Pension Pulse

Davos 2012: Another Monumental Failure?

2012-01-29T10:07:00.010-05:00

As Davos 2012 wraps up, it is my chance to write a critical comment denouncing the world's top 0.00000000001% for another boring summit where they myopically focused on Europe's debt crisis, warning that the eurozone continues to pose a severe threat to the global economy.

Crackling tension among European leaders in Davos is set to spill over into an equally charged EU summit this week. Soros said it all when he took Germany to task. Even if a Greek debt deal is in the works, unless they come up with a lasting long-term solution, this deal won't mean a thing and eurozone will remain vulnerable to more speculative attacks. There is a reason why Soros is so successful, unlike most of his peers, he gets the bigger picture.

But in my opinion, all this talk about "debt crisis" is completely misplaced. The developed world has an unemployment crisis and a retirement crisis, not a debt crisis, two themes that were largely ignored at this World Economic Forum.

What scares me the most about the state of the global economy? Easy, the youth unemployment disaster:

Davos is used to bluster from political leaders. But when usually quietly spoken company bosses from all corners of the earth warn of "not a crisis, but a disaster," when they call something a "cancer in society," you know we have a problem.

The world, they say, is "sitting on a social and economic time bomb". The world is plagued by youth unemployment.

The numbers are stark: In some countries of the Arab world, up to 90% of 16-24 year olds are unemployed. In the United States the youth unemployment rate is 23%. In Spain nearly 50%. In the UK 22%.

Worldwide, some 200 million people are unemployed. 75 million are between 16 and 24 and every year about 40 million young people are entering the workforce.
'Unemployment sucks'
The business leaders at the World Economic Forum (WEF) know why it matters: Young people who were unemployed for a long time will earn less throughout their whole lives.

They will be less employable. They won't have the skills that business needs. They are more likely to have long-term health problems. And it can cause social unrest.

There's a term for it: Lost generation. Or as one business school professor puts it: "Unemployment sucks. Youth unemployment sucks even more."

"The youth has lost a line of sight to the future."

Unless something is done to tackle youth unemployment, the world's 'debt crisis' will only get worse. You'd think the world's power elite would focus all their energy there. Instead, the discussion centered around Europe's debt crisis, which is exactly what the financial oligarchs want us to focus on.

There are many smart economists who attended Davos who would agree with me on this issue, but it's striking how little press coverage this issue got. Sure, they talked about preventing another lost generation, but little was done to take concrete actions to tackle the unemployment crisis that threatens the global economy and the very foundations of capitalism.

Interestingly, Davos founder Klaus Schwab did focus on jobs and morals:

Capitalism is out of whack, the founder of the World Economic Forum says, welcoming critics' ideas of how to fix it — even those camped out in protest igloos near his invitation-only gathering of global VIPs.
This anti-big money mood is surprising for a man who embraces free markets and whose livelihood consists of bringing world CEOs and political leaders together for brainstorming sessions.
Klaus Schwab is also unusually downbeat, his trademark optimism tempered by global economic turmoil and public unrest ahead of this year's forum, which ends Sunday.
"We have unfinished business, and we have to act fast," he told The Associated Press in an interview ahead of the forum's opening on Wednesday.
"I'm a deep believer in free markets, but free markets have to serve society," he said in Davos, the ski resort tucked away deep in the Swiss Alps. He lamented excesses and "lack of inclusiveness in the capitalist system."
"We have sinned," he said, adding that this year's forum would put particular emphasis on ethics and resetting the moral compass of the world's business and political community.
Schwab said the forum invited members of the Occupy protest movement, camped in igloos in Davos, to a session on the sidelines to talk about reforming capitalism.
Thousands of Swiss soldiers and police shoveled snow to erect a "ring of steel" against any demonstrators who hoped to gatecrash the meeting. Some 3,500 soldiers provided security to the VIPs, who included German Chancellor Angela Merkel, British Prime Minister David Cameron and nearly 40 other world leaders.
President Obama didn't attend, but Treasury chief Timothy Geithner was there, as were some members of Congress.
When half a dozen demonstrators appeared briefly Tuesday outside the security perimeter, daubing the snow with anti-capitalist slogans, police checked their IDs but allowed the protest to go ahead.
"Everybody who could make a constructive proposal is very welcome. We need new ideas," Schwab said.
He did note a general aversion to allowing too much anti-capitalist fervor to reach Davos.
"I also emphasize that Davos is a place for dialogue. . . . The participants are usually reluctant to be confronted with people who are not open to dialogue and just want to serve their own sometimes one-sided interests," he said.
He warned that an "intergenerational conflict" could be looming as governments compromise future spending to pay today's debts.
"People feel it's a difficult time. They are irritated. There is, they feel, a lack of future perspective," he said.
Schwab also urged that more attention be paid by leaders and governments alike to jobs — saying Davos participants should focus on "talentism" instead of capitalism — and said leaders must work harder to win public trust.
Schwab has watched the world transform in the 41 years that he's nurtured the forum and turned it into one of the world's leading economic gatherings.
While China, Brazil and other developing economies remain robust, the United States and Europe are still struggling with financial issues that erupted in the credit crunch of 2008, including high unemployment. That contributes to a feeling that the world's economic problems are worse than leaders meeting at Davos in previous years had foreseen.
"We were too optimistic (last year)," Schwab acknowledged.

Indeed, the power elite were too optimistic last year and in my opinion, too pessimistic this year. And once again, they failed to address major issues, including the global disconnect, which will only get worse unless we tackle youth unemployment and the looming retirement crisis.

I suggest the power elite take the time to carefully read Michael Hudson's latest comment, Banking Wasn’t Meant to Be Like This. I quote his conclusion:

Banking has moved so far away from funding industrial growth and economic development that it now benefits primarily at the economy’s expense in a predator and extractive way, not by making productive loans. This is now the great problem confronting our time. Banks now lend mainly to other financial institutions, hedge funds, corporate raiders, insurance companies and real estate, and engage in their own speculation in foreign currency, interest-rate arbitrage, and computer-driven trading programs.
Industrial firms bypass the banking system by financing new capital investment out of their own retained earnings, and meet their liquidity needs by issuing their own commercial paper directly. Yet to keep the bank casino winning, global bankers now want governments not only to bail them out but to enable them to renew their failed business plan – and to keep the present debts in place so that creditors will not have to take a loss.

This wish means that society should lose, and even suffer depression. We are dealing here not only with greed, but with outright antisocial behavior and hostility.

Europe thus has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy. History provides a wealth of examples illustrating the dangers of capitulating to bankers, and also for how to restructure banking along more productive lines. The underlying questions are clear enough:

Have banks outlived their historical role, or can they be restructured to finance productive capital investment rather than simply inflate asset prices?
Would a public option provide less costly and better directed credit?
Why not promote economic recovery by writing down debts to reflect the ability to pay, rather than relinquishing more wealth to an increasingly aggressive creditor class?

Solving the Eurozone’s financial problem can be made much easier by the tax reforms that classical economists advocated to complement their financial reforms. To free consumers and employers from taxation, they proposed to levy the burden on the “unearned increment” of land and natural resource rent, monopoly rent and financial privilege. The guiding principle was that property rights in the earth, monopolies and other ownership privileges have no direct cost of production, and hence can be taxed without reducing their supply or raising their price, which is set in the market. Removing the tax deductibility for interest is the other key reform that is needed.

A rent tax holds down housing prices and those of basic infrastructure services, whose untaxed revenue tends to be capitalized into bank loans and paid out in the form of interest charges. Additionally, land and natural resource rents – along with interest – are the easiest to tax, because they are highly visible and their value is easy to assess.

Pressure to narrow existing budget deficits offers a timely opportunity to rationalize the tax systems of Greece and other PIIGS countries in which the wealthy avoid paying their fair share of taxes. The political problem blocking this classical fiscal policy is that it “interferes” with the rent-extracting free lunches that banks seek to lend against. So they act as lobbyists for untaxing real estate and monopolies (and themselves as well). Despite the financial sector’s desire to see governments remain sufficiently solvent to pay bondholders, it has subsidized an enormous public relations apparatus and academic junk economics to oppose the tax policies that can close the fiscal gap in the fairest way.

It is too early to forecast whether banks or governments will emerge victorious from today’s crisis. As economies polarize between debtors and creditors, planning is shifting out of public hands into those of bankers. The easiest way for them to keep this power is to block a true central bank or strong public sector from interfering with their monopoly of credit creation. The counter is for central banks and governments to act as they were intended to, by providing a public option for credit creation.

Michael wrote on Europe but the truth is the world has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy.

Jonathan Nitzan, another insightful economist who knows a lot about differential accumulation, doesn't see this as useful dichotomy as he considers the banking and "real" economy as one. But both of them would agree that capitalism is headed down an unpredictable and destabilizing path.

What would I like to see at Davos 2013? I'd like to see Michael Hudson, Jonathan Nitzan and other "radical" economists discuss their views. I'd also like to see some intellectuals like Charles Taylor, Michael Walzer and many others address these global leaders.

Below, Charles Taylor talks at a public debate on the role of religion in the public sphere in Milan on June 8, 2010. Listen carefully to his comments on the basic challenges to solidarity and how we can need to "create mutual respect for different views " to come together and address the challenges that confront our societies.

I also embedded a clip of Michael Walzer discussing free market and morality as well as a BBC piece on positive vs. negative liberty, drawing on the wisdom of the late Isaiah Berlin. Watch all clips below.

Taylor was the greatest genius I ever had the privilege of learning from. Davos desperately needs such great thinkers at their future conferences. Doesn't make for a good interviews on CNBC or Bloomberg but the biggest deficit at Davos is a deeper dialogue on ethics and how we can improve the global economy, making it more inclusive, serving all our citizens, not just the power elite.

Betting on BlackBerry's Revival?

2012-01-28T10:13:00.009-05:00

Hugo Miller of Bloomberg reports, RIM’s Heins ‘Here to Fight’ for BlackBerry Revival:

Research In Motion Ltd. (RIMM)’s Thorsten Heins, five days into his job as chief executive officer, pledged to regain lost ground in the U.S. smartphone market and said he held talks with rivals eager to license its software.

RIM will begin a campaign with U.S. carriers next week to entice consumers to try its latest BlackBerry 7 devices with touch screens and better Web browsers, Heins said yesterday in an interview at Bloomberg headquarters in New York. The promotions won’t be about “just simply money,” they will also involve mobile applications, or apps, he said.

“We have to do something dramatically different in the U.S. to get our market share back,” said Heins, 54. “I’m here to fight. I’m here to win.”

Heins, a 24-year veteran of Siemens AG (SIE), faces the challenge of reversing momentum at RIM after the company lost out in the smartphone market to Apple Inc. (AAPL)’s iPhone and devices that run on Google Inc. (GOOG)’s Android software. RIM’s revenue has slumped for two quarters, driving RIM shares down 75 percent last year.

Heins, who took over from co-Chief Executive Officers Jim Balsillie and Mike Lazaridis, said his immediate priority is to revive BlackBerry sales in the U.S., get a revamped version of Waterloo, Ontario-based RIM’s struggling PlayBook tablet onto the market next month and introduce its new operating system, BlackBerry 10, on time later this year.

“In the first 100 days, that is what you’re going to see me focus on,” Heins said. “My first job is to get BlackBerry 7 into all of your hands.”
U.S. Missteps

The Munich native is getting by on a handful of hours sleep a night so that he can travel by day to meet customers and run the business by night on his BlackBerry. The company needs to improve its marketing and communicate better to build excitement about its products, he said.

U.S. sales fell 45 percent last quarter, dragging revenue lower even as sales in emerging markets like Indonesia and India surged. The BlackBerry’s share of the global smartphone market fell to 11 percent in the third quarter of 2011, from 21 percent two years earlier, according to Gartner Inc. The aging BlackBerry lineup failed to match the features and number of applications available on the iPhone and Android devices.

“When BlackBerry got positioned the way you experienced it, it was on a set of values: battery life, network efficiency, security and best typing experience,” Heins said. “In the U.S. specifically, what we missed is a shift in those paradigms” to more consumer-oriented features like Web-browsing and apps, Heins said.
Licensing Talks

Now, RIM is rebuilding its lineup of BlackBerrys on BB10, an operating system based on software used to run nuclear power plants and unmanned aerial drones. During his interview, Heins repeatedly went back to a video demonstration of PlayBook 2.0, its new tablet software which incorporates many of the features that will come with BB10. He showed how users can flip between e-mail, Web browsing, Facebook and Twitter without ever leaving any of those programs.

RIM’s new software is appealing enough that he’s been approached about licensing it, Heins said. The company has held discussions with interested handset makers and personal-computer makers, he said, declining to name them.

“We’ve had lots of interest about this,” Heins said.

RIM rose 3.3 percent to $16.80 yesterday. The stock was given a lift after Fairfax Financial Holdings Ltd. (FFH) said it doubled its stake in RIM. Prem Watsa, who runs Fairfax, was named as a director at RIM this week as part of RIM’s leadership changes.

The stock has rebounded after falling earlier in the week when comments by Heins on a conference call were interpreted by some investors as a sign that he would run RIM much in the way of his predecessors.

Neither that nor the suggestion that he will be unduly influenced by Lazaridis, who is staying on as vice chairman and leads RIM’s innovation committee, is correct, Heins said.

“I love to work with Mike in his visionary capacities,” he said. ’’But make no mistake, I run the company.’’

One look at RIM's share price over the past two years (click on chart below) will show you the company has been struggling to keep up with rivals like Apple which overtook Samsung in Q4 smartphone sales.

But don't count RIM out just yet. The stock is rebounding and some very successful funds are snapping it up. One of RIM's top institutional holders is Fairfax Financial Holdings, which recently doubled its stake in the Blackberry maker:

Fairfax Financial Holdings Ltd. (FFH), the insurer run by Canadian investor Prem Watsa, doubled its stake in Research In Motion Ltd. (RIM) in a vote of confidence in the BlackBerry maker after Watsa joined the company’s board.
Fairfax owns 26.85 million RIM shares, up from 11.8 million shares in September, according to a regulatory filing today. The company raised its stake to 5.12 percent, worth about $451 million at today’s closing price.

Watsa was named a RIM director on Jan. 22 as part of a management shakeup that included the replacement of co-Chief Executive Officers Jim Balsillie and Mike Lazaridis with former operating chief Thorsten Heins. The company is rebuilding its product line to try to stem recent market share losses to Apple Inc. (AAPL)’s iPhone and devices that run on Google’s Android platform.

“This is a vote of confidence in the current trajectory of the company or he thinks that there’s some value here that can be unearthed,” said Adnaan Ahmad, an analyst at Berenberg Bank in London. “Watsa is extremely well-respected, kind of like the Warren Buffett of Canada, so the bottom line is that the stock today should be up on the back of this.”
Shrinking Market Value

RIM rose 3.3 percent to $16.80 at the close in New York. The stock, which fell 75 percent last year, lost more value this week after Heins told investors there isn’t “drastic change needed.”

RIM’s share of the smartphone market tumbled to 11 percent in the third quarter of 2011, from 21 percent two years earlier, according to Gartner Inc.

The largest shareholder in RIM is Primecap Management Co., with a 5.5 percent stake, according to data compiled by Bloomberg. Lazaridis has a 5.4 percent stake in the company and Balsillie owns 5.1 percent, the data shows.

“This is a huge psychological boost,” said Ian Nakamoto, director of research at MacDougall MacDougall and MacTier Inc. in Toronto, whose firm oversees C$4 billion for clients, including RIM shares.

Fairfax has said RIM is an attractive investment because the company is trading at less than book value with free cash flow, yet still has a growing subscriber base and increases in revenue.
Favors Buffett

The stock purchases were made by Watsa, Fairfax and about a dozen of the Toronto-based company’s subsidiaries, according to the filing.

Toronto-based Fairfax bought 6.5 million shares on Jan. 25 and another 7.6 million shares yesterday, according to the filing. That means the company has spent about $230 million buying RIM shares in the past two days, based on Nasdaq prices for those dates.

Born in Hyderabad, India, Watsa has built Fairfax by investing in the assets of out-of-favor securities, and said this week he may increase his stake in Waterloo, Ontario-based RIM.

Watsa, 61, founded Fairfax in 1985 and has patterned his style of value investing after Warren Buffett, recommending shares of companies such as Wells Fargo & Co., Johnson & Johnson, Kraft Foods Inc. (KFT) and US Bancorp. (USB)

Fairfax benefited from declines in U.S. banks during the financial crisis, purchasing credit-default swaps on lenders. The swaps, instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt, led to investment gains of $2.72 billion in 2008.

Watsa has shifted in recent years to investing in U.S. municipal bonds backed by Buffett’s Berkshire Hathaway Inc. (BRK/A)

I wonder what Watsa thinks of the solar boom in 2012, but he's too conservative to be investing in solar stocks. Although I do not own RIM shares right now, the share price is attractive at these levels and on my radar. If the company is able to boost market share successfully launch Blackberry 10, RIM will rebound and thrive. And although I love my iPad and iPod, I will never give up my BlackBerry (but the Torch disappointed me).

Pension funds should be looking at RIM and many other companies that are at attractive valuations. I can come up with at least 20 'revival stories' off the top of my head but there are literally hundreds. For example, look at the recent selloff at Corning (GLW) as an opportunity to buy an excellent company on the cheap (no rush, share price may fall further, but put it on your radar).

I know it's sexy to focus on private equity but pensions should be focusing a lot more on public equities, opportunistically taking outsized positions to deliver alpha. That's what Neil Petroff and the folks over at Ontario Teachers' are doing on active management and that's what every pension fund should be doing.

Below, Thorsten Heins, Research In Motion Ltd.'s new chief executive officer, says the maker of the BlackBerry needs to "be constantly communicating" with customers about its products. Heins, who replaced co-Chief Executive Officers Jim Balsillie and Mike Lazaridis, spoke in a video posted by the company. Jon Erlichman reports on Bloomberg Television's "Bottom Line."

Bloomberg also spoke with Vic Alboini, chief executive officer of Jaguar Financial Corp., who talked about the outlook for Research In Motion Ltd.'s strategy under CEO Thorsten Heins and the possibility that the BlackBerry maker will be bought or split.

Mr. Alboini is very critical and thinks that the appointment of Heins means RIM is staying the course. He makes some excellent comments in this interview, especially on beefing up the marketing. It's pathetic, they need Peter Economides to rebrand RIM, just like he rebranded Apple. Watch his amazing lecture (in English) below.

Solar Boom in 2012?

2012-01-27T15:12:00.017-05:00

Alex Morales and Jacqueline Simmons of Bloomberg report, Solar CEOs Predict Boom in China Will Ease Glut in 2012:

China may double its installations of solar panels this year, absorbing excess production that depressed prices and margins in 2011, chief executive officers from two of the industry’s top five manufactures said.

Suntech Power Holdings Co. CEO Zhengrong Shi estimated the nation may add 4 gigawatts or more of panels, and Trina Solar Ltd. (TSL) CEO Jifan Gao expects 5 gigawatts. That compares with about 2.2 gigawatts installed in the country in 2011, more than double the capacity of the average nuclear reactor in the U.S.

The cost of solar panels fell 47 percent last year as Chinese manufacturers led by Suntech boosted production, winning market share from Western rivals such as Q-Cells SE and First Solar Inc. With China’s government pushing to consolidate the industry, the remarks from Shi and Gao suggest rising demand may support the biggest panel manufacturers.

“It’s a huge market,” Gao said through an interpreter in an interview at the World Economic Forum’s annual meeting in Davos, Switzerland. “Excellent companies with good technology, balance sheets and also brands will win out. A lot of companies without those advantages will be taken away.”

Those forecasts are more optimistic than the projections of Bloomberg New Energy Finance, which expects Chinese installations of 3 gigawatts this year and world demand from 25.5 gigawatts to 32.8 gigawatts. Trina expects global demand of 30 gigawatts to 35 gigawatts.
Solar Rebound

Solar shares have rebounded in recent weeks, driven in part by politics in Germany, the world’s largest solar market. After adding a record 7.5 gigawatts of panels last year, more than double the government’s target, lawmakers proposed cutting subsidies. A meeting Jan. 25 ended without an agreement and solar stocks climbed.

The Bloomberg Large Solar Energy (BISOLAR) index of 17 companies, which lost more than two-thirds of its value in 2011, gained 1.7 percent yesterday and has increased 20 percent this year. In New York, Suntech rose 2.7 percent and Trina by 5 percent. 30. An index of eight Chineses solar companies rose 5.4 percent, more than five times the pace of the NEX index of clean energy shares.

In Britain, the government estimates that capping subsidies in December would have saved 1.5 billion pounds ($2.4 billion) over 25 years. A court ruled it illegal to end the support then, ahead of schedule, and developers are rushing to complete new solar plants that will earn the old tariff before officials decide when to scale them back.
Chinese Demand

Suntech’s view shows that growing demand in China may also drive a solar recovery this year.

“I’m hearing a lot from on the ground in China about how hopping demand has been,” said Aaron Chew, an analyst with Maxim Group LLC in New York. “China could surpass Germany” as the world’s largest solar market.

Prices of polysilicon, the raw material in most solar panels, rose in four of the past five weeks after falling 65 percent in 2011.

The Chinese government is spurring clean energy to diversify away from coal, which fuels 70 percent of the economy and is blamed for pollution blanketing industrial areas from Hong Kong to Beijing. Renewables currently account for less than 1 percent of supply, which is growing faster in China than anywhere else in the industrial world, according to data from the oil company BP Plc.

Jenny Chase, head of solar analysis at New Energy Finance, said the forecasts assume China will meet and not surpass the government’s target to have 15 gigawatts of solar capacity by 2015. The estimates from Suntech and Trina suggest that China, like Germany, Spain and Italy, may have trouble keeping a lid on installations once developers start understanding how subsidies will apply to their projects.
Supply-Side Push

“Many other governments who have tried to limit their markets have failed,” Chase said in a phone interview from Zurich. “There could be a supply-side push that pushes this equipment out incredibly cheaply without the need for the federal subsidy.”

Solar panel prices have fallen so quickly that the technology is near reaching parity with fossil fuels in terms of the ability to supply power to national electric grids at a competitive price, said Gao of Trina.
‘Grid Parity’

“We have confidence that we will reach grid parity in several years in China -- like in three to four years,” said Gao, adding that Trina had about 10 percent of its sales in China last year. “In places like Australia, this year they will reach grid parity. Next year, it will be Italy and in 2014, regions like California.”

For now, falling prices are hurting companies throughout the industry. Trina cut its forecast for shipments last year along with First Solar, SunPower Corp., Yingli Green Energy Holding Co., Renesola Ltd. and JinkoSolar Holding Co.

Gao also predicted consolidation in the solar industry, and said that while the 10 biggest panel makers now account for just over 55 percent of the market, by 2015, that proportion may reach more than 80 percent.

“Although the industry faced some challenges, if you look at the trend, it’s growing,” Trina’s Gao said. “We expect that by 2015, the new installations that year will be about 50 gigawatts, so it’s constantly growing.”

China, the manufacturing hub for seven of the eight biggest solar panel makers, until 2010 accounted for less than 3 percent of the market for photovoltaics, with 490 megawatts installed. Installations more than quadrupled last year.

Shi of Suntech said China’s market was “exciting” and the market there this year could be “4 gigawatts or more.” Suntech is the biggest supplier of solar photovoltaic panels, and Trina is the fifth largest.

Solar stocks got clobbered in 2011 largely because of euro woes. Germany recently announced it would speed up subsidy cuts and all the solar bears are warning that the solar industry is in trouble.

Rubbish, total rubbish! First, Germany’s solar subsidy program is now the subject of dispute between two ministers in Chancellor Angela Merkel’s Cabinet. But beyond Germany, China is a powerhouse in the solar industry and they are increasing their demand. Moreover, in India, falling costs of solar energy are making it a viable alternative to power generated by fossil fuels.

In fact, Bloomberg reports that India is producing power from solar cells more cheaply than by burning diesel for the first time, spurring billionaire Sunil Mittal and Coca-Cola Co. (KO)’s mango supplier to jettison the fuel in favor of photovoltaic panels.

But solar skeptics abound. Investors prefer listening to bears like Jim Chanos who is shorting China and solars. I prefer looking at what top hedge funds and long-only funds are actually buying. I pay attention to charts, see if the pullbacks are being bought hard and see if fundamentals are gradually improving.

I also love reading articles on the most shorted solar stocks. Why? Just look at Netflix (NFLX), up over 75% this month, and ask those bears on Zero Hedge how their "short Netflix" position is going (LMAO!).

Here is a snapshot of the 10 most shorted solar stocks at the close today (click on image to enlarge):

Bunga Bunga! Keep on shorting those solars, baby, will only make the solar melt-up that much funner for us solar longs! And if the Greek gods are smiling, a debt deal over the weekend will help propel all risk assets, including solar shares, much higher.

Below, Suntech Power Holdings Co. Chief Executive Officer Shi Zhengrong talks about the outlook for solar energy prices. He speaks with Maryam Nemazee and Matt Miller on Bloomberg Television's "Countdown" on the sidelines of the World Economic Forum's annual meeting in Davos, Switzerland.

Hopes Rise For Greek Debt Deal?

2012-01-27T09:43:00.011-05:00

Hui Min Neo of AFP reports, Hopes rise for Greek deal as US praises euro salvage bid:

Europe's economic pointman said Friday he expected Greece to agree a deal with private creditors to write down its debt this weekend as the US praised efforts to combat the eurozone crisis.
Speaking at the Davos forum, EU economic affairs commissioner Olli Rehn said the Greek debt agreement may be hammered out before a gathering of European Union leaders Monday, in what would be a major shot in the arm to the summit.
"We're very close," he told the World Economic Forum in Davos. "They're about to close a deal, if not today maybe over the weekend, preferably in January rather than February."
As he spoke in Switzerland, the Greek government in Athens was in talks with private creditors on a voluntary exchange of bonds that would wipe 100 billion euros ($130 billion) off the country's debt of 350 billion euros.
The deal under discussion would see private creditors take a "haircut" of at least 50 percent on 200 billion euros in debt. Previous talks stalled over the amount of interest to be paid on the remaining debt.
Any failure to strike a deal could trigger a messy default, which would be an economic disaster for Greece itself and a threat to banks holding too much sovereign debt while piling pressure on other eurozone states.
Rehn said Greece would remain a special case and that the private lenders would not be required to take losses on any other eurozone country's debt, thanks to plans for a better eurozone financial safety net.
"While I know more or less how the eurozone will look in the next three years, I know that next three days will be very crucial," he said.
"We need a very sustainable solution for Greece, even if Greece is a special case," he told the audience of business leaders and top politicians. "Private sector involvement will not be applied to any other country of the EU."
Speaking at the same debate, German Finance Minister Wolfgang Schaeuble said he expected Greece to avoid a default but he warned its debt level should not exceed 120 percent of GDP.
"We don't expect a default of Greece," he said. "I know that most participants have for a long time, but I don't expect a default from Greece. I'm sure that everybody is ready to deliver what has been agreed."
The head of Germany's top bank, Deutsche Bank, also said he was confident a solution could be found to Greece's woes.
Josef Ackermann said the "haircut", or losses that banks were being asked to take on their holdings of Greek debt, was "almost 70 percent."
"That is a great, great deal. But everyone has to make their contribution and then we will see where we are. We're going to carry on," he told Germany's NTV.
Speaking the day after the Federal Reserve cited the eurozone crisis as a reason for cutting its growth forecast, US Treasury Secretary Timothy Geithner said there were signs a corner was being turned.
"Europe is making some progress," he told delegates. "Over last two months in part they are laying foundations for more credible framework."
"We have three new governments (Italy, Greece, Spain) doing some very tough things, an ECB doing the things you have got to do."
The annual forum has been marked by gloom about the state of the global economy, and in particular about Europe's struggle to cope with yawning public deficits while at the same time seeking growth and jobs.
The euro has been under pressure -- amid fears that Greece or even eventually a giant like Spain or Italy could default on its debts -- and the 17-nation bloc's economy in on the brink of renewed recession.
Davos has reverberated with calls for eurozone nations to act decisively to restore confidence, with Mexican President Felipe Calderon calling on Europe to "bring out the bazooka immediately" to prevent the problem from sinking Italy and Spain.
Geithner said Europe needs a "stronger and more credible firewall" and hinted that the US and emerging economies could supply the International Monetary Fund with more funding to help the eurozone rescue effort.
"If Europe is able to do that, we believe that the IMF can play a substantive role. It can't be a substitute for a European response," he said.
Further fuelling the mood of optimism, Italy successfully passed another market test by selling 11 billion euros ($14.5 billion) in short term bonds at sharply lower rates.

But opposition to a debt deal is mounting. Abigail Moses of Bloomberg reports, Greek Debt Wrangle May Pull Default Trigger:

Opposition to payouts on Greek credit-default swaps from European Union policy makers is softening as disputes over a voluntary debt exchange threaten to push the nation into default.

Any agreement between the Greek government and the Washington-based Institute of International Finance on debt writedowns will only bind 50 percent of investors in the 206 billion euros ($270 billion) of notes being negotiated, Barclays Capital estimates. Hedge funds may resist a deal, seeking to get paid in full or compensated from insurance contracts.

Greece must repay 14.5 billion euros of bonds in March and an agreement that triggers as much as $3.2 billion of default insurance may be necessary unless all bondholders approve, said Marco Buti, head of the European Commission’s economics division. EU Economic and Monetary Affairs Commissioner Olli Rehn said today in Davos that a deal is “very close.”

“Politicians seem less concerned than before about CDS triggers,” said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. “Having a payout on Greek CDS is probably better than the alternative: a loss in market faith of the product’s ability to provide a hedge against sovereign risk.”
Worsen Crisis

Officials, including former European Central Bank President Jean-Claude Trichet, have insisted that a swaps trigger was unacceptable because traders would be encouraged to bet against indebted nations and worsen the crisis.

Analysts at New York-based JPMorgan Chase & Co. and Citigroup say a Greek payout may actually bolster confidence in the $232 billion sovereign insurance market and also help boost the government bond market.

Greek Prime Minister Lucas Papademos resumes talks in Athens today with Charles Dallara, the IIF’s managing director, after “some progress” was made at a meeting last night.

Default swaps insuring $10 million of Greek debt for five years cost $6.3 million in advance and $100,000 annually, according to CMA. That implies an 82 percent chance the government will default in that time, assuming investors recover 22 percent of their holdings.

Greek 10-year bonds fell today, pushing the yield on the securities up 16 basis points to 33.64 percent. The price slipped to 21.05 percent of face value. Two-year notes advanced, with the price climbing to 21.33 and the yield dropping 1,814 basis points to 182 percent.

Greece said it may impose losses on investors who fail to support the debt restructuring by adding a so-called collective action clause, or CAC, into its bond documentation. That would force holdouts to accept the same terms as the majority.
Restructuring Event

Use of CACs would trigger a restructuring credit event and a payout of default swaps, according to rules from the International Swaps & Derivatives Association.

Credit events can be caused by a reduction in principal or interest, postponement or deferral of payments, or a change in the ranking or currency of obligations. Any of these must result from a deterioration in creditworthiness, apply to multiple investors and be binding for all holders. ISDA’s determinations committee rules whether swaps can be triggered.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

“A CAC is looking increasingly like the best option,” Citigroup’s Hampden-Turner said. “That route seems to tick a lot of boxes: they don’t have a bond default, the official sector gets treated differently than the private sector, and everybody has to participate in the exchange without anybody getting paid in full.”
ECB Opposition

While the ECB oppose any involuntary restructuring of Greek debt, policy makers such as Dutch Finance Minister Jan Kees de Jager say they aren’t against a credit event.

The softer stance signals Greece is unlikely to get sufficient participation in a voluntary bond swap to make its debt burden sustainable. Negotiations have focused on the coupon bondholders will accept on new debt with Europe’s finance ministers pressing investors to accept bigger losses after the IIF made what they described as their “maximum” offer.

“It would be welcome if the ECB is no longer blocking the only sensible route for Greece to resurrect itself,” said Georg Grodzki, the London-based head of credit research at Legal & General Plc, which manages $550 billion of assets.

Hedge funds in New York and London are trying to profit from trading Greek government bonds as banks brace for losses from a debt swap.
Greek Bonds

Saba Capital Management LP, founded by former Deutsche Bank AG credit trader Boaz Weinstein, York Capital Management LP, the $14 billion fund started by Jamie Dinan, and London-based CapeView Capital LLP are among managers that now hold Greek bonds, according to people with knowledge of the transactions.

Officials are now more concerned about preventing a disorderly Greek default that might threaten indebted European nations such as Italy, Portugal and Spain. An orderly credit event would be positive for the market, according to Saul Doctor, a London-based credit strategist at JPMorgan.

“There’s less emphasis on the perils of triggering CDS,” said Barnaby Martin, a European credit strategist at Bank of America Merrill Lynch in London. “It’s now about making sure Greece’s debt is sustainable.”
Portuguese Bonds

Portuguese bond yields widened this month on speculation the indebted nation may follow Greece in seeking losses from private investors. The country’s 10-year bonds yield 14.88 percent. Two-year note yields are higher at 16.54 percent.

The upfront cost of insuring Portugal’s debt jumped 5 percentage points since Jan. 13 to a record 38 percent, according to CMA, meaning it costs $3.8 million euros in advance and $100,000 euros annually to insure $10 million of the country’s debt for five years.

Outstanding contracts on Portugal have tumbled to $5 billion from about $8 billion last year, according to data from Depository Trust & Clearing Corp., covering 2 percent of the nation’s debt.

“Contagion has already happened to a large extent and officials are probably not as scared of triggering CDS as they were six months ago,” said Cagdas Aksu, a European rates strategist at Barclays Capital in London. “If there is any way to avoid the CDS trigger, they will of course prefer it, but the chances of this has become low at this stage.”

Not as scared of triggering CDS? Give me a break! There will be no CDS trigger and no big fat Greek payday for hedgies who bought Greek bonds looking to make a killing.

In his latest comment, Andreas Koutras writes, The Restaurant at the end of the World. Bang or Whimper?:

"Are you going to tell me," said Arthur, "that I shouldn't have green salad?"

"Well," said the animal, "I know many vegetables that are very clear on that point. Which is why it was eventually decided to cut through the whole tangled problem and breed an animal that actually wanted to be eaten and was capable of saying so clearly and distinctly. And here I am." …….

"A very wise choice, sir, if I may say so. Very good," it said, "I'll just nip off and shoot myself."

(D.Adams, The restaurant at the end of the Universe)

Douglas Adams the writer of the Hitchhikers Guide to Galaxy, in his science fiction book the “The Restaurant at the End of the Universe”, has a wonderfully surreal scene. Guests at the restaurant are asked to choose which parts from a live animal they wish to eat, while watching the end of the Universe. The animal voluntarily wants to be eaten.

In a strange sort of way this is what Troika is demanding from Private bondholders. Bondholders are asked to voluntarily kill, or at least half-mutilate themselves while the guests (Troika) are watching the end of Greece. The end however could be either a big crunch (default) or a whimper (no default but just slow death).

This I guess is the 14.4billion euro question (Redeeming on 20^th March 2012). Would the end come with a default or would it be just a big whimper? In other words, a slow drift to a cold death with no bangs and no defaults.

My guess is that it all hinges on what the ECB does with its Greek bond holdings. Answering this would in my mind give you almost certainly the answer to the Crunch/Whimper dilemma. Here is why:

Big Crunch(Default)

ECB owns around 20% of the outstanding Greek debt in Bond form. If it is excluded from the PSI then others would free ride on the back of the ECB driving participation down and making the introduction of CAC (Collective Action Clauses) to force it up almost inevitable. There are many problems with this strategy and we have outlined them in previous posts (CAC Warpath, PSI Enigma, ECB and Europe, ECB Accounting).

With or without the ECB, however, there are very few that would gain from a default. Banks holding bonds outright certainly don’t want this. The ECB does not want this as it would mean losses for her and also supporting the Greek banking system. Germany and the EU would have a much bigger problem to solve in an election year. After all, Germany benefits from the lower value of the Euro caused by the Greek crisis.

It would be optimal to stretch the rope to the breaking point but no further. Only a small fraction perhaps less than 5% would stand to gain. The net CDS volume is around 3billion and is insignificant. So, why is it you may ask that they cannot find an agreement to the PSI? To me all this back and forth is just poker playing trying to secure a better deal. Viewed under this light, many actions make more sense. The only problem is that the rope might break earlier and for unforeseen reasons (Greek political turmoil for example).

Big Whimper (Slow cold death)

If on the other hand Europe finds a way to relieve the ECB of its holding or if the ECB decides to take the hit and participates in the PSI, the hold outs would be reduced to a minimum. Namely, to retail bond holders and possibly owners of Greek bonds under English (non-Greek) law. In this scenario, Greece would not need to cause a credit event or introduce CAC’s to force the participation up. It would also respect market practices and give time for reflection and Election (see France, Germany)!

Conclusion

The end game is very hard to call. Rationality and logic point towards a whimper solution. Human failings and unpredictable events point to a big bang. D.Adams motto in the hitchhiker guide to the galaxy is DO NOT PANIC.

Will it all end in a bang or a whimper? I'm not panicking. My take is that the power elite at Davos have enough of the turmoil in financial markets and they will do whatever it takes to put an end to this Greek debt debacle. Stay long risk assets and keep buying the dips hard.

Below, Nobel Prize-winning economist Joseph Stiglitz, talks about income disparity and employment in the U.S., and the European sovereign-debt crisis. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday."

And International Monetary Fund Managing Director Christine Lagarde discusses Greece's progress on structural overhauls and the role of the IMF in avoiding a default. She speaks with Maryam Nemazee and John Fraher on Bloomberg Television's "The Pulse" .

Finally, George Soros talks about the European debt crisis, stating that defenses for Greece are too weak. He speaks with Erik Schatzker on Bloomberg Television's "InsideTrack" from the World Economic Forum in Davos, Switzerland. As I stated earlier this week, Soros gets it, and European leaders would be wise to listen to him carefully.

Anxiety Mounts Over Maturing Real Estate Loans?

2012-01-26T22:09:00.005-05:00

Julie Satow of the NYT reports, Anxiety Mounts Over Maturing Real Estate Loans:

Borrowers and lenders are starting to grapple with the billions of dollars in commercial real estate loans made during the boom year of 2007 that are coming due this year, in a greatly contracted economy.

Experts have warned of a rash of recapitalizations, refinancings and building sales. In New York City alone, nearly $70 billion worth of commercial mortgages that were bundled together and issued as collateral for bonds are maturing this year. Of those, $26 billion, or 37.4 percent, are five-year loans that were originated during the height of the real estate bubble, when underwriting standards were loosest, according to data from the research firm Trepp LLC.
These include loans on prominent properties, including the Manhattan Mall, with $232 million maturing, and the Jumeirah Essex House, with a $180 million loan, according to Trepp.
“These loans are going to have the hardest time being refinanced since they were underwritten when property values and revenues were far higher,” said Thomas A. Fink, a managing director at Trepp. “We are going to see a wave of loans maturing this year, then again in 2014 and 2017, when the 7- and 10-year deals underwritten during the bubble mature.”
Most large commercial mortgage loans are typically not self-amortizing — that is, they require a balloon payment upon maturity.
While the number of loans maturing is expected to spike this year — $40.7 billion worth of securitized commercial mortgage loans matured last year and $49.5 billion worth is expected to mature in 2013 — the universe of lenders has shrunk. European banks, reeling from the debt crisis, have mostly stopped underwriting loans in the United States, while the market for commercial mortgage-backed securities remains relatively small, at roughly $30 billion in new issuance expected this year. And while insurance companies have increased their appetite for commercial mortgage loans, they are very conservative in their lending standards and selective in their deals.
“This means there may not be enough money available to refinance all of the debt that is coming due,” said Lawrence J. Longua, a clinical associate professor at the Schack Institute of Real Estate at New York University.
In a typical situation, a building that was worth $100 million in 2007 was financed with 80 percent debt, or $80 million. Now the loan — which was interest-only, meaning no principal was paid — is maturing. The borrower owes $80 million, but the value of the property has also dropped, to $80 million. This means that the ratio of the loan to the value of the property is 100 percent. Lenders have little appetite in this market environment for highly leveraged loans, so in one increasingly common outcome, the borrower will recapitalize the property by finding an equity partner to inject new capital into the deal, thereby lowering the overall amount of debt on the property.
Other possible resolutions include the lender extending the maturity date of the loan in the hopes that the property’s value will rise, or pursuing a foreclosure. It is also becoming more common for banks and other lenders to sell their loans to third-party investors who may negotiate with the borrower.
One factor that may drive more deal activity this year is that banks, special servicers and other lenders are eager to find solutions to troubled loans now, rather than postpone a resolution in the hope the market will improve down the road, said Scott Rechler, the chief executive and chairman of RXR Realty, which has recapitalized several properties in the last year, including the recent acquisition of 620 Avenue of the Americas.
“The first half of 2011 was very strong, with a lot of deal-making,” Mr. Rechler said, “but then several incidents, including the European debt crisis and the downgrading of the U.S. debt, made the market seem frothy. This was actually somewhat healthy because it put things back into perspective.”
As a result of these market jitters, he said, “lenders who had been waiting in the hopes that the market would improve, realized that things were still unstable and so they are more ready to resolve their loans now than in the past. Maybe not in the first quarter of this year, but by the second and third quarter I see a lot of things in the pipeline.”
Already, the number of recapitalizations has ballooned. There was $13.3 billion worth of recapitalizations nationwide in 2011, according to the research firm Real Capital Analytics, the most since the firm began tracking the number in 2001.
Another factor driving deal flow is the efforts by European banks to offload some of their American loan portfolios. In December, for example, Blackstone bought a $300 million portfolio of commercial loans backed by American properties from Eurohypo, the troubled real estate arm of Commerzbank in Germany. Other sellers include Allied Irish Banks, Bank of Ireland and Anglo Irish. American banks have also been shedding loans: In September, Bank of America sold nearly $1 billion worth of loans to several investors at a discount.
The sale of these loans can help spur deals because investors who buy these loans at a discount have more room to negotiate a payoff with the borrower, said Andrew A. Lance, a partner at the law firm Gibson, Dunn & Crutcher. A loan that has an outstanding balance of $100 million, for example, may sell to an investor for $80 million, enabling the investor to settle the loan with the borrower for any price between $80 million and $100 million, resulting in a profit for the investor and a discount for the borrower. While under this situation the original lender loses out, in the case of several European banks, regulators are ordering them to increase capital and shrink their balance sheets.
Dune Real Estate Partners participated in such a deal last year when it acquired the loan on the Mark Hotel on East 77th Street from Anglo Irish, recently completing a recapitalization of the property. Dan Neidich, the chief executive of Dune Real Estate Partners, said: “There are so many players now who aren’t the natural owners of real estate — like banks and special services — that never intended to own equity and who want to exit those positions. It opens opportunities for people like ourselves, who are in the business of taking equity risk, and bringing capital into the market to restructure deals.”
But not all borrowers will find themselves in trouble. There are many New York landlords who can simply pay down the loans without much struggle, market experts say. Vornado Realty Trust, for example, refinanced a $430 million loan at 350 Park Avenue in January with $300 million in debt and $132 million in cash. It is currently in the market to refinance the $232 million loan maturing on the Manhattan Mall, at Broadway and 33rd Street.
Still, even those borrowers who can pay down the loans themselves will have to contend with the softened market. “The key issue that cuts across all property types and all kinds of loans,” said Dennis W. Russo, a partner and co-chairman of the real estate practice at the law firm Herrick, Feinstein, “is that property values — the value of the collateral that secures the debt — are down. Combine that with the fact that lenders are conservative right now, and the bottom line is that in many scenarios, borrowers are going to have to find additional capital.”

Despite these jitters, commercial real estate sales rose sharply in 2011. Hui-yong Yu of Bloomberg reports, Commercial Property Sales Rose to More Than $220 Billion in U.S. Last Year:

Commercial property sales rose 57 percent to more than $220 billion U.S. last year, led by retail properties and garden apartments, Real Capital Analytics Inc. said in a report today.

More than 14,700 properties, each worth at least $2.5 million, changed hands in 2011, the New York-based real estate research firm said. Retail-property transactions rose 91 percent from a year earlier to $42.4 billion, and sales of low-rise apartments increased 70 percent to $34.5 billion. Manhattan accounted for 12 percent of total deal volume.

Sales rose as investors sought relatively higher yields from income-producing real estate and debt-laden owners unloaded properties acquired during the bubble years. Deals slowed in the second half of 2011 as turmoil in the market for commercial mortgage-backed securities curbed financing. Office and hotel transactions fell in the three months through December after six quarters of “large” year-over-year gains, Real Capital said.

“Buyers have started to broaden their horizons both geographically and by property type,” the firm said.

The biggest declines in capitalization rates were seen in well-leased, high-quality suburban offices and in shopping centers anchored by grocery stores, Real Capital said. Cap rates are calculated by dividing a property’s net operating income by purchase price, with rates dropping as prices rise.

Banker & Tradesman reports that Boston ranked 18^th on a listing of the top 30 cities worldwide that attracted commercial real estate investment in 2010-2011, and are expected to continue leading the way over the next decade according to a recent report from Jones Land LaSalle (JLL). Even Northern Nevada’s embattled real estate and construction industry has hit bottom and is on the road to recovery (buy casino stocks like Las Vegas Sands).

In Canada, commercial real estate transactions in the Calgary region ballooned in 2011 with both dollar volumes and deal velocity significantly higher than the previous year. But you already know my thoughts on the Canadian housing bubble (commercial is less vulnerable because large public plans own most of the prime properties).

In Europe, Property Wire reports on strong demand for German commercial property:

Transaction volumes for Germany's commercial real estate market will exceed €20 billionin 2012 with continued strong demand from both somestic and foreign investors, it is claimed.
According to research by international real estate advisor Savills real estate worth €22.6 billion changed ownership in Germany in 2011, marking a 20% increase on 2010.
‘The final quarter of 2011 recorded the second best investment volume of the year at approximately €5.8 billion, showing little evidence in the investment market of a deteriorating macro economic environment,’ said Lars-Oliver Breuer, head of investment at Savills Germany.
‘Given a number of uncertainties it is difficult to provide an outlook to 2012 but what will be crucial is whether the situation in the financial markets stabilizes and if the eurozone succeeds in convincing investors of its stability,’ he explained.
‘Financing will be the predominant issue this year but if the continuously strong demand for German real estate can be translated into deals the 20 billion mark is realistic for 2012,’ he added.
Savills research shows that as in previous quarters the retail sector dominated German markets in the last quarter of 2011. Overall retail generated an investment volume of over €11 billion, making up almost half, 49%, of total transactions in 2011 and representing an increase of 60% on 2010.
The office sector, which has historically dominated the German investment market, accounted for just below 35% of all transactions in 2011. Overall offices accounted for €6.58 billion of the investment volume in 2011, up from €4.88 billion in 2010.
According to Matthias Pink, head of research at Savills Germany the reason for the increase in retail investment is partly due to the higher rental stability of retail properties. ‘Investors who continue to focus on secure investments appreciate this characteristic. Another reason is the stable and currently very good consumer sentiment in Germany,’ he said.
Overall almost half of Germany’s 2011 total transaction volume was invested in the leading five markets of Frankfurt, Berlin, Hamburg, Düsseldorf and Munich. Due to several large volume deals Frankfurt led the way generating a single asset transaction volume of over €2.3 billion, making up 14% of the total German transaction volume.
Munich also recorded a strong increase almost doubling its volume invested in single assets in 2011 to €1.6 billion. In Berlin volumes were up 11% and in Hamburg they were up 14%. But in Düsseldorf the transaction volume decreased by approximately 40% compared to 2010.

The share of foreign buyers was approximately one third in 2011 with investors of Anglo Saxon origin accounting for over half of all foreign investment. As in the first half of the year open ended and closed ended funds were among the strongest buyer groups and jointly invested €7.6 billion.
The second half of 2011 saw a notable increase in investment activity from insurance companies and pension funds as well as listed property companies and REITs.

Indeed, pension funds have been busy snapping up real estate in Germany and other European cities like London and Paris (click on image below):

As you can see, institutional investors aren't too anxious about maturing real estate loans. Private equity real estate funds like Blackstone and Lone Star will be scooping up distressed loans for a song and making a killing in the process for themselves and their limited partners.

Below, John Levy and FOX Business hosts Connell McShane and Jenna Lee discuss the current commercial real estate market.

'Major' Changes to Canada's Pension System?

2012-01-26T13:25:00.025-05:00

Prime Minister Stephen Harper is in Davos touting 'major' changes to Canada's pension system:

Prime Minister Stephen Harper has signalled his government will bring forward “major transformations” to the country in the coming months — in areas such as the retirement pension system, immigration, science and technology investment and the energy sector.
Of those reforms, Harper said, getting a grip on slowing the rising costs of the country’s pension system is particularly critical.

In the wake of Harper’s speech, it now appears that the Conservative government could be poised to gradually change the Old Age Security system so that the age of eligibility is raised to 67 from 65.
Harper made the revelations in a major keynote speech Thursday at the World Economic Forum, the annual gathering of the world’s political and business elite.

As expected, the prime minister was critical of Europe and the United States for not adequately dealing with the economic problems that have gripped them in recent months and years.

But it was Harper’s assessment of the major changes that lie ahead for Canada that stood out in the speech.

“In the months to come, our government will undertake major transformations to position Canada for growth over the next generation,” said Harper.

The Conservative government will table a budget in the coming weeks that is expected to set the stage for years of deficit-slashing and government reform.

“Under our government, Canada will make the transformations necessary to sustain economic growth, job creation and prosperity now and for the next generation,” said Harper.

He said that means two things: “Making better economic choices now. And preparing ourselves now for the demographic pressures the Canadian economy faces.”

Harper said the country’s aging population has become a backdrop for his concern about how to keep the country strong over the long term.

“If not addressed promptly, this has the capacity to undermine Canada’s economic position and, for that matter, that of all western nations well beyond the current economic crises.”

Indeed, Harper said the country’s demographics — an aging populating and a dwindling workforce — constitute “a threat to the social programs and services that Canadians cherish.”

For that reason, he said his government will “be taking measures in the coming months.”

Harper did not specify what those measures will be, but he said they are necessary — not just to bring the government’s finances back to a balanced budget in the medium term, “but also to ensure the sustainability of our social programs and fiscal position over the next generation.”

“We have already taken steps to limit the growth of our health care spending over that period,” said Harper.

“We must do the same for our retirement income system.”

Harper said the centrepiece of the public pension system — the Canada Pension Plan — is fully funded, actuarially sound and does not need to be changed.

But he added: “For those elements of the system that are not funded, we will make the changes necessary to ensure sustainability for the next generation while not affecting current recipients.”

So far, the government has come forward with a plan to create a private pooled pension system to encourage Canadians to prepare for their retirement.

Still, there are concerns that as baby boomers approach retirement, the cost to government of providing public pensions will skyrocket.

In December, the National Post reported that there was internal debate within the government about increasing the age of eligibility for the other major element of the public pension scheme — Old Age Security — from 65 to 67.

Internal government documents project the cost of the OAS system will climb from $36.5 billion in 2010 to $48 billion in 2015. By 2030 — when the number of seniors is expected to climb to 9.3 million from 4.7 million now — the cost of the program could reach $108 billion.

Among the other priorities where change is coming:

Energy

The Conservative government will make it a “national priority” to ensure the country has the “capacity to export our energy products beyond the United States, and specifically to Asia.”

“In this regard, we will soon take action to ensure that major energy and mining projects are not subject to unnecessary regulatory delays — that is, delay merely for the sake of delay.”

Harper did not explain what he has planned, although he and Natural Resources Minister Joe Oliver have complained that foreign-backed “radical” opponents of the $5.5-billion Northern Gateway project have threatened to slow down hearings by the National Energy Board.

Immigration

The system faces “significant reform,” said Harper.

“We will ensure that, while we respect our humanitarian obligations and family reunification objectives, we make our economic and labour force needs the central goal of our immigration efforts in the future.”

Science

The government will continue to make “key investments in science and technology” that are necessary to sustain a “modern competitive economy.”

“But we believe that Canada’s less-than-optimal results for those investments is a significant problem for our country.”

In future, he said, there will be changes to rectify that problem.

Trade

Harper expects to complete negotiations on a Canada-European Union free-trade agreement this year.

Furthermore, he said, his government is committed to also completing negotiations for a free-trade deal with India by the end of 2013.

And Canada will begin talks to become a member of the Trans-Pacific Partnership while also pursuing opportunities to trade in the emerging market of Asia.

Harper arrived Wednesday at the World Economic Forum determined to tout Canada as a trading nation with a solid economic record and massive oil resources which are ready to be sold and shipped to customers worldwide.

Other members of cabinet who are attending the conference in the exclusive mountainside resort in the Swiss Alps are Finance Minister Jim Flaherty, Foreign Affairs Minister John Baird, International Trade Minister Ed Fast and Bank of Canada governor Mark Carney.

The Canadian delegation used private meetings in the corridors and backrooms at the forum to promote Canada’s hopes for a free-trade deal with Europe, and also break into the emerging marketplace in Asia.

The forum, which dates back to 1971, has drawn 2,600 participants, including 40 political leaders and more than 1,600 senior business leaders.

While the economic uncertainty of Europe gripped the discussions, participants — at the urging of the forum’s founder, Klaus Schwab — also discussed whether capitalism itself needs to be fundamentally reformed to ensure greater social responsibility.

On Thursday morning, British Prime Minister David Cameron told the conference that Europe’s economies had entered a “perilous time” and called for European leaders to avoid “tinkering” with the eurozone debt crisis.

Cameron boasted of his government’s actions to get British debt under control and said the countries in the eurozone (Britain is not a member) must also take “bold and decisive “ action if they want to solve the debt crisis.

Harper issued a scathing criticism of countries in the developed world, which he suggested had forgotten about the importance of creating economic growth.

“Is it the case that, in the developed world, too many of us have in fact become complacent about our prosperity?” Harper asked.

He suggested that developed countries had taken wealth “as a given . . . assuming it is somehow the natural order of things.”

As a result, he said, countries in the western world had become focused primarily “on our services and entitlements.”

As a result, he said, it’s not surprising that, in addition to banks facing debt, countries themselves were also facing sovereign debt crises.

The problem, he suggested, could be “too much general willingness to have standards and benefits beyond our ability, or even willingness, to pay for them.”

Harper warned that the wealth of western economies “is no more inevitable than the poverty of emerging ones.”

He said the problems afflicting Europe and the U.S. threaten to become even more serious in future.

“Each nation has a choice to make. Western nations, in particular, face a choice of whether to create the conditions for growth and prosperity, or to risk long-term economic decline.”

The solution, he said, is for countries to make the sometimes tough, but correct, decisions now.

“Easy choices now mean fewer choices later.”

Easy choices now? Like pandering to banksters and insurance hacks, banking on PRPPs? Thanks but no thanks, that is a recipe for pension poverty, higher debt and less growth down the road.

As a Canadian who blogs on pension issues every single day, I stand against "easy solutions" which will only exacerbate income inequality and reduce retirement security for all Canadians.

If our PM and Finance Minister are serious about solving Canada's pension enigma, they would recognize the need to bolster our public defined-benefit plans, the envy of the world. Some of our smartest pension leaders have made the case for boosting defined-benefit pensions, but they're being completely ignored by our government who panders to banks and insurance companies.

And Canadian banks and insurance companies are being advised by shortsighted fools. If they had any vision and thought about what is best for the country and their long-term profits, they'd be pushing hard to expand CPP and defined-benefit plans for all Canadians. They simply don't get it.

I'm tired of our politicians and corporate leaders telling us that pensions are "too expensive" and that we can't fix pensions and make them better. NDP interim leader Nycole Turmel says MP pension reform should be handled by independent group and that the government should focus on the retirement security of millions of Canadians. Great idea from another MP with her snout in the pensions trough, but who will form this independent group of thinkers?

I know who I would recommend to lead such an independent Royal Commission. Bernard Dussault, the former Chief Actuary of Canada, and John Crocker, the former President and CEO of Healthcare of Ontario Pension Plan (HOOPP), one of the best defined-benefit plans in the world.

Instead our government is going to take the easy route. Canada is facing serious issues, including a major housing bubble about to burst (high end condos are first to go), and all the government can think of is cut everywhere and replace defined-benefit plans by defined-contribution plans.

Don't get me wrong, I'm a fiscal conservative (social liberal) and believe we need serious pension reform, but we are not going about it in an intelligent manner and it's going to end up costing us a lot more in the future.

Every single day I tweet about some company that suffered a pension bomb. Today, it was AT&T who lost a whopping $6.7 billion in the fourth quarter due largely to a change in how it accounts for its employee pension benefits and the breakup fee it was required to pay after scrapping its bid to buy T-Mobile USA.

AT&T is not alone. Many U.S. and Canadian companies are unable to deal with their employee pension benefits. Many have opted out of defined-benefit plan for 'low cost' defined-contribution plans but this is not in the best interest of their employees or in the best interest of their country.

If the leaders at Davos are serious about growth, debt, inequality and other social issues, they have to start thinking hard about retirement security and coming up with a sustainable solution for the long-term.

In a nutshell, here are some of my 'radical' proposals:

Increase the retirement age to 67 (people are living longer; some economists think we need to raise the retirement age to 70)
Review cost-of-living adjustments (COLAs) and cut when necessary
Scrap all private companies' defined-benefit plans and consolidate them into a few large public defined-benefit (DB) pension funds. Companies should focus on producing goods and services, not managing pensions.
Consolidate all municipal and city pension plans into large public DB plans
Consolidate all Crown corporations DB plans into one large DB plan
Expand CPP to all Canadians and get the funding right
Cap CPPIB and all large public DB plans at a certain size and create new ones as needs arise
Make pensions portable so no matter where people work, their pensions are safe, secure, well managed and will follow them
Last but not least, get the governance right and improve it continuously.

I wasn't invited to speak at Davos but that's fine, I'm not into schmoozing with billionaires. But some very powerful people do read my blog and they are there, hobnobbing with the world's power elite. Hopefully they will pass on my message.

Below, World Bank President Robert Zoellick talks with Bloomberg's Erik Schatzker about the economic woes facing Italy. And Kenneth Rogoff, an economist at Harvard University, talks about the European debt crisis and the impact of a Greek default on the region.

The Shrinking Private Equity World?

2012-01-26T08:28:00.008-05:00

Maureen Farrell of CNN reports on the shrinking private equity world:

The notoriously private private equity industry can't escape the glare of the spotlight these days, but the more immediate issue facing the industry is a lack of funding.
In 2011, U.S. firms invested just $32.1 billion in private equity, down nearly 79% from the industry's peak year in 2007.
And 2012 is expected to be even worse.
"It's taking a lot longer to raise funds," said Jeffrey Bunder, head of Ernst & Young's global private equity practice. "The process isn't like it used to be. They're having to demonstrate why they deserve the money."
Pensions and endowments, which make up the bulk of private equity investors, have been casting a wary eye on the industry because of the combination of high fees, lackluster returns and generally erratic returns.
Keith Garrison, the director of alternative assets for Texas Christian University's $1.1 billion endowment, said he's been more cautious about investing in buyout funds since the financial crisis.
"The returns have been more drawn out than you would have originally anticipated," said Garrison. "We need to manage liquidity. I'm not the only endowment closely watching its allocation to private equity."
Unlike hedge funds or other assets that offer quarterly returns, private equity funds return cash to investors only when the companies they're invested in are sold, go public or add new debt.
Part of the problem for the industry is that since the financial crisis, private equity firms have had a hard time selling their acquired companies, as mergers and acquisitions and initial public offering activity slowed down.
In fact, current returns are at their worst level since at least 1990, when the California Public Employees' Retirement System first started tracking the data.
Private equity funds raised in 2006 have returned just 4.2% to investors, according to the pension fund's website. Funds raised in prior years generated double digit returns. Similar to hedge funds, managers of private equity firms generally earn 2% fees on all funds they manage and 20% of all profits.
Meanwhile, the same firms are struggling to find companies to take private that could generate returns. The industry is sitting on roughly $400 billion of cash globally. Private equity managers haven't found the right companies to put this so-called dry powder in.
All but the best performing firms are expected to shrink, as investors put a smaller amount of their portfolio into private equity firms.
Firms that have raised between $1 billion and $5 billion with so-so performance will have the most trouble raising new funds.
Most of the largest funds that already have a spot in a public pension such as CALPERs, which manages $219 billion of California employees' retirement funds, will keep some money from these funds. CALPERs and its larger pension peers spend a lot time and a lot of money vetting new investments, so earning that initial spot in a pension portfolio helps keep a private equity firm alive in all but situations of extremely poor performance.
As U.S. investors scale back their private equity investments, the industry is increasingly looking to sovereign wealth funds and wealthy families in Asia and Latin America for new money.
"Funds are spending a lot of time overseas telling their story and thinking there's an appetite there," said Ernst & Young's Bunder. "That money doesn't come in overnight though."
For many private equity funds, that extended fundraising cycle could strike a fatal blow.

So what is going on? Is private equity fundraising really drying up? Not according to Michael Corkery of the WSJ who reports, Public Pensions Increase Private-Equity Investments:

Large public pension plans are pouring more money into private-equity funds, deepening ties between government workers and an industry currently under the harsh glare of U.S. presidential politics.

Big public-employee pensions had about $220 billion invested in private equity in September, or 11% of their assets, according to Wilshire Trust Universe Comparison Service, which tracks the holdings of pensions, foundations and endowments.
That is up about $50 billion from a year earlier, when such investments accounted for 8.6% of large pension funds' assets. A decade ago, pensions with at least $1 billion under management had just 3% of their money with private equity.

Private-equity funds buy companies, restructure them and try to profit by reselling them at a higher price. That approach, particularly with respect to the fate of workers at companies they buy, has become an issue in the Republican campaign because Mitt Romney formerly led private-equity firm Bain Capital.

In Monday's debate in Florida, which holds its primary on Jan. 31, Mr. Romney defended his business track record, which he said involved creating thousands of jobs.

Some of Mr. Romney's critics are labor unions, including those who count public employees as members and have representatives on pension boards that determine how much to invest in private equity. The retirement benefits of thousands of police officers, firefighters and teachers depend in part on the profits of investments in private-equity firms such as Bain.

Earlier this month, the Service Employees International Union, a major public-sector labor group, blasted Bain for what it described as "a long and troubling track record of putting profits above workers." The union said, for example, that Bain had acquired a plant in Indiana where workers were fired and then rehired at a lower wage.
SEIU members have pension money invested in numerous state and county pension plans around the U.S., many of which are invested in private-equity funds. And SEIU members serve on the pension boards that make decisions about where funds are invested.

An SEIU member, for example, serves as a trustee of the Ohio Public Employees Retirement System, which holds billions of dollars in private-equity investments and, in recent years, increased its target private-equity holdings to 7% of assets, from 5%.

Investment officials at the Ohio fund and other public pension plans say their primary duty is to secure the highest returns possible for public workers.

"Our board members are fiduciaries who act in the best interest of the fund, regardless of whatever political leanings they have personally'' or their unions have, said Julie Graham-Price, a spokeswoman for the Ohio pension fund.

An SEIU spokesman declined to comment.

The American Federation of State, County and Municipal Employees, or Afscme, which represents 1.6 million active and retired public employees, is taking a swipe at Mr. Romney for one of Bain's many investments.

"What kind of businessman is Mitt Romney?'' asked a new Afscme-funded television advertisement. The ad said Mr. Romney collected a "fortune" from a company, formerly held by Bain, that was accused of Medicare fraud.

A spokesman for Bain declined to comment.

Afscme's members have billions of dollars of pension money invested in about 150 public pension plans around the nation, many of which are invested in private-equity funds. Afscme's members also serve on pension-fund boards in about a dozen states and cities.

An Afscme member, for example, is one of the trustees overseeing the New York City Employees' Retirement System, which recently increased its targeted allocation for private equity to 7%, from 5%.

The Afscme member on the New York City pension board, Lillian Roberts, said in a statement: "I have a fiduciary duty to protect the investments Afscme members and others have made to the pension fund.''

Ms. Roberts added that she has pushed pension officials to address high fees and other drawbacks of private-equity investments.

A national spokesman for Afscme said it was "ridiculous" to question whether there was a conflict for the union to criticize Mr. Romney's private-equity track record while union members' pensions were invested in private equity generally. "The purpose of the ad was to shine light on Mitt Romney's dubious record in the private sector. …Afscme members have savings in banks that engaged in questionable behavior, too," the spokesman said. "They still know that this kind of behavior needs to be reined in."

Asked about the SEIU and Afscme criticisms, a spokeswoman for the Romney campaign said in a statement: "The last thing President Obama and his cronies want is Mitt Romney as an opponent because they know he is the only candidate that can beat President Obama and put an end to the big labor's power."

Pension-fund officials say they increasingly are turning to private equity in an effort to hit annual return targets of 8%. Over both the past five years and the past 10 years, private-equity returns were more than double those of the S&P 500 stock index and the Dow Jones Industrial Average, according to Cambridge Associates LLC, which tracks over 4,500 private-equity firms.

As of September 2011, median private-equity returns for large public pension funds over the past five years was 6.6%, according to Wilshire Associates. Median stock-market returns for those funds were a negative 0.9% over that same five-year period.

During the private-equity buyout boom of the 1980s, many pension funds steered clear of the sector, fearing the unknown.

Today, pension-fund managers "would say you may be breaching your fiduciary duty if you avoid this asset class," said Bill Kelly, a lawyer at Nixon Peabody who has worked with pensions and private-equity firms for 30 years.

Wilshire said private-equity investments surged last year as a percentage of pension-fund holdings partly because pension funds' existing investments in private equity increased in value while other holdings, such as stocks, were mostly flat.

Pension funds are experimenting with new ways to team up with private-equity firms, such as publishing joint research and investing directly in companies alongside private-equity partners.

In November, the $100 billion Teacher Retirement System of Texas made one of the largest single private-equity investment ever—a $6 billion commitment to new partnerships with Apollo Global Management and KKR & Co. The pension fund and the two New York firms will swap strategies and share resources.

The Texas fund has private-equity portfolio with investments in about 1,500 companies. It doesn't disclose the names of those companies publicly.

"I am confident that our private-equity investments have created more jobs than they have lost,'' said Steve LeBlanc, head of private markets at the Texas fund. "The way you make money is through growth."

Some pension funds enter into side agreements with private-equity firms barring certain investments, such as in tobacco or firearms companies. Since 2004, the largest U.S. public pension plan, California Public Employees Retirement System, or Calpers, restricts private-equity investments in companies that are likely to outsource government jobs to the private sector, such as prison guards and garbage collectors.

In 2010, the Ohio Public Employees Retirement System sent a letter to private equity firm Permira protesting plans by one of its portfolio companies, clothing retailer Hugo Boss, to close a local factory. Permira declined to comment. A spokesman for Hugo Boss said the plan ultimately remained open.

Calpers investment officials had no comment on the criticisms being leveled at private equity in the presidential campaign.

CalPERS' delivered paltry returns in 2011 but their private equity portfolio is up 12% for the first three quarters of 2011.

Increasingly, large public plans are looking to private equity to bolster their returns. Top funds have no problem raising assets. Bloomberg reports that Blackstone secured more than $6 billion of pledged capital for a new real estate fund that will buy mainly distressed-property assets:

The New York-based buyout firm plans to raise at least $10 billion for the fund, known as Blackstone Real Estate Partners VII, said the people, who asked not to be identified because the capital-raising is private. Blackstone expects the vehicle to be fully funded this year, they said.

The company has remained one of the most active investors in commercial real estate at a time when such Wall Street competitors as Goldman Sachs Group Inc. (GS)’s Whitehall funds and Morgan Stanley’s real estate funds retreated after incurring losses in the crash.

“Blackstone is in a bit of a unique position because so many mega-funds have been eliminated or are struggling with ongoing legacy issues,” said James Corl, a managing director at Siguler Guff & Co., a New York-based private-equity firm that raised $630 million for distressed-property investments.

But while the top firms thrive, others lag behind, and private equity is being scrutinized by politicians and investors alike. Some are complaining about private equity's public subsidy while others are calling private equity profits into question:

Private equity has proved better at enriching its own managers than producing investment profits for US pension funds over the past decade, according to a study prepared for the Financial Times by academics at Yale and Maastricht University.

The industry faces mounting political scrutiny as the presidential candidacy of Mitt Romney, a former private equity executive, has drawn attention to its business model and favourable tax treatment. Mr Romney will release his tax returns today after pressure from Republican challengers.
From 2001 to 2010, US pension plans on average made 4.5 per cent a year, after fees, from their investments in private equity. In that period, the pension funds paid an average 4 per cent of invested capital each year in management fees. On top of those, private equity often collects a variety of other fees and a fifth of investment profits.
“Assuming a normal 20 per cent performance fee, this would amount to about 70 per cent of gross investment performance being paid in fees over the past 10 years,” said Professor Martijn Cremers of Yale.

Private equity describes its fees as “two and twenty”, a 2 per cent management fee and 20 per cent share of profits. However, the management fee is usually calculated as a proportion of total capital committed by the investor, which takes time to invest.

So in the early years, the management fee can be a much higher proportion of actual cash invested. For instance, if a $1bn fund invests $100m in its first year, the $20m management fee would be 2 per cent of committed capital, but 20 per cent of invested capital for that year.

From 1991 to 2000, US pension funds paid an average 2 per cent of invested capital each year in management fees, and received 21 per cent returns, after fees, annually from their private equity investments, according to data from the CEM Benchmarking database used for the study. The database covers about a third of US pension fund assets.

The rise in management fees since 2000 may reflect greater fundraising, meaning that more funds are in the early investment phase when fees are high. The increased use of third-party fund of funds to invest in private equity could also have added an extra layer of fees.

The Private Equity Growth Capital Council, a trade body, said that calculating fees on the basis of committed capital was the industry standard, and it was inappropriate to compare fees on the basis of invested capital.

Indeed, Steve Judge, Interim President and Chief Executive, The Private Equity Growth Capital Council, responded to the FT claiming that private equity data isn't rocket science:

Sir, Dan McCrum’s article “Private equity fees called into question” (January 24) describes statistics about private equity performance and fees that we at the Private Equity Growth Capital Council do not recognise. His main finding is that in recent years the pension plans have paid higher fees to private equity funds than in previous decades. In contrast to this assertion, most industry observers believe that management fees have declined in recent years. Preqin, a leading provider of data on alternative assets, finds that management fees for private equity funds are at or below 2 per cent and fees for funds over $1bn in assets have declined to an average of 1.71 per cent.
The reason the nominal amount of fees went up is simple: pension funds and other sophisticated investors have invested substantially more money in private equity over the past 10 years. Since management fees are typically based on the amount of money committed by the investor, it logically follows that the nominal amount of fees to private equity funds will go up as more capital is committed to these funds. This finding is simple mathematics, not news.

Pension plans have found private equity investments to be a superior performing asset class. Just this week Calpers, the pension plan for California’s public employees and the US’s largest public pension, reported that private equity investments returned more than 12.3 per cent during the year while the rest of the portfolio returned only 1.1 per cent.

Mr McCrum’s assertions rely on a study conducted specifically for the Financial Times. Your newspaper should release the study publicly so that the data, methodology and conclusions can be reviewed. Until then, the findings of any unpublished study are inconclusive.

Mr. Judge is talking up his industry. That's his job. The truth is that the bulk of private equity funds are mediocre and if you factor in illiquidity and leverage, they've underperformed the S&P 500 over the last 20 years.

And the fees are high, especially for pensions and endowments investing in private equity funds of funds (totally insane!!!). This is why large Canadian and U.S. public pension funds are increasingly co-investing alongside private equity funds so they can reduce fees.

Of course to do this properly, you need deep pockets and you need to hire talented professionals and pay them properly. For example, Financial News reports that the Ontario Teachers’ Pension Plan has appointed Jo Taylor, a former 3i executive, to be its head of its London office, a new role for the key private equity investor:

The role will involve finding and executing investments, which typically range from between around C$100m (US$98m) and $300m. The London office was set up in 2007 but had until now been run from Toronto by vice-president Andrew Claerhout.

Taylor had spent over 20 years with 3i Group holding a number of senior investment roles before departing in 2008. His last role was as head of venture at 3i, before he then launched an unsuccessful bid to acquire 3i’s venture portfolio in 2009, creating the now-defunct firm Ethean Capital for the bid.

Other large Canadian public pension plans are doing the exact same thing. Will it all pan out? We shall see. None of the Canadian or U.S. funds publish the performance of their direct investments separately from that of their fund investments.

In the end, pensions looking to private equity, real estate and infrastructure to 'save' them might be better off focusing a lot more on public markets. Keep in mind, private equity's landscape is changing and its fortunes are inextricably tied to what's going to happen in public equities.

Below, Jim Bianco thinks the stock market is living on borrowed time. Giving his outlook for the rest of 2012, the president of Bianco research says stocks "might have another 5 to 6% to go and that's on the topside." He has two main reasons for his relative gloom: The end of stimulus and rapidly shrinking earnings.

As much as I respect him, I happen to disagree with Jim. With the Fed committed to keeping rates low until 2014, and other central banks pumping up the jam, I see a massive rally in risks assets once we get over all the Euro gloom and doom. Germany should listen to Soros, he understands what's at risk.

So Much For That Big Fat Greek Payday?

2012-01-25T22:26:00.007-05:00

Stefan Kaiser at Spiegel reports, Hedge Funds Bet on Profits from Greek Debt Talks:

The negotiations over the Greek debt haircut are becoming increasingly suspenseful, with euro-zone finance ministers and the IMF pushing investors to accept greater losses. Hedge funds, more than any others, stand to profit, and are betting that the voluntary debt rescheduling will fail.

Who will bleed for Greece? For weeks, private creditors like banks and insurers have been trying to negotiate a debt rescheduling with the country without success. Even when they seem close to agreement, it remains unclear if all creditors are on board. In particular, hedge funds that own Greek bonds could have a significant interest in ignoring the results of the negotiations, instead preferring to focus on an official national default.

Bank representatives assume in the meantime that many hedge funds are not really interested in an agreement. With a controversial investment strategy they have assured themselves of profiting with either a low level of Greek bad debts, or a complete Greek bankruptcy.
At issue are Greek bonds with a total volume of about €200 billion. How many are owned by hedge funds is unclear, but the amount is estimated to be about €70 billion (including other funds).

The bondholders are expected to voluntarily give up 50 percent of their claims. Another 15 percent is to be compensated with either cash or secure bonds of the European rescue fund EFSF. The remaining 35 percent should come in the form of new Greek bonds, that will likely reach maturity in 30 years.

The amount of money the creditors will actually have to give up depends on the interest rates on the new bonds. The Institute of International Finance (IIF), which is leading the negotiations with Greece, is insisting on an average of at least four percent. The euro-zone finance ministers and the International Monetary Fund (IMF) have instead insisted on rates lower than four percent, in order to make the burden on Greece more bearable. The banks calculate that this means they would actually lose closer to between 70 and 80 percent of their claims, and they are balking.

'Not Worried About Their Public Image'

For some hedge funds, the fight over interest rates has given them more incentive to push for a breakdown of the proposed plan. Officially, they are in the same boat as the banks and insurance companies. But in reality their interests are vastly opposed.
"Hedge funds don't need to worry about their public image," one banker says. Their reputation has already been destroyed. Therefore, they can be relatively cavalier in gambling with the possibility of a Greek bankruptcy.

In an internal analysis of the German Savings Banks Association (DSGV), which represents the public banks, the hedge funds come off fairly badly. With the financial investors "only the performance" is most important. There is "hardly a political or economic corrective factor," such as long-term customer or contractual relations, the analysis says. Therefore, "one can conclude that they are not really interested in an actual Greek rescue."

Unlike the creditors who have long held Greek state bonds and definitely stand to lose in the case of a Greek debt haircut, some investors have only jumped in over the past few weeks. They have stocked up not just on Greek bonds, but also on the related Credit Default Swaps (CDS). These Credit Default Swaps guarantee the buyer protection in the event that the underlying bonds default. "This week alone there will be scores of new CDS transactions," one insider says. "And some of them at exorbitant prices."

Those who in the past few days have bought Greek state bonds worth €1 million euros and wanted to protect them against loss with CDS, would have had to pay more than €400,000 or even €500,000. And they fluctuated wildly -- depending on the news, the price of CDS rose and fell sharply. That indicates that the CDS are being used mainly for gambling.

This example shows how the calculations made by short-term investors work:

One hedge fund stocks up on Greek state bonds. Since the market participants have long expected a haircut of 50 percent, the prices of the bonds are extremely low. They are, for example, at 30 percent of the nominal value at which the bonds were issued. The funds, for example, have bought Greek state loans with a nominal value of €100 million, but paid €30 million for them.
At the same time, the hedge funds are protecting themselves with so-called Credit Default Swaps (CDS) against a Greek payment default. Such Credit Default Swaps are deals between two market participants. The seller agrees to compensate the buyer for losses, should the underlying obligation default, in this case the Greek state bonds.
As long as a debt haircut for Greece has not officially been finalized, the CDS secure the full nominal value of the bond, or 100 percent. Therefore they are also very expensive and cost, for example, 30 percent of the nominal value. In addition to the €30 million for the bonds, the funds have also paid €30 million for the CDS, or a total of €60 million euros.

But there are other ways in which the poker game can play itself out, and the funds can make large profits.

If it comes to a haircut of 50 percent, then two things would happen: The Greek state bonds would gain in value and instead of costing €30 million, run at maybe €45 million. At the same time, the CDS safeguard for the hedge funds would fall significantly in value. Therefore, the funds would only reap a small profit. This variation, therefore, is not attractive for them.
Things look different for the hedge funds if an agreement breaks down. In this case, the threat of insolvency exists. The chance that the bondholders would get their money back would dramatically decrease. The bonds would have less value than before, and would no longer be worth €30 million, but say just €10 million. And the CDS guarantees would be due. The hedge funds would, depending on the arrangement of the CDS, receive up to 100 percent of the bonds' nominal value, or €100 million. Under this scenario, the hedge fund that invested €60 million would get €110 in return - a profit of almost 100 percent.

If the Institute of International Finance (IIF) and Greece agree on a voluntary haircut, it is attractive for the hedge funds holding the CDS to simply not to take part. In this case, there are three possibilities:

Too few of the bondholders take part in the haircut. Should more than 20 percent of the bondholders refuse to accept the negotiated conditions, the debt rescheduling could break down, and with it also likely the second rescue package for Greece. The country would be bankrupt, the CDS would be due, and the hedge funds could cash in.
A lot of bondholders partake. Should, for example, 90 percent of the investors promise to take part, the few holdouts could emerge unscathed, and bet on Greece paying off the bonds as they mature. Hedge funds that hold Greek bonds could in this case become the classic definition of a freeloader.
The Greek government, though, has threatened not to tolerate such freeloaders. If an agreement is reached with 80 percent of the bond holders, they want to force the remaining 20 percent to take part in the haircut. In that case, the existing bonds would later be so-called "Collective Action Clauses." The hedge funds could still cash in because in this case the debt repayment would not be voluntary, and it would be considered a payment default, making the CDS also come due, and the gamblers would profit.

The strategy does have one snag. The hedge funds assume that in the event of a payment default all CDS providers can pay. That is by no means certain, though. The CDS papers are distributed opaquely throughout the financial system. No one knows for sure who holds them at a given time, and who, in the end, will be responsible for them.

The majority of large banks have both issued and bought CDS. The net risks are therefore officially quite small. But should only one of the larger CDS issuers turn out to have difficulty paying, a chain reaction could be possible with unknown consequences. Under that scenario, it would also likely affect the hedge funds.

Some hedge funds are preparing for a legal battle. Sarah White and Tommy Wilkes of Reuters report, Hedge funds prepare legal battle with Greece:

Hedge funds are combing through the small print of Greece's planned rescue deal with private creditors, readying a wave of potential litigation to squeeze a better payout from the country.

Most bondholders face an uphill battle in wringing a payment from Athens through the courts, but shrewd funds picking up specific bond issues with investor-friendly small print have a much better chance of succeeding.
This is so worrying those negotiating Greece's private sector deal that many are trying to keep the final structure of a rescue package under wraps until it is done to prevent the funds from finding a legal edge, sources close to the talks say.
Challenging countries through the courts is a well-worn hedge fund strategy - some are still battling Argentina for payouts more than 10 years after its record-breaking default.
The closer Greece edges to a disorderly default where it imposes losses, rather than a managed one in which it agrees a deal with a majority of bondholders, the more creditors are likely to go down the legal route.
Athens is racing to cut a deal to slash its debt pile by some 100 billion euros (83.5 billion pounds) through a voluntary bond swap that would see private creditors swallow 50 percent losses.
If a deal is not in place by mid-March, when a 14.5 billion euro bond falls due, Greece may not get the funds it needs from the European Union and other lenders to avoid a managed default.
"If the path followed (in Greece) is a non-voluntary one, there will be excessive litigation," said Rodrigo Olivares-Caminal, a banking and finance law specialist at Queen Mary, University of London, and an expert in sovereign debt.
Madrid-based Vega Asset Management threatened it would take legal action when it quit the committee leading private creditors in talks with Athens last year, unhappy about the size of potential losses, sources said at the time.
One lawyer specialising in debt restructuring said on Tuesday he had been contacted by funds looking at legal options relating to Greece, while several funds also told Reuters they were weighing up strategies if they are forced to take losses.
BLOCKING TACTICS
Funds forced into losses as part of the bond swap or default have several avenues to bring a case, including the European Court of Human Rights or the International Centre for Settlement of Investment Disputes, Olivares-Caminal said.
Hedge fund tactics range widely. Many will be keen for a deal to get done and will not sue, especially if they can profit from the difference between the level of losses imposed and the price they paid for the debt in the secondary market.
Others hope to be paid out in full if enough other private creditors -- primarily banks and insurers -- sign up to the bond swap.
If Greece can get the go-ahead from about two-thirds of private creditors, it plans to pass laws to coerce reticent bondholders, like the hedge funds, into taking losses, sources have told Reuters.
To counter this, some hedge funds are going for defensive strategies and buying up some of the 18.3 billion euros of Greek bonds that were drawn up under English or foreign law, industry and legal sources said. These would be immune from any changes to Greek law.
The English law bonds do contain so-called collective action clauses designed to force outliers into a deal -- but they state Greece would have to get 75 percent of creditors to back a deal, most likely higher than the threshold Athens would impose in domestic law bonds in its bid to get a deal done.
They also contain precise clauses that could help hedge funds sue or eke out a settlement if they are forced into an unfavourable bond swap, because they are not being treated equally to other creditors like the European Central Bank.
The English law bonds include pari passu clauses, which mean creditors have to be treated on an equal footing and could give them leverage over the ECB, which owns around 45 billion euros worth of Greek bonds bought in the secondary market.
So far the ECB has shown unwillingness to participate in the bailout, but if Greece can succeed in forcing funds to take losses, the holders of these English law bonds could argue the ECB's immunity is unfair.
One big worry is that hedge funds could buy up enough of the English law bonds to block the clauses from being triggered for specific bond issues, although none of the sources contacted by Reuters had evidence of this happening yet.
That would make an overall agreement with private creditors very hard to reach, and give hedge funds ways of resisting further deals if Greece were to default.
RESTORING REPUTATION
Suing bankrupt governments is still a risky game, however. Funds such as New York-based Elliott Management and its affiliates, which specialise in these types of tactics and have won court cases against Argentina, are still chasing the money they are owed.
That debt restructuring saga was also easier for hedge funds to play as the bulk of the bonds were under U.S. law, limiting Argentina's influence over them.
One hope in the far tougher game that is the Greek negotiations is that Athens, keen to restore its reputation as a reliable debtor, might prefer to settle with reticent creditors than head into years of courtroom battling.
That would echo strategies employed by Ireland to deal with unhappy bondholders when it restructured the debt of its banks.
"The primary strategy is unlikely to be a court judgement after protracted litigation," said Steven Friel, a litigation partner at Brown Rudnick.
"Bondholders are much more likely to work towards settlement, if necessary using the threat of litigation as leverage to negotiate a better deal."

Finally, Landon Thomas Jr. reports, Hedge Funds Scramble to Unload Greek Debt:

So much for that big fat Greek payday.
Hedge funds that loaded up on Greek bonds in the last month — betting on a quick gain — are now scrambling to sell those holdings, fearful that European policy makers will force them to take a deep and binding haircut on the debt.
But walking away from the trade may not be that easy. While the money managers had little problem snapping up the bonds from European banks eager to sell, the pool of potential buyers is drying up.
Hedge funds have few options. Although talks between Greece and its bondholders have stalled, European officials are pressing for a deal by the end of this month. Under the proposed debt restructuring plan, hedge funds and other private sector creditors would have to incur losses of 50 percent or more — whether or not the bondholders agreed.
“I think it’s going to be take it or leave it. And if you do not participate you will get massively beaten up,” said one hedge fund holder of Greek debt, alluding to the unpleasant prospect that if he did not take the deal — and the steep loss in value, or haircut — he would end up with nearly worthless Greek bonds and with virtually no legal protection.
The situation represents a significant shift in how Europe has approached the issue. Last year, when the idea of a Greek debt default seemed a remote possibility, the private sector agreed to a “voluntary” 21 percent loss on its bonds. The fear was that forcing mandatory losses would lead to a disorderly default and scare investors off European debt altogether.
But as Greece’s economic problems have worsened and the need for debt relief has become more acute, Europe, particularly Germany, has come around to the realization that the private sector must take a deeper loss. In a sign of the new direction, the region’s leaders have begun discussions with the European Central Bank on an arcane debt swap that would strip 55 billion euros ($72 billion) of Greek bonds from the central bank’s portfolio, thus removing the possibility that the central bank might share losses with the private sector in a debt restructuring deal.
Now, the smart money isn’t looking so smart. Starting in December, the counterintuitive, go-long Greece bet was one of the more popular pitches made to hedge funds in New York and London. Investment banks — Merrill Lynch was particularly aggressive in recommending the trade, investors say — argued that even though Greece was nearly bankrupt, those who bought the paper maturing in March could double their money when Greece received the next installment of its bailout, due that same month.
The theory was that the bulk of that money would be paid to bondholders to keep Greece solvent, just as was the case with past payments from the European Union and the International Monetary Fund. Greece might well restructure its debt, the bankers said, but added it was likely to happen later and would not affect the March payout.
The pitch worked. In the last month or so, hedge funds purchased an estimated 4 billion euros ($5.2 billion) of beaten-down Greek bonds that mature on March 20.
But the bonds have gone from bad to worse. “There was a lot of volume going in, but not a lot going out,” said one broker, speaking on condition of anonymity. The broker said prices for March 2012 bonds had slipped to about 35 cents on the dollar, from approximately 40 cents to 45 cents.
Brokers estimate that of the 14.5 billion euros worth of these bonds outstanding, the largest holder is the European Central Bank, which bought the securities in 2010 at a price of about 70 cents in an early, ultimately futile, attempt to lift Greece’s failing bond market. The brokers say that 4 billion to 5 billion euros of bonds are owned by hedge funds at an average cost of about 40 cents to 45 cents on the dollar, with some of the larger positions being held by funds in the United States that have large London offices.
“It was a very binary trade,” said one hedge fund executive who listened to the pitch but passed. “If you got paid, you double your money in a month. But you may also look like an idiot.”

As I stated, it's crunch time for Europe, and politicians will ram this deal down hedge funds' throats. Smart hedge funds will take the offer and walk. Those foolish enough to sue Greece will be taught a lesson. There will be no big fat Greek payday for them.

Below, Nobel laureate Michael Spence, a professor of economics at New York University, talks about the European debt crisis. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday" at the World Economic Forum's annual meeting in Davos, Switzerland.

Soros Taking Germany To Task?

2012-01-25T17:00:00.013-05:00

Svenja O'Donnell and Jana Randow of Bloomberg report, Soros Says German Austerity Drive Threatens Breakup of Region:

Billionaire investor George Soros said that German-driven austerity plans in Europe risk creating tensions that could splinter the region as it struggles with a debt crisis entering its third year.
“Germany is acting as a task master, imposing fiscal discipline,” Soros told reporters at the World Economic Forum in Davos, Switzerland today. “But that could create tensions that could destroy the European Union.”

Investors have become less upbeat about the euro region, according to a Bloomberg Global Poll today. For the first time, a majority -- 56 percent -- say one or more nations will leave the single currency in the next 12 months. Meanwhile, Greece is trying to complete a deal with private bondholders on a debt- relief plan before a summit of European leaders on Jan. 30.

“Greece may pose a problem if it in fact defaults,” Soros said. “Defaulting by itself doesn’t necessarily mean they will leave the euro. But the need to at least reach a primary surplus may force Greece out of the euro.”

Soros also said there is a “big difference between Greece and Italy,” with the latter doing “really quite well.”

As Italian Prime Minister Mario Monti has stated, “there needs to be some reward,” Soros said. “There need to be some benefits for Italy and that would strengthen the Monti government.”

Strict Discipline

Monti has pushed through a 30 billion-euro ($39 billion) austerity plan and a package designed to boost growth in the past two months. Italian borrowing costs have fallen since he came to power in November, and he said this week his measures have been “appreciated” by European colleagues.

“You must impose strict fiscal discipline on deficit countries, but then you must find some stimulus to get out of the deflationary spiral,” Soros said. “Structural reforms alone won’t do it.”

He said eurobonds will be needed to provide additional economic support and that while measures by the European Central Bank “relieved the liquidity problems of European banks,” they “didn’t cure the financing disadvantages highly indebted countries suffer.”

“Stimulus has to come from the EU,” Soros said. “This will require eurobonds one way or the other.”

“Half a solution isn’t enough,” he said.

Soros is right, half a solution isn't enough. I completely agree with him that eurozone will require eurobonds if they are to tackle this debt crisis in a meaningful way.

Eric Pfanner of the NYT's DealBook reports, Soros Promotes Crisis Plan for Europe:

The billionaire investor George Soros said on Wednesday that it was possible Greece could be pushed out of the euro zone this year.

“The odds, let’s say, are in that direction,” Mr. Soros said in a speech at the World Economic Forum in Davos. Instead of working to keep the country as a member of the single currency, he added, European policy makers ought to focus on saving the rest of the euro bloc.
Recent action by the European Central Bank, which in December moved to provide large amounts of liquidity to the region’s banks, have calmed the financial markets for now, he acknowledged. But he said these measures would not be enough to solve the festering sovereign debt problems that have driven up the borrowing costs of weaker euro zone countries. Spain and Italy, he said, remain “dangerously exposed.’’
“It leaves the weaker members of the euro zone relegated to the status of third world countries that became highly indebted in a foreign currency,” he said. “Germany is acting as the task master imposing tough fiscal discipline. This will generate both economic and political tensions that could destroy the European Union.”
Mr. Soros used the occasion to promote an alternative plan to deal with the euro crisis, as outlined in his new book, “Financial Turmoil in Europe and the United States.”
Under his proposal, the European Central Bank and others, including the European Financial Stability Fund, would act in concert as “lenders of last resort” to governments, a role that the central bank has steadfastly disavowed. Mr. Soros says this would allow Italy and Spain to issue treasury bills at around 1 percent.
The European economy will also need stimulus to get moving again, Mr. Soros said, adding that the cost would have to be shouldered collectively. As such, it will require the issuance of so-called euro bonds under which the debt of euro zone members would be pooled “in one guise or other.”
If nothing more is done, and if policy makers continue to mostly pursue austerity measures, the euro zone will fall into a debt-deflation spiral, he said. That, in turn, could prompt widespread social disorder, he added.
“What is happening in Hungary today,’’ Mr. Soros said, “is a precursor of what is in store.”

And Soros painted an equally bleak picture for America, predicting riots, police state and class war:

I am not here to cheer you up. The situation is about as serious and difficult as I’ve experienced in my career,” Soros tells Newsweek. “We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”
Soros goes on to compare the current state of the western world with what the Soviet Union was facing as communism crumbled. Although he would think that history would have taught the globe a thing or two about noticing trends, Soros says that, despite past events providing a perfect example of what is to come, the end of an empire seems imminent.
“The collapse of the Soviet system was a pretty extraordinary event, and we are currently experiencing something similar in the developed world, without fully realizing what’s happening,” adds Soros.
Soros goes on to say that as the crisis in the Eurozone only worsens, the American financial system will continue to be hit hard. On the way to a full-blown collapse, he cautions, Americans should expect society to alter accordingly. Riots will hit the streets, says Soros, and as a result, “It will be an excuse for cracking down and using strong-arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained, which would be a break with the tradition of the United States.”
The recent adoption of the National Defense Authorization Act for Fiscal Year 2012 and the proposed Enemy Expatriation Act, if approved, have already very well paved the way for such a society. Under the NDAA, the US government is allowed to indefinitely detain and torture American citizens suspected of terror crimes without ever bringing them to trial. Should lawmakers Joe Lieberman (I-CT) and Charles Dent (R-PA) get their Enemy Expatriation Act through Congress, the US will also be able to simply revoke citizenship without trial, essentially removing constitutional rights from anyone deemed a threat.
Others have cautioned that, as inequality becomes more rampant in America, the country’s citizens are becoming increasingly agitated with those on the other side of the extreme. In a recent survey released by the Pew Research Center, 66 percent of the adults studied believe that either “very strong” or “strong” conflicts exist between America’s elite and the impoverished, a statistic that has skyrocketed in recent years. Between 2009 and 20011, the proportion of those that sense conflicts exist as such between the class groups grew by 19 percentage points. While less than half of Americans fearing a fight brewing at the dawn of the Obama administration, today two-out-of-three Americans feel that there is a strong conflict between both extremes of society.
Addressing the issue of inequality, Soros tells Newsweek that the main issue that will make or break a reelection for US President Barack Obama will be whether or not the rich end up being taxed more. Among the current frontrunners in the Republic Party’s race for the GOP nomination, wealth and taxes have been of the biggest concern of party rivals. The top candidates have made millions off of investments, and at a time of immense inequality, represent what 99 percent of Americans don’t. Taxing the rich to a bigger degree might finally bring a chance, and Soros says, “It shouldn’t be a difficult argument for Obama to make.”
Soros adds that if the US manages to make it through the troubled times to come, it come allow the nation to enter another golden era. “In the crisis period, the impossible becomes possible. The European Union could regain its luster. I’m hopeful that the United States, as a political entity, will pass a very severe test and actually strengthen the institution,” he tells Newsweek.
With almost seven percent of Americans living below half of the poverty line, four unemployed Americans for each job, a shrinking middle class and an increasingly overzealous police state, it could very well be a tough road to get there, though.

Perhaps this is why Soros agrees with the President Obama that the richest Americans should pay more in taxes. "I'm a rarity in the hedge fund community," he said.

He is indeed a rarity in the hedge fund community and EU leaders would be wise to listen carefully to what Soros is saying about tackling the debt crisis. Below, Soros addresses the World Economic Forum (h/t, Guardian). I also embedded this CNBC interview.

Caisse on Financial Steroids?

2012-01-25T08:55:00.010-05:00

Nicolas Van Praet of the National Post reports, ‘Leverage is financial steroids’:

It’s become a fact of life in Quebec that if you’re the coach of the Montreal Canadiens or the chief executive of the Caisse de dépôt et placement du Québec, there’s always somebody, somewhere out there screaming for you to resign.

In Michael Sabia’s case, it happened even before he set foot in his 11th-floor corner office suite.

As the first anglophone and non-Quebecer to lead the Caisse, Canada’s largest pension fund manager, Mr. Sabia was the subject of attacks from the moment he was named to the job in March 2009. His employment track record? “Controversial at best,” wrote one columnist. His connection to Jean Charest by way of Brian Mulroney and the Privy Council? Proof of political favouritism, wrote another.

The critics were merciless. He’s an outsider from Ontario, they charged. He could never succeed in steering the Caisse in its historical role fostering a Quebec French-speaking financial class. He’s a crony, they said. Not the right person needed to plant the Caisse back on course and claw back the embarassing $39.8-billion annual loss under his predecessor in 2008 — the biggest in Canadian pension-fund history.

Funny how time can change perceptions. Funny, too, how the bottom line tends to speak for itself.

When Mr. Sabia took over from former CEO Henri-Paul Rousseau, the Caisse had $120.1-billion in net assets as of the end of 2008. Since then, the fund has grown that asset base by $37.8-billion through the end of June 2011, to $157.9-billion. Its two-year annualized return is 14%.

If the pension fund’s private investments sufficiently offset likely stock market losses, it could tally a third straight year of positive returns when it reports 2011 results as scheduled at the end of February. That would put it within striking distance of recouping the money lost under Mr. Rousseau.

Those who know Mr. Sabia will tell you he will not be taking sole credit for the recovery, when it happens. That’s just not his style. He’s not a flashy guy. He doesn’t like fancy restaurants. He doesn’t fuss with expensive suits or watches. Prone to self-deprication, the bilingual 58-year-old is not a fan of hyperbole or dramatic language.

In an interview last week at Caisse headquarters on the edge of Montreal’s old quarter, he wore a casual red wool sweater. No tie. In many ways, he’s Quebec’s Sergio Marchionne, an expert in industrials who talks straight, dresses down when he can, and thinks three steps ahead.

Besides, as Mr. Sabia well knows, the real test is yet to come: How to protect depositors’ money more permanently against the kind of volatility currently lashing the world economy. And how to more definitively restore public confidence in the Caisse, shredded after a spectacular failure of risk-management that showed it simply didn’t understand many of the investments it was making.

“When I got here … the place really felt under siege and there were lots of morale issues,” Mr. Sabia says. “The thing that has mattered a lot is getting people to feel like the organization is moving forward, that is has a direction, that they’re part of something that’s progressing. And I think that’s happening.”

Make no mistake, this is not the same Caisse that saw one quarter of its assets wiped out in 2008. Its 13-member executive committee has been almost completely shaken up. New executive talent has been tapped including Roland Lescure, an investment specialist from France who led one of that country’s largest asset management firms. As well, risk-control practices have been dramatically tightened.

That work done, Mr. Sabia is focussing on the next phase in the Caisse’s development, one that’s arguably a lot tougher.

The former Bell Canada chief executive is now trying to build an organization in which all of its investment professionals have a profound understanding of what the Caisse has bought and why, a knowledge of investments that goes beyond profit and loss statements and digs into the quality of operations. He’s already got real-estate professionals who run shopping malls and office towers. Now he’s begun hiring specialists who know airports and pipelines and mines.

It’s all part of a rethink of the pension fund’s diversification strategy — one that will see it shift away from buying indexed stocks towards fewer but more targetted investments that are much better mastered, and from both public to private markets.

“You’re going to see people moving away from the extent of the reliance that we’ve all had on public markets,” Mr. Sabia says. “There are probably better returns” privately, he added, and they’ll be more stable over time.

Pulling back from public markets will create some accountability challenges for the Caisse because its performance is measured against that of various public benchmarks such as the S&P/TSX composite index and the S&P 500. It will have to figure out different ways to communicate successes and failures and what exactly it is doing. That may be difficult given the trust between the fund and its 25 Quebec depositors remains on the mend.

“The confidence of retirees in the Caisse is still shaky,” says Madelaine Michaud, president of the Association québécoise des retraité(e)s des secteurs public et parapublic, a group representing 27,000 retired workers, most of them civil servants. She says the Caisse has been unresponsive to its demand that it allow a retiree representative on its board.

Underpinning Mr. Sabia’s transformation of the Caisse is the belief that it should use leverage in a much more limited way.

In this, he is certainly not alone. Many companies, notably Magna International Inc. under Frank Stronach, have displayed a nearly religious aversion to carrying debt. The Caisse itself has reduced its liabilities by half during the past five years, to 17% of total assets in 2010 from 30% in 2004.

If the financial crisis of 2007-2008 taught the world one thing, it’s that borrowing big is bad. As the U.S. government commission analyzing the debacle concluded: The crisis was avoidable and was caused in part by widespread failures in financial regulation, dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk, and an explosive mix of excessive borrowing and risk by households and Wall Street.

Where Mr. Sabia differs from others on debt is in his willingness to pass up investments using leverage because of the chance it will come back later and bite. To him, buying an investment that generates small and consistent profits with no debt is better than using debt to buy something that may result in big profit-loss swings.

“Look, leverage is just a financial steroid. That’s all it is,” he says. “[And] in a volatile world, you don’t want to be on steroids.”

Michel Nadeau, a former Caisse vice-president, agrees. “The Caisse abused its use of leverage in the past,” he says. “Way too much.”

There are conflicts in that dogmatic position.

If leverage is so bad, why is the Maple Group, that consortium of 13 institutions including the Caisse, using it in spades to buy the TMX Group? And won’t the steroid actually turn into a straightjacket — immobilizing the Caisse at the very time it is convinced there are massive buying opportunities out there because of depressed asset valuations and desperate governments?

To be sure, the Caisse has plenty of cash to play with. But its appetite for asset purchases sounds bigger than what those cash stores may hold.

Mr. Sabia says there will be a wave of substantial infrastructure privatizations in Europe in the months ahead as governments deal with their fiscal issues. The Caisse is a buyer in that scenario, likely in club deals with other investors. Like the Ontario Teachers Pension Plan and others, it has become a potential saviour for states that can sell instead of slashing social programs and risk undermining economic growth in their bid for budgetary sanity.

“If I were in a European government, I would be way more interested in trying to sell a port, sell a toll road, sell a bridge, sell a whatever than I would be … to constantly cut social expenditures,” he says. “There are limits to the political tolerance for those things.”

Likewise, the Caisse is very bullish on the United States. It is watching for motivated sellers of U.S. assets, particularly Europeans who may want to offload real estate. The Caisse has been bitten in this market recently — a Jan.11 Wall Street Journal report said it sold $111-million worth of debt it held on Manhattan’s Park Central Hotel at a loss. But there are plenty more deals to be had.

“The degree of motivation has been increasing recently,” Mr. Lescure says of the sellers. “We’re not a vulture. But what we’re looking at is good opportunities …. The prices are slowly but surely coming down.”

There are other plans on the table. The Caisse is underinvested in emerging markets and wants to increase that exposure. And it has people working on putting together infrastructure investment proposals to support the resource boom projected as part of Quebec’s $80-billion plan to develop its northern territories.

Companies pulling iron ore out of the ground to fuel production in China’s steel-making factories will need shelter for their employees, roads or railroads to get the resources out, and ports to ship it overseas. Funding for a couple of projects has been announced but the infrastructure needs vastly outweigh current supply.

Stoking economic development in Quebec is one of the Caisse’s mandates, something many observers consider a hindrance to the larger imperative of making profits for its depositors. And yet, there are many influential people who believe the Caisse still isn’t doing enough to fuel growth in the province.

It all amounts to a delicate political balancing act for Mr. Sabia, one made all the more complicated when the Caisse runs afoul of provincial language laws. Still, for all the pension manager’s missteps, it is difficult to imagine another Caisse CEO bearing down as hard to prove the naysayers wrong.

The Caisse is a machine whose overhaul is still in progress. It’s all about deepening the understanding of its investments. And Mr. Sabia has plenty more deepening to do.

“I have a pretty simple view of this, and maybe it is an outsider’s view,” Mr. Sabia concludes. “But the whole problem with the investment world is that it got way too preoccupied, way too convinced that as a sector it was the smartest guy in the room. Well, it didn’t turn out to be.”

The article covers many points so let me tackle them one by one. First, it is true that Sabia's appointment created quite a ruckus in Quebec. When his predecessor, Henri-Paul Rousseau, was appointed, the French media lauded him as some sort of 'financial God'. And when the $40 billion train wreck took place, they turned on him, viciously attacking him (Rousseau wasn't the only one to blame in that debacle).

It's easy to attack leaders, and in some cases they deserve it, but Quebec's media is particularly ruthless and shallow. Witness the recent language fiasco at the Caisse and how the French media totally ignored the real issue, namely, the public sector should reflect Quebec's diversity:

When the issue of linguistic or cultural diversity comes up in Quebec, it's rarely to show how diversity benefits the province's economy or helps its workforce become more open, tolerant and flexible. Too often, diversity in the workplace is seen instead as a threat to the primacy of French as the language of work. For weeks last year, the province was embroiled in the issue of whether the Caisse de dépôt should continue to employ two senior executives who did not speak French. The previous year's big Caisse issue - its largest ever loss of $39.8 billion - didn't seem to upset people nearly as much, or for as long.

I will repeat, the Caisse, PSP Investments, the National Bank, Desjardins, Hydro Quebec and other financial institutions in Quebec need to do a hell of a lot more in improving the diversity of their workforce at all levels. This is especially crucial at a time when Quebec's unemployment rate is spiking up (it's not a 'statistical anomaly', it will get worse).

Back to Sabia. He has made several important changes to the Caisse to bolster governance making operations more transparent and managers more accountable but he and his team have a lot more work ahead of them, which they are well aware of.

The shift to private markets is basically what every other large public pension fund is doing in Canada. Why are they doing this? First, to escape the volatility in public markets but the other reason, one that they won't tell you about, it allows them to beat bogus benchmarks and collect big bonuses claiming they added value in private markets. Let me remind people, when it comes to pension investments, it's all about the benchmarks, stupid! And the third reason is leverage -- it allows them to use external managers who can lever up a lot more than they can do internally.

On the point of leverage, Sabia is right and wrong. For me, using leverage is like using derivatives. In the hands of a fool, it can wreak havoc and lead to huge losses. However, those who know how to use derivatives properly can mitigate risk, index properly and efficiently, and make money. Same for leverage. If you know how to use leverage wisely, you can add value to your operations.

Some pension funds use more leverage than others. It's well known that Ontario Teachers' uses a lot of leverage in their operations. But if they know how to use it properly, they can enhance risk-adjusted returns. Leverage is a double-edge sword. You can enhance returns but if you take foolish risks, you'll get burned.

On this last point, the Caisse needs to do a lot more work on taking risk, especially in public equities where they underperformed over the last few years. In my opinion, the Caisse focuses too much risk management and not enough on taking opportunistic risk. But to do this properly, they need to better leverage off their external managers and create a central research group similar to the one at CPPIB and even better.

In short, the Caisse needs to centralize investment research. I already mentioned that Roland Lescure is the CIO of public markets, not all investments at the Caisse. Some say this doesn't matter but if you ask me, the best pension funds have a dedicated CIO and a dedicated research team that looks at all asset classes, focusing on allocating risk across public and private markets. This way you break down silos and leverage information from all sources to make critical decisions, including asset allocation decisions which determine overall returns.

Finally, the Caisse needs to hire more investment professionals and less administrative and support staff. I'm concerned about the lack of jobs in Montreal's investment community and think the Caisse and others, like PSP Investments, need to do a lot more hiring of investment professionals and a lot more to support and seed investment funds in this city.

And they can start by helping me out, the world's best and most underpaid pension analyst. I'm being facetious but the truth is any pension fund would be lucky to have a guy like me on their team. Nobody can cover pensions and markets the way I do, nobody. When I'm on my game, working with good people (not weasels), I thrive and deliver results. Just ask the president of a major pension fund in this city who once told me: "You're the best investment analyst I've ever worked with". At least he got that right!

Below, James Gorman, chairman and chief executive officer of Morgan Stanley, talks about global market conditions, the European sovereign-debt crisis and financial regulation. Gorman, speaking with Bloomberg's Erik Schatzker at the World Economic Forum's annual meeting in Davos, Switzerland, also discusses Morgan Stanley's compensation measures. Tell them to stop whining, they're lucky to have a job and still grossly overpaid.

CalSTRS Returns 2.3% in 2011

2012-01-24T22:26:00.010-05:00

A follow-up to my earlier comment on paltry returns for pensions in 2011. Marc Lifsher of the Los Angeles Times reports, California teachers' pension fund posts 2.3% gain in 2011:

Battered by a volatile market, the California State Teachers' Retirement System posted a 2.3% return on its investments last year.
The performance, though extremely modest, was more than twice as large as that reported by CalSTRS' bigger sister agency, the California Public Employees' Retirement System.
CalPERS had a return of just 1.1% on its $229.5-billion portfolio last year.

The $144.8-billion CalSTRS fund had a rough year in 2011. It got a return of 0.9% on its U.S. stocks, 7.2% on bonds, 9.9% on private equity and 15% on real estate. It lost 14.1% on non-U.S. stocks.
CalSTRS did better a year earlier, reporting a 12.7% return that boosted the fund's value to its October 2008 level in the midst of the recession that ended in June of 2009.
The fund's portfolio lost about a quarter of its value during the worst downturn since the 1930s.
"We continue to feel the effects of the most precarious markets in decades," said CalSTRS Chief Executive Jack Ehnes.
The lingering financial crisis has had a strong effect on CalSTRS' ability to meet medium- and long-term obligations to its membership, 856,000 public school educators and their families.
It currently faces a $56-billion shortfall. As of June 30, 2010, it had only 71% of the funds it estimates are needed to pay future benefits.
CalSTRS' funding differs in one significant way from CalPERS'. The CalPERS board has the independent authority to ask participating governmental agencies to increase their annual employer contributions.
But CalSTRS' board lacks that power and needs the approval of lawmakers and the governor to raise contributions.
"The funding shortfall can be managed," Ehnes said, "but the governor and the Legislature must develop a specific funding plan, as only they have the authority to do so."

Despite doing twice as well as CalPERS, the truth is these are modest gains for two of the largest public pension funds in North America. Just like CaPERS, private equity and real estate delivered strong results (CalPERS did better in private equity while CalSTRS fared better in real estate). CalSTRS does not allocate to hedge funds but they did recently announce the selection of Lyxor Asset Management as its advisor in the development of a new global macro hedge fund strategy.

One thing that struck me is the 14% loss in non-U.S. stocks. Obviously they were exposed to European stocks which got hammered but were they overly exposed to financials? Do they hedge currency risk? I do not know but those are steep losses for non U.S. stocks which also include emerging markets which got clobbered in 2011.

As for the funding, Ehnes is right, it is manageable but the state has to come up with a funding plan. The last thing California wants is to go the way of Texas where two Republican state senators have proposed overhauling the state pension system by taking such steps as ending pensions for new state employees and instead offering them a 401(k) plan. That is a step in the wrong direction.

In New Jersey, public pension funds may have gotten a much-needed boost from Gov. Chris Christie’s landmark overhaul last year, but reports released today show the funds continue to be hampered by the state’s failure to make full payments into the plans.

And its not just Republicans looking to reform pensions. New York Mayor Michael Bloomberg told state lawmakers he backs Governor Andrew Cuomo’s proposals to increase payments for Medicaid, reduce pension-benefit costs for future workers and impose evaluation standards on teachers.

The squeeze on pensions is on. Paltry returns, exploding liabilities are increasing pension costs, pressuring politicians from all sides of the political spectrum to tackle pension reform. Below, Governor Cuomo speaks to reporters on why he thinks "pension reform is essential".

Paltry Returns For Pensions in 2011?

2012-01-24T11:52:00.010-05:00

Janet McFarland of the Globe and Mail reports, Pension plans eke out positive return in 2011:

Canadian pension plans eked out a positive return in 2011, averaging a 0.5 per cent return for the year.
A survey of major Canadian pension plans by RBC Dexia Investor Services found plans reported they earned 4.2 per cent on their investments in the fourth quarter last year, pushing their full-year returns into barely positive territory.
“It’s been a tumultuous year for global markets,” said Don McDougall, director of advisory services at RBC Dexia.
“We had a natural disaster in Japan, geopolitical tensions in the Middle East, a stubborn U.S. recovery with its ensuring political backlash, sputtering Chinese growth and the ever-lingering European debt crisis. Most pensions will be pleased it’s over.”
The survey compiles results from pension plans across Canada with assets under management totalling $340-billion.
The results are similar to estimates published early this month by pension consulting firms that track investment returns using hypothetical model portfolios with typical asset allocations.
The break-even returns mean pension funds still saw their funded status decline in 2011. Pension liabilities are calculated based on long-term bond yields, which fell in 2011, driving up the amount of money pension plans are required to set aside to provide pensions to plan members.
RBC Dexia said pension funds reported Canadian equities were their hardest-hit asset class, with mining, energy and financial services accounting for the bulk of the market’s decline in Canada in 2011.
Canadian equity portfolios underperformed the S&P/TSX Composite index by 0.9 per cent for the year, RBC Dexia said, although beat the composite index in the fourth quarter by 0.6 per cent.
Foreign equities also dragged down returns last year, losing 4.2 per cent and underperforming global benchmarks by 1 per cent. Mr. McDougall said there was broad weakness in foreign markets, although the U.S. market was up 2 per cent for the year, making it one of a select few to remain positive.
“Canadian plans also benefitted from a weaker Canadian dollar against most major currencies with the exception of the euro,” Mr. McDougall said.
Strong returns from bonds offset stock losses, RBC Dexia reported. Bonds climbed by 9.8 per cent in 2011, with the global DEX Long Term bond index recording its best calendar year since 1997.

Things aren't any better in the United States where Marc Lifsher of the Los Angeles Times reports, CalPERS earns 1.1% on investments in 2011:

The nation's largest public pension fund, the California Public Employees' Retirement System, posted a 1.1% return on its investment portfolio in 2011, Chief Investment Officer Joseph Dear told his board.

The 2011 performance was well below the estimated average annual return of 7.75% that the fund's actuaries say is needed to meet current and future obligations to its members.

The $229.5-billion CalPERS provides retirement and other benefits for 1.6 million state and local government employees and their families.

CalPERS' annual investment results, whose volatility has echoed that of the overall markets, have become the focal point in an ongoing debate about looming pension fund liabilities and the ability of future generations of taxpayers to continue financing them. Gov. Jerry Brown has said he wants to overhaul state and local government pension programs, but whether he and the Legislature have the political wherewithal to do so in an election year remains unclear.

During the 2011 calendar year, CalPERS lost 7.95% on its public equity investments, lost 2.29% on its hedge fund investments, earned 12.38% on bonds and earned 9.92% on real estate.

In the first three quarters of the calendar year, it earned about 12.37% on its private equity investments. (The availability of these results lags a quarter.)

CalPERS' 2011 return was well off the 12.6% return for 2010 and 12.1% for 2009.

Calendar-year results, however, are used only as indicators, a CalPERS spokesman said. The fiscal year returns, posted as of June 30 each year, are the legal basis for annual decisions by the CalPERS board to raise or lower the contributions it gets from 3,100 participating government agencies, including the state of California.

As of June 30, CalPERS had a return on its investments of 20.9%, its best annual showing in 14 years. It had a return of 11.6% for fiscal 2010 and a massive recession-related loss of 23.4% for fiscal 2009.

Last fiscal year's strong showing, combined with the signing of a number of state labor contracts that increased the amount that employees contribute to their own retirements, allowed CalPERS to lower by $170 million the amount it sought from the state government this fiscal year.

This fiscal year, the state is contributing $3.51 billion. Next fiscal year's contribution is to be determined in the late spring.

I use CalPERS' calendar year results as a gauge of what to expect from other large public pension funds and it won't be much. The third quarter was a tough one and even though stocks snapped back, many pension fund managers underperformed in their public equities portfolio.

Hedge funds also underperformed in 2011, and even though CalPERS didn't get clobbered in hedge funds, they still doled out huge fees and lost money. When it comes to hedge funds, always ask where are the customers' yachts, and make sure you get the right alignment of interests. Think CalPERS should reevaluate their hedge fund portfolio (too much beta) and seed more hedge funds, including Canadian hedge funds. They should also manage more internally.

Their private equity team, led by Réal Desrochers, is performing well, delivering outstanding results in a tough environment. But private equity is no panacea, and as I recently discussed, this is a challenging environment for all asset classes, including private equity.

Nonetheless, gains private equity, real estate and infrastructure might save Canadian public pension funds from an otherwise bad year. We shall see, but don't expect much as most pension funds will report paltry returns for 2011.

Below, Janine Guillot, CalPERS Chief Operating Investment Officer, discusses improvements, goals and challenges in the operational aspects of the Investment Office (transcript available here).

Crunch Time For Europe?

2012-01-24T08:36:00.013-05:00

By Jan Strupczewski and Dina Kyriakidou of Reuters report, Greece clings to hope of debt deal despite setback:

Greece was clinging on Tuesday to hope of a last-minute bond swap deal to avoid a messy default after euro zone officials sent talks back to square one by rejecting a final offer from the country's private bondholders.

Athens is desperate for a deal within days to ensure funds from a 130 billion euro rescue plan drawn up by European partners and the International Monetary Fund arrive before 14.5 billion euros bond redemptions fall due in March.
After weeks of haggling with creditors in Athens, euro zone finance ministers in Brussels on Monday dealt a sharp setback to those hopes by rejecting creditors' demand for a 4 percent coupon, or interest rate, on new, longer-dated bonds in exchange for existing debt.
Private sector creditors now have the upper hand in deciding whether Athens will be forced into a hard default that could sow chaos across the global financial system and push other weak euro zone members closer to a default.
Charles Dallara, the head of the Institute of International Finance negotiating on behalf of creditors, is due to speak in Zurich later on Tuesday after leaving Athens over the weekend.
Greece's top official at the Brussels meeting remained stoic, saying the country had the euro zone's support to complete the debt swap talks in the "coming days."
"In reality, we are now entering the final stretch," , Finance Minister Evangelos Venizelos said in a statement.
"I believe everyone has now realized that Greece must be supported in its effort, which is of vital importance not only for us but for the euro zone as a whole and the global economy."
Asked if there was still hope of a deal, IMF chief Christine Lagarde said she remained positive.
"I'm determined to be positive," she told Deutschlandradio Kultur. "Political leaders have the instruments and possible measures in order to manage this situation and bring the euro zone back on to a sustainable path."
Conservative leader Antonis Samaras, head of one of three parties backing Greece's technocrat prime minister, told Reuters he expected the talks to be wrapped up by March 5 at the latest and said the country must head to polls as soon as the EU/IMF bailout is finalized.
He set April 8 as the deadline for elections.
"PLAN A MODE"
With weeks of talks yielding little progress and growing concern that Greece's fast-deteriorating economic prospects mean it will need more aid from partners either way, European policymakers appeared to be more willing to consider the previously taboo option of an involuntary debt swap.
A "voluntary" swap where both sides agree to the terms of the deal is required to prevent insurance against a Greek debt default from being paid out.
"There has been a slight change in mood, but no change in the policy lines pursued," a senior euro zone source told Reuters when asked about the mood among policymakers on Greece.
A second euro zone source confirmed the perception of a shift but cautioned: "We are still in Plan A mode."
A source close to the talks said creditors would go towards an involuntary debt swap if there was no agreement by the end of the week -- raising the risk of a messy default.
The bond swap is meant to cut 100 billion euros from Greece's debt burden of over 350 billion, in a bid to ultimately slash its debt from around 160 percent of GDP to a more manageable 120 percent of GDP by 2020.
Sources close to the talks told Reuters on Monday that the impasse in Brussels largely centred on questions of whether the deal would return Greece's debt mountain to levels that European governments believe are sustainable.
Greece and its private creditors had been converging on an agreement that would see private creditors accepting a real loss of 65 to 70 percent, sources close to the talks said after several rounds of talks last week.
At the time, Athens and its creditors were discussing new bonds would likely feature 30-year maturity and a progressive interest rate averaging out at 4 percent, sources said.
Greece is stumbling through its worst post-World War II economic crisis, with unemployment at record highs and frequest protests against austerity measures demanded by its international lenders as a condition for bailout loans.
The country is now in its fifth year of recession.

Greece is stumbling and European political dithering has not helped. We are witnessing political masturbation at its worst.

And what is this rubbish that the private sector creditors "have the upper hand"? I will repeat, it's high time Europeans banded together to resolve this debt crisis once and for all and they should start by teaching hedge funds a lesson.

Let me be blunt: Fuck the hedge funds and anyone else holding out, just impose the debt deal on all bondholders and get on with it already. And Greeks need to get serious on cutting their over-bloated public sector, go after big tax evaders, cut corruption and bureaucratic red tape, and focus on growing the private sector.

And what about CDS triggers? Agustino Fontevecchia at Forbes reports, Greek Debt Deal Will Force Bondholders To Take 'Voluntary' 70% Haircut:

Greece is back in the news again, as the government of Lucas Papademos negotiates the terms of the Greek debt restructuring, dubbed PSI, with the Institute for International Finance (IIF). Private bondholders are expected to take a 65% to 70% haircut, forced by retroactive collective actions clauses (CACs) that will probably spark credit default swaps, according to research by UBS.

UPDATE: Reports have surfaced that suggest Eurozone Finance Ministers rejected the latest PSI deal, asking private bondholders to take a coupon rate below 4%.
As mentioned below, troika (ECB, IMF, and European Commission) had already asked private creditors to take the lower rate, which would push the haircut up to 70%.

The IIF’s two top negotiators, Charles Dallara and Jean Lemierre, have sent markets mixed messages as of late. Dallara told reporters he is “confident that our offer, that was delivered to the prime minister, is the maximum offer consistent with a voluntary PSI deal,” according to Dennis Gartman.

Reports suggest that latest offer will come with both a 70% haircut and a reduction of the coupon rate to an average 3.5%, from the previously accepted 4%, according to the FT. This should help cut Greek debt by €100 billion ($129 billion). In a prepared statement, Dallara said “the elements of an unprecedented voluntary PSI are coming into place.”

Restructuring Greece’s massive debt load, to lower its debt-to-GDP ratio from the nearly 180% it’s at now, is one of the pre-requisites the IMF put on the troubled peripheral nation to be able to tap about €130 billion ($167 billion) in additional bailout money that should keep the country going until 2014. The passing of a structural reform package is the second; a troika delegation is expected in Athens this week to work a plan to cut about €7 billion ($9 billion) from the 2012 budget.

Failing to restructure Greece’s debt in time could lead to a so-called “disorderly default.” Greece faces a €14.5 billion ($19 billion) bond redemption on March 20. “In all likelihood, the Greek government will not have the cash to repay the bond, which means this is in effect the deadline for restructuring the country’s debt,” wrote UBS’ Stephane Deo, global investment research economist.

The whole situation also begs the question about the meaning of “voluntary” in the context of bond and credit default swap (CDS) markets. IIF has been negotiating with top European policymakers and the Greek government in order to avoid a credit event, i.e. a default, in order to avoid triggering CDS contracts. While net open positions in Greek CDS total €3.3 billion ($4.2 billion), making them relatively negligent, they would set a precedent that could be hard to escape in the case of a much bigger problem, such as an Italian or Spanish restructuring. Major banks like JPMorgan have come out to say their exposure to Europe is limited, while Morgan Stanley and Goldman Sachs came under fire by investors last year on their reported exposure.

UBS’ Deo expects the Greek restructuring to rely on CACs in order to force participation. “Because more than 90% of Greek debt is under Greek jurisdiction, these CACs would retroactively apply to existing bonds, and hence drive the participation rate up to 100%,” he wrote.

Rules governing the CDS market are hazy at best. The International Swaps and Derivatives Association (ISDA), the body responsible for determining whether CDS have been triggered, has been on a media campaign to try to justify how these restructuring can be made to seem like they do not constitute an actual default.
Many have been outraged by their position. Dennis Gartman, for example, noted the current deal “is a default in all but name only.” UBS’ Deo, on the other hand, explained “not triggering the CDSs would wipe out the credibility of this market, which would be very detrimental in our view.”

ISDA has relied on the technical nature of CDS contracts and, in particular, the blurry line that exists when it comes to determining defaults in the sovereign bond market. While Deo expects CACs to trigger this particular form of protection, ISDA has been able to pull a rabbit out of a hat every time complications surfaced that suggested a credit event would occur. In response to possible CACs, ISDA explained:

If bonds contain a Collective Action Clause (CAC) with a 75% threshold for making a change to bond terms, then if 75% or more of the holders vote in favour, that change is binding on all the holders, even those that voted against. That is, the change does not have to be agreed upon by all the holders to trigger a Credit Event, just the relevant majority of them. In that sense, the change is “mandatory” for those who voted against it. We understand that Greece’s domestic law debt, which accounts for over 90% of all of its outstanding debt, does not contain CAC clauses.
The dust should begin to settle as this week passes and final details on the actual restructuring deal (PSI) are released. Deo believes that policymakers will have to rely on CAC and that those won’t trigger CDS; I wouldn’t underestimate ISDA Credit Derivatives Determinations Committee’s capacity to act as a magician and pull the proverbial rabbit out of the top hat.

We'll see if any debt deal is settled but according to Andreas Koutras, it's crunch time for Europe and it needs to relieve the ECB before the PSI:

This is crunch time for Europe, Greece and the ECB. The PSI has reached an impasse not because the coupons demanded by bondholders are too high but because bondholders can afford to Free Ride along the ECB.

By insisting on a voluntary PSI with the largest bondholder the ECB, exempted, a huge free riding problem has been created. This more than anything else (coupon, English law etc) is the major obstacle for a successful PSI. Europe must come up with the money to take the Greek holdings out of the ECB’s SMP program NOW. It would do it anyway at some point in time.

Let us see why:

ECB stays out, the PSI proceeds in a voluntary manner. Greece would have to find the money to repay fully this 45-55billion. This probably means the EU (Germany) providing new loans to cover these redemptions in the next 3years (market believes that the ECB holdings concentrate in the near maturities).
ECB participates in the PSI and takes the losses. Then, barring magic tricks, the National Central Banks (ECB shareholders: Germany 19%, France 14%, Italy 12.5%) would have to cover the losses.
Greece default through the use of CAC’s or otherwise. The ECB would have to write down the value of the Greek bonds again. Therefore shareholders pay again.

We thus see that in all plausible scenarios, the EU (Germany) would have to come up sooner or later with the money to cover either the losses or the redemptions at Par. It is better to do it now and change the odds in the PSI offer and give Greece and Europe a fighting chance. By removing the ECB early, holdouts would have very little to stand on. In addition, insisting on a special status for the ECB, Europe risks contagion to other countries whose bonds the ECB owns.

The ECB is NOT a creditor (preferred or otherwise) towards Greece (through the SMP) but a bondholder who bought the bonds in the secondary market. Whatever the reasons of the ECB, they cannot play a part in the decision process. If we allow distinguishing holders of bonds with regards to their investment or buying motives then we should grade the debt according to who owns. The ECB is a supranational entity but does not enjoy unlimited immunity[1].

The relief can come either by giving the money to Greece to buy (at cost) and destroy the bonds immediately or by exchanging the ECB holdings (at cost) with EFSF paper and then passing the bill again to Greece if Europe does not want to shoulder the pain.

Selling the bonds back at purchase price can be justified by the size of the holding (20% of total outstanding) and also by the particular needs of the buyer. The bond market is an OTC market.

Allowing during a default or through CAC’s a special status for the ECB would be detrimental to the other peripheral countries. It would mean effective subordination of every other bondholder since it would create a two tier system. The European Government market would immediately re-price to reflect the increased risk.

Europe must act fast to remove that risk factor from the market. Doing so, would show leadership and the determination to deal with the European Peripheral debt crisis.

Historical Context

Back in 2010 as the Greek debt tragedy was unfolding the ECB took the controversial decision to support the Greek government bond market with outright purchases of Greek bonds. The ECB had to act swiftly on the face of EU inaction and squabbling. It justified this though their mandate on Financial Stability. Despite the fact that article 123 (TFEU) explicitly prohibits Credit facilities or outright purchases of government debt the ECB was allowed to violate the spirit of the law. The exact wording was “purchase directly from them by the European Central Bank”. Since the purchases were in the secondary market and not in the primary (at issuance) the ECB had only to comply with the “without prejudice” it its other mandate i.e. Price Stability and Monetary policy. This gave rise to the so called Securities Markets Program (SMP) sterilization. Thus on a regular basis the ECB withdrew the same amount of liquidity from the system as it was supplied by their direct purchases.

Despite the heavy intervention by the ECB to the tune of 45-55billion (in nominal) the Greek bonds continued their accelerated descend. As a result the ECB silently suspended the purchases of Greek bonds and was thus left with around 45-55billion of Greek debt. Bonds acquired by the ECB were also marked at purchase price and amortized to Par at maturity.

Problem was however, that the ECB, as explained above, does not mark the SMP holdings to market but at purchase price. Attempting to mark the Greek bonds at the current levels would generate losses that would not be covered by the equity (10.8billion). Unless the ECB waves a magic wand and comes up with some revaluations or other accounting gimmicks it would need to go back to its shareholders to raise the requisite capital. And this apart from the humiliation of having a Central Bank going bankrupt also requires taxpayers’ money. As the largest shareholder is the Bundesbank this means German money.

JC Trichet very quickly identified this problem and tried in March 2011 to sell the SMP holdings to the newly created EFSF. Unfortunately, his recommendation was not adopted by Europe’s politicians and this was also a source of friction between the ECB and the EU. The EU politicians refused to take responsibility of the losses that the Greek bonds generated.

In July 2011 the council of Europe decided to restructure the Greek debt in a very unconventional way. In order to avoid default and the ECB taking heavy losses it demanded the PSI restructuring to be voluntary. It also assigned 100billion for bank recapitalization to soften the blow of the Greek debt write-downs. This decision unfortunately turned the benign intention of the ECB into a huge headache. Europe should deal with this first before any PSI restructuring.

As for hedge funds, Andreas disagrees with me:

As for the hedge funds, I don't agree. Firstly it is not the hedge funds that stop the PSI from becoming reality. Hedge funds represent only few % of the total. And in any case they did not cause the misery in Greece. It was politicians and now European policy makers that screwed up big time. Hedge funds are part of the market (good or bad) and they will fall or rise by market rules. As for the CAC's it will not affect the hedge funds as they hold mostly bonds under English law and not under Greek. The whole thing is just a big poker game to push participation up....

... hedge funds in Greece were a late comers. The CDS game could not be played as it was too expensive for them and the bid-offer to wide for playing. On top the volatility was too great. Few funds could afford the swings. We all new from the start that Greece had the upper hand in any restructuring due to the Greek law. Europe fucked it up big time by not calling a default back in 2010. Now they are cornered. A default would cause more damage to Europe and Greece now.

I was one of the few who called for a quick default and restructuring early on. Now the stakes are too big and we already have 73billion of super senior and untouchable debt.

True, hedge funds didn't cause the misery in Greece and they represent a small percentage of the debt holders, but it's also true some stand to make a lot more money if Greece defaults, which is why they're prepared to sue Greece if they don't get their way.

But I agree with Andreas that it is time for Europe to get its house in order and make some hard political decisions. The longer they continue putting off these decisions, the worse it will be eurozone and the global economy.

Below, euronews reports that fears that Greece could default on its massive debts are mounting after eurozone finance ministers in Brussels rejected an offer from the country's private creditors late on Monday night. Despite that, the Greek finance minister Evangelos Venizelos said he was confident an agreement would be reached. "We have the green light of the eurogroup to close the deal with the private sector in the next few days," Venizelos said.

Teaching Hedge Funds a Lesson?

2012-01-23T15:15:00.019-05:00

David Paul reports in Huffington Post, Politicians Seeking Upper Hand Over Hedge Funds in Greek Bailout:

Negotiations to avert a default by Greece continue to move haltingly. The closer the parties get to a resolution--presumably replacing existing short-term debt with new, long-term bonds with a reduced coupon--the clearer it is becoming that a solution may require 100% participation of bondholders while sustaining the illusion of "voluntary" investor participation.

The holders of the Greek debt range from European banks to hedge funds. The European banks--for decades among the titans of the world financial system and the envy of U.S. banks--have been a shadow of their former selves since 2008. Many were essentially insolvent in the wake of the 2008 collapse, and only survived through a combination of sovereign guarantees, public injections of capital and actions by the U.S. Federal Reserve Bank.

Those banks are the largest holders of Euro-denominated sovereign debt of Eurozone members, in large part because they viewed that debt as carrying an implied guaranty--much as U.S. banks viewed the mortgage-backed securities that were their undoing--and because those bonds were eligible collateral for their borrowing from the European Central Bank. In a larger sense, however, those purchases reflected the extent to which the banks have become an integrated part of the public policy apparatus of the new Europe, where the boundaries between the public and private sectors have becoming increasingly blurred.

Hedge funds, on the other hand, live with no such ambiguity. Hedge fund buyers of Greek bonds are in it for financial gain. If a fund trader buys a medium-term Greek bond, they do so in anticipation of being able to sell that bond in the future at a higher price or in the extreme case holding the bond until it matures at 100% of its par value. To effectively protect against downside risk, they might concurrently enter into a credit default swap that would pay off in the event Greece were to default on its payment obligation. Ideally, a well-structured trade provides an upside to the hedge fund regardless of the outcome for Greece. Heads they win, tails they win, and only the math would tell you which way they would win more.

But in the new world order, things are not so simple. There are many participants involved, and each has their own set of metrics for a successful outcome of the Greece workout. The proposed resolution would provide for a swap of currently outstanding Greece bonds for new bonds that would pay out over a longer term, at lower rates. In theory participation is voluntary, but clearly some are kicking and screaming as they seem to be voluntarily coming to the table.

For the banks, the proposed swap is not such a bad outcome. First, because their holdings are of both short and long-term bonds, and based on the complex portfolio accounting, what they lose on swapping their short-term bonds in the deal, they make up in part at the long end. Second, as part of the complex public-private Euro-policy apparatus they have been told by their new political masters to play ball. But finally, and of critical importance, the European banks want to avoid an official default--or "credit event" as defined by ISDA, the International Swap Dealers Association--on Greek debt, as those banks are the primary providers of the credit default swap insurance purchased by the hedge fund community, and they want very much not to have to pay out on those derivative contracts.

For Greece, the objective is clearly to survive the restructuring with a balance sheet that causes as little domestic pain as possible, and to retain access to new borrowing going forward. To any rational observer, this outcome seems counter-productive, as it is hard to imagine that such continued market access for new borrowing will not lead all of the parties back to the table for a new workout down the road. Same script, another year.

For the hedge funds, this may be, to use that paternalistic cliché--a teachable moment. The banks seem to be getting out of the deal what they need--putting off a hit on their capital and avoiding a credit event under their credit default swap exposure. For its part, Greece seems to have garnered increasing leverage the longer the negotiations drag on, at least in part through its threat to recast the terms of the bonds. The bonds were sold under Greek law, and someone seemed to have realized that the Greek parliament could have the power to unilaterally change the terms of the outstanding obligations. It is hard to fathom that such an action would be legal, but no doubt Greek legislators would be only too eager to vote on the matter. It is the hedge funds that seem to have ignored the extent to which rules in the financial markets are increasingly subject to political intervention, and they may find themselves to be the odd man out.

The deal on the table is evidence of the growing interplay between the financial markets and political forces. Like the GM bondholders, the hedge funds are finding themselves subject to massive political and coercive pressures to consent to a workout that takes away both the upside that they thought they owned and the downside protection that was their fallback. In the most ironic of twists, hedge fund managers have threatened to sue in the European Court of Human Rights to prevent the usurpation of their economic rights through the proposed "voluntary" restructuring. Perhaps they are right on the merits, but it may be that trading and making a profit on the life and death of nations is not going to be as easy as it once seemed.
Early on, the new, dynamic interaction between the private financial markets and the political world was evident in the enormous pressure felt by Greek politicians to vote to cut public sector salaries, pensions and services. The worm seems to have turned, and now it appears that the Greek politicians are not as dumb as they seemed, nor the hedge fund traders as smart as they thought.

Indeed, Greek politicians are not as dumb as they seemed and if I were advising the Greek coalition government and EU politicians, I'd tell them straight out: screw the hedge funds and tell them this is the final offer, take it or leave it (Update: Eurozone finance ministers reject private bondholders' Greece offer).

All the doomsayers who claim default is Grece's only option, warning of "CDS triggers", are delusional. Won't happen in a million years. Why? Because it will wreak total chaos on the global financial system and the politicians and banksters will burn hedgies before they let that happen. Hedge funds can bitch and scream all they want, at the end of the day, they'd be wise to take what is being offered on the table or risk endless legal battles and huge losses.

On this last point, Drew Benson of Bloomberg wrote an interesting article, Billionaire Hedge Funds Snub 90% Returns:

Billionaire investors Kenneth Dart and Paul Singer rejected Argentina's defaulted debt restructuring in 2005. Since then the securities have beaten returns on emerging-market bonds, global stocks and oil.
While Dart's EM Ltd. and NML Capital, a unit of Singer's Elliott Management Corp., seek a U.S. Supreme Court hearing to help their lawsuits aimed at recouping at least $2 billion they say they are owed, creditors who accepted the 2005 offer of 30 cents on the dollar have received returns of about 90 percent, according to estimates by Morgan Stanley. The Supreme Court asked the Obama administration last week for advice on whether it should hear an appeal from the hedge funds.

The restructured securities have outpaced the 70 percent return on emerging-market dollar debt, 24 percent gain in global stocks and 75 percent rally in oil as Chinese demand for Argentine soybeans helped propel growth. Dart and Singer, who used similar legal tactics to make money during Brazilian and Peruvian restructurings in the past two decades, have been unable to seize Argentine assets that could satisfy their demands.

"Tendering in 2005 was by far the best option for investors," said Alberto Bernal, head of fixed-income research at Bulltick Capital Markets in Miami. The holdout funds "will make money, but it's debatable if they'll make more than if they tendered before."
Two Restructurings
Argentina, which defaulted on $95 billion of bonds in 2001, offered foreign investors a choice of par bonds due in 2038 or discount debt maturing in 2033 in the 2005 exchange. Warrants that pay investors based on annual economic growth were issued with the bonds as well and now trade as separate securities.

Yields on the discount bonds have fallen 102 basis points, or 1.02 percentage points, this year to 10.77 percent, leaving them down 115 basis points over the past two years. The dollar- denominated warrants have more than tripled in price since the exchange to 13.15 cents as of Jan. 20 and have made five annual payouts worth a total of 11.75 cents, according to data compiled by Bloomberg and Argentina's Economy Ministry. Annual economic growth has averaged 7.1 percent over the past six years.

Morgan Stanley's 90 percent return estimate is for creditors who have held onto the securities since the swap.

Dart and Singer's funds, which also turned down a second exchange offer in 2010, are seeking to enforce several judgments they've won in U.S. courts. The Supreme Court is considering whether to hear an appeal from the funds related to their attempts to seize $100 million in Argentine central bank assets being held at the Federal Reserve Bank in New York. A federal appeals court said that money is shielded under the U.S. Foreign Sovereign Immunities Act.
'Whatever It Takes'
Argentina expects the U.S. will support its position in the case, said an official at the country's central bank who declined to be identified because he isn't authorized to speak publicly. The government says that so-called vulture investors holding about $4 billion of debt are pursuing litigation against the country.

Officials at Elliott declined to comment.

"We're glad to see the Supreme Court is seriously considering hearing the appeal," said John Missing, a lawyer for Dart's EM at Debevoise & Plimpton in London. "It's important that the courts get this right especially given the welter of potential sovereign defaults that are hanging out there. We're prepared to go the distance, to do whatever it takes to get what we're entitled to on these bonds."

The U.S. Department of Justice declined to comment on the appeal, said spokesman Charles Miller.
Past-Due Interest
The hedge funds are pursuing an "expensive strategy," yet will likely profit if they recover past-due interest and interest on interest in addition to principal, said Siobhan Morden, the head of Latin America strategy at RBS Securities Inc. in Stamford, Connecticut.

"The value of their claim is going to become increasingly dependent on interest in arrears as opposed to the recovery of principal," Morden said. "There's an inflection point at which you will reach break-even in terms of accruing interest."

President Cristina Fernandez de Kirchner, who began her second term in December, four years after succeeding her husband, said in 2010 that the second restructuring offer was the final chance for holdout creditors to get new bonds. Argentina hasn't sold bonds overseas since the default, tapping central bank reserves instead to make debt payments.
'Opportunity Cost'
The cost of protecting Argentine debt against non-payment for five years with credit-default swaps fell 112 basis points last week to 789, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

The peso fell 0.1 percent to 4.3245 per dollar at 10:06 a.m. in Buenos Aires.

The extra yield investors demand to hold Argentine government dollar bonds instead of U.S. Treasuries fell 36 basis points to 785, according to JPMorgan Chase & Co.'s EMBI Global Index. The yield spread has declined from 925 basis points at the end of last year.

"Argentina has been one of the strong performers during the past five years in emerging markets," said Vitali Meschoulam, head of Latin America strategy at Morgan Stanley in New York. "Obviously there is an opportunity cost of these guys not having participated in the 2005 exchange."

These hedge fund managers were unwise not to accept the offer in Argentina. And hedge funds refusing to accept the offer in Greece will suffer a similar fate. Contrary to what Reuters reports, hedge funds holding Greek bonds that mature in March do not have the strongest hand in the critical negotiations. They will be taught a lesson.

Of course, all this is trivial to Yanis Varoufakis, Professor of Economics at the University of Athens. Below, he tells BBC any deal will be "unsustainable" and "forgotten in the annals of history". Varoufakis is hopelessly cynical and he will be proven wrong.

Private Equity’s Public Subsidy?

2012-01-23T07:53:00.019-05:00

Bloomberg columnist William Cohan reports, Private Equity’s Public Subsidy a Tragedy:

The real reason that private equity executives need to be full taxpayers -- paying 35 percent of their income in federal tax as opposed to the 15 percent capital-gains rate they have enjoyed for years -- is not because, generally speaking, they make so much money.

Nor is it because the return they get on what personal capital they risk is dwarfed by the profits they get on their investors’ capital.

Nor is it so they will pay the same tax rates as their secretaries (although this is a good reason, too).

No, the real reason the tax loophole for private equity mavens must be closed once and for all is that American taxpayers subsidize the private-equity industry -- and its outsize paychecks -- and simple fairness demands that they don’t also get an additional break in the form of lower tax rates.

Mitt Romney, the co-founder of Bain Capital LLC and the leading contender for the Republican presidential nomination, got blindingly rich because of this taxpayer subsidy, and it isn’t right that he and his cohort can also pay taxes at a 20- percentage-point discount compared with the rest of us.

Here is how the subsidy works: The Internal Revenue Service allows for the tax-deductibility of interest expense on corporate debt. Since corporate debt is the mother’s milk of a leveraged buyout, there would be no private-equity/LBO industry without this huge tax benefit. Indeed, anyone who has used an Excel spreadsheet to model a leveraged-buyout -- you know who you are! -- knows that the magic of the entire industry depends almost solely on the interest-expense provision in the tax code.
Loading Up Debt

By loading up a company with debt and then deducting the resulting interest expense, tax payments are generally wiped out, allowing the remaining “free cash flow” to be used to pay down the debt taken on to buy the company in the first place. Given that tax revenue is necessary for the government to function, this means the rest of us provide a subsidy that allows the private-equity firms to thrive.

If the company a private-equity firm invests in does well, the original borrowed money is paid down, interest expense is reduced and profits slowly but surely rise, creating equity value for the private-equity investor. Over time, if the company is performing well enough to pay off its debt load and show net income, it will either be sold outright, taken public through an initial public offering or re-leveraged to allow the private- equity firm to take out a hefty dividend and begin the process of financial alchemy all over again.

This is the moment when the private-equity practitioners really ring the cash register (not to minimize the importance of the annual fees also paid to them by investors, generally amounting to 2 percent of the money under management and which can add up to hundreds of millions of dollars per year, spread among a relatively few people). In most cases, the private- equity firms take 20 percent of the increase in equity value between when they bought the company and when it is sold. (In Bain’s case, it can be 30 percent because for a while investors were clamoring to be in its funds.)

Fine enough: This seems to be the industry’s convention, savvy investors have agreed to the arrangement time and time again, and undoubtedly many companies that might have failed have been turned around (while many others haven’t).

The problem is that, having used the tax code to create the financial magic in the first place, the people working at these firms and sharing in the equity payoff then get the additional benefit of paying tax on their profits -- which are called “carried interest” -- at a 15 percent rate rather than 35 percent.
Fighting the Inevitable

This nifty tax treatment can add up to considerable wealth. Come to think of it, I can’t name a single partner of a major private equity firm I know who doesn’t live in the most lavish way. Many -- Steve Schwarzman of Blackstone Group LP, Henry Kravis and George Roberts of KKR & Co., David Rubenstein of the Carlyle Group LP (CG) and David Bonderman of TPG Capital LP -- are among the wealthiest people in the country. This isn’t meant as criticism -- what they have been doing is not illegal or unethical, it’s actually quite brilliant. Rather, I think it’s a statement that the industry must stop fighting the inevitable.

The tax rate on carried interest must be raised to 35 percent on the profits that come to private-equity partners from their investors’ capital. The gravy train for private-equity partners has gone on for three decades. It has been a great party, but -- as the Bloomberg View editors have also made clear -- it’s time to take the punch bowl away. The private-equity moguls know it. The American people know it. Even Mitt Romney knows it, despite sheepishly admitting that why, yes, his federal tax rate has been around 15 percent lately, come to think of it.

It is simply illogical, and unfair, for the IRS to give private equity two major benefits, one for their businesses and one for their wallets, while the rest of us pay much higher federal tax rates with nary any comparable subsidies at all.

There is no question about it, private equity firms have profited handsomely from the tax-deductibility of interest expense on corporate debt.

But the real public subsidy which Cohan doesn't discuss in his article is the trillions of dollars that US and global public pension funds have allocated and continue to allocate to private equity funds and funds of funds.

And just like hedge funds, most private equity funds are terrible. Academic studies have shown there is clear evidence of performance persistence in private equity, but buyer beware, studies have also found current fund performance is not correlated with the second and third follow-on funds. "Therefore, performance persistence is short lived, and, interestingly, performance converges across funds over time."

Investors should also keep in mind that post-2008, credit remains tight. Private equity's changing landscape means the old model of levering up debt is pretty much finished. The new kings of private equity won't be financial engineers but guys and gals with actual operational experience, people who know how to roll up their sleeves and restructure a company from the bottom-up.

Investors looking for more in-depth insight into private equity should read Coller Capital's Global Private Equity Barometer Winter 2011-12. Some of the key highlights below:

Europe’s sovereign debt crisis will deter one in five PE investors
Half of LPs have ‘zombie’ funds in their portfolios – and see no solutions for them in most cases
Investors regard the re-financing of existing buyout debt as a major challenge for the industry
93% of LPs will refuse re-ups in the next 18 months – and reductions in commitments will be common
Private equity investors (LPs) see major challenges for the industry in the next few years, according to Coller Capital’s latest Global Private Equity Barometer – but despite these worries they think 2012 will be a good vintage year and they expect strong medium-term returns from their private equity portfolios.
Fallout from the bubble years is very visible to private equity investors. Half of LPs believe they have ‘zombie’ funds in their portfolios – that is, situations in which private equity managers (GPs) with no prospect of earning carried interest are motivated to keep funds going for their management fees. Neither are investors optimistic about their ability to remedy these ‘zombie’ fund situations: 72% of LPs think they will find solutions in only a minority of cases; a further 22% of LPs expect none of these situations to be susceptible of remedy.
With the fragile state of today’s credit markets, the majority of investors also think re-financing the ‘wall’ of buyout debt due to mature in 2013-15 represents a major risk to the industry.
Despite these worries, investors generally believe 2012 will be a good or excellent vintage year – over two thirds of North American LPs share this view – and their 3-5 year return expectations for private equity have almost returned to pre-crisis (Winter 2007-08) levels: one third of LPs expect returns of 16%+ from their private equity portfolios; half of LPs expect returns of 11-15%.

I think a lot of LPs expecting returns of 16%+ in private equity are in for a shocker. These investors are deluding themselves and their plan beneficiaries if they think private equity will continue to deliver outsized returns of the last 20 years.

Importantly, conditions in credit markets and public equities will continue to challenge private equity. It's ludicrous to allocate more into private equity to "escape the volatility of public equities." That only buys you some time, it doesn't solve the fundamental issue, which is that private and public equities are highly correlated (with a lag).

Another Bloomberg editorial states that The Trouble With Private Equity Is Privilege Not Profits:

Mitt Romney, the favorite to win the Republican presidential nomination, has brought the rights and wrongs of private equity to the front of U.S. politics. He once ran a private-equity firm, and he has been attacked for it even by fellow conservatives.
This is a new version of an old complaint, and the quality of the discussion is not improving with age. The question to ask about private equity -- which involves taking over companies, restructuring them and selling them at a profit -- is not whether it creates jobs. It is whether taxpayers should be subsidizing its practitioners’ paychecks.

Many politicians say private equity is rapacious. Not long ago, the same charge was laid against leveraged buyouts, and before that against hostile takeovers. The issue is essentially the same. When control of a company changes hands, are the new owners so intent on short-term profits that they act against the interests of other stakeholders -- not just shareholders, but also employees, customers and the wider community?

The current debate has revolved around jobs. Defenders of private equity say the new owners tend to boost employment, and critics say the opposite.
Small Effect

The most comprehensive study to date -- by Steven Davis of the University of Chicago and four other economists, one of whom has been a paid adviser to the private-equity industry -- found that private equity has only a small overall effect on employment. The researchers looked at 3,200 target companies and roughly 150,000 operating units (factories, offices, retail outlets and so on). They found that the acquired companies lost jobs at existing units but added jobs at new ones. Altogether, employment at companies bought by private-equity investors fell in the first two years by less than 1 percent relative to employment at similar companies.

More revealing than the net effect on jobs was gross employment turnover -- jobs created plus jobs eliminated. This total was 13 percent higher for private-equity targets than the control group. In other words, companies bought by private equity both fired more people and hired more people. The study concluded that “private equity buy-outs catalyze the creative destruction process.”

Exactly. In a market economy, some companies or industries are shrinking, while others are growing. You can’t have one without the other, and the spur for both kinds of adjustment is profit. Market forces raise living standards not by increasing wages and employment enterprise by enterprise, but by applying capital and labor to the best uses. Private equity, leveraged buyouts and hostile takeovers all serve this purpose. To keep managers on their toes, capitalism requires a functioning market for corporate control.

Now let’s suppose, contrary to the findings just quoted, that private-equity owners always reduce jobs. Suppose they always drive wages down, too, as some critics say. Would this prove that private equity is bad? Before you answer, remember that -- again at the level of the company, not for the whole economy -- labor-saving innovation also tends to have those effects. So does competition from new entrants. Such is capitalism.

If private-equity owners cut costs and improve efficiency, they are doing what incumbent managers should have done already. If the new owners manage incompetently, they will lose money. As for investors’ selfish motives, Adam Smith gave the wisest advice 250 years ago: “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.”
Valid Concerns

While politicians focus on misguided complaints about private equity, valid concerns are all but ignored. Two are pressing and closely related: debt and political influence.

The private-equity business relies on borrowing. If government policy were neutral on the matter, leverage and the risk that goes with it would be for managers old or new to decide. But policy is far from neutral. The U.S. tax code discriminates strongly in favor of leverage, for example, by giving companies a tax break on interest payments. Without this bias -- which should be reduced as part of a larger tax reform - - the private-equity business would be conducted differently, if it existed at all.

Private-equity and other high-paying financial firms also receive a tailored preference in the form of special tax rates on “carried interest.” This allows income to be taxed as if it were capital gains, hence at 15 percent instead of 35 percent, even if the person concerned has put no capital at risk. Romney said Tuesday that his effective federal tax rate is “probably closer to the 15 percent rate.” Efforts to close this loophole - - a move Bloomberg View supports -- have come to nothing, demonstrating how private equity has made an art of political connections and influence.

If private equity can succeed without preferences, that’s fine: The more competitive the market for corporate control, the better. Its current mode of operation, though, is largely a symptom of a flawed tax code. The industry’s borrowing is subsidized and so are the generous incomes it pays its staff. These privileges are a problem. The issues its critics choose to emphasize aren’t.

I want to be careful not to demonize private equity firms, just like I do not want to demonize hedge funds. There are many excellent private equity firms in the world and they do serve an important part in restructuring companies and making them more competitive. The current political discourse attacking PE firms on employment is terribly flawed.

But there is no question that private equity firms also enjoy privileges that come from an advantageous tax code which they lobbied hard to change. And we all know that some of the richest private equity funds have huge political connections with many former presidents and prime ministers sitting on their board of directors.

Private equity is on the defensive. Bloomberg's Cristina Alesci and Deirdre Bolton report on Stephen Schwarzman, the chief executive of Blackstone Group LP who said four months ago he pays an effective personal income tax rate of 53 percent, is taking steps to avoid releasing his personal financial information (also watch on YouTube).

And David Rubenstein, co-founder of Carlyle Group, was on Fareed Zakaria GPS on Sunday defending private equity's track record on job creation. Carlyle has been the target of many critics in the past, but it was a good interview where Mr. Rubenstein talked about alignment of interests, his humble background, how he gives away most of his profits, has pledged to give away his fortune, and how he thinks Americans need to learn more about their history. Watch a clip of that interview below (wish CNN posted the entire interview).

The Impact of a Great Leader?

2012-01-22T10:45:00.025-05:00

It's Sunday, been watching all the morning news shows discussing Newt Gingrich's big victory in South Carolina and learned of the death of Joe Paterno, the legendary coach at Penn State. So I decided to take a break from pension investments to discuss what makes a great leader.

Patrick Alain of Industry leaders Magazine reports, The Impact of a Good Leader and Good Leadership in Society:

When people talk about leadership, they mostly want to learn how to be good leaders at work. leadership in the corporate context is one of the hottest topics in the world, and everyone wants to learn how to become a billionaire and be the best possible boss. However, leadership is not just limited to the work frontier, it extends to all of society. In fact, leadership began as a societal phenomenon much before it evolved into a professional one. In fact, many of the present-day leadership qualities that corporate and professional leaders aspire to are based on the social and political leaders of the yesteryears.
Human beings are social animals and living together in large groups naturally meant that people needed to adopt different roles and accomplish different groups. In order to give structure to society and help society grow and develop, people were naturally divided into leaders and followers. The leaders paved the way and moved from one frontier to another, directing the others, while the followers completed the tasks assigned to them and helped bring the changes about.
Understanding the role and impact of good leadership in society makes for an interesting study. While it’s easy to break down the effects of leadership in the work environment into small, easily identifiable structures, analyzing how positive leadership affects society is somewhat complex. Society is a multi-phenomena structure, with a myriad of social forces, elements and factors at play all the time. Society is not limited to a few defined goals, and hence, leadership in society is a vast, and often intangible, phenomenon.
Leadership For Adopting Social Change
Leadership is instrumental to achieving social change. All through history, whether it was for abolishing social norms, overcoming social evils or modernizing history, social change has been impossible without the right kind of leadership. When it comes to mobilizing the masses, igniting passion in people towards a common goal and motivating people to act towards the said common goal, it isn’t possible to unite the people and inspire action without leadership. One person has to spear the movement, and he may not professionally be a leader, and does not have to be a political leader, but he should have the charisma to inspire people and motivate them. A great example from recent times would be that of Anna Hazare, and Indian citizen who inflamed thousands of Indians against the injustices of the Indian political system and the rampant corruption in society and politics and launched one of the biggest civil movements Asia has seen in a long time. In terms of social change, the leader is the face of the movement as well as the backbone of it, while the people form the heart and soul.
Leadership For A Positive And Content Society
It is interesting to note that one person or a small group of people has the power to influence how millions feel. A society that is bereft of competent leaders is invariably thrown into dissatisfaction at a small scale and turmoil and anarchy at a larger scale. A leader who is good at what he does, is able to keep people motivated and inspired, works for the greater good of society and not just his own personal gains, and is able to respect his people will be successful in creating a positive and happy society. When people have faith in their leader and feel that they are taken care of, be it economically or socially or politically, they are in a better frame of mind on the whole. Good leadership creates a happy society, and a happy society can build a strong nation!
Leadership For Improved Professional Performance
It is quite remarkable that even when leadership is effective in the social, not corporate, context, it has an impact on people’s professional lives. When a society is led by a powerful, positive and forward-thinking leader, one of the main areas of focus is people’s professional development. It goes without saying the professional progress is required for economic growth and no society can do well without financial stability. Hence, good leaders are those that take all factors into consideration, even if their role is ostensibly limited to one niche. A positive leader will always be mindful of the fact that people need to be achieving something in their professional capacities in order to lead the society forward, and hence the leader will emphasize the importance of education, picking the right career, working hard and focusing on performance.
Leadership For A Strengthened Identity
Most people fail to appreciate how a common leader is often the face of the society and a symbol for it. When people elect a leader they are proud of, or they are placed under the care of a leader who does a good job, there is a sense of pride and identification with the individual that also ties the society together. An effective leader is one that people of the society are happy to call their own, and in turn, the leader ends up bringing the society together and giving them a common, positive identity that the people are all happy to have. Societies are often remembered by their remarkable leaders and not the people, and it is a unique social phenomenon that one man or woman can not only shape the future of several people but can also make them feel closer to one another and strengthen their bonds with each other and with a common identity by virtue of being an effective leader.

Sara Jacobi of the Wakefield Patch reports, Three Tips for Great Leaders from Laura Sen, CEO of BJ's Wholesale Clubs:

Laura Sen, a Wakefield native who has gone on to become the chief executive officer of BJ's Wholesale Club, returned to town on Jan. 18 to speak to the Chamber of Commerce about the qualities of successful leaders.

The most important factor of what makes a great leader is the individual's underlying set of values, according to Laura Sen, president and chief executive officer of BJ's Wholesale Club, Inc., a Wakefield native who returned to town on January 18 to speak to the members of the Wakefield Chamber of Commerce.
Sen, who grew up in town has spent the last three decades working in, managing and leading the retail business, and has served as CEO at BJ's since 2009. She got her start working for Jordan Marsh, and continued on to the Zayre Corportation in Natick.

Throughout her distinguished career, Sen has had the opportunity to learn and grow as a leader, and has fine-tuned her own personal approach to leadership. She said she doesn't just look to businesses and business leaders, but also to sports and coaches.

She said one of the stories she's most inspired by is how Tony Dungee, coach of the Indianapolis Colts, reportedly scouted his players. Sen told how Dungee first employed all the regular means, including stats, performance, history, etc. But he also wanted a way to determine the player's underlying character as a person. He asked an unlikely scout: the equipment guy.

"This says, what's most important isn't your uniform or your number, but what's on the inside," Sen said.

It's this focus on personal character and values that Sen says most influences her leadership style.

1. Establish a set of values: Sen said that although strategic plans and financial plans and all kinds of other business plans are important, the most important plan that seeks to inform all others should be a set of values.

"At BJ's, our values are permanent, and we use them to hire the right people, to make decisions, to steer our personal conduct and to create value every day," Sen said.

Those values are to respect others, speak with truth and candor, act with integrity, to succeed as a team, to impress members with great service, to embrace diversity, and to give back to the community.

2. Stand by the values: "I would argue these values are what we've all been taught by our teachers, coaches and parents, but unless you hold them up on a regular basis, things get in the way," she said. "We remind people that there's no business decision that will take priority, and that we will not win without insisting on both."

Sen mentioned she's been in situations where she's had highly skilled people in specialized areas that she's had to part company with along the way due to conflicts over values.

"You just have to say, sorry, I'll find somebody who can produce the results I want, and also buy into the set of values," she said. "If everyone else looks at me as someone who is supporting somebody who is not the right type of person, it's just a bad apple situation."

3. Succeed as a team - Sen said when she was faced with some underperforming stores, she brought the issue before the entire team.

"It's much better for ten brains to work on something than for one to have all the answers," she said.

The idea everyone came up with was to implement a buddy system, to pair underperforming stores with successful stores, and allow them to work together and advocate for one another.

"Those buddy clubs turned around and outperformed the company in sales and growth and never looked back," she said.

Sen said what she loves most about leadership is the opportunity for it each and every day.

"There's an opportunity to lead every day by example," she said. "And yes, the equipment guy is watching."

I like what Laura Sen says about values and hiring the right people. I've seen firsthand the positive effects of hiring the right people and the destructive effects of hiring the wrong people.

In running a pension fund, an investment fund, a corporation, or any organization, it's crucial to have the right leadership and to have the right people around at leadership roles. The worst thing you can do is place someone in a position of power who will rot your organization from the inside out.

It doesn't matter if this person is a great "individual achiever," an asshole is an asshole, and if you place them in a leadership role, you will suffer the consequences. It will totally demoralize and demotivate your employees, sucking away all the positive energy, and severely impact the culture and performance of your organization. I write this because I've seen enough assholes being placed in positions of power and watched organizations suffer huge losses and employees being totally demoralized and demotivated.

How do you recognize a weasel in a position of power? Easy, they take all the glory when things go right and look for scapegoats when things go terribly wrong. They never own up to their mistakes.

When you're running an organization, you have to evaluate your leaders properly and ask a lot of hard questions, not just whether this person is a good performer, but is he or she a good leader, mentor, someone who owns their decisions and motivates their team to come into work and rise to the challenge.

Sadly, in my experience, very few leaders are able to do this properly and consistently. The very same people that have given me the best opportunities in my professional career are also the same individuals who disappointed me the most. They were unable to see past my personal flaws/ circumstances and understand my strengths, building on them to bolster their team and organization.

A true leader will recognize the value of someone who is fearless in making a call and willing to stick their neck out. A real leader doesn't want someone who only praises them, but wants and needs to be challenged. That is my idea of loyalty and that is my idea of what makes a great investment analyst and a valuable employee.

At this point of my life, I should have been the CIO of a major pension fund. Instead, I lost years of great income, great benefits because those leading me failed to take me under the wings and groom me to the position they knew I was more than capable of doing.

Very few senior investment analysts have been exposed to public and private markets in the pension industry. Very few understand the big picture. None of them would ever have the balls and brains to start a blog from nothing and bring it up to a financial blog that has now been read by almost a million people around the world.

But while I enjoy trading and blogging on markets and pensions, it's not providing me with a steady income. I need a job and most importantly, need to interact with others. I am calling upon leaders from my past and present to step up to the plate and help me. You do not need to see my resume. This blog is my resume. Don't worry about my health or attitude; see it as an asset, not a liability.

I have no regrets in my life. We all have different life paths. I've made my share of mistakes and been subjected to my share of gross injustice, but I am not angry or bitter about the past. I am disappointed with certain individuals because they failed to understand my frustration and why I acted a certain way. Empathy is one of the most important leadership qualities and they don't teach you that in business school. It's either in you or it isn't.

Above all, great leaders are great motivators. No matter how difficult my circumstances are, every day I try to read inspiring stories of others to motivate me and stay positive. Last night, I tweeted on a Sudbury lady, Rachel Proulx, who despite battling MS, is still active in the cause to end violence against women. I also shared the story of Kevan Brininger, who is is not letting his MS stop him from participating in an Arizona Marathon. And shared the stories of Sandy Henson Corso who went on a raw vegan diet to tackle her MS and how MS sufferers are praising the new controversial angioplasty therapy for MS (I know I feel much better after undergoing the Liberation treatment last year and look forward to seeing the results of clinical trials).

All these stories motivate me and make me realize how lucky I am to be able to walk and live a relatively normal life despite battling MS for over 14 years. Sometimes I get down. It's only normal, but I get back on to climbing the mountain and try to focus my energy on positive things.

And when I need inspiration, I find it. This past week, I felt a little down and under the weather and watched a movie called Soul Surfer, the inspiring true story of teen surfer Bethany Hamilton, who lost her arm in a shark attack and courageously overcame all odds to become a champion again, through the love of her family, her sheer determination and unwavering faith. I was also touched by the tragic death of Canadian freeskier Sarah Burke, who was too young, too smart to go that way. As tragic as her death is, she lived her dream and her life is inspiring.

Below, watch the final scene of Soul Surfer and some clips on Bethany Hamilton and Sarah Burke. And on a day where we learn of the death of a great football coach, take the time to listen to listen to Vince Lombardi, one of the greatest football coaches of all time. In his famous keynote speech, he laid out the principles that brought him to greatness.

Remember, life is short. Stop focusing on what you don't have and be grateful for what you have. And great leaders need to motivate us into believing in ourselves and the common good, rising above our expectations and playing our part in making this a better world.

Where Are The Customers’ Yachts?

2012-01-20T12:51:00.017-05:00

Earlier this week, a wise and skeptical senior Canadian pension fund manager sent me this Bloomberg article, Hedge Funds Buy Ferraris, Clients Often Get Phantom Gain:

Hedge-fund managers treat themselves to absolutely fabulous toys: Ken Griffin is fond of Ferraris, Steve Cohen is known for his Damien Hirst pickled shark and ice rink outfitted with its own Zamboni in a gabled cottage.

So where are the customers’ yachts?

“Who can name even one hedge fund investor whose fortune is based on the hedge funds he successfully picked?” asks Simon Lack in his stinging expose, “The Hedge Fund Mirage.”

If anyone is qualified to pose that question, it’s Lack, whose Wall Street career lofted him through the multiple mergers that begat JPMorgan Chase & Co. His answer ought to drive many hedgehogs -- and their investors -- into hibernation.

Sitting on JPMorgan’s investment committee, Lack helped to allocate more than $1 billion to promising hedge-fund managers, the book says. His conclusion about the broader industry, stated baldly on page 1, can be boiled down to one statistic.

“If all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good,” he writes.

Lack isn’t saying that hedge funds never reap superior returns for investors. Far from it. He clearly admires John Paulson’s bet against the U.S. housing bubble and George Soros’s wager against the Bank of England. And the industry did perform well and preserve capital during the 2000 to 2002 bear market, which is why so many institutional investors threw money at them, driving assets under management to more than $1.6 trillion, Lack says.
Flood of ‘08

Yet the star performers are outliers. Research shows that “a few dozen have produced most of the investors’ returns,” Lack says. And don’t forget the “thousand-year flood” of 2008, when the hedge-fund industry “lost more money than all the profits it had generated during the prior 10 years,” he writes. So much for the “absolute, uncorrelated returns” they promised: Investors would have done better by shoveling their money into T-bills, earning 2.3 percent, Lack says.

Shunning simple average annual returns, Lack measures hedge funds with an index weighted by assets, just as the stocks in the Standard & Poor’s 500 Index are weighted by their market value. This gives a better sense of the returns, he argues, because investors in aggregate have invested more in the bigger funds. Then he turns his attention to the real profit killer: fees.

He starts with two data sets: annual assets under management (as tracked by BarclayHedge since 1998) and returns as measured by the HFR Global Hedge Fund Index (HFRXGL), which is weighted by assets. Next, he estimates fees using the standard “2-and-20” formula -- a 2 percent management fee and 20 percent incentive fee.
Real Profit

This involves a few simplifications. Some managers, for example, charge more than 2 and 20, some less. Yet the methodology does reveal a clear picture of the total profit hedge-fund investors received minus fees and the return they could have gotten by parking their money in Treasury bills.

From 1998 through 2010, these “real investor profits” totaled $70 billion, compared with fees of $379 billion, Lack estimates. Adding the fees back in, hedge fund managers salted away 84 percent of $449 billion in total profits, leaving 16 percent for their investors, he says.

And that’s not the worst of it, Lack says. HFRX index doesn’t account for factors such as “survivor bias,” meaning that only surviving hedge funds report returns (just as the victors write history, he says). Adjusting for those biases, the annual fees sink to $324 billion, while the real investor profits plunge to a negative $308 billion, he says.

Consider, too, the fees charged by funds of hedge funds, used by roughly a third of hedge-fund investors, Lack says. Throwing that into the mix, investors were left with $9 billion, while the industry amassed $440 billion in fees, or 98 percent.
So Much, So Little

The risks and rewards are so cockeyed that Lack can’t resist paraphrasing Winston Churchill’s encomium about Royal Air Force fighter pilots during the Battle of Britain: “Never in the history of Finance was so much charged by so many for so little.”

If Lack’s calculations are wrong, he can kiss his career goodbye. If he’s right -- and I think he is -- pension funds have a lot of questions to answer.

Lack does more than crunch numbers in this book. He recalls a chance JPMorgan had to invest with Bernie Madoff (they passed) and an “opportunity” to do a tricky trade with Long-Term Capital Management LP. LTCM’s Myron Scholes, of Black-Scholes Option Pricing fame, offered to help price the deal. Lack declined.

“Trading options with Myron Scholes didn’t sound like a poker game I should join,” he says.

As damning as his analysis is, Lack ultimately concludes that hedge-fund managers aren’t the villains of this sad story. The real fault lies with the “supposedly sophisticated investors” who fling so much money at funds with so little skepticism and critical analysis.

“The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True” (Wiley, 187 pages, $34.95, 23.99 pounds, 28 euros). To buy this book in North America, click here.

Simon Lack is absolutely right, most hedge funds, including Canadian hedge funds, are terrible and investors are better off investing in T-bills. And don't get me started on fund of hedge funds, the biggest scam of all, charging an extra layer of fees for mediocre results.

And hedge funds aren't the villains. Too many institutional investors are lazy and sloppy, listening to the advice of brainless pension consultants who've never invested in hedge funds. Remember the famous quote from Tom Barrack, the king of real estate, on why he cashed out before the downturn. "There's too much money chasing too few good deals, with too much debt and too few brains."

In a recent interview with Pension Funds Online, Lack was quoted as saying pension funds investing in hedge funds are "rich enough to know better":

The author of a controversial new book on hedge fund investing has warned UK pension funds that the real money in the asset class lies in fees for the industry rather than returns for clients.
Simon Lack, an independent asset manager formerly of JPMorgan, has hit the headlines in the financial press with his scathing analysis of hedge funds' real value. He suggests that the annual return figures promoted by hedge funds disguise poor overall returns weighted by each asset as smaller hedge funds perform much better than larger ones (the latter being more accessible to institutional investors).

Lack's analysis has in turn been sharply rebutted by the Alternative Investment Management Association. The body claims that Lack's analysis would be equally critical if applied to other asset classes and point to the increasing numbers of institutional investors putting money into hedge funds being a vote of confidence in the industry.
Pension funds have been upping their appetite for hedge funds in recent years since the financial crisis reduced the attractiveness of traditional assets. For the wider public and many pension fund members though, hedge funds remain a virtual by-word for financial greed.
Lack recently shared his views with Pension Funds Insider from his New York office.
Pension Funds Insider (PFI): When did you first become sceptical of the value of hedge funds?
Simon Lack (SL): I was an investor in hedge funds with JPMorgan and I always used to have a feeling that the fees were really where the money was. I never felt very comfortable going to the big hedge funds of the time where you almost had to ask "please take me on as a client!"
Then I set up a private equity fund ten years ago to take a venture capital stake in hedge funds, providing seed capital to a hedge fund in exchange for some of their fees (we were seeing a lot of interest of institutional investors in hedge funds after the dot-com bubble). But it turned out that most of our returns from that strategy came from fees rather than investment themselves.
Only when I started my own business two years ago and sat down to do the maths did I realise that, unbelievably, the clients of hedge funds haven't made much money. I wrote an essay on this topic for my company and what's more found out that the asset-weighted returns from hedge funds are far lower than the average annual returns, so in looking at the latter investors have a false proxy for the asset class's performance.
Hedge funds did very well in the 1990s, as did their clients – there just weren't too many funds or clients at the time. As the industry has grown, the returns have gone down fairly steadily. It turns out there is a pretty clear correlation between the size of the industry and returns. Any hedge fund you look at did better when it was small and the same goes for the industry as a whole.
Amazingly, investors don't appear to apply the same test in making the decision to allocate assets to the hedge fund industry that they would do when picking individual managers.
The overall rate of return from the hedge fund industry is lower than if the money had been invested in treasury bills. In writing an essay for Absolute Return magazine on this I realised there is some academic research which supports my point. That's when I thought 'man, this is a huge story!'
PFI: How have people you do business with reacted to your controversial research?
SL: When I've spoken to people in the hedge fund industry and tell them that treasury bills have actually outperformed hedge funds, they aren't surprised by this at all. Then you talk to people who are not in the hedge fund business but are in financial circles and they are surprised. I feel there's a huge gulf of misunderstanding, and if those close to the hedge funds know it, isn't that something that the investors should know?
It doesn't alarm me that I'm one of only a few people who have dedicated themselves to looking at hedge funds negatively. If you don't agree with what hedge funds are doing it's difficult to make a living out of that position – you can't short hedge funds.
PFI: Are you saying that pension funds should avoid hedge funds entirely?
SL: Well, in my view, all institutional investors who have money in hedge funds are rich enough to know better. I think pension investors have been poorly advised, with the consultants (who promise them good returns and a better sharpe ratio with hedge funds) guilty of sloppy analysis.
It's bold to say that the $2 trillion invested in the global hedge fund industry is all in the wrong place. There are some fantastically gifted hedge fund managers, there always will be, and there are happy clients – it's important to stress that it isn't all bad.
I would say though that, in the overall picture, that is not typical.
Hedge funds have been fantastic investments, it's just that the profits have mainly stayed within the industry rather than going back to the clients.
PFI: What advice would you give to pension funds who do decide to invest in hedge funds?
SL: Frankly, every pension fund should consider the asset-weighted returns in my view and ask from that if hedge funds have a useful role in their portfolio or not. There are some great hedge funds but it's a huge challenge to build a portfolio out of them.
The analysis shows that hedge funds performed well in the past when small. Pension funds just aren't going to get the results that they want in these massive industrial strength $20 - $30bn funds.
I asked people at a roundtable event recently what returns they expected from hedge funds and 7%, the figure the industry likes to promote, was a popular view. Well, if you want those kind of returns the industry would need to post record returns year-on-year. And as an investor I wouldn't count on that.
Having said all that, it's true a couple of well-selected hedge funds could benefit a pension fund.
Important things to do in any hedge fund selection process are negotiating for optimal returns, lower fees and transparency. All that should ensure investors get better outcomes and better rights in their dealings with hedge funds.
PFI: UK pension funds on the whole have increased their exposure to hedge funds from 1.8% to 4.1% in the last two years (according to the National Association of Pension Funds), as part of a general rise in 'alternative' asset investments (up from 10.3% in 2010 to 17% in 2011 according to Pension Funds Online). Does that not indicate that many hedge funds are doing well and impressing pension fund investors?
SL: There are some great hedge funds out there but in general it seems to me that pension funds have been won over by the fairly simplistic analysis of average annual hedge fund returns beating those from fixed income and possibly equities.
I'm sceptical whether the absolute return industry really has that much absolute return to deliver.
PFI: What alternative would you recommend to pension funds that have become interested in allocating to hedge funds when looking for some alpha in recent years?
The equity risk premium is very wide at the moment in the US, and I imagine that the same would be true in the UK. There is a pretty strong case for investing in public equities – the fact that they have underperformed for ten years just means that they have generally grown book value without going up in price.
So as a pension fund trustee I would be at the upper end of my allocation band for equities. I'd be underinvested in fixed income because bond yields in every industrial country are grossly distorted by central bank activity.
It's a challenge of course, especially for all the pension funds that are seeing their funding deficits widen. Pension funds are investors with some of the longest time horizons though and they are supposed to look for the best long-term returns possible.

The interview above should be read by every pension fund trustee on the planet, it's spot on. Some analysts, notably in India, are going beyond Simon Lack's 'The Hedge Fund Mirage':

The key contribution that Lack has made is to focus unrelentingly on what can be called asset-weighted returns of the hedge funds.
The traditional way that all investment managers report their life-time returns is by a compounded average growth rate. This calculates how much an investor would have made had he invested a certain amount at the beginning of the fund's life and then held on to it till the present time.
By this count, hedge funds have returned about 7% since 1998, which is not bad for those markets.
However, Lack proposes an alternate measure, which is how much money did investors actually make. By this measure, hedge funds that invest in the US have earned less than 2% a year over the same period.
As he memorably puts it in the first sentence of his book: "If all the money that's ever been invested in hedge funds had been put in treasury bills instead, the results would have been twice as good". The reason why hedge funds' returns are so much higher than what the investors made is simple.
Investors' returns are weighted by the money they have put in. If a fund has 100 and it gains 20% in a year, investors have earned 20. Next year, the fund has grown to 200 and it loses 10%. Investors have lost 20 and are back to even but the fund's performance number are still positive at 3.9% a year.
He has shown that larger funds systematically do worse than smaller ones. Not just that, the same funds did better when they were small compared to how they did when they became large.
Even more interestingly, the entire industry as a whole did better when it was smaller. The takeaway for investors really is that the performance numbers reported by an investment manager can be accurate but still misleading and investors have to apply intelligent thought to what is being reported vs. what they are actually getting.
There are a couple of other important points in The Hedge Fund that are applicable everywhere. One is that profit-linked fees which are based on annual returns (or other formulae that are currently used) are inherently unfair and result in investment managers taking a far greater share than is indicated by their stated terms.

The point on large versus small hedge funds should be underscored. While there are large hedge funds like Bridgewater Associates and Brevan Howard managing billions and performing exceptionally well, there are plenty of others that are just large asset gatherers, collecting millions in fees, delivering mediocre results. That's why smart investors are chopping hedge fund fees, or shunning them altogether, bringing assets internally.

So what is it with hedge funds and private equity funds? Why are institutions piling into them? Just this week, I read an article on how the head of Florida’s $120 billion pension fund wants to double down on “alternative investments” in the future:

The official managing Florida’s $120 billion pension fund wants lawmakers to double the amount of money his agency can set aside for special investments that critics say are harder to value and carry more risk than traditional stocks and securities.
Ash Williams, reaffirmed Wednesday as the State Board of Administration’s executive director and chief investment officer for another year, said increasing the spending cap on “alternative investments” from 10 percent to 20 percent will diversify the state’s portfolio and reduce risk in a dreary market.
“It is not about struggling to get higher returns and taking on more risk in the effort,” Williams said.

But critics say just the opposite, painting the investments as secretive and potentially dangerous.
Alternative investments include hedge funds, private equity, venture funds or an investment in a portfolio company through an investment manager. They are not publicly traded.
Florida’s pension fund, the fourth-largest in the nation, was valued at about $120 billion on Monday, down about $8 billion since June.
“It’s a hell of a lot of money,” said Edward Siedle, president of Benchmark Financial Services, which investigates money-management abuses on behalf of pensions. “It’s a fifth of the portfolio.”
If approved by the Legislature, the target percentage would be 16 percent, not the full 20 percent allowed, Williams told a Senate committee mulling the cap on Jan. 9. The national average allocation on alternatives is 19 percent, he said, so the request is not “outlandish.”

Read more here: http://www.miamiherald.com/2012/01/18/2596284/state-pension-chief-wants-to-double.html#storylink=cpy
No, itÈs in line with wha

Read more here: http://www.miamiherald.com/2012/01/18/2596284/state-pension-chief-wants-to-double.html#storylink=cpy

No, it's not 'outlandish', especially when compared to what other US public pension funds are doing, but it is it smart? Are pension beneficiaries going to be the ones that will ultimately benefit out or will it be the fund managers charging huge fees? That is the key question.

And yes, there are excellent hedge funds and private equity funds, but there are so many charlatans and snake oil peddlers looking for dumb pension money. How do I know? I used to allocate to some of the best hedge funds all around the world and have seen my fair share of bullshitters and frauds. From a previous post of mine:

Most pension funds are absolutely stupid and clueless when it comes to investing in hedge funds. All too often, they are intimidated by charismatic managers who use "sophisticated" lingo to try to impress or intimidate unsuspecting pension fund managers.
I'll never forget my due diligence experience with some of these charlatans. It took me less than 15 minutes to figure out Norshield was a Ponzi scheme. Johnny "X" (John Xanthoudakis) walked into the boardroom sporting a tan, wearing a fancy Italian suit, smiling with his bleached white teeth, flaunting his "incredible risk-adjusted returns," a perfect 45 degree line. When I told him they are "too good to be true," he asked me if there was anything he could do to "facilitate an investment" (code for "how much to bribe you?"). That meeting was over fast. Amazingly, municipal pension plans in Quebec invested hundreds of millions in this joke of an outfit (too many of them are on the take; you better believe it is time to take action on municipal pensions).
I also dealt with my share of arrogant assholes in the hedge fund industry. Guys like "von Muffins" (our pet name for him) who was threatening us that if we do not invest with him, we will "never have access to his fund". Or another condescending jerk who was talking down to me telling me "Soros taught me risk management, you guys don't get it" to which I replied "is that why Soros fired you?" (don't ever get cute with me in a meeting, I'll rip your balls off and shove them down your throat!).

As you can see, I'm not impressed with hedge funds or private equity funds. I've gone toe-to toe with Ray Dalio, one of the few hedge fund managers I respect, but I don't think he's God. I don't think any hedge fund manager or private equity manager walks on water and is invincible.

Importantly, when I was investing in hedge funds and private equity funds, I treated everyone the same. I asked a lot of tough questions and if I didn't like the answers, I asked more questions and if I wasn't satisfied, I cut allocations or pulled the plug. The toughest thing investing with hedge funds is knowing when to walk away or when to pull the plug. Any dummy can write a big cheque, very few know when it's time to cut.

And I never chased after any hedge fund manager. I cringe reading silly articles on The Fabulous Life Of Chase Coleman: The World's Most Profitable Hedge Funder In 2011. Don't get me wrong, he is Julian Robertson’s 36-year-old disciple, a "Tiger cub," and might very well be the next Ken Griffin or George Soros, but my point is simply never "chase" after any hedge fund, ever. If you do, you deserve to get your head handed to you.

Finally, Bloomberg reports that R. Allen Stanford’s investors are enduring a 'living hell':

R. Allen Stanford’s investors, after waiting three years to see the Texas financier go to trial on charges of leading a $7 billion fraud, must hold on even longer before learning when they will get some of their money back.

Stanford’s customers have received nothing since the U.S. Securities and Exchange Commission closed his businesses in February 2009.

Stanford, accused of misleading people who bought certificates of deposit from his Antigua-based bank, spent their money on bad investments, sports sponsorships and a lavish lifestyle that included yachts, a fleet of jets, mansions and a private Caribbean island, U.S. prosecutors said.
Jury selection in his criminal trial is scheduled to start Jan. 23 in federal court in Houston. Stanford, who denies any wrongdoing, faces as long as 20 years in prison if convicted.

“It’s not fair that we have to be put through this living hell,” said Blaine Smith of Louisiana, who claims to have lost $1 million in life savings invested with Stanford.

I have a lot of sympathy for these investors but warn everyone, including pension funds, in this economy, there are plenty of other Stanfords and Madoffs looking to sucker you in. If it looks too good to be true, run, don't just walk away.

I can spot bullshitters from a mile away. I have a knack for that which has landed me in hot water at times. But when I see people being robbed or pensions getting hoodwinked by unscrupulous psychopaths, it really bothers me. In the case of pension funds, however, they really should know better but they too fall for all the glamor and glitz of the alternatives industry, eschewing their fiduciary responsibility. And some pension fund managers are on the take. Period.

Below, Douglas Burns, a former federal prosecutor, talks about an investigation into insider trading at hedge funds by the FBI and the Justice Department. Seven people were charged in Manhattan federal court with counts including securities fraud and conspiracy as part of the five-year probe.

I also embedded some Bloomberg interviews with Marc Faber, publisher of the Gloom, Boom & Doom report, and Nouriel Roubini, the New York University professor who predicted the 2008 financial crisis, and Ian Bremmer, president of Eurasia Group. As you know, I'm long risk assets, think the US economy will surprise to the upside, that eurozone will be a positive black swan, and reject claims that bonds are in a bubble.

Solving Canada's Pension Enigma?

2012-01-20T09:38:00.015-05:00

Kathryn May of the Ottawa Citizen reports, Flaherty’s 2010 promise on PS pensions not meant to be permanent, spokesman:

Finance Minister Jim Flaherty wants to be clear. The commitment he made in 2010 that the Conservative government wouldn’t touch federal pensions didn’t mean they would never be reviewed again.
The Public Service Alliance of Canada was banking that public servants’ paying higher contribution rates for their pensions would spare them from further changes or cuts to their pension plans. This was based on assurances PSAC President John Gordon said Flaherty gave him during a meeting with the Canadian Labour Congress’s executive council in the fall of 2010.
In that meeting, Gordon claims Flaherty confirmed the government wouldn’t be touching pensions as long as employees agreed to pay 40 per cent of the yearly contribution rates for their pensions by 2013.
The government is phasing in an increase that would boost employees’ share of contributions — which dipped to a low of 25 per cent — to 40 per by 2013. Last fall, the unions agreed to an accelerated rate increase, effective Jan.1, to ensure the 2013 target was reached.
With all the recent speculation that pension reform was on the Tories’ radar, Gordon publicly questioned how solid that commitment was. He has since written to both Flaherty and Treasury Board President Tony Clement to “clarify” if they have changed their minds and what they plan for pensions. The union has also revived its “hands-off our pensions” campaign and petition.
But Flaherty’s office said that “two-year-old conversation was taken out of context.” Flaherty’s assurance was never intended as a “commitment that it would never be reviewed again,” said Chisholm Pothier, his director of communications.
“In fact, Mr. Gordon knows our government continually reviews public service compensation and benefits to ensure they are fair to taxpayers and sustainable for employees — as we have stated publicly several times,” he said in an email.
The fall of 2010 is also when PSAC was in the throes of collective bargaining for a controversial three-year wage deal that included negotiating the surrender of severance pay for voluntary departures from the public service. Gordon said the union didn’t bring Flaherty’s pension assurances to the bargaining table, but he said public servants were aware of the commitment. He said he also met with then Treasury Board President Stockwell Day and received the same assurances.
“Now what I am hearing is that ‘that was then and this is now’,” said Gordon.
“I asked him a direct question, in front of the CLC, and took him at his word and if he’s moving in another direction, I know nothing about it and, if that’s the case, he should come clean on where he is intending to go.”
Many argue any pension review should be part of a broader examination of compensation in the public service, including wages, pensions and all other benefits. Many public servants would rather pay more for their pensions and benefits than lose them.
This week, Prime Minister Stephen Harper responded to questions about reforming public service pensions. He said no decision has been made but the issue must be examined because of a demographic shift in Canada leaving fewer people in the workforce and more older people living on pensions. He said pension plans for public servants and MPs have to be fair to taxpayers.
“We have to have a pension plan that is reasonable and attractive to get people into the public sector, but it should not be significantly more generous than what would be available in the private sector,” Harper said.
Clement, who is leading the spending review that is looking to trim $4 billion from departments’ operating budgets, is looking at “all options” to achieve those savings. Clement has criticized PSAC for failing to offer any “concrete responsible input” on how to help reduce costs.

Get ready for a major showdown on public pensions. The federal government has an agenda to go after public pensions. According to government officials, it's not just MPs that have their snouts in the pension trough, everyone in the federal civil service is a pension pig.

And some in the media are all aboard. Mark Sutcliffe of the Ottawa Citizen reports, Why Canada’s public pension format is patently unfair:

Imagine if you and I each put our money in the stock market on the same day. We might choose different companies or funds, but let’s say for the moment that we both picked relatively safe investments and were looking for long-term results.
Each of us might expect a reasonable return on our investment in 10 or 20 years. But — and I probably don’t have to remind you of this, given recent events — there would also be the risk that we’d lose some money.
Now, what if the market was structured in a way that if both our investments tanked, I was still guaranteed a reasonable return on mine but you were exposed to the loss? I still get my money, you get nothing. Would you consider that fair?
How about this: What if, in the event my investments didn’t grow at the rate I expected, the money to pay my guaranteed return came from none other than you? So, on top of taking a hit on your portfolio, you’d have to cough up the cash to cover the shortfall in mine?
Impossible terms, right? No one would ever agree to them.
Well, that’s basically the way things are structured if you’re saving for your retirement on your own and I have a public-sector pension. If the market doesn’t perform well, you take a hit and I don’t. Oh, and you also have to top up my fund.
Now that Finance Minister Jim Flaherty has hinted that there might be some tweaks coming to federal public service pensions, the plans are under intense scrutiny. Some columnists and taxpayers groups have pointed to many reasons why the plans are too rich, while unions have, naturally, rushed to their defence.
(Before the government does anything about its employees’ pensions, it will have to introduce dramatic reforms to the pensions of Parliamentarians, which are exceedingly generous. But since there are only a few hundred MPs, the total cost isn’t as significant as the pensions of public servants.)
To the unions, of course, no changes are required to public-sector compensation whatsoever. All the government has to do to balance its books is increase taxes on corporations. The math on that doesn’t actually work, but that’s of no concern to union bosses.
The union also argues the security of a pension is part of what it takes to attract an employee to a government job, that it’s a trade-off in return for a lower salary. But there’s lots of evidence that public-sector workers are actually paid more than equivalents in the private sector.
Some critics of government pensions point to the fact that pensions are based on the best five years of income, regardless of how much was contributed by employees in earlier years. Others raise the fact that the government contributes 60 per cent toward pensions while the workers contribute 40 per cent. Both these formulas could be adjusted, but even a different average income and a 50-50 contribution split wouldn’t fix what’s fundamentally wrong.
The central problem is this: the guaranteed, indexed, defined-benefit format is patently unfair. In a defined-benefit pension plan, if the market doesn’t perform, the shortfall has to be made up by someone. In the case of public-sector pension plans, that someone is the taxpayer.
So the private-sector worker whose RRSPs or employee pension value takes a hit when the markets drop is then given a second hit: he has to chip in to prop up the pension of a retired government worker, who has no such liability.
Canadians without pensions or with plans that are susceptible to market conditions are effectively the insurance policy for the public-sector plan. And, thanks to the performance of the markets recently, there’s a huge shortfall right now.
The government can’t take away the risk of market performance for every Canadian. Even if it did, we fund the government, so it would have to raise our taxes with one hand and top up our investments with the other. That’s the kind of investment scheme Bernie Madoff would design. Or maybe the government of Greece.
If the government can’t provide guaranteed retirement income for all Canadians, why should it give it only to some, at the expense of the others?
Across the private sector, and even in government agencies like Export Development Canada, where defined-benefit plans existed, they are being phased out in favour of defined-contribution pensions.
That’s the fundamental switch the government needs to take. They could phase in the changes for new government employees only. But the bottom line is this: the government shouldn’t expect taxpayers without pensions or with retirement savings tied to market risk to insure the plans of others who have no risk whatsoever. It’s incredibly unfair.

I had no idea that defined-benefit plans are being phased out at the Export Development Bank Canada (note to self, call Steve Poloz to check). But this article is so flimsy on so many grounds. I'm getting tired of pension ignoramuses like Mark Sutcliffe and others who write articles on pensions making grandiose statements that are patently false.

First, as I've explained many times, defined-benefit plans are much better than defined-contribution plans. All you have is to look at the surprising strength of Canada's public pension funds, lauded as the best in the world. Are they perfect? Hell no! But I'd much rather have our pension fortunes with them than some crappy mutual fund the banks and insurance companies are peddling in defined-contribution plans.

Importantly, large public pension funds pool resources, lower fees, bring activities internally and invest in the best public and private market funds in the world. They also engage in direct investments in private markets throughout the world, something which no mutual fund can compete with.

Are there abuses in public pensions and room for pension reforms? Yes, the most flagrant abuse is with MPs' pensions, which are guaranteed by public coffers, but there clearly has to be a public discussion on PS pensions. Employees fund these pensions but unions are going to have to realize that people are living longer and the economic reality is that unless these pensions are fully funded, they will not be sustainable.

Is the solution to phase out defined-benefit plans and introduce defined-contribution plans? This is the dumbest idea ever. It will only accelerate pension poverty and increase our public debt down the road. Did you get that? Moving to DC plans will ensure pension poverty for millions and increase our public debt down the road because society will be saddled with all sorts of medical and social costs.

In fact, Matthew Brett, a graduate student in political science at Concordia University, specializing in political economy, wrote an excellent op-ed column in the Montreal Gazette, Public pensions help sustain, not erode, economic stability:

In their Jan. 7 Opinion piece under the headline, "Courage is needed to tackle fartoo-generous pensions," Bill Tufts and Lee Fairbanks attack one of the last vestiges of social security by targeting public-sector pension funds in Montreal and elsewhere.
Tufts and Fairbanks are using the ongoing economic crisis to foster a climate of insecurity. They proclaim that there is a crisis in public-sector finances, and that public sector workers must therefore tighten their belts.
They say that Montreal Mayor Gérald Tremblay must be courageous and tackle public-sector pensions, which they claim are the root of the problem. They situate themselves as the guardians of the taxpayer.
Their logic is troubling. It is the excesses of capitalism that are to blame for our current economic predicament, not the excesses of labour. In fact, public workers and public financing ensured that nations weathered the crisis by sustaining economic output. Yet, now the public, not the banks and multinational corporations, is being asked to shoulder the burden.
Public-sector work really is the last bastion of "decent" work, providing employees reasonable wages and a level of job security. As the global crisis drags on, one would hope that we have learned from granting private interests too much power.
Public-sector provisions should be strengthened rather than eroded in order to ensure greater economic and social stability.
Further eroding public pensions during an economic downturn is an invitation to prolonging economic stagnation. A more sensible approach would entail sustaining public pensions as a means of ensuring reasonable consumption habits. Extending public-sector standards to the private sector is the best means of ensuring that the current crisis is not prolonged. It is also the best means of ensuring that future crises do not emerge.
But the debate over public pensions must extend beyond strictly economic concerns. As Tufts and Fairbanks themselves state, "pensions were created for a noble reason: to provide employees a reasonable level of income in their golden years."
People have a right to decent levels of security and well-being, plain and simple.
Moreover, this noble endeavour did not fall from the skies. Social security emerged after years of popular struggle by people concerned for their future and their communities.
Preserving and extending public pensions is a struggle worth fighting for. One can only hope that working people in the public and private sectors are up to the challenge.

This article prompted the following responses from these readers:

Re: “Public pensions help sustain, not erode, economic stability” (Opinion, Jan. 18)
Political-economy graduate student Matthew Brett recommends extending public-sector pension standards to the private sector as the best means of ensuring that the current crisis is not prolonged. He then totally avoids the obvious question – How will this be financed? – by stating “the debate over public pensions must extend beyond strictly economic concerns.”
The problem with public-sector pensions is that they are massively subsidized by taxpayers who invariably have vastly inferior pensions, if they have a pension at all.
Although I am not a political economist, and as much as I would appreciate a massively subsidized pension, I recognize that someone somewhere would have to pay for it.
Derek Wisdom
Anjou
Matthew Brett writes: “People have a right to decent levels of security and well-being, plain and simple” in his defence of public-sector pensions.
All people, or just a percentage of the workforce employed by federal, provincial and municipal governments and their agencies? We can’t reform a broken system by perpetuating a double standard. I refer readers to an excellent La Presse series on public-pension structures in Scandinavian countries.
A Canadian version would ensure every working Canadian his or her personal pension, administered by professionals at arm’s length from whichever government is in power. It would reduce the fiscal burden on small and medium business owners, while encouraging people to remain with their employers, rather than hopscotching among jobs with regular landings on EI.
Structured properly to include registered retirement and tax-free savings plans, it would help clean up predatory financial-planning practices.
Rather than arguing in favour of an outmoded system that favours a minority, we need to find the political courage to pioneer a better way for everyone.
Jim Duff

That first comment is wrong, public pensions are not "massively subsidized" by taxpayers. Public sector workers pay for their pensions and pension funds invest their retirement savings to fund their pensions. The second comment is excellent and bang on.

Let me end my comment with some personal reflections. Are there abuses in the Canadian public pension system? You bet there are, and there needs to be reforms, including reforms on MPs' pensions, retirement age, city and university pension plans, and even reforms on how we compensate public pension fund managers.

But I simply do not buy the argument that the cure-all to our pension woes is to phase out defined-benefit plans and replace them with "cheaper" defined-contribution plans. You get what you pay for, and in the case of defined-contribution plans, all you'll get is pension poverty.

All Canadians deserve a secure retirement. Maybe not as lavish as the one our MPs get, but they deserve the same peace of mind as public sector workers. It's not an impossible goal and if we do it right by building on our large public defined-benefit plans and creating new ones which are funded properly, managed by professionals and governed by independent investment boards, we will not only mitigate pension poverty, we will increase economic productivity and reduce our debt. Supplemental CPP is a step in the right direction, but it's not enough.

Years ago, Canada introduced a universal health care system. It's far from perfect but it allows all Canadians access to quality health care. I think it's time we introduce universal pensions with requisite pension portability so workers can rest assured that no matter where they go work, their pensions are always going to be managed by professional pension fund managers. It's time we stop demonizing the public sector and start thinking how we can improve our retirement system for all Canadians.

Below, Making Medicare: The History of Health Care in Canada, 1914--2007 is a new online exhibition produced by the Canadian Museum of Civilization. It offers a thorough, reliable and engaging account of the birth and development of Canada's publicly-funded health care system. It is an essential resource for anyone interested in Medicare's past, present and future in Canada.

Hedge Funds Going to Sue Greece?

2012-01-19T15:47:00.015-05:00

Ekathimerini reports, Hedge funds considering legal action over Greek deal:

Hedge funds that hold Greek bonds and who are reluctant to voluntarily agree to the haircut being negotiated between Greece and private investors could appeal to the European Court of Human Rights, the New York Times has reported.
The newspaper reports that the funds would claim that their bondholder rights are being violated but this would be a lengthy project and there would be no guarantee of a payoff at the end.
“The tactic has emerged in conversations with lawyers and hedge funds as it became clear that Greece was considering passing legislation to force all private bondholders to take losses, while exempting the European Central Bank, which is the largest institutional holder of Greek bonds with 50 billion euros or so,” writes Landon Thomas Junior of the NYT.
“Legal experts suggest that the investors may have a case because if Greece changes the terms of its bonds so that investors receive less than they are owed, that could be viewed as a property rights violation — and in Europe, property rights are human rights,” adds the journalist.
The hedge funds stand to make more money if a default occurs. But they stand to gain something even without a default because of the credit protection they have purchased.
Credit Default Swaps, agreements that allow bondholders to collect the original value of a defaulted bond, were supposed to make holding Greek debt safer. But the prospect of the voluntary swap has rendered some of the contracts worthless, leaving investors out the initial fee they paid to purchase the agreements.
Investors holding CDS were supposed to be able to win in the Greek play no matter how it ends. Either they collect high interest rates from the Greek government, or -- if the government cannot repay the debt and has to default -- they collect the par value of the bonds they bought cheaply during the euro zone debt crisis.
The cost of buying CDS on debt issued by Greece and other European countries has risen steadily since the crisis began. That means investors who bought Greek debt lately had to pay dearly to hedge their exposure.
Since the debt swap is voluntary, it will not be considered a default. There will also be far less of a return on the bonds being swapped out, since the point of the swap is to dramatically lessen the debt burden on the Greek government.

MPs' Snouts in the Pension Trough?

2012-01-19T12:20:00.023-05:00

CTV reports, Pension plan for MPs faces $1 billion shortfall:

A report from a prominent think tank says Canada's parliamentarians are facing even graver pension woes than the rest of the country.
The C.D. Howe Institute says the pension plan that secures retirement benefits for members of parliament and senators is underfunded by up to $1 billion.

The report says the plan provides MP's with more than 50 per cent of their six-figure salary, but has no assets set aside to pay for those future benefits.

The Institute says the funding shortfall is at odds with actuarial reports on the plan, which say it has an excess of $176 million.

The institute says the deficit could expose taxpayers to greater financial risks if the pension plan ultimately fails.

It suggests the Federal government should address the problem by raising MP's current wages in exchange for lower retirement benefits.

"When the time comes to pay cash to retiring MPs, Ottawa has to raise it at that time -- by taxing more, spending less elsewhere, or borrowing," the institute said in its report.

Such a fix, the report said, would allow MP's to set retirement funds aside in registered plans without delving as deeply into the public purse.

The institute's plea for reform echoed a similar call issued Wednesday by the Canadian Taxpayers Federation, which exhorted MP's to surrender their pension plan and adopt a more modest system.

The federation contends the existing plan is the best-funded in the world, but lamented that taxpayers foot the bill for most of its perks at a rate of $23.3 for every dollar contributed by an MP.

The federation called on MPs to set up a new program in which government matches their payments on a dollar-for-dollar basis.

"There's no way the prime minister and these MPs can do what they need to do to balance the budget and control spending if they've got their own snouts in the pension trough," federation federal director Gregory Thomas said. "They need to lead by example. They need to put Canada ahead of their own personal bank balance."

You can read the C.D. Howe Institute's report here. The Canadian Taxpayers Federation wasted no time lambasting MP pension 'rip off':

The Canadian Taxpayers Federation says it's high time MPs stopped making Canadians pick up the tab for their "gold-plated" pension plan.
"This is a ripoff on a massive scale," the advocacy group's federal director, Gregory Thomas, said at a news conference on Parliament Hill Wednesday announcing its report on parliamentarians' pensions.
The federation says that while officially taxpayers contribute $5.80 for every dollar an MP contributes to his or her pension, that figure does not include "disguised 'interest' and accounting fiction." Its calculations say taxpayers are actually on the hook for $23.30 for every dollar an MP contributes.
While MPs earn a base salary of $157,731 per year, the total contributions to the parliamentary pension fund amounts to $248,668 per year, Thomas said.
MPs are eligible to collect full pension benefits when they are 55, if they sit in Parliament for six years or longer. If all current MPs collected their pensions, Thomas said, the total lifetime payout would amount to some $277 million.
Thomas said the MP pension fund does not invest in the market like the Canada Pension Plan or RRSPs, but instead just dips into public coffers each quarter.
"The government simply passed a decree paying interest to the MP pension fund, and at a staggering rate," he said. "This outrageous rate means they have basically the best performing pension over 10 years on the planet."
Insulated from market forces, Thomas said, the MP pension fund has done 60 per cent better than the Canadian Pension Plan over the past 10 years. "The 'return' on this fund is set by cabinet," Thomas said. "But it's a phoney return on an imaginary investment."
Treasury Board President Tony Clement said he is examining the issue of MP pensions as part of the larger government-wide spending review. He said the government's first step was to freeze MP salaries, but that this will not be the last.
"I've been tasked to come back with some options on MP and public service pensions, and I will be doing so," he told CBC News. "These options are on the table."
Clement said no decisions have been made, but alluded there would be some announcement on MP pensions in the next budget.
The Opposition says Parliament has better things to do than tinkering with MPs' pensions.
"We've got a lot more important things to be doing," said NDP MP Joe Comartin. "There are just too many other things that need to be addressed in the pension field specifically."
Comartin said the government is beating the MP pension drum to distract the public from its lack of action on pensions that directly affect Canadians.
"This is really a smokescreen for the government not to act on the other ones, such as reforms to the Canada Pension Plan," as well as looking after Old Age Security and the Guaranteed Income Supplement, he said.
Liberal MP Rodger Cuzner said Canadians should be wary of the federation, which he described as a "branch office of the Conservatives" and "so deeply entrenched in (the) digestive tract of Tories that it's embarrassing."
He noted that senior Tories, such as Immigration Minister Jason Kenney, and others got their start in politics at the federation.
Cuzner said it's strange the group launched a full-scale attack on parliamentary pensions, but stayed silent on accountability issues such as G20 spending or the untendered F-35 stealth fighters contract.
"Obviously, this is something to shift the attention of Canadian taxpayers," he said. "To trot out the old faithful pension plan, it seems to be just the thing to do by these guys."
Opposition MPs said it was the government's job to make proposals on how to fix MP pensions, if they need fixing at all.
"As our leader, Bob Rae, said back in November, we're happy to look at any proposal the government brings forward," said Liberal MP John McCallum. "MPs should set an example during a time of austerity."
Comartin said if the issue is to be examined, the government should appoint an independent commission to adjudicate the issue.
"If there is going to be a review of the MPs' pensions, it has to be done by an independent commission, as it has been the last two times," said Comartin. "It takes partisan politics out of it."
Finance Minister Jim Flaherty said Canadians expect their politicians to be reasonable in how they fund their pension plan.
"Pension remuneration for people in the public service, and public service in Canada ought to be — including members of Parliament, including senators, including everybody in public life, including provincial politicians, including mayors, including councillors — ought to be reasonable, and the test of reasonableness requires a review of these types of systems," he said.
"People of Canada expect us to be reasonable in the pension compensation and the other compensation that is received for benefits and for salaries as well."

Damn right Canadians expect our elected officials to be reasonable in pension compensation, and the same goes for compensation being doled out to senior Canadian public pension fund managers.

The thing that strikes me is that the MP pension fund does not invest in the market like the Canada Pension Plan or RRSPs, but instead just dips into public coffers each quarter. Excuse moi? The MP pension fund is not managed by CPPIB or PSPIB? Worse still, it is funded by dipping into public coffers? Talk about no alignment of interests!

The NDP, Liberals and Conservatives are all in the same boat. I am all for giving MPs a decent salary and good pension but this is ridiculous. And yes, the Conservatives need to reform MP pensions but they should also revisit those silly PRPPs they're banking on. Total nonsense.

I'm warning all Canadian politicians -- federal, provincial, municipal -- we have a looming pensions crisis in this country that needs to be seriously addressed. And when the Canadian housing bubble bursts, it will get worse. Wake up already an stop living in dreamland!

The same goes in the US where Bloomberg reports, Congress’s Six-Figure Benefits Add to $674 Billion Pension Gap:

Almost 15,000 federal retirees, including former leaders of Congress, a university president and a banker, are receiving six-figure pensions from a system that faces a $674.2 billion shortfall.
About one of every 125 retired federal civilian workers collects more than $100,000 in benefits annually. They include physicians, postal workers and presidential candidate Newt Gingrich, according to data obtained by Bloomberg News under the federal Freedom of Information Act.

“We don’t want to bash federal employees,” said Jim Kessler, vice president for policy at Third Way, a Washington- based research organization. “Still, when you have today’s economy, public sector jobs look better and better. And there are some pensions that make you question the system as a whole.”

About half of all private-sector workers have no retirement plan other than Social Security, according to figures from the Employee Benefit Research Institute, a Washington-based nonprofit that studies pensions. About 16 percent are in plans similar to the federal system, which guarantees payouts based on workers’ earnings. Some private employers offer so-called defined-contribution plans, including 401(k) plans, in which benefits depend on employees’ contributions and how they’re invested.

The federal retirement system has emerged as a cost-cutting target as the government faces a budget deficit exceeding $1 trillion. A 2010 Congressional Research Service study reported that U.S. government pension programs had a shortfall of $674.2 billion, mostly due to insufficient funding for workers hired before 1984.

Employee Contribution

The U.S. Treasury pays about $4.9 billion every month for about 1.8 million retirees, an average of $31,633 annually. Federal employees contribute $1 of every $14 toward retirement, according to the National Commission on Fiscal Responsibility and Reform, a bipartisan panel created by President Barack Obama.

Public employees at the state and local levels already have faced moves to cut future benefits, as officials seek to address a cumulative pension gap that exceeds $4 trillion. Dallas Salisbury, president of the benefits institute, said in an interview that federal pensions might be “richer than we can now afford. Something’s going to have to give.”

The number of current federal employees eligible to retire and collect a pension will grow to 956,613 by the end of the 2016 budget year, a 35 percent increase from the 707,750 who could have retired at the end of September, according to a 2008 study by the Office of Personnel Management.

Roughly 27 Years

Retirees in the database that OPM released to Bloomberg News had careers that lasted an average of roughly 27 years. The database is dated Sept. 29, 2011, and doesn’t contain the names of employees’ survivors who receive benefits. The Congressional Budget Office said in a report last March that in 2010, the U.S. government paid $69 billion to 2.5 million civilian retirees and their survivors, and $51 billion to 2.2 million military retirees and their survivors.

Retired physicians and politicians ranked among those collecting the largest benefits. The chance of getting a six- figure pension was best at the Securities and Exchange Commission, where 9.3 percent of retirees collect at least $100,000 annually.

Irving K. Jordan Jr., former president of Gallaudet University in Washington, led the list at $375,900. Gallaudet gets about $120 million federal funding each year. Jordan didn’t return a request for comment left with the university president’s office.

Right Time

Maxey D. Love Jr., of Columbia, South Carolina, is second on the list at $322,272 a year. For years, he was president of a farm credit bank he first joined as a college student, he said. His salary eventually topped $300,000 a year.

“I’m a fortunate person to have been at the right place at the right time,” said Love, 78. Shortly after he was hired, the chance for workers at farm credit banks to stay in the federal pension system ended, he said.

Because of cost of living adjustments, at least 48,500 retirees are making more now than they did on the federal payroll. For example, former U.S. Representative Robert Michel, 88, a Republican from Illinois, is collecting $211,452, fourth on the list and more than any other employee of the congressional branch. The average of his three highest annual salaries was $146,875. He retired in 1994 as House minority leader with 49 years of federal service and is now a senior adviser in Washington to Hogan Lovells, a law firm.

“Oh, for heaven’s sake,” Michel said in an interview when told of his ranking. “I didn’t realize it was up there.”

Lawmakers’ Pensions

Former lawmakers, including some who have become lobbyists or strategic consultants, also received six-figure pensions, according to the OPM database. They include former House Majority Leader Richard Gephardt ($106,512 for 28 years of work as a Missouri Democratic congressman); Senate Majority Leader Tom Daschle ($105,804 for 33 years as a South Dakota Democratic lawmaker); Senate Majority Leader Bob Dole ($144,432 for 40 years as a Kansas Republican lawmaker); and Senate Majority Leader Trent Lott ($110,352 after 39 years as a Republican lawmaker from Mississippi). Calls to the offices of Gephardt, Daschle, Dole and Lott weren’t returned.

Edward J. Derwinski had the highest pension of any former cabinet official, collecting $193,368 annually after more than 36 years of federal work that included 24 years as an Illinois congressman before he became the first secretary of the Department of Veterans Affairs. Derwinski, 85, died Sunday.

Former Vice President

The list of former federal employees collecting more than six figures also includes former Vice President Dick Cheney ($125,976 for 28 years of work, including as a Wyoming congressman, White House chief of staff, and defense secretary). Cheney didn’t respond to a message requesting comment.

Gingrich, the former House speaker, receives a pension of $100,200 after 20 years in Congress, according to the data. He has argued as a Republican presidential candidate that government employees ought to shoulder more of the burden for planning their retirements. His campaign spokesman, R.C. Hammond, didn’t respond to a request for comment.

The federal retirement system changed in 1986 to bring federal workers hired after 1984 into the Social Security system and make other changes, including offering a thrift savings plan that resembles a 401(k). The earliest a federal worker can retire with a full pension is at 55, with 30 years of service.

Three Highest Years

The amount of a federal retiree’s pensions is generally based on his or her three highest-paying years; the commission on fiscal responsibility has recommended switching that to five years as part of a plan to trim benefit costs by as much as $70 billion over 10 years.

“The average American would probably be delighted to trade plans,” said Joshua D. Rauh, a finance professor at Northwestern University’s Kellogg School.

The federal pension shortfall is reflected in other levels of government, such as the California Public Employees’ Retirement System (Calpers), the nation’s largest. Calpers pays 536,234 retired state workers an average annual pension of $27,984. California employees contribute between 5 and 11 percent of their salary to retirement.

Like the federal program, California pensions are based on the top three highest-paying years. State employees with more than 25 years of service may base their pension on the single highest year of pay. The California fund currently faces a $51.2 billion shortfall.

“Retirees and employees are going to take some kind of hit,” Dave Snell, head of the National Active and Retired Federal Employees Association’s retirement benefits service department, said in a telephone interview. “Congress is honing its blade.”

Wow, no wonder the Treasury is dipping into federal pensions to avoid debt, it's a goddamn cash cow! Here you have millions of Americans struggling to find work and some of these retired politicians are collecting outrageous pensions, more than what they were making while in office. It's precisely this stuff that outrages hard working citizens. Pension reforms in Canada and the US can't come soon enough, but be careful, don't throw the baby out with the bathwater.

Below, Global News reports on MPs' pensions and CTV Morning Live's Kurt Stoodley talks with Gregory Thomas of the Canadian Taxpayers Federation. Mr. Thomas' comments on the Chief Actuary of Canada's proposal on MP pensions are priceless.

After reading all this, I feel like a fool for not running for office in Quebec, missing the opportunity to work alongside newcomer Ruth Ellen Brosseau. She has the cutest 'snout' I've ever seen on any Canadian MP. -:)

Caisse, CPPIB Still Buying Brazil's Boom?

2012-01-19T08:40:00.022-05:00

Ben Dummett of the WSJ reports, Canadian Pension Funds Bulk Up Real Estate Holdings In Brazil:

Two of Canada's biggest pension funds said Wednesday they acquired a combined 49% stake in a shopping center in Rio de Janeiro for C$80 million, further bulking up their real estate holdings in Brazil.
Ivanhoe Cambridge, the real estate arm of Caisse de depot et placement du Quebec, and Toronto-based CPP Investment Board acquired the stake in Botafogo Praia Shopping center from Brookfield Brasil Shopping Centers, an arm of Brookfield Asset Management (BAM), an asset manager based in Toronto. They are each paying C$40 million towards the total price and as a result of the transaction, Invanhoe Cambridge and its Brazilian affiliate Ancar Ivanhoe Shopping Centers increased their position to 75.5% from 51%. CPP now owns a 24.5% stake in the shopping center.

Canadian pension funds have been active buyers of real estate holdings globally, attracted to the steady income these assets can generate to help them meet their payout obligations.

The Brazilian market is particularly attractive because of the relative strength of the country's economy, the resulting growing middle class and an under supply of high-quality institutional real estate, CPP says.

"Its fits very well" with the fund's objective of identifying real estate markets that "we think can outperform over...10-20 years," said Peter Ballon, CPP's head of real estate investments for the Americas.

The 166,824-square-foot Botafogo Praia Shopping center, located along Botafogo Beach in Rio, is comprised of 138 stores that benefit from the plaza's prime location and close promixity to public transit, the pension funds said.

The transaction is Ivanhoe Cambridge's first joint acquisition with CPP, but Ivanhoe Cambridge is already well established in the Brazilian market. With the latest deal, Ivanhoe Cambridge now owns 10 shopping centers across Brazil. Ivanhoe Cambridge's parent Caisse de depot oversees about C$151.7 billion in assets.

CPP, which has about C$152.3 billion under management, owns three retail properties, two office developments and eight industrial projects in Brazil.

In Brazil, CPP currently favors retail real estate because of the growing middle class. That group is expected to increase by an estimated 30 million over the next few years, or by the equivalent of Canada's population, Ballon noted.

CPP also likes the industrial real estate market in Brazil because of a shortage of buildings with the height, loading dock and heating requirements that international tenants and an increasing number of domestic tenants seek, he said.

Now we know who Michael Sabia was referring to when he said Canadian pension funds need to do more 'club deals'. However, as noted by the Montreal Gazette, Ivanhoe, through a Brazilian affiliate, already owned control of the center, so the Caisse’s interest is now 75.5 per cent and CPPIB’s 24.5 per cent.

Claude Sirois, senior vice-president of emerging markets for Ivanhoe Cambridge, said “the Brazilian retail sector is a strong focus for us and the latest deal confirms our long-term relationship with our affiliate Ancar Ivanhoe, with whom we now own 10 shopping centers across Brazil.”

Does it make sense to still invest in Brazil? There is no question the fundamentals are strong. In December, BBC reported that according to the Centre for Economics and Business Research (CEBR), Brazilian economy overtakes UK's:

The Centre for Economics and Business Research (CEBR) said its latest World Economic League Table showed Asian countries moving up and European countries falling back.

The CEBR also predicted that the UK economy would overtake France by 2016.

It also said the eurozone economy would shrink 0.6% in 2012 "if the euro problem is solved", or 2% if it is not.

CEBR chief executive Douglas McWilliams told BBC Radio 4's Today programme that Brazil overtaking the UK was part of a growing trend.

"I think it's part of the big economic change, where not only are we seeing a shift from the west to the east, but we're also seeing that countries that produce vital commodities - food and energy and things like that - are doing very well and they're gradually climbing up the economic league table," he said.
A report based on International Monetary Fund data published earlier this year also said the Brazilian economy would overtake the UK in 2011.

Brazil has a population of about 200 million, more than three times the population of the UK.

Brazil's economy grew by 7.5% last year, but the government has cut its growth forecast for 2011 to 3.5% after the economy ground to a halt in the third quarter, with analysts blaming the country's high interest rates and the worsening situation in the eurozone.

And although Brazil currently sells more to China than it imports, Brazilian manufacturers have complained that their industries are being affected by cheap mass-produced goods from the Asian giant.

The CEBR also said that Russia moved up one spot in its league table to ninth in 2011, and predicted that it would rise to fourth spot by 2020.

It predicted that India, the world's 10th biggest economy in 2011, would become the fifth largest by 2020.

And it said European countries would drop down the table, with Germany falling from fourth in 2011 to seventh in 2020, the UK from seventh to eighth, and France from fifth to ninth.

It is worth noting that CPPIB is betting big on India too as part of its Asia strategy. As for Brazil, there is no question that it's an emerging market powerhouse, but one that has its own growth challenges, including public sector pension woes:

The deficit in Brazil's publicly-administered social security system should remain stable in 2012 after narrowing last year, but deficits in a separate system for public employees could balloon out of control unless reforms pass congress, the country's social security minister said Wednesday.
Brazil's social security ministry reported the deficit in the country's general program for non-government workers narrowed to 36.5 billion Brazilian reais ($20.5 billion) in 2011 from an inflation-adjusted BRL47.1 billion in 2010. The 2011 result was equivalent to 0.9% of gross domestic product, and was the best performance on record since 2002, when the country posted a deficit of only BRL30 billion.

At the same time, however, the deficit for the special system serving public employees widened to BRL56 billion from BRL51 billion in 2010. The ministry estimated that the deficit in the country's separate system for public workers will widen by an average of 10% per year, surpassing BRL61 billion in 2012 alone, if congress doesn't pass a reform bill currently under consideration.

"The country needs to create an awareness that the social security system can't continue in this manner," said Social Security Minister Garibaldi Alves after the release of the latest data.

Alves said the deficit in the general system covering non-government workers would likely remain stable in 2012 at its current level, as increased benefits related to a 14% hike in the country's minimum wage are offset by expected increases in revenues from a growing economy. Brazil's government is forecasting 2012 economic growth in a range of 4% to 5%, up from estimated 2011 growth of 3.2%.

Garibaldi said the proposed reform bill, which has been approved in a Chamber of Deputies committee, could see a vote on the floor of the lower house as early as March.

The bill under consideration would transfer all public workers contributions linked to salaries above BRL3,691 per month to a specially administered complementary pension fund, reducing some of the government's burden under a current pay-as-you-go system that is fully financed by public sector revenues.

Brazil's social security deficit has been a key contributor to the country's public sector nominal budget deficit, which stood at BRL98 billion, or 2.4% of gross domestic product, through the 12 months ending in November.

Brazil's central bank is scheduled to release 2011 public sector deficit and debt figures at the end of the month.

And it is worth noting that Brazil's fortunes are inextricably linked to China and some worry that its banks will suffer from eurozone contagion. Also worth noting is what Leo de Bever, President and CEO at AIMCo, said about Latin America in a recent Reuters article:

In emerging markets, said De Bever, deals are bubbling to the surface as struggling European banks back away from non-core projects.

He is now less keen, though, on Latin America, where AimCo struck a couple of big deals in the last couple of years, in power lines and toll highways.

Of course, along with other Canadian public pension funds, AIMCo invests in emerging markets, including direct investments in Brazil and Columbia, but as Brian Gibson, Senior VP, Public Equities at AIMCo, wrote in his white paper, investing in emerging markets "isn't what is used to be."

Some of my other contacts investing in Argentina's wineries are also less enthusiastic on Brazil, worried that it is another bubble ready to burst. Investors need to be careful. There is no question that Brazil's economy is now marching to the samba beat, but there will be setbacks along the way and inequality remains a deep structural issue plaguing all emerging markets.

Below, Al Jazeera's Gabriel Elizondo reports on Brazil's economy. I also embedded a couple of reports exploring the Brazil-China connection. Finally, take the time to watch this BBC Newsnight report exploring whether Brazil's economic boom can last. It is fascinating, well worth watching, and you'll learn a lot about Brazil's booming economy and the challenges of poor infrastructure, bureaucracy, corruption, and restrictive labor laws.

Treasury Dipping Into Pension Funds?

2012-01-18T12:23:00.010-05:00

Reuters reports, Treasury dips into pension funds to avoid debt:

The Treasury on Tuesday started dipping into federal pension funds in order to give the Obama administration more credit to pay government bills.

"I will be unable to invest fully" the federal employees retirement system fund beginning Tuesday, Treasury Secretary Timothy Geithner said in a letter to Democratic and Republican leaders in Congress.
The House of Representatives is expected to vote on Wednesday on the Obama administration's request to raise the country's legal debt limit to $16.394 trillion.
However, unless the lower chamber and the Senate are able to shore up enough votes to block the White House request, the debt limit will be increased by $1.2 trillion next Friday and a repeat of last year's debt ceiling debacle will be averted.
Geithner said Treasury started suspending reinvestments in a federal pension fund known as the G-Fund -- a tool Treasury has had to employ six times over the past 20 years in order to keep the country below the statutory debt limit.
The Treasury Department has already tapped another seldom-used fund in order to allow the government to continue borrowing without running afoul of the country's laws.

Great, just what the tea party and other right-wing groups need to hear to stoke conspiracy theories that Uncle Sam is plotting to "steal" their retirement savings to pay off debt.

It amazes me watching the debates over debt, taxes and employment in the US. What really irks me is that most people are economic ignoramuses who have never taken a course in economics and simply do not understand that the US has an unemployment crisis, not a debt crisis.

If you throw it their face, they label you as a "Keynesian clown," but the case of Greece proves my point that austerity without growth is a recipe for disaster. And it's counterproductive; it exacerbates the debt crisis. True, Greeks are raising taxes on the poor and working poor, making things worse, but they need to shore up government revenues.

In the US, David Cay Johnston wrote a comment for Reuters, Honey, they shrunk the IRS:

Congress will spend a trillion dollars more than it levies this year, so how do Washington’s politicians respond to the 11th consecutive year of federal budgets in red ink? They plan to shrink the IRS.

Go figure. Cutting the IRS budget by more than 5 percent in real terms makes as much sense as a hospital firing surgeons or a car dealer laying off salespeople when customers fill the showroom.

Shrinking the IRS makes sense if you believe government is too big and that cutting everywhere is the best way to shrink government. But this is the staff that generates revenue, and there is easy money to be made.

Congress should listen to the national taxpayer advocate, a position it created to make sure taxpayers had a voice in how the IRS operates. In her annual report, released last week, advocate Nina Olson said Congress needed to “ensure that the IRS continues to be effective, either by reducing the IRS’ workload or by providing adequate funding to enable it to accomplish its assigned mission.”

Instead of cutting, we should be expanding the revenue-generating staff because there is plenty of tax money to be had, even in this awful economy.

IRS data show that auditors assigned to the 14,000 or so largest corporations found $9,354 of additional tax owed for every hour spent testing tax returns in the 2009 fiscal year. The highest-paid IRS auditors make $71 an hour. Based on a 2,080-hour work year, that works out to around $19 million of lost revenue annually for every senior corporate auditor position cut from the payroll.

WHY CUT?

It makes no economic sense to trim the ranks of auditors who generate more than a hundred times their annual salaries. Run a business that way and you go broke.

So why would President Barack Obama and Congress cut the IRS budget? Their actions illuminate the rise of corporate power and values, and the diminishing voice of Joe Sixpack, thanks partly to how we finance election campaigns. Then there is the growing army of corporate lobbyists and the Supreme Court’s decision in Citizens United, which allows corporations (and unions) to spend all they can afford on influencing elections.

Keep in mind the IRS costs just a half penny for each dollar of tax collected. Its proposed $11.8 billion budget would be less than the Agriculture Department spends each month.

If the IRS budget is cut, the losers will be workers and ordinary investors, who will find it harder to get their questions answered and their problems resolved by the agency. On the whole, these people do not cheat on their taxes because their incomes are easily checked — through reports by employers, mortgage banks and others. Under a law taking effect in stages between last year and next, brokerages must report the cost basis of securities. This change will reduce capital gains cheating.

TAX CHEATS

The winners will be tax cheats among sole proprietors and other business owners, who are subject to less verification. The latest IRS tax gap report, issued Jan. 6, estimates that just one percent of wages escapes tax, while 56 percent of “amounts subject to little or no” verification do so.

America’s biggest corporations, those with more than $250 million in assets, also may escape some tax if the IRS budget is cut. These nearly 14,000 companies pay about 86 percent of corporate income taxes.

Audits of these big firms were down even without a budget cut. And audits have become far more complicated, partly because Congress changed the tax code more than once a day on average from 2001 through 2010, Olson reported.

From 2005 to 2009, hours spent auditing the biggest corporations declined by 33 percent, according to IRS records analyzed by the Transactional Records Access Clearinghouse at Syracuse University in New York.

Two decades ago, when the economy was a third smaller, the IRS staff numbered about 118,000. Now it numbers 95,000 and is on the way to about 90,000. The likelihood of a big company being audited has plummeted 50 percentage points from 72 percent in 1990 to 22 percent in 2010.

Big company audits are now limited to specific issues known to the companies in advance, not unlike when cops tip off owners of favored gambling dens before a raid. Each audit also begins with an “estimated time to completion.” Working auditors tell me this is really a hard deadline that allows companies to run out the clock with delays in producing documents.

Some IRS tax detectives privately ridicule this system, calling it “audit lite.”

Whether you like the corporate income tax or think it is an abomination, failing to enforce it with the same rigor as taxes on wage earners and most investors is indefensible on economic, budget deficit and moral grounds.

IRS budget cuts worsen budget deficits and send a corrosive signal that only chumps file honest tax returns. So you have a choice. Do nothing and suffer the consequences or call your congressman, senators and the White House — today — and then vote in politicians who support, rather than undermine, tax law enforcement.

So there you have it, the US government is dipping into pension funds and cutting the budget at the IRS. Brilliant, absolutely brilliant!

It's high time the US gets serious on taxes. Everyone on Capitol Hill needs a course on taxation. Below, PBS Newshour economics correspondent Paul Solman explores the question of just how high US tax rates should or shouldn't be and examines the relationship between economic activity and tax rates. Listen carefully to David Cay Johnston and Nobel laureate Peter Diamond.

Canada's Housing Bubble About to Burst?

2012-01-18T08:11:00.004-05:00

Doug Alexander and Sean B. Pasternak of Bloomberg BusinessWeek report, Canada Bubble Seen as IMF Risk With Record Low Rates:

Kevin Lau, a Toronto-based technology consultant, says he can’t wait to take advantage of the lowest mortgage rates in Canadian history to buy a second condominium and rent his current home.
Lau, 28, plans to get another mortgage and refinance his C$160,000 ($157,000) home loan after Bank of Montreal, Toronto- Dominion Bank and Royal Bank of Canada cut borrowing costs last week.

“It’s always tempting when the credit is available at much lower rates than they ever have been,” Lau said. “The fact that house prices have been going up and continue to go up much faster, you need to really take advantage of it.”

Banks are competing to offer mortgages at rates as low as 2.99 percent as their funding costs drop on investor demand for the relative safety of Canadian bonds amid Europe’s fiscal crisis. That’s fueling real estate purchases, potentially inflating a housing bubble and adding to record household debt, which the International Monetary Fund says poses a risk to the nation’s economy.

“It could increase the housing bubble,” said Sheryl King, head of Canadian economics at Bank of America Corp., who estimates the country’s housing prices are overvalued by about 10 percent. “The lower interest rates are, the more speculative demand you will have in the market.”

Credit easing by central banks and commercial lenders around the world is sparking a household debt surge in haven countries such as Canada and Norway, which escaped the last housing crisis by steering clear of subprime mortgages that escalated the U.S. slump.

Bank of Canada Rate

The Bank of Canada today kept its benchmark lending rate at 1 percent, extending a record period of unchanged rates to counter economic risks posed by Europe. The central bank will probably maintain the key overnight rate at 1 percent until the first quarter of 2013, according to forecasts from economists compiled by Bloomberg.

At the same time, record-low bond yields have prompted the country’s commercial lenders to drop mortgage rates to entice borrowers ahead of the spring home-buying season. Canadian bonds have rallied as investors are drawn to the country’s AAA rated debt after France, Spain and other European nations were downgraded by Standard & Poor’s.

Bank of Montreal, Canada’s fourth-biggest bank, dropped the rate for a five-year fixed-rate mortgage by 50 basis points, or 0.5 percentage points, to 2.99 percent on Jan. 12, the lowest in its 195-year history. Toronto-Dominion and Royal Bank, Canada’s two-biggest lenders, followed suit the next day with the same rate on a fixed four-year loan. Canadian Imperial Bank of Commerce, the fifth-biggest bank, matched the offers yesterday, as did Bank of Nova Scotia today.

Market Correction

“This type of pricing obviously makes headlines, so you’re starting to see other lenders now jockeying for position,” Rob McLister, a mortgage broker who runs the Canadian Mortgage Trends website from West Vancouver.

The heads of Bank of Montreal and Royal Bank warned as recently as last week that housing markets in Toronto and Vancouver are at risk of a correction, particularly for condominiums.

“Investor-owned condo properties have got to be a cause for concern, just because of supply and demand,” Bank of Montreal Chief Executive Officer William Downe said Jan. 10 at a banking conference in Toronto. Royal Bank CEO Gordon Nixon said “there’s no question” that the condo markets in Vancouver and Toronto are the most vulnerable in the country.

Price Gains

Canadian home sales last year increased 9.5 percent to C$166 billion, the Canadian Real Estate Association said yesterday, as home prices rose 7.2 percent. Toronto-Dominion Bank estimated in a Dec. 22 report the average Canadian home is overvalued by about 10 percent.

The average resale price rose 0.9 percent in December from a year earlier to C$347,801, the smallest monthly increase since October 2010, the real estate group said.

Other reports last week showed strength in the housing market, with new home construction increasing 7.9 percent in December and residential building permits rising 6.9 percent in November.

Canadian home prices fell by 8.5 percent between August 2008 and April 2009, but have since increased by 22 percent, according to the Teranet Home Price Index. By comparison, U.S. home prices fell by 33 percent between July 2006 and March 2011, and have since increased by 1.9 percent, according to the S&P/Case-Shiller Composite-20 Home Price Index.

Plunging Rates

Mortgage rates have also plunged in the U.S., with the average rate for a 30-year fixed loan dropping to 3.89 percent last week, the lowest in records dating to 1971, Freddie Mac said in a statement.

“While the expectation is that housing will stay strong, it could slip out of control if the Canadian economy’s growth falters due to a new U.S. recession,” said Scott MacDonald, head of research for MC Asset Management Holdings LLC in Stamford, Connecticut.

Canadian household debt rose to a record 153 percent of disposable income in the third quarter of 2011 as borrowing increased, Statistics Canada said Dec. 13. That contrasts with 146 percent in the U.S., and a projected 204 percent this year for Norway.

Norway, whose oil wealth is attracting investors to its government bonds, may suffer a collapse in its housing market that would be “dangerous” to the economy, Robert Shiller, the co-creator of the S&P/Case-Shiller home-price index said Jan. 12 in an interview in Copenhagen.

“It looks like a bubble to me, so the collapse of that bubble, that’s dangerous to any economy,” said Shiller, who is also an economics professor at Yale University.

Economic Risk

The Bank of Canada said last month that consumer debt is the main domestic risk to financial stability, predicting the burden will keep setting records as income growth lags behind borrowing.

Finance Minister Jim Flaherty tightened lending rules a year ago, shortening the maximum amortization period for government-insured mortgages to 30 years from 35 years, and lowering the maximum amount homeowners can borrow against the value of their homes.

He may be forced to take additional steps to ensure banks don’t bloat household debts that are threatening the recovery, said King at Bank of America.

“If we are in a competitive environment like this, rates are going to continue to go lower,” King said in a telephone interview from Toronto. “There is no other way to control it other than more regulation of the mortgage market.”

IMF Report

The IMF agrees, saying Canadian authorities may need to take more measures to rein in household debt, which along with high house prices pose a risk to the nation’s economy.

“Adverse macroeconomic shocks, such as a faltering global environment and declining commodity prices, could result in significant job losses, tighter lending standards, and declines in house prices, triggering a protracted period of weak private consumption as households reduce their debt,” IMF staff wrote in the annual assessment of the country’s economy last month.

Flaherty said today he’s prepared to intervene in the housing market if necessary, although the government has no immediate plans to take action. He said he’s watching the condominium markets in Toronto and Vancouver, and said there has been some softening in the housing market.

The commercial banks say the low rates are a reflection of falling bond yields, and will help consumers pay off debt faster. The 10-year yield touched 1.837 percent on Dec. 16, the lowest level in data compiled by Bloomberg going back to 1989 as Europe’s crisis drives demand for Canada’s AAA rated bonds. The premium to equivalent-maturity U.S. Treasuries is seven basis points, compared with 32 basis points on Sept. 5, the most in 2011.

‘Not an Invitation’

“Low rates are absolutely not an invitation for Canadians to overextend themselves,” Farhaneh Haque, director of mortgage advice at Toronto-Dominion, said in an interview from Toronto. “If you look at the low rates, you could look at them for the interest savings that will help you get debt-free faster.”

Bank of Montreal’s mortgage offer is limited to 25-year amortizations to ensure consumers pay off their loans faster, the lender said. About 22 percent of Canadian mortgages have amortization periods of more than 25 years, according to a survey by the Canadian Association of Accredited Mortgage Professionals.

“We’re giving a low rate with a shorter amortization to help people reduce their debt quicker,” said John Turner, Bank of Montreal’s national director of specialized sales and investment lending. “It’s about doing prudent things for customers that want to be debt-free sooner.”

Reduce Risks

Part of Bank of Montreal’s motivation may be to reduce risks by drawing more people into fixed-rate mortgages, where the rate is guaranteed for the full term, King said. About 60 percent of mortgages in Canada are for fixed terms, according to the CAAMP survey. The remainder are adjusted and so-called variable, tied to the prime lending rate, which rises and falls with the Bank of Canada rate.

“Variable has been the story for the last couple of years,” King said. Banks “are worried about the fact that households are taking on too much risk.”

Lau says he’s aware of the risks, yet can’t resist the low rates to add to his real estate investments.

“I read that the three banking chiefs are saying that housing prices have to go down, and now here they’re offering the lowest mortgage rates we’ve seen in a long time, which sparks people to actually want to purchase more places,” Lau said. “I don’t know what to believe.”

Bank of Canada Governor Mark Carney prolonged a record period of low interest rates to support an economy that he said would be hobbled by slowing growth in China, Europe and the U.S.

Carney kept his benchmark overnight rate at 1 percent for the 11th straight time today, the longest stretch since the central bank began targeting that rate in 1994. Growth in Canada and the U.S. will be “more modest” than forecast in October as European leaders struggle to contain a debt crisis, the Ottawa- based bank said in a statement today.

“It’s quite unusual to have rates this low this far into the cycle, but it’s also unusual to have all these risk factors over their head,” said Stefane Marion, chief economist at National Bank Financial in Montreal.

Canada’s exports of services and goods from oil to automobiles, which account for about 35 percent of the world’s 10th largest economy, are threatened by slowing global demand and the “persistent strength” of its currency, the Bank of Canada said. Recent signs of a pickup in the U.S., Canada’s largest market, are likely to be transitory, it said.

While the U.S. “had more momentum than anticipated in the second half of 2011, the pace of growth going forward is expected to be more modest than previously envisaged, largely due to the external environment,” policy makers led by Carney, 46, said in the statement. “There is considerable monetary policy stimulus in Canada,” the bank said, echoing its previous decision.

The Bank of Canada also reiterated that household debt will keep rising to records, after reaching 153 percent of disposable income in the third quarter. The Bank said last month consumer debt is the main domestic risk to financial stability.

I happen to think the pace of growth in the US and elsewhere will surprise everyone, including the Bank of Canada, to the upside. The Citigroup Economic Surprise Index for major economies keeps rising, signaling better days ahead.

Canada, however, is in its final stretch of a fairly sizable real estate bubble. As the debate over the housing bubble rages on, it pains me to see a lot of young Canadians overextending themselves to buy a house or condo. Even if rates stay low, if they lose their job, they're toast. And if rates do start rising, watch out, it's going to be a bloodbath.

Thus far, Canada has been lucky. China's demand for resources has cushioned the blow of the US downturn over the last three years. And if the US economy does recover, it will help Canada. But that might also mean that the Canada bubble keeps going until it runs out of steam and economic gravity takes over.

Importantly, in any economy where housing prices rise a lot faster than incomes, it means consumers are taking on a lot of debt. This is a recipe for disaster and sooner or later, fundamentals kick in and the pain of deleveraging leads to a serious housing slump.

Just look at what is going on in Sweden right now. Of course don't say that to Canada's mortgage monster. They are going to tell you that everything is just fine and that all those mortgages are guaranteed. Sure, the banks are protected -- banksters always offload risk -- but that doesn't mean Canadian home buyers are. And if things really get ugly, taxpayers are on the hook.

I know a lot of people will dismiss any talk of a real estate bubble in Canada. They're delusional if they think housing prices will keep rising. I'm extremely nervous about what is going on in Canada and worry that far too many of my fellow Canadians are living way beyond their means.

Please note Ed Harrison of Credit Writedowns will be on BNN today at 12:40 discussing the economy and maybe even the Canadian housing market. You can track the latest news on Canada's housing bubble here.

The other country I'm worried about is Greece where private creditors are beginning a final push to renegotiate debt as a member of the investor group. Below, John Fraher reports on Bloomberg Television's "The Pulse" with Maryam Nemazee. Marathon Asset Management LP Chief Executive Officer Bruce Richards, said private creditors are likely to get cash and securities with a market value of about 32 cents per euro of government bonds.

Bankers Brace For Bonus Blues?

2012-01-17T21:56:00.014-05:00

Want to follow-up on an earlier story. Michael Moore of Bloomberg reports, Morgan Stanley Said to Limit Cash Bonuses:

Morgan Stanley (MS), owner of the world’s biggest brokerage, is capping immediate cash bonuses at $125,000 as the firm curtails pay and defers more compensation for senior executives, according to a person briefed on the plans.

Members of the company’s operating committee, led by Chief Executive Officer James Gorman, 53, won’t get any immediate cash, said the person, who declined to be identified because the plan hasn’t been made public. Mark Lake, a spokesman for the New York-based bank, declined to comment.

The decision comes after a fourth quarter that some analysts predicted was the worst for trading and investment- banking revenue since the financial crisis. Increased salaries and previous moves toward deferring more pay have limited investment banks’ flexibility to cut compensation costs, analysts including Atlantic Equities’ Richard Staite have said.

Morgan Stanley’s decision will increase the average amount of pay deferred to about 75 percent, the person said. The firm deferred an average of 60 percent in 2010 and 40 percent in 2009. Deferred cash for 2011 performance will be paid out in two equal installments in the final month of 2012 and 2013, a change from the previous deferral plan that paid out in thirds over 18 months, the person said.

Details about the compensation plan were reported earlier by the Wall Street Journal.

Morgan Stanley’s investment-banking unit set aside $5.74 billion for pay in the first nine months of 2011, an 8 percent increase from a year earlier. Companywide compensation and benefits rose 6 percent to $12.7 billion as revenue climbed 13 percent.
Junior Employees

The amount deferred for junior employees won’t exceed 25 percent of their bonuses, and those who are paid less than $250,000 annually won’t have any cash deferred, the person said. Some of Wall Street’s biggest firms are considering freezing pay levels for some junior bankers, people familiar with the deliberations said earlier this month.

Credit Suisse Group AG (CSGN) is likely to suspend its practice, an industry norm, of boosting pay automatically each year for analysts, associates and vice presidents within the investment- banking division, a person with direct knowledge of the decision said. While those employees will get their regular annual salary increases, bonuses probably will be lowered to keep total pay flat from a year earlier, the person said.

And across the Atlantic, investment bankers brace for more ‘doughnut’ bonuses:

The bars around London’s finance district may soon start filling up with bankers fresh from pay discussions, but not many will be there to splash their bonus cash.
This year zero bonuses, known as “doughnuts”, will affect even senior staff and could include a bigger proportion of employees than in the 2008 financial crisis, bankers and headhunters predicted as U.S. firms start telling bankers this week what they will get.

Slumping quarterly profits, a darkening long-term outlook for the industry and unrelenting pressure from politicians and an angry public, are pushing bank bosses to break away from a culture in which most staff expect a bonus every year and base their personal budget around it.

“This will probably be the worst year for zero bonuses we’ve seen, although those that will have done well will still get something,” said Jason Kennedy, who runs recruiting firm Kennedy Group.

“Global heads and senior managing directors are among those that will get nothing—they’re the expensive staff, and they’ll be living off their higher salaries.”

Underperforming bankers already came under pressure in the 2010 bonus round as “doughnuts” multiplied, but this time division heads are raising the bar and reserving payouts for an even smaller group of star bankers.

Bonuses would be down at least 30 percent for those that do get one, Kennedy said, while other recruiters predict cuts of up to 70 percent in some areas, such as bond trading.

Bankers at Goldman Sachs, Morgan Stanley, JP Morgan and Citi are among those expecting to hear about their bonuses this week, coinciding with these firms’ fourth quarter results.

Overall pay at JP Morgan’s investment bank came in at $8.8 billion, down 9 percent on 2010 levels, while total revenues for the year were flat, its filings showed last week.

WHITER THAN WHITE

Bonuses are only one part of those pay costs, however. Since 2009, salaries have often doubled for top investment bankers, to around 350,000 pounds ($536,500) on average, according to recruiters’ estimates.

This was after firms tried to find ways around a bonus tax in Britain and tougher rules on rewards across Europe. It put additional pressure on bonus pots, through which firms still have some leverage to cut pay costs.

Senior bankers in charge of bonus decisions for their teams have been talking tough about pay for months, preparing staff for lower payouts by pointing to the thousands of jobs being cut across the industry and to the rise in salaries.

“We’ve got to be realistic. We’re not talking hardship here,” said a division head at one major U.S. firm.

“There is a psychological impact when you don’t get a bonus—it used to mean you’re not doing well and could be let go. It doesn’t make the (bonus) conversation very easy, but this year there will be strength in numbers.”

Many expect these senior bankers to be among those to forgo big payouts, partly as a move to appease disgruntled staff.

“They have to be seen to be whiter than white, and not to be necessarily paying themselves but the performers in their teams,” said Jonathan Evans, chairman of headhunters Sammons Associates.

CRACKDOWN CONTINUES

The rise of “doughnuts” will not mean the end to bonuses or to public anger over payouts.

At government-controlled banks like Britain’s Royal Bank of Scotland, where bonuses are likely to total between 400 million and 500 million pounds, according to sources and company reports, these rewards are still under fire.

“It’s extremely difficult to justify any bonus at all at a state-owned bailed-out bank,” British Conservative Member of Parliament Steve Baker told Reuters.

Baker joined about 40 anti-capitalist protesters from the “Occupy London” movement in a gathering outside the offices of Britain’s financial watchdog last week, condemning excessive executive pay.

Ahead of this year’s bonus season, the British government has also moved to clamp down on rewards by suggesting shareholders should get a veto on pay.

As scrutiny of investment banks’ pay practices mounts, many are already taking their own steps to amend the structure of rewards, beyond just cutting them.

Morgan Stanley will reportedly tell employees this week that cash payouts will be capped at $125,000, with any portion received above this deferred until at least the end of the year. Top management might defer their entire bonuses for 2012.

What's going on? Are the glory years of investment banking behind us? You bet they are, and it will only get worse, especially for those junior bankers. They are better off joining a Canadian public pension fund (I'm not kidding).

I see a long-term secular decline in the finance industry where employment as a share of GDP will contract. This isn't necessarily a bad thing. Lots of Wall Street banks were sucking valuable human capital away from traditional industries. We have too many financial engineers and not enough mechanical and electrical engineers. All these "whiz kids" making half a million dollars a year "creating structured crap" or "programing algorithms" for high frequency trading platforms are more valuable to society in other industries.

And take it from a guy with progressive multiple sclerosis who's seen it all, the whole industry is full of shit and there are way too many overpaid weasels and psychopaths on Wall Street and even some at Canadian public pension funds. There is a bonus 'culture of entitlement' that is way out of whack.

How will disgruntled bankers react? Some of them will head off to work for a hedge fund or start their own hedge fund. I wish them luck. Most hedge funds are coming off a very humbling year and institutional investors are chopping their fees. And unlike investment bankers, hedge funds have significant skin in the game. If they perform, they get rewarded, and if they don't, they feel the pain and get massacred (or close shop and reopen under a different name!). Of course, as one institutional investor reminded me, hedge funds buy Ferraris while clients get phantom gain.

But don't shed too many tears for bankers. The invisible hand behind Wall Street bonuses is tightening its grip, but bankers are still extremely well paid relative to the rest of society. As Kevin Roose of Dealbook so aptly comments: "to those in industries unaccustomed to large year-end bonuses, even the paltriest Wall Street bonus would rank as a princely sum."

Below, the WSJ's Deborah Kan speaks to Alison Tudor on Morgan Stanley's banker bonus blues. I also embedded an excellent PBS Newshour interview where Judy Woodruff discusses what the declining dollars tell us about the big firms with financial writer William Cohan and compensation consultant Brian Foley.

Institutional Investors in Risk-On Mode?

2012-01-17T14:37:00.012-05:00

Elizabeth Pfeuti of aiCIO reports, Institutional Investors: Risk-On in 2012:

Institutional investors regained more confidence in the global economy in January than in the last 30 months, and are ready to take on more investment risk, a major survey has shown.
Just 3% of asset allocation specialists, with over $818 billion in combined assets, told the monthly Bank of America Merrill Lynch Fund Manager survey that they believed the global economy would weaken in the next 12 months.

This figure was significantly lower than the 27% of them who reported the same sentiment in December and was the sharpest drop since May 2010.
Bank of America Merrill Lynch’s Composite Risk and Liquidity Indicator was the highest since July last year, indicating investors are more likely to take on risk.

The average level of cash in portfolios has also fallen from 4.9% in December to 4.4% this month.

Michael Hartnett, Chief Global Equity Strategist at Bank of America Merrill Lynch Global Research, said: “Investors are tip-toeing rather than hurtling toward higher risk exposure; the US market and high quality cyclical sectors, such as energy and tech, have been the main beneficiaries of lower cash holdings.”

Last week, MFS Chief Investment Strategist James Swanson told aiCIO that technology stocks were some of his main picks for outperformance in 2012.

The proportion of investors taking lower than normal levels of risk has improved to a net 33% of the panel, compared to a net 42% in December.

However, the survey said that investors had become more concerned about geopolitical risk than a month earlier. It said the proportion of respondents viewing geopolitical risk as “above normal” had jumped to 69% from 48% in December.

Europe – and more specifically the Eurozone, which saw several of its member states downgraded last week – remained unpopular with investors.

Gary Baker, Head of European Equities Strategy at Bank of America Merrill Lynch Global Research said: “Despite improvement in global and European growth expectations asset allocators remain deeply sceptical towards European equities, especially banks.”

Are institutions taking on more risk? Some are but most aren't as they remain fearful of what might happen if Greece defaults on its debt this week. A lot of hedge funds are sitting out the rally, worried they'll get clobbered again. No wonder institutions are squeezing hedgies on fees.

But top hedge funds are not sitting out the rally. Just like the big banksters, they have been in Risk-On mode since Q3, 2011, and some of them are going to make their year in Q1 2012 if things continue like this.

Importantly, forget about what Bill Gross or other gurus are warning about and focus on what top hedge funds and long-only funds are doing in their portfolio. It's their actual book that matters, stupid!

If I was the CIO of a major Canadian public pension fund -- and notwithstanding petty politics, I could easily be one -- I would be looking hard at all risk assets right now, not just stocks, to gauge risk appetite and see if we're on the precipice of another major liquidity rally. I would be examining the top and new holdings at all the best hedge funds and long-only funds, even those I'm not invested with, to see where they're positioning their portfolios (exactly what I do now).

Institutional investors that just write big cheques to external funds -- hedge funds, long-only funds, private equity funds -- and ask minimum information in return, are dumb as nails and not fulfilling their fiduciary responsibilities.

I know I sound like an arrogant prick when I write my comments but I've seen so much nonsense in the pension world that it behooves me to keep drilling into institutional investors to demand a lot more from their external partners, especially during these uncertain times.

Am I in Risk-On mode? You better believe I am, well positioned for La Dolce Beta. I've had enough of eurotrash. If I'm wrong, I'll suck it up, dust myself off, and reposition myself. But so far so good in 2012, and if my hunch is right, this is only the start of a major liquidity rally in risk assets. Don't worry, if I'm wrong, I won't abandon ship!

Below, Charles Calomiris, a professor at Columbia Business School, talks about the outlook for the U.S. housing market and global central bank policy. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday" and says he sees a 'magic year' for US housing.