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The scenario we spelt out last week of the splitting of the monoline insurers into two, with the municipal side maintaining its AAA rating and the corporate and asset-backed side being downgraded, is gradually unfolding. The implications for the corporate bonds remain as dire as we described last week, and there is a little more detail on how the vicious circle will develop. |
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Just when we thought that the banks had done the right thing in bringing onto their balance sheets the special investment vehicles using CDOs to back commercial paper issued on behalf of corporate customers, a new three-letter abbreviation has raised its ugly head: the VIE or Variable Interest Entity. VIEs sell short-term debt backed by securities and often insured against default. Actually VIEs are not so new. For corporate accountants the term entered general usage in January 2003 with the post-Enron issuance of Financial Accounting Standards Board (FASB) “Interpretation No. 46, Consolidation of Variable Interest Entities”. This rules that, regardless of the absence of a formal equity participation, the majority bearer of the loss or beneficiary of the profit of a VIE must consolidate the performance of the VIE into its financial statements. The banks have not been consolidating, although is not clear why not in the light of No. 46. However, as the securities held by the VIEs to back their short-term debt are downgraded because of the monoline shambles, losses will occur and consolidation will be inevitable. CreditInsight advances a figure of USD 88 billion of the potential losses, which will affect even the banks which have escaped major sub-prime write-downs so far. |
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How wrong indeed were the authorities when first they claimed that the impact of sub-prime would be limited to housing. An atmosphere is developing in which nothing in “official” announcements can be trusted. Now we hear that the US economy will still grow, just at a slower rate and that inflation in 2008 will be moderate. Oh yes? Then may we have some explanation of why the 5-year low in consumer confidence, the surge in producer prices, the fall in the dollar exchange rate and the massive increase in foreclosures do not matter? |
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An explanation will not be forthcoming, any more than the full cost of the Iraq war will be officially divulged. Remember Wolfowitz’assurance that the Iraq war would pay for itself, and Economic Advisor to the President, Larry Lindsey, being shot down for suggesting that the cost could be as high as USD 200 billion. How about USD 3 trillion, the latest unofficial estimate? In the UK, too, current estimates are in the range of 15-20 times the original guess of GBP 1 billion. |
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We raise the issue of war costs because it all adds to the problems of debt-ridden societies having to adjust to the reality that, in the end, expenditures cannot remain massively ahead of incomes. |
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Somewhat tongue in cheek we wonder whether the USA and many European countries applauding the bribery of bank employees in Liechtenstein to sell secret, stolen information have not seized on countering tax evasion as a great means of filling their budget gaps. If so, they will be disappointed in the sums. |
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Our positive appreciation of high-quality corporate bonds is being confirmed by successful new issuance with medium maturities. Our optimism about Brazil also remains, with more stress on the currency than on the interest outlook for the bonds. |
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Focus |
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(–) Canada: annual growth forecast revised down from 2.3% to 1.8% |
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(+) USA: core inflation has increased only marginally (from 2.2 to 2.3%) but that excludes energy and food. The Fed has injected USD 60 billion liquidity to date in February. 102.90 to 104.10 |
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(+) Thailand: economic growth is expected to run at 5.5% in 2008 thanks to both exports and inward investment |
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(–) Iceland: inflation increased from 5.8 to 6.8 % in January (mainly because of oil prices) |
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(+) Austria: a budget deficit of 0.7% GDP vs. 0.9% expected. The macroeconomic and budgetary situation in Austria is judged as one of the strongest in the EU |
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(–) South Africa: modest slowing of growth in 2007 at 5.1% vs. 5.4% in 2006 |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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