent. Consequently, the excesses of deficit countries were partly a response to the behavior of surplus countries.

On the other hand, the pattern of global deficits and surpluses was solely caused by western policymakers, particularly the Federal Reserve’s lax monetary policies and unregulated expansion of credit.

Whoever is more correct, one point is certain: huge asset price bubbles made possible the excess supply of some countries, particularly China. Since the Asian financial crisis of 1997-98, the developed world – and the US in particular – have experienced, successively, the largest stock market bubble and the biggest credit-fuelled housing bubble in their histories. And now, this era is over. We will struggle with its aftermath for years. So what happens next? The implosion of demand from the private sectors of financially enfeebled deficit countries can end in one of two ways, via offsetting increases in demand or via brutal contractions in supply.

If it is going to be through contractions in supply, the surplus countries are particularly at risk, since they depend on the willingness of deficit countries to keep markets open. That was the lesson learnt by the US in the 1930s. That’s why a lot of people concern the future of China and its export-oriented economy.

Obviously, expansion of demand is much the better solution. The question, though, is where and how? Managing this adjustment is far and away the biggest challenge for the world leaders and economies.At this stake, it is essential to clean up the huge current mess. But it is also evident that an open world economy will be unsustainable if it remains dependent on bubbles. Collapse of globalization is now no small risk. It’s time to not only reshape the US financial industry, but also the world economy system.

How to market a Hedge Fund after crisis

The right pedigree, strategy and track record is no longer a guaranteed recipe for success in raising or retaining of assets. More so than ever both hedge fund startups and established hedge funds are distinguishing themselves from similar strategies by marketing not only their track record and pedigree but also their operational, portfolio and regulatory infrastructure.

Funds that fail to address the growing concern over fraud, mismanagement, operational and regulatory risk may miss out on the opportunity to attract the billions of dollars of capital that has left the industry and may well be reallocated after 2008 financial crisis. Like it or not the perception of the new world investor is that infrastructure and performance are directly connected.

To be well positioned after the crisis, hedge funds must address an investor’s growing concern over operational and regulatory risk. This new level of scrutiny will increase the importance of effective and documented operational and regulatory risk management. Responding to a potential investor’s increasing desire for full transparency will be paramount.

Even if a fund’s AUM is small it can still improve its marketing position with investors in a cost effective manner by communicating a clear, transparent and customized plan to strategically mitigate risk as assets grow. Noted below are just some of the minimum “high risk” areas a successful hedge fund should focus on no matter its size or strategy:

Portfolio management, investment guidelines, trade allocation, trade errors, best execution;

independent and verifiable valuation policies and procedures, and for illiquid securities, strong consideration to the creation of a valuation committee;

personal trading policies and procedures, processes and controls; contingency planning and business continuity.

Hedge Funds Challenges in a Changing World

Never before in its short history was the hedge funds community confronted with the challenges nor the pressures it is facing today, following a six-year boom with Madoff’s scandal coming as the icing on the cake following the US financial crisis.

With investors already becoming more demanding with regards to fees, transparency and regulation, these and other industry standards are expected to become topics of contention within this once powerful industry globally and in the region.

Hedge Funds managers and providers are expected to share their plans to make the industry more transparent and investor-friendly and to show the steps they are taking as a community to self-regulate the industry after a miserable year that saw the industry face its worst 12 months on record.

In fact, hedge funds are already facing increased competition in addition to all the other challenges that the financial turmoil has brought about. Fee cuts, transparency, revealing the underlying instruments without giving away the ‘secret formula’ to copycats, due diligence, redemptions and selling pressures, less restrictions on investors and getting in new money are all topics that might change the face of the industry as we know it today, which might find itself adopting a new model.

One of the successful hedge fund managers respected by people in this financial crisis is John Paulson, whose Credit Opportunities Fund in 2007 turned a $500m investment into $3.5bn, widely believed to be the largest dollar gain ever generated by a hedge fund manager in a single year. In 2006 he realized that the growing risk of defaults on mortgages made to sub-prime US household borrowers was grossly mispriced, and he executed complex debt trades to benefit from this. John Paulson eventually made $15 billion from predicting the US sub-prime mortgage crisis. He is now one of the largest hedge funds in the world, managing approximately $35bn in merger, event and distressed strategies. Its credit funds were up by 15 per cent to the middle of December and in the past few weeks have been one of the biggest buyers of prime mortgage-backed securities. Paulson & Co’s other funds were up to 38 per cent ahead by mid-December.

Paulson is a living proof that it is not all doom and gloom for the industry. Some good news is coming out for investors, such as reduced fees in some strong performing funds, including quantitative strategy funds. Also, the UK’s Financial Services Authority dropped its ban on short-selling, or betting against, banks and insurers, and introduced a tighter disclosure regime. Also, Hedge funds will be allowed to borrow from the US Federal Reserve for the first time under a landmark $200bn program intended to support consumer credit.

Manhattan property market began to feel hurt

Manhattan apartment sales fell for the fourth straight quarter and prices for the most expensive apartments dropped for the first time since the recession began as the national housing slump hit the metropolitan area.

Fourth-quarter transactions dropped 9.4 percent to 2,282 units from a year earlier. While the overall median sales price rose 5.9 percent, luxury prices dropped 3.9 percent and the median for all resale apartments slid 3.6 percent.

In Manhattan, the inventory of apartments listed for sale rose almost 40 percent from a year ago to 9,081 units. Apartments sat on the market for an average 159 days before selling in the fourth quarter, up 21 percent from a year earlier.

On the other side, Manhattan office rents fell the most in at least two decades last quarter as securities firms cut jobs and tenants leased less space. Fourth-quarter rents dropped 4.8 percent to $69.44 a square foot from the third quarter.

Finance jobs drive the Manhattan market. Employment at Wall Street investment banks accounted for almost 15 percent of the city’s total privately paid wages in the first quarter of 2006. So it’s unsurprising that the U.S. recession and the global credit crisis have charged heavy tolls on Manhattan property market.

The end of the year marked the beginning of Manhattan’s entry into a new kind of market. Manhattan has gone from being a seller’s market to a buyer’s market, buyers are being now more cautious and hunting for bargains. Tenants are gaining the upper hand in negotiations with landlords and winning discounts on rents, brokers are seeing normal 15% discount or more.

Many new condominiums there were built to attract wealthy Wall Street bankers and foreign investors. But foreign investors are having a real tough time getting mortgage money, and a lot of those young affluent buyers aren’t so affluent any more.

Wall Street miracle should be found in the history book now.

Buffett and China banks top cash-rich list

Twenty of the largest listed companies in the world are sitting on a combined cashpile of $570bn, demonstrating how some of the world’s biggest groups retain substantial firepower in the current downturn.

However, only 29 of the top 100 global companies by market value have net cash, according to analysis by the Financial Times. But those that do should be in a strong position in a severe downturn that is causing companies to scramble to conserve cash.

The list is led by four financial institutions with Warren Buffett’s Berkshire Hathaway at the top with $106bn in net cash, defined as cash and short-term investments or marketable securities minus debt. Strikingly, the next three positions are filled by Chinese banks with Bank of China, ICBC and China Construction Bank having $101bn, $89bn and $82bn, respectively.

People are divided on what cash-rich companies are likely to do with their money. Some believe that with company valuations at a relative low compared with recent years the time is ripe for acquisitions. If you have the cash, there are some unparalleled opportunities out there. You have rock-bottom prices and some very willing prices.

But some others disagreed and argued obviously the banks are hoarding cash, so why shouldn’t the corporates. Probably both banks and corporates will remain cautious in this global market downturn.

Some cash-rich companies already took actions: Berkshire is one of the exceptions, having already invested in blue chips such as GE and Goldman Sachs. Some other cash-rich companies have looked to take advantage of the relatively low valuations by boosting share buybacks or trying to buy rivals. Microsoft has done both.

However, investors, who were only recently crying out for cash to be returned to them through buy-backs, now care cash position more. They’re being more relaxed with managements in a high net cash position.

M&A retreated in 2008

A record number of deals were cancelled in 2008 leading to a sharp fall in fees for investment bankers. The total volume of worldwide mergers and acquisitions reached $3,280bn in the year to date, down 29 per cent from the full year 2007 as financing difficulties, volatility in valuations and widespread risk aversion saw deals pulled.

Companies abandoned 1,309 transactions valued at a total of $911bn. In 2007, there were 870 withdrawn deals valued at $1,160bn.

BHP Billiton’s $147.bn bid for fellow miner Rio Tinto was the largest-ever withdrawn deal while the $48.5bn acquisition of Canada’s BCE telecoms group by a consortium of private equity groups marked the biggest failed buy-out ever. On the other hand, the fall in activity saw investment bankers generate less than $20bn in fees for advising on M&A in 2008, down 30 per cent from the $28.1bn in 2007.

But the floor has not been built yet. The combination of falling earnings, the absence of credit, lack of confidence and ongoing market volatility will deter activity. M&A outlook for 2009 was the worst for many years.

Deals among financial institutions helped prop up the volume of deals as banks and insurers raised capital and restructured assets to repair balance sheets.

Financial deals accounted for 19 per cent of all M&A volume with $636.6bn deals during the year, including the $44.4bn acquisition of Merrill Lynch by BoA. What’s worse, Private equity deals fell 71 per cent to $188bn from $658.9bn in 2007 – the lowest annual volume in five years as lenders stopped providing debt for buy-outs.

China aims to boost consumption

I never thought so-called RMB4000 billion stimulus plan has any meaningful points to current painful China economy, but this time, China government seems to be on the right track.

China’s economic policymakers meet towards the end of every year to establish a broad agenda for the coming 12 months. Yet this year’s conference, which begins on Monday, December 8, is likely to focus on specific policy measures.

When the Chinese government launched a fiscal stimulus package a month ago, it was more a statement of intent than a battle plan. Officials wanted to send a signal that they were taking action.

The “central economic work conference”, as the meeting is known, will give leaders a chance to refine and potentially expand spending plans for the next two years. The government has indicated it will introduce measures to boost consumption.

The initial announcement of the fiscal stimulus was rushed out, officials have acknowledged, because growth in the economy was slowing rapidly. And since the first announcement, the economy appears to have deteriorated further, including a drop in car sales and electricity production in November and reports that exports had decreased for the first time in nearly a decade.

One of the main criticisms about the fiscal stimulus plan is it focuses too heavily on infrastructure. According to the commission, about 80 per cent of the Rmb4,000bn ($581.8bn) investment over two years will be in roads and railways.

Ha Jiming, economist at China International Capital Corporation, an investment bank, said that infrastructure spending would not have as big an impact as it did after the 1997 Asian financial crisis because facilities were much better developed than a decade ago and state-owned companies were no longer such an important part of the economy.

If not carefully controlled, economists warned, infrastructure spending could also stimulate even more investment in the manufacturing sectors which are suffering from over-capacity, such as steel.
Given the concerns about the efficacy of massive infrastructure investment, there is widespread speculation that the authorities will do more to try to boost domestic consumption. That could include raising the threshold for income tax and help for low-income families, as well as accelerating spending on pensions, education and healthcare.

There appears to be a growing consensus within the central government that China has to stimulate domestic consumption more aggressively. The authorities are also under pressure to boost the stock market.

In the fact, this worldwide financial crisis offers an opportunity for China government to adjust the economic development path and solve the deep-rooted social issues. It’s hard to wheel a big train, but we have to.

Berkshire, next default target?

The cost of protecting against default by Warren Buffett's AAA-rated Berkshire Hathaway Inc. has almost tripled in two months, based on CDS, jumping to 388 basis points from 140 basis points two months ago. That translates to a cost of $388,000 a year to protect $10 million for five years. This is a sign of just how skittish investors have become amid the global financial crisis.

At those levels, the swaps are typical of companies rated Baa3 by Moody's Investors Service, one level above junk. The price may have risen on concern that the billionaire's firm could lose a $37 billion bet on world stock market values more than a decade from now. Not only Berkshire would have to exhaust its $33.4 billion cash hoard, but also Buffett's decades-long record as the world's most successful investor would have to come to a cataclysmic end. President-elect Barack Obama, Goldman and GE all turned to Warren Buffett for advise or capital.

The increase may be tied to a series of bets that Buffett has taken on four stock indexes across the globe. Buffett sold contracts to undisclosed buyers for $4.85 billion that protect the buyers against declines in those markets. Under the agreements, Berkshire will pay as much as $37 billion if, on specific dates beginning in 2019, the market indexes are below the point where they were when he made the agreements. By Sept. 30, Omaha, Nebraska-based Berkshire had written down the contracts by $6.73 billion as the S&P declined for a fourth straight quarter.

Buffett defended those structured products as he said: “I believe these contracts, in aggregate, will be profitable We are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run. That is our philosophy in derivatives as well.”

People should realize that he was able to obtain that capital gained from sales of CDS to invest on such attractive terms for years before the chance comes that he'll have to pay. However, before the market gets stabilization, the increasing cost of Berkshire credit protection in the swaps market isn't crazy in light of the way the markets performed.