Tuesday, October 21, 2008

Argentina Tangos With Private Pensions


It's official: Argentina's President Cristina Kirchner moved Tuesday to nationalize $30 billion in private pension funds, saying it was necessary to protect retirees in the global financial crisis:

"We are taking this decision in the international context in which the G-8 countries and others are seeking ways to protect banks," Kirchner said as she presented the nationalization plan, which still must be approved by the Argentine congress.

"We are protecting our retirees and workers," she said.

The government is taking the step after the 10 companies in the private pension sector suffered severe losses in the crumbling stock and bond markets, according to an official who insisted on anonymity.

Local media cited official sources as saying the funds had incurred losses of around 20 percent as global financial markets succumbed to panic.

The Argentine stock market plummeted another 11 percent Tuesday in reaction to the announcement, as the private pension funds strongly criticized the measure as a "short-term" move and insisted that their assets remained health.

"The market was shattered by the drastic change to the rules of the game concerning the pensions. It amounts to a confiscation of private capital," said stockbroker Luis Corsiglia.

The ten firms together administer around 30 billion dollars in retirement savings of 53 percent of Argentine workers, and take in about 4.6 billion dollars each year in new contributions.

Eight of the ten are controlled by private banks. One is a cooperative and another is controlled by state-owned Banco Nacion, the country's most important bank.

The political opposition accused the government of confiscating the private pension funds to help service the national debt of some 150 billion dollars.


Confiscation of private capital? Argentina's President has taken her cue from Comrades Bush and Paulson who have effectively nationalized Fannie, Freddie and are in the process of partially nationalizing other financial giants.

The rules of capitalism have forever changed. The brokers can complain all they want but if it's between them and their mega rich hedge fund clients or the financial safety of millions of retirees, I am pretty sure that government officials around the world are going to screw the brokers and the hedge funds.

When it comes to hedge funds and buyout funds, some are now openly asking: Going, Going,...Gone?:

The value of publicly traded hedge funds has taken a hit. Man Group, the world's biggest publicly traded hedge fund, has lost about 41% of its value since July.

And things are likely to get worse. Look for hedge funds to take a hit, because the credit crunch means they can no longer leverage investments. The reason: Credit won't be widely available.

Hedge funds had little to do with the underlying conditions that led to the mortgage crash, but nevertheless will face increased restrictions as part of politicians' need to regulate the markets and do something -- anything -- to address the recent turmoil.

In retrospect, Sarbanes-Oxley may look benign.
[that's for sure!!!]

The immediate result of new regulation will be less wiggle room for fund managers. This will almost certainly erode returns, and make hedge funds less attractive to investors.

Big Ben and the central bankers will do their best to prevent future bubbles from building in various markets. This may be good news for the economy - but it will take a bite out of hedge funds, because deft managers were adept at chasing inflated asset classes and knowing when to get out, thereby pocketing a nifty profit.

Buyout funds routinely tapped the debt markets to finance the next acquisition. Such businesses can't thrive if debt markets seize up. What's next? Anyone interested in buying some used office furniture from a hedge fund?

The worldwide economic slowdown will hurt major industries, including those buyout funds routinely trolled, such as retailing and manufacturing. That means there will be few, if any, new deals ahead and existing deals may go bad.

The once saucy financial markets will become increasingly dowdy. That means innovative hedge-fund managers will have few chips to play in a game that has largely disappeared.

There will be rough times ahead, but the sun will continue to rise in the east.

"To get through it, we need to go through it. And on the margin, that's a healthy thing," Harrison says.

At the margin, it is healthy, but it also means we are in for a long, tough slug with lots of volatility.

Moreover, Sudden Debt reminds us of those dirty "D" words:

Deflation is finally making its way into the popular media, as this editorial from the New York Times clearly shows ("The Bubble Keeps On Deflating"). After mentioning the obvious trouble in the real estate sector, the article focuses mostly on the likelihood of a rising tide in corporate bankruptcies, caused by past credit excesses, e.g. cheap and dirty loans for buyouts by private equity funds (a particular pet peeve of yours truly). There is even note of complicating factors like credit default swaps (CDS) - another item very often examined in this blog.

As the editorial points out, so far there have been few major corporate bankruptcies. The question is, however, what happens if (or more likely, when) failures start to increase rapidly. Will the CDS market be able to absorb the shocks and act as a crisis attenuator, as its adherents claimed not long ago? After all, they had piled on trillion upon trillion of unregulated credit insurance, betting heavily on continued sunny credit weather.

Or will CDSs instead become amplifiers of trouble?

Defaults may very well swamp the CDS market and create a negative amplification effect, multiplying several-fold the losses sustained by the financial system. One single corporate bankruptcy can cause many more losses than the amount of its entire debt outstanding, as multiple CDS dominoes fall and cascade through all those who issued them with abandon.

Governments and regulators are ill-equipped to handle what is happening, hampered as they are with imperfect understanding and lack of relevant experience. So, they just do what they have always done: throw money (ours) into the problem, inadvertently feeding more fuel into a growing credit fire that requires debt cancellation "water", and not additional debt "oil".

Paraphrasing the fictional Gordon Gekko, "Deflation and default are good".

....

Update on CDS

Today (10/21) is the day of reckoning for Lehman's CDS settlements. Some $400 billion notional is said to be at stake and we'll soon know (?) who's holding the bag. Other than AIG, who wrote credit insurance on anything that fogged the mirror and has already choked on it, several formerly high-flying hedge funds are also said to be on the hook...

This is only the first major bankruptcy and the market seems to have already dealt with it, even breathing a (temporary?) sigh of relief. I'm not sure it will do so with the next one, though...

I am not sure either. I also wonder how many pension funds will be left "holding the bag" on this toxic debt which is probably trading (if it could trade) at pennies to the dollar.

No wonder government regulators are scrambling to create a central clearinghouse for credit-default swap trading. According to Bloomberg, one may open by next month after pressure from the U.S. Federal Reserve for a means to absorb losses should a market maker fail:

Fed officials and New York's insurance regulator have been pressing the $55 trillion market to create a central counterparty after Lehman Brothers Holdings Inc.'s bankruptcy last month. Because swap contracts are traded bilaterally between banks, hedge funds, insurers and other institutional investors, default by a major dealer threatens market stability by risking losses at everybody they've traded with.

While ``progress has occurred at a slower-than-desirable pace, recent events have accelerated the rollout,'' New York- based Barclays credit strategists Bradley Rogoff and Gautam Kakodkar wrote in a note to clients dated Oct. 17. ``Expected go- live date is late October or early November.''

Four groups have been vying to operate clearing operations, including a partnership between Chicago-based CME Group Inc. and Citadel Investment Group LLC and a group that includes dealer- owned Clearing Corp., Intercontinental Exchange Inc. and credit swap index owner Markit Group Ltd. Eurex and NYSE Euronext have also submitted proposals.

...

A clearinghouse, capitalized by its members, all but eliminates the risk of trading partner default by being the buyer for every seller and the seller for every buyer. It employs daily mark-to-market pricing where margin calls are made if a trader's position has lost money that day. Traders who can't pay have their positions liquidated.

The model differs from the over-the-counter market where traders rely on their counterparty to make good on their agreements. The credit-default swap market trades OTC and has faced payment problems after Lehman and Bear Stearns Cos. collapsed this year.

Clearing Corp. is owned by Goldman Sachs Group Inc., Morgan Stanley and other finance companies.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities, or the cash equivalent, should a company fail to adhere to its debt agreements.

It's about time they introduced transparency in this market. In early June of this year, before everything went haywire, U.S. and foreign regulators’ pushed for a clearinghouse to process the $2 trillion worth of credit-default swaps that trade annually because of fears of lingering systemic risk tied to over-the-counter derivatives (they knew we were about to hit a colossal CDS iceberg).

But I agree with the Financial Ninja, you'd better get ready for some ugly realities when these instruments start trading mark-to-market:

This would go a long way towards adding desperately needed and sought transparency to the derivatives market. This would also almost completely eliminate counterparty risk, which has now become the number one problem.

The downside risk of course is that these products and positions will then see the light of day, where they very well may turn out to be quite ugly.

I still expect Credit Default Swaps (CDS) to blaze a wide, unpredictable path of destruction thru both the financial system and the real economy. (Like the guy in the picture.) But in the meantime, this is progress. This is good.

It will also expose the bagholders, including some well known public pension funds that used their triple AAA government credit ratings to write CDS, foolishly believing that the probability of a systemic crisis is next to zilch. SURPRISE!

It all makes me want to cry but how does that song go...

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