Should Filipinos Invest Abroad?

``No drug, not even alcohol, causes the fundamental ills of society. If we're looking for the source of our troubles, we shouldn't test people for drugs, we should test them for stupidity, ignorance, greed and love of power.”-P.J. O'Rourke, American Political Commentator, Journalist

In a recent discussion, a colleague raised the issue of whether locals should consider investing overseas given today’s financial globalization. My immediate reply was that there is no general answer to these concerns as this would depend on the distinct goals of each individual.

Some could see overseas investing as a way to tap overseas opportunities unavailable to the domestic market, others may contemplate on putting eggs into different markets or for portfolio diversification, some because of perceived higher returns or lower transaction costs, some for tax purposes or “recycling of funds” or some for just plain curiosity or even vanity (the need to feel sophisticated).

Nonetheless, global retail overseas investing has been a growing trend supported by the ongoing integration and the deepening of financial markets, technology advances such as real time online trading platforms, relaxation of capital flow regulations and the lowering of so-called Home Bias.

As an example, we previously mentioned of the metaphorical Mrs. Watanabes of Japan, an embodiment of retail investors who, because of their high savings and nearly zero interest rates, have used the international currency market to enhance returns, which became an important foundation of the global carry trade arbitrages.

According to the Economist, the ``Mr and Mrs Watanabe account for around 30% of the foreign-exchange market in Tokyo by value and volume of transactions, according to currency traders, double the share of a year ago. Meanwhile, the size of the retail market has more than doubled to about $15 billion a day.” (highlight mine)

For those who are contemplating to undertake offshore investments should consider the risk-reward tradeoffs than simply plunging into the pool without appropriately understanding the risks involved. As Warren Buffett cautioned, ``Risk comes from not knowing what you're doing.”

Risks From Direct Investing

Here is a rundown on some of the risks we need to consider when investing abroad:

1. Currency Risk-

As defined by Investopedia.com, ``A form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.”

As an example, you may gain 10% from your equity investments abroad but a corresponding 10% loss in the currency from which your equity investments are denominated effectively offsets your gain. A worst case would be to see your equity investments values fall in a currency that is also losing- a double whammy!

The important point is that investing abroad requires the comprehension of the fundamental dynamics of the currency market.

This perhaps is the main reason why the Mr. and Mrs. Watanabes opted for the carry trade arbitrage in the currency market which has now evolved into a $3.2 trillion a day turnover than from equity investments, because currency trading signifies as the simplest route to access offshore opportunities.

In other words, you only have to deal with the currency equation without having to complicate your investing perspective with other risk concerns.

As an aside, this is where home bias has a defined advantage for equity investments, simply because you reduce the risk of currency volatility or your risk spectrum is mostly confined to domestic related influences or variables.

Hence, the optimum goal in investing overseas is to profit from investments on a market that has both an upside potential on the currency and the equity aspects.

2. Beta Risk-

As per Investopedia.com, ``Beta is a measure of a stock's volatility in relation to the market. By definition, the market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stocks pose less risk but also lower returns.”

Essentially such risk measure is one of correlation of a market (or a benchmark) among other markets or of individual stock or sectoral benchmark relative to its operating market; see Figure 1 as our example.

Figure 1: Danske Bank: Correlation of EM Markets (left) and Global Equity-Financials (right)

In today’s generally deteriorating equity markets, we see the US markets, despite being the epicenter of the crisis, outperforming Emerging Markets (EM). Of course, the chart’s perspective comes from a one year period and doesn’t show the larger picture. Prior to the crisis EM benchmarks have markedly outperformed the US; where, in spite of the present losses, EM continues to outperform over the past 5 years (remember framing matters).

From here we can deduce that EM markets tend to outperform during better days and underperform during periods of stress. The broad implications to portfolio allocations would be to long EM once the recovery is in the horizon and long US markets when the world tilts to a crisis, although perhaps an alternative proposition would be to long Gold or traditional currency havens as Swiss Franc or Japanese Yen for the latter scenario. This also suggests that in order to distribute or dissipate risk requires the arbitrage of different asset classes in different markets around the world.

Another, the left pane illustrates how Financials stocks have been tightly correlated with the general global equity bellwether. While Financial stocks have suffered more than the bellwether of global ex-financial stocks, the strains of the former has likewise generated a downside trajectory to the latter, the causality of which generally accounts for the function of macroeconomic links (see below).

It doesn’t make sense to invest in a market which is highly correlated to your base market unless your goal is to tap industries that are unavailable to the local market. Therefore, if the objective to invest abroad is to diversify, then the ideal approach would be to deal with markets that have either a low or negative correlation.

3. Macroeconomic risk-

Macroeconomic risk generally deals with the performance, structure, and behavior of a national or regional economy as a whole (wikepidia.org).

Figure 2: wikipedia.org: Macroeconomics Circulation

The fundamental reason why the world has been suffering from a growth slowdown or the financial markets agonizing from heavy losses is due to the fundamental impairment of the financial channels (market and banking) whose transmission mechanism is clearly demonstrated above in figure 2.

The tightening of credit conditions from the US led housing-securitization bubble bust have effectively been raising the cost of capital, eroding corporate profits, decreasing business expenditures, magnifying losses in asset holdings among public and private institutions, prompting for the balance sheet restructuring by reducing leverage in private institutions, contracting consumer demand, raising unemployment, lowering prices of commodities and increasing government intervention in markets. And this weakness has been spilling over to the world.

Thus, the recent liquidity contraction translates to a magnified purview of the financial and economic structure of each nation under present turbulent conditions.

Said differently, the performance of markets in reaction to the gummed or gridlocked credit markets and economic downdraft has probably been a reflection of: one) the depth of interconnectedness of a country to the world via trade/financial/political channel, or two) the overall vulnerability of a country’s economic framework.

In essence, macroeconomic risks deal with the risks of an investment theme relative to economic output, national income, inflation, interest rate, capital formation or savings and investment, consumption, fiscal conditions and international trade and finance.

Thus, investing abroad means understanding how economic, financial and political linkages could impact your portfolio.

3. Taxation and Transactional Cost Risk-

From Reuters financial glossary ``The risk that tax laws relating to dividend income and capital gains on shares might change, making stocks less attractive.”

Whereas transaction cost means ``cost incurred in making an economic exchange” (wikipedia.org) which involves the “search or information” cost (search for availability of goods or securities in a specific market), “contracting” cost (cost of negotiation or bargaining) and “coordination/policying and enforcement” costs (meshing of different products and process aside from cost of enforcing the terms of contract) [wikipedia/wikinomics].

This means that prospective investments in overseas market requires the understanding of risk dynamics from the underlying cost structure of the present taxation regime of the host market, aside from its potential changes.

Taxation is part of the transaction costs that could determine the viability of investing overseas. Lower cost of transactions could function as a critical variable if only to wring out additional profits or returns from an economies of scale standpoint.

4. Liquidity Risk-

As defined by investorwords.com, ``The risk that arises from the difficulty of selling an asset. An investment may sometimes need to be sold quickly. Unfortunately, an insufficient secondary market may prevent the liquidation or limit the funds that can be generated from the asset. Some assets are highly liquid and have low liquidity risk (such as stock of a publicly traded company), while other assets are highly illiquid and have high liquidity risk (such as a house).”

In short, liquidity risk can mean the tradeable-ness of a given security or market.

This is somewhat related to the transaction cost where the more liquid or scalable a market is translates to lesser transactional cost.

Example, the Philippine state pension fund Government Service Insurance System (GSIS) has allotted some $1 billion, which makes up around 12% of GSIS’s total loans and investment portfolio for its global investment programme.

This dynamic can be lucidly seen from the AsianInvestor.net article (highlight mine), ``The GSIS will have a tough time generating returns for its members if it continues to stick with Philippine shares because of limited choices and relatively low volume. Low interest rates and the absence of a strong secondary fixed-income market in the Philippines are also constraints.”

Thus, a prospective overseas investor needs to aware of the liquidity conditions of the market or of the specific issues which one intends to deal with.

5. Political and Regulatory risks-

Political risk is a broad definition which essentially encompasses the changing nature of a country’s political structure. This from investorwords.com ``The risk of loss when investing in a given country caused by changes in a country's political structure or policies, such as tax laws, tariffs, expropriation of assets, or restriction in repatriation of profits. For example, a company may suffer from such loss in the case of expropriation or tightened foreign exchange repatriation rules, or from increased credit risk if the government changes policies to make it difficult for the company to pay creditors.”

Such risks get accentuated when government becomes more adverse to private sector participation or to market oriented economic platforms (e.g. Venezuela and Bolivia) or when government policies run roughshod over its constituents (e.g. Zimbabwe) or with its neighbors (e.g. Russia).

As we have noted in Phisix: Learning From the Lessons of Financial History, trade, current account and fiscal surpluses, high forex reserves, low debt or favorable economic or market conditions can be radically overturned by 5 cardinal sins in policymaking; namely-protectionism (nationalism, capital controls), regulatory overkill (high cost from added bureaucracy), monetary policy mistakes (bubble forming policies as negative real rates), excess taxation or war (political instability).

Whereas Regulatory risks are political risks applied more to specific sectors; from investopedia.com, ``The risk that a change in laws and regulations will materially impact a security, business, sector or market. A change in laws or regulations made by the government or a regulatory body can increase the costs of operating a business, reduce the attractiveness of investment and/or change the competitive landscape.”

Hence it is imperative for any overseas aspiring investor to anticipate risks of policy changes that could negatively impact an investing environment.

6. Other Risks

Of course there are other domestic risk issues to deal with such as valuation risks (financial valuation ratios), leverage risks (risks due to debt related exposure) or company specific risks (labor, management, etc.).

Risks From Indirect Investing

Nonetheless one may argue that you can deal with foreign markets through a variety of funds, such as Exchange Traded Funds, ADRs, Hedge funds, mutual funds or trust related funds sold by banks (UITFs) or insurance companies.

But as we previously noted there are issues like:

A. Principal-Agent Problem

This deals with the conflict of interest by investors when dealing with other market participants because of differing goals mostly due to the varied business models. For instance, investors would be mostly concerned about profits or returns on investment (ROI), whereas most brokers would be concerned with the commissions from client transactions while mainstream bankers or fund managers would be interested with the fees generated from the products they sell.

Thus, when bankers, fund managers or brokers issue their inhouse literatures they are mostly designed to sell the products or services they offer than to meet the investor’s objectives.

As Legg Mason’s Michael Maubossin writes in the Sociology of Markets, ``agency theory is relevant because agents now control the market. And, not surprisingly, agents have very different incentives than principals do. And this game is close to zero sum: The more the agents extract, the lower the returns for the principals.”

B. Asymmetric Information

``A situation in which one party in a transaction has more or superior information compared to another. This often happens in transactions where the seller knows more than the buyer, although the reverse can happen as well. Potentially, this could be a harmful situation because one party can take advantage of the other party’s lack of knowledge.” (investopedia.com)

Applied to the financial markets this means that sellers of financial products have more information than the buyer or clients. Thus, clients or investors are likely to submit to the whims of the finance manager, who are usually not invested. In other words, many people have committed their trust and money to fund managers or bankers who don’t even have much stakeholdings in the funds they manage except via fees or profits.

From Chuck Jaffe (marketwatch.com), ``In 46% of the domestic stock funds surveyed, the manager hadn't invested a dime. Other asset classes were far worse with nearly 60% of foreign stock funds reporting no manager ownership, two-thirds of taxable bond funds having no managers with money in the fund, up to 70% of balanced funds having no manager cash and some 78% of muni bond funds having shareholder cash only.”

Besides, investors who bought into funds are subject to information asymmetries on how fund managers or bankers allocate their portfolios. The risk strategies employed by fund managers may not square with the overall risk appetite of the investor or investment managers could be taking in more risks than would be tolerated by their clients.

How Distorted Incentives Contributed To The Mess

How does this relate to investing overseas?

First, no institutions are insuperable. The idea that funds are backed by big institutions should be questioned or scrutinized by every investor here and abroad.

As the lessons from Enron (formerly 7^th largest corporation in America) in 2001, the recent fall of the 158 year old Lehman Bros (formerly 4^th largest investment bank in the US) and American International Group (largest insurance in the US), fund managers and bankers are not immune to cognitive biases of the herd mentality whose agency problem, because of the desire for more share in the fees derived from profits piled into more leverage and momentum despite being aware of the unsustainable trend and compounded by guiding principle of implicit guarantees of government bailouts, helped triggered the colossal overspeculation fueled by monumental overleverage. It’s not their money anyway.

Evidence? Look at the performance of the $1.9 trillion hedge fund industry (Wall Street Journal), ``Nine out of every 10 of the 4,000 hedge funds surveyed globally by data provider Eurekahedge are performing insufficiently well to beat their high-water mark–the level at which they can charge performance fees, equivalent to a fifth of returns.

``All but 3% of funds of hedge funds were under the mark, according to the survey, as were 90.6% of equity long/short funds, 86% of portfolios focusing on market events, 85.4% of those investing in distressed securities, and 82.6% of futures managers. The picture was also bleak for long-only absolute return funds, 96.5% of which were below their high-water mark. The survey used figures compiled for July 31–the most recent available–and are likely to have worsened since then.”

To consider hedge funds have the ability to trade and profit even on when the market moves to the downside, except for the recent ban on short selling on 950 financial stocks which clearly handicapped their strategies.

Moreover, the agency problem and the information asymmetry dynamics had clearly been a functional component in the bubble formation when investment banks turned into the “originate and distribute models”-where they packaged and sold low quality or subprime mortgages or distributed credit risk, in complicity with the seal of goodstanding from credit rating agencies who ironically derive their revenues from the originators (effectively distorting the incentives to be objective appraisers), to equally unthinking clients or institutions worldwide. Thus, when the bubble imploded, the negative externalities caused by failed government policies espoused and profited by institutional oligopolies borne out of the cartelized financial system will once be folded into the arms of the US government whose concentration risks to the remaining institutions have equally been amplified.

Summary and Recommendations

To recap, to invest overseas isn’t the same as to invest locally primarily because of more risks concerns; particularly currency, beta, macroeconomic, taxation and transactional cost, liquidity, political and regulatory risks and other domestic related risks.

In addition, to rely on indirect exposure abroad via institutional products isn’t as risk free as portrayed by some, or impervious to the corrosive effects of principal-agent and the asymmetric information problem as recent events have clearly shown.

Big institutions have failed and will possibly go under the wringer as the world’s financial system adjust from taking up too much debt more than it can afford. The global credit crisis basically is a consequence of global financial institutions not knowing “who holds what” (similar to the Old maid game), thus we can’t really know who among the big financial players will remain standing or “strong” until the fog from the battlefield has lifted. What we understand is that Asian institutions are supposedly the least impacted compared to their counterparts because of the rear view mirror effects from the Asian Crisis.

The lesson for every investor is to increase their financial literacy and do their homework under some of the risk guidelines as presented above.

For beginners, before trying out overseas investment I suggest for you to get your hands dipped into the local market. Vanity won’t do you any good because tuition fees can be very costly and emotionally distressful. Once you gain experience via the learning curve, you can begin to dabble with markets abroad.

Refrain from the assumption that all markets operate similarly, as advocated by many hardcore technicians, because they aren’t. To analogize using George Orwell’s Animal Farm, ``All animals are equal, but some animals are more equal than others.” In addition, the supposition that markets contain all the information isn’t true as the information asymmetry dynamics above suggests.

It would be recommended that you should use the international markets to compliment your overall portfolio strategy by either going for opportunities not accessible in the domestic markets or to diversify to less correlated markets or to hedge your portfolio using intermarket arbitrage.

Finally, be cognizant of the possible conflict of interest when dealing with institutions whose economic model and incentives are different than yours.

Phisix: Back To The Global Divergence Mode

``In the short run, the stock market is a voting machine and long run is a weighing machine. Five years from now and 10 years from now we will see that we could have made some extraordinary buys. I do know that the American economy will do well, and that people that own a piece of it will do well. But they shouldn't do it on leverage, and that's what people have learned in this period. "-Warren Buffett (at a CNBC interview with Becky Quick)

Following the bloody carnage in the global equity markets during the previous week, the Phisix reverted to its “divergent” mode by recovering most of its losses. The Philippine benchmark was up by 5.46% over the week, even amidst a mostly dreary global outlook and was one of rare bright spots in the Asian market alongside Vietnam (+10.19%) and China’s Shanghai (10.54%).

What seems to have driven the Phisix to stoically climb to the upside, amidst the interim weakness in most of the global markets, has been an erosion of foreign selling. Curiously enough, we even saw select blue chip buying by foreign money, albeit they were seen sporadically selling over the broad market to account for a minor net inflow of Php 188 million over the week.

Of course one week does not a trend make. But as what we have been saying before, if the estimates of foreign liquidation relative to the previous years of inflows have been accurate, then the pressure from another round of AIG-type of forcible liquidation has probably peaked and should be declining. And if we continue to see this trend reinforced, then the threat from any future selling pressures is likely to emanate from local retail investors who are the easiest to be swayed or spooked by media reports. Thus, perhaps the diminishing trend of foreign selling plus future risks of “contagion dynamic” from local retail investors are likely to be indicative of the bottoming process we have long talking about. And a bottom process entails rangebound trading or gradual confidence building recovery.

As we have repeatedly argued, the Phisix doesn’t share the same problem with most of the world. In fact, the Phisix sorely missed out (or is it serendipitously?) the real estate boom during the last few years. The contagion linkage the Philippine has with the world is through the trade, remittances, the booby traps from toxic US instruments held by some financial institutions and financial flows.

One year into the crisis we have yet to see any material deterioration from these external channels. Ironically, what has sharply impacted the local economic growth data has been the “rising food and fuel” component or imported “cost push” inflation. With food and fuel prices down, the risk towards the extended impact from the latter influences could be seen as likely to diminish which in essence should support “growth”.

Albeit, with the recent jump of oil to above $100 ($106 as of Friday) had been mainly on the account of the weakness of the US dollar rather than from demand recovery as industrial metals and the Baltic Index continue to soften see figure 3. In other words, oil and gold have been the beneficiaries (safe haven?) of the growing anxiety over a massive scale of US intervention to rescue its financial system.

As this Bloomberg report avers (highlight mine), ``Domestic banks are cutting trading with international firms in the interbank market, according to Zhuang Zhiqiang, a trader at Xiamen International Bank Co., which is partially owned by the Asian Development Bank. The move aims to control risks after the bankruptcy of Lehman Brothers Holdings Inc. stunned domestic investors, said Zhao Qingming, an analyst in Beijing at China Construction Bank Corp., the nation's second-largest lender. We've turned more cautious,'' said Zhuang, who is based in the southern Chinese city of Xiamen. ``Bank officials are worried about settlement risks as the ongoing crisis has weakened people's trust in U.S. banks.''

Figure 3: stockcharts.com: US Dollar Driven Oil Rebound!

Now with some Asian countries beginning to tow the line of monetary policies directed at resuscitating growth, where according to a Bloomberg report, ``Taiwan cut borrowing costs on Sept. 25, joining China, Australia and New Zealand in easing the price of money this month,” we are likely to see some of these effects via a recovery in the second quarter of 2009 barring a crash of the US economy.

We just hope that our central bank will not get cowed by pressures from our politicians and to remain focused on fighting the “ravages of residual inflation” by continuing to tighten.

Fiscal Bailout, US Monetary Policies To Ensure Inflation Transmission To Global Economies

``It seems clear that much of the current crisis has been exacerbated by mark-to-market accounting, which has created massive, and unnecessary, losses for financial firms. These losses, caused because the current price of many illiquid securities are well below the true hold-to-maturity value, could have been avoided. The current crisis is actually smaller than the 1980s and 1990s bank and savings and loan crisis, but is being made dramatically worse by the current accounting rules." Brian Wesbury, FT Advisors, Mark-to-Market Mayhem

As we have repeatedly been saying, the US Federal Reserve hopes to inflate the world through its currency pegs or dollar links in the hope that the monetary stimulus applied will revive global growth to support its export sector as the local economy is being battered by the deflating debt storm.

Chairman Ben Bernanke understands that without exports the US economy would even be more vulnerable. Thus, the United States’ over reliance on foreign trade underscores the need for such stimulus transmission. It had been an unintended consequence before it looks like an unstated policy goal today.

Of course, another reason for passing the inflation buck is that EM countries have been more than willing to take on the real currency and interest rate risk-which means EM economies can afford to suffer from real value losses (via inflation) of their US portfolio holdings.

Since the Bretton Woods II framework has been driven by political objectives-for EM countries keeping currency undervalued for mercantilist goals- than by economic ones, as EM economies continue to support the US economy by buying into US treasuries despite the extremely low yields or expensive bonds, the risk is that perhaps the changing political objectives might lead to a shift in the global currency framework and consequently a US dollar crisis.

In the same plane, the fundamental reason why the US financial markets are being rescued is probably because Chairman Ben Bernanke understands that the current account deficit has been continuously plugged by foreign financing via the acquisition of paper claims on US assets. First it was Fannie and Freddie. Next it was AIG.

Now signs of growing political heft by foreigners into shaping domestic US policies, from an article in the New York Times,

``Foreign banks, which were initially excluded from the plan, lobbied successfully over the weekend to be able to sell the toxic American mortgage debt owned by their American units to the Treasury, getting the same treatment as United States banks.”

Another reason why? Because Chairman Bernanke understands that the US needs to get its feet back on the ground by having foreigners to provide the much required recapitalization of its severely impaired banking system aside from its present actions to cobble enough resources for a system wide bailout long enough to buy time for the world to recover.

From Kenichi Amaki of Matthews Asia, ``This week, two Japanese financial institutions stepped out of the shadows of the past to pick up stakes in some of their more recognized competitors. Japan's largest securities firm and investment bank announced the acquisition of Lehman Brothers' Asia Pacific, European and Middle Eastern businesses, including Lehman’s 5,500 employees in those regions, for an undisclosed amount. At the same time, Japan’s largest bank, announced that it had agreed to take an equity stake of up to 20% in Morgan Stanley for roughly $8.5 billion. These deals are expected to significantly boost both firms’ investment banking capabilities in geographic regions traditionally weak for them.”

Think of it this way, if the overall outstanding mortgage debt on non farm homes is $11.2 trillion where Fannie and Freddie holds $5.4 trillion, a 10% loss is easily equivalent to $1.12 trillion. This does not include the $2.4 trillion of “other mortgage debt” (corporate farms et. al.) and the $2.5 trillion outstanding consumer credit, which could likewise be impacted by a slowing economy and the ongoing credit crunch (hat tip: Brad Setser). So the proposed $700 billion package for the bailout will probably be insufficient.

Figure 4: The Economist: Cost of Previous Bailouts

Anyway, there had been greater amounts of bailouts as measured by the fiscal cost in % the GDP. According to the Economist,

``CONGRESS is under pressure to approve the Treasury's proposed $700 billion rescue package. Lawmakers, however, are conscious of the cost to the taxpayer: together with loans to AIG and Bear Stearns, public backing so far approaches 6% of GDP. This is well above the 3.7% of GDP of the savings-and-loan bail-out in the late 1980s and early 1990s. But some 6% of GDP is still much less than the average cost of resolving banking crises around the world in the past three decades, which a study by Luc Laeven and Fabian Valencia, of the IMF, puts at 16%.”

In nominal terms the present bailout would be gargantuan but the justifications using historical average cost of 16% could mean there might be more in store in the future as the weakness in US economy spreads.

Thus, my view is slanted towards the idea that any possible rescue package will tacitly be directed to stimulate global economies to enable them to fund the US current account deficit by buying into US financial claims on a guarantee aside from attracting potential financing flows from overseas state and private institutions to recapitalize the floundering US banking system.

There has been a barrage of thoughtful solutions on how to go about the bailout scheme some of which had been suggested by noteworthy figures as Raghuram Rajan suspend dividends and rights offering on solvent banks, Nouriel Roubini New HOLC, Luigi Zingales Debt for equity swap and debt forgiveness, Charles Calomiris Preferred stock assistance, Steve Waldman nationalization, Brian Wesbury temporary suspension of FAS 157 mark-to-market rules and Bill King create a new system parallel with the existing dysfunctional system and decentralization of liquidity (hat tip: Barry Ritholz) among the others.

It’s a wild guess on how the US Congress will go about configuring this package.

Nonetheless, it does seem that most of the world markets have been anxiously awaiting for the details of the US Congress led fiscal bailout of the US banking system.

This poignant New York Times quote from an anonymous Wall Street broker seems to have captured the essence of the markets abroad (highlight mine), ``People have definitely been saying that this is no longer an investor’s market, nor even really a trader’s market — it’s all entirely speculation on what the government is going to be doing next…Anyone who thinks they have a handle on where things are going is deluding themselves.” Indeed, since the credit crisis surfaced last year, the market has been living off from the onslaught of speculations to what government actions would be to done to stave off to magically vanquish the crisis.

Unfortunately, after over a year and upon waves after waves of government actions through assorted means of bridge financing and rescue takeovers this hasn’t prevented its financial markets or of most of the world markets from falling.

However, I think that as the contagion selling should eventually wear off despite the continued pressures in the US markets, aside from the indirect policy stimulus applied to foreign economies, which might give rise to a recovery of ex-US markets first in 2009.

Besides, the streak of selling has been ferocious enough to bring valuations to extremely oversold levels, see our last chart figure 5 from Daily Wealth,

Figure 5: Daily Wealth: Markdown on Emerging Market Valuations In Overshoot Mode!

From Chris Mayer ``The selloff is making things striking on the valuation front... which makes me bullish here. As you can see from the chart below, emerging markets haven't looked this cheap on a forward earnings basis in 20 years...”

First Test On Asia’s Banking System? Hong Kong’s Foiled BEA Bank Run

It was bound to happen.

The most recent spike in of LIBOR rates (courtesy of Bloomberg) in the international money markets (IHT) sparked rumors through a barrage of panicky text messages that suggested of a Hong Kong bank that had become vulnerable due to the recent losses in Lehman Brothers.

Depositors then thronged to the branches of the Bank of East Asia-founded in 1918, which makes it the oldest bank in the city-triggering a 2 day bank run.

Courtesy of BBC

But unlike the counterparts in the US or in UK, newswires reported that a combination of massive injection of funds to its system- about HK$3.9bn/$500m/£269m (BBC) by the Hong Kong Central Bank, plus domestic tycoon Li Ka-shing’s reported massive buying of the bank’s shares, which earned him the moniker of the “superman” by the local media (NYT), eased depositors’ concerns.

The overall damage, according to Timesonline, ``Total withdrawals from BEA on Wednesday were estimated at HK$2 billion by analysts at DBS Vickers Securities – a manageable 0.7 per-cent of the bank’s HK$300 billion deposit base.

``Some of those queueing to withdraw their money cited fears that BEA had not properly assessed its exposure to the unwinding of Lehman Brothers’ huge positions, which the bank puts at about $54 million. Many savers took to the streets in protest after discovering that HK$13 billion of minibonds guaranteed by Lehman Brothers that they had bought were rendered worthless after the bank’s collapse. Some pointed to the suddenness of Lehman’s demise, saying that in the days before the Wall Street giant went bankrupt it was issuing assurances of its stability, in similar terms to those used on Wednesday by BEA.”

From our understanding, the strongest possible reason why BEA survived the ordeal was PROBABLY because it wasn’t insolvent unlike its contemporaries in the US (IndyMac) or UK (Northern Rock). Liquidity injections can do some temporal patch up work, but can’t hide the company’s structural infirmities. The equity support provided by tycoon Li Ka-Shing signified as a vote of confidence or opportunity to profit than from altruism.

Second, in a world where people are anxious about the stability of the world’s financial system, the flow of information has been real time and powerful enough to trigger an unwarranted stress or panic.

Lastly, while this will NOT be the last of the systemic tests for Asian banks, they are likely to be better conditioned to weather the storm of panics.

The differences in the outcome of how an Asian bank and US banks reacted to Bank Runs clearly demonstrates signs of brewing divergences.

The Green Religion: Do As They Say and Not As They Do

Interesting article from the Guardian on the political rhetoric of environmentalism....

``People who believe they have the greenest lifestyles can be seen as some of the main culprits behind global warming, says a team of researchers, who claim that many ideas about sustainable living are a myth.

``According to the researchers, people who regularly recycle rubbish and save energy at home are also the most likely to take frequent long-haul flights abroad. The carbon emissions from such flights can swamp the green savings made at home, the researchers claim.

``Stewart Barr, of Exeter University, who led the research, said: "Green living is largely something of a myth. There is this middle class environmentalism where being green is part of the desired image. But another part of the desired image is to fly off skiing twice a year. And the carbon savings they make by not driving their kids to school will be obliterated by the pollution from their flights."

``Some people even said they deserved such flights as a reward for their green efforts, he added.

Read the rest here

Lesson: Be wary of holier than thou preaching. They may be sounding noble, but the preachers themselves don't practice what they advocate.

Market Talk on Select Philippine Energy issues: Refinancing Woes or Available Bias?

Recently because of the poor performance of some locally listed energy issues, we were asked of the opinion of why this has been so and if we agreed with a study of a domestic broker on the notion that the recent share price decline have been prompted by 1) the question of having to raise money in today's environment given the scale of the company's refinancing requirements and 2) the falling value of the equity collateral of its recently acquired subsidiary which mandates the said company to raise funds to cover such deficit.  

Some FACTS first:

1.    These issues have been on a downtrend since October last year, which basically reflects overall market decline. 

2.    Since the advent of the credit crisis, foreign selling has dominated the selling side 

Our observations:

One, the study has been ambiguous in the order of causality: have the decline of share values in the said issues been "causing" debt refinancing problem, or has debt refinancing woes "caused" the losses in its share prices? 

Two, given the "facts" above, we really doubt if the declining trend had been all about debt refinancing. The Phisix bear market has been due to net foreign selling which has been a broadmarket affair since the credit crisis surfaced. And as we have been saying it is the deleveraging dynamic that has been the vicious knot that ties the miseries of global markets. The debt refinancing issue has only been recently raised.  

On our end, the thesis of "debt refinancing woes" could be based on sheer speculation than of genuine concerns.

Three, while there has indeed been some spillover of the credit woes to Asia, this hasn't totally sucked liquidity out enough to squeeze the Asian or Emerging Market sovereign or corporate debt markets. 

According to Christian Monitor: "Dutch bank ING has calculated that $111 billion worth of emerging market bonds must be refinanced during the next year. But credit is tight. That's raising doubts about whether corporate borrowers will be able to refinance their loans.

"I don't think we'll see a sovereign debt default problem," when a country can't repay its loans, says Mr. Das. The focus will instead be on banks and "companies that have been major issuers into the credit bubble."

"He says, "Russia, Kazakhstan, and Ukraine had a number of banks issuing debt. They haven't all lost access [to credit], but if even Gazprom is having to pay higher [interest rate] spreads [on loans], you can be sure that the weaker names will continue to have a much harder time getting bond deals done.""

Another, it seems the loan market in Asian remains vibrant, click on FinanceAsia article.

Fourth, the underlying business models of these companies generate immense cash flows. Thus, the problem won't necessarily be about the access to debt but instead to the cost of debt.  This means the high cost of financing (assuming the tight credit environment) risks taking a bite out of the company's earnings or bottom line.

Having said so this bring us to perspective of the company's solvency; will the "high" cost of debt refinancing render the company insolvent? Unlikely in my view.  And since the problem is NOT one of INSOLVENCY, thus, the controversy over the company's refinancing could be seen as "rationalization" (looking for excuses to justify present market action) or Available Bias (the use of current events to explain market actions). We think that the company will easily find a lending window given its generally feasible business model.

Fifth if the company is faced with any risk, it could emanate from the political front (populist policies), as the owners of the said companies have been seen as political foes.

All told we adhere to Edwin Lefevre's advise (truism), "In a bear market all stocks go down and in a bull market they all go up...I speak in a general sense."  

CDS Market: Is the US Dollar Losing Its Safehaven Status?

In Global Markets: From “Minksy Moment” To The “Mises Moment” we pointed out that despite the massive “flight to safety” as seen by US Treasury bills which almost yielded to nothing during the recent riot in the global credit and equity markets, credit default swaps on US debt have reached record levels! 

From the Liam Halligan of Prosperity Capital published at the Telegraph “Financial crisis: Default by the US government is no longer unthinkable”

 

This is a very compelling picture which shows of the real emerging risks of a default by the US government on its snowballing debts as it is being compounded by the systemwide rescue of the financial sector.

 

Likewise it puts to question the foundations of the US Dollar as a “safehaven”.

Global Markets: From “Minksy Moment” To The “Mises Moment”

``In their haste to be wiser and nobler than others, the anointed have misconceived two basic issues. They seem to assume: (1) that they have more knowledge than the average member of the benighted, and (2) that this is the relevant comparison. The real comparison, however, is not between the knowledge possessed by the average member of the educated elite versus the average member of the general public, but rather the total direct knowledge brought to bear though social processes (the competition of the marketplace, social sorting, etc.), involving millions of people, versus the secondhand knowledge of generalities possessed by a smaller elite group.-Thomas Sowell, "The Vision Of The Anointed: Self-Congratulation as a Basis for Social Policy"

It has been a most eventful week! Looking at the end numbers won’t do justice to the drama that had unfolded. And we should expect this to continue. And for the first time, even Philippine broadsheets highlighted the ruckus in the global financial sphere on its headlines, giving the oblivious public the opportunity to attest of the ongoing dynamics at the “macro” framework of global finance. Unfortunately, many of these reports only focused on the “surface” than of the “genuine” pressures which has been rattling the “core” of the system.

None of these have been new to us. We’ve dealt with the risks of evolving finance (structured products, derivatives, etc…), since we became bullish in GOLD in 2003 (The Rip Van Winkle in Gold series.)

Warren Buffett’s Philosophical Victory

We even subscribed to the views of Mr. Warren Buffett, the world’s premier investor, on his advocacy against the menace of newfangled exotic financial products or as Mr. Buffett has repeatedly warned, the “financial weapons of mass destruction” (see Figure 1) and of the follies of “squanderville” economics or conspicuous debt driven consumption as manifested by US current account deficits in November 2003 Fortune Magazine “America's Growing Trade Deficit Is Selling the Nation Out From Under Us”.

Figure 1: US Global: Derivatives In Perspective

And as always and contrary to the mainstream, in the fullness of time, Mr. Buffett has once again been utterly validated. As a reminder, Mr. Buffett’s themes have almost always materialized from a LONG term and NOT ticker (short term) based perspectives, as commonly espoused by the public.

And recent events only have only reinforced such theme where market forces have been wracking at the pillars of the much maligned world’s monetary (financial) system.

And this has not just been foretold by Mr. Buffett but also by the Austrian School of Economics.

The “Minksy Moment” At its Finest

“Minsky Moment” has been coined by the distinguished UBS Economist George Magnus. It refers to the illustrious American economist Hyman Minsky (1919-1996) who is known as the father of Financial Instability Hypothesis, from which he gained popularity over the theory of “stability leads to instability”.

In our August 2007 article, Global Markets: An Advent to the Minsky Moment and the Kindleberger Paradigm?, we described Minsky’s credit cycle as,

``Minsky’s model actually basically depicts of the credit cycle underpinning the business cycle, where credit transforms from a function of HEDGE financing (ability to pay principal and interest) to SPECULATIVE financing (ability to pay interest only, which needs a liquid market to enable refinancing and debt rollovers) and finally to PONZI Financing (basic operations cannot service both interest and principal and strictly relies on rising asset prices to service outstanding liabilities).”

Or said differently, complacency tends to foster greed, via the transition mechanisms of the credit cycle where people imbue more risks by adopting unsustainable arcane credit instruments, which eventually culminates to a break point known as the “Minsky Moment”.

So the perturbation you have been witnessing from today’s financial sphere is exactly how the late Minsky described all these to be; the diverse alphabet soups of highly leveraged complex instruments-slice, diced and repackaged, stamped with investment grade ratings by credit rating agencies and sold to investors all over the world.

Banks and Investment Banks which traditionally held on the mortgages they underwrote and took the underlying credit risks morphed into “originate and distribute” models from which disseminated credit risk to investors, who instead of conducting their own credit scrutiny to establish the viability of these products, almost entirely depended on the seal of approval from credit rating agencies. For global investors faced with a “savings glut” and institutional requirements to match investments with liabilities, in behaving like lemmings, it became an “in” thing to get into these papers on the assumption they were safe as determined by the Credit Rating Gods.

With capital freed up from warehousing credit risk, these institutions worked to assume more risk by the extension of credit facilities to a wider scope of the population who were less creditworthy or “subprime” on ultra-favorable loan terms in order to generate additional returns via the economies of scale.

Moreover, these institutions piled into more dubious loans from the real economy (real estate mortgages) which were recycled with more leverage and wrapped into complex financial labels into the financial economy underpinned by the creation of off balance sheets vehicles (SUV) from banking institutions from which emerged the Shadow Banking system. Aside, derivative instruments as credit default swaps (CDS), originally meant as an insurance against company defaults was likewise utilized as another tool for obtaining leverage (CDS issuance vastly greater than underlying bonds), whose mind boggling size further enhanced counterparty risks.

Thus, the full scale transition towards the Ponzi structure.

Who can forget the infamous quote from Citibank’s Charles Prince, ``But as long as the music is playing, you've got to get up and dance. We're still dancing.” Yes, almost every participant knew this was bound to happen, but assumed that they could get out ahead of the others. Unfortunately like cartoon character Wily E. Coyote, who runs off the cliff and keeps going on until he looks down and realizes that he’s been running on air, the industry plunges to the ground!

Nonetheless when the Minsky Moment emerged, the risk distribution on an international scale revealed that risk weren’t really reduced but instead, as vividly shown last week, had been spread and became the source of the tremors which rippled throughout global markets.

From the effects side, Minsky was absolutely correct. Stability created conditions for greed which allowed for more risk taking appetite backed by a pyramid of unsustainable gearing.

The Emergence of Mises Moment?

We have been saying for so long that the entire premise of today’s suspenseful episode has been centered on the structure of the prevailing monetary system- the Paper Money US dollar standard operating on the fractional banking reserve platform as defined by wikipedia.org as ``only a fraction of their deposits in reserve with the choice of lending out the remainder while maintaining the obligation to redeem all deposits upon demand.”

It means that it is the intrinsic nature of global central banks to foist boom conditions derived from leveraging (modeled after the banking system) or by means of expanding money and credit to the point that it becomes unsustainable. From which the ensuing bust will tend to prompt liberals or interventionists to unjustly brand such cyclical inflection as “market failure”, when market forces had been repeatedly tweaked and distorted to the extremes by constant policy based interventionism.

Besides, had there been automatic adjustment mechanisms meant to curb excesses by allowing market forces to determine the resource allocation process (e.g. gold standard), boom bust scenarios would have greatly been reduced.

Unfortunately while many articulate voices cite the lack of regulation or its ineffectualness, a large part of this laissez faire blaming has not been consistent with reality; this noteworthy quote from George Mason University Professor Tyler Cowen from the New York Times (highlight mine),

``But the reality has been very different: continuing heavy regulation, with a growing loss of accountability and effectiveness. That’s dysfunctional governance, not laissez-faire.

``When it comes to financial regulation, for example, until the crisis of the last few months, the administration did little to alter a regulatory structure that was built over many decades. Banks continue to be governed by a hodgepodge of rules and agencies including the Office of the Comptroller of the Currency, the international Basel accords on capital standards, state authorities, the Federal Reserve and the Federal Deposit Insurance Corporation. Publicly traded banks, like other corporations, are subject to the Sarbanes-Oxley Act.

``And legislation that has been on the books for years — like the Home Mortgage Disclosure Act and the Community Reinvestment Act — helped to encourage the proliferation of high-risk mortgage loans. Perhaps the biggest long-term distortion in the housing market came from the tax code: the longstanding deduction for mortgage interest, which encouraged overinvestment in real estate.

``In short, there was plenty of regulation — yet much of it made the problem worse. These laws and institutions should have reined in bank risk while encouraging financial transparency, but did not. This deficiency — not a conscientious laissez-faire policy — is where the Bush administration went wrong.”

We’d like to add the implicit guarantees of Fannie & Freddie Mac and Community Reinvestment Act of 1977-forcible lending to minorities as additional unintended consequences to the present boom bust scenario. Of course as we earlier brought up, the most compelling dynamics of the recent tragedy arose out of the policies to expand credit or money.

At this point, events are proving to be strongly in transition towards our “Mises moment”,

From Ludwig von Mises’ Human Action (highlight mine), ``The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Our “Mises moment” assumes that governments faced with a crisis will run the printing presses to reflate the system at the expense of its currency system.

Why?

Because for governments, credit is the only panacea for any economic or market ailment. This from Ludwig von Mises from Human Action, ``Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.”

“Too big to fail or too interconnected to fail” has been the overwhelming justification for recent government actions to inject massive doses of credit into the global financial system for the implicit aim to stave off a financial meltdown. Of course, with it comes the unintended consequences which will reveal itself overtime.

As for “inflationary” credit expansion, here is a list of the recent activities…

-The US took the Fannie Mae and Freddie Mac into conservatorship ($200 billion).

-The US rescued its largest insurer AIG with an $85 billion in loan package (three-month Libor plus 850bp) collateralized by its assets with the US government assuming 79.99% in equity through warrants and has the right to veto payment of dividends and preferred shareholders in condition that it pay the loans by orderly liquidation of its assets.

-The US through in coordination with global central banks have made available nearly $300 billion ($180 initial and $100 additional) for short term loans (New York Times) see figure 2.

Figure2: Wall Street Journal: US Running the Printing Press To Save the System

-U.S. will insure money-market funds from a backstop of $50 billion from an emergency pool (Exchange Stabilization Fund) against losses for the next year as it seeks to prevent a run on $3.35 trillion of assets that average investors and institutions rely on as a safe alternative to bank deposits. (Bloomberg and Wall Street Journal)

Other prospective courses of actions include the following (From Danske Bank):

“-Setting up an entity that would take bad assets off financial companies’ balance sheets: As in past financial crises the plan is to set up a fund that could take over troubled assets from the balance sheet of financial companies. This is in many ways similar to the RTC fund set up during the savings and loans crisis.

“Such fund would create an investor of last resort in troubled assets and remove the significant black box element from balance sheets of banks. In turn, this should increase downside visibility and thereby confidence among banks.

“-The creation of federal insurance for investors in money market mutual funds: As investors have become increasingly worried about money market mutual funds, otherwise thought off as one of the safest investments, insurance akin to the one currently safeguarding bank deposits could hinder a massive outflow from the money market funds currently under scrutiny

As of this writing, the US Treasury has appealed to its Congress to be granted with $700 billion to buy on a carte blanche basis ``bad mortgage investments from financial companies in what would be an unprecedented government intrusion into the markets.” (Bloomberg)

Will Systemic Socialization Be Successful?

With the US Federal Reserves finally opting to expand its balance sheets, the response from the gold market has been breathtaking as it has been with global equity markets, see figure 3, but to a lesser extent.

Figure3: stockcharts.com: Gold Smells Bloody Inflation!

The extraordinary run up in gold prices comes even in the face of the raising of margin requirements on Comex gold and contracts by 47% and 20% respectively. (Bloomberg) This is another sign of government intervention to halt spiraling precious metals. Notice that the turn in the US dollar index could mark an inflection point.

Again this hasn’t been unexpected since we noted in our June article, Global Financial Markets: US Sneezes, World Catches Cold!, “Maybe if all the above measures cease to work then the last ace for Mr. Bernanke would be to expand the Fed’s balance sheets by printing money or otherwise the US economy could succumb to deflationary recession!”

Obviously with the recent accentuated downside volatility in the equity markets, aside from the freezing of the credit markets, Mr. Bernanke’s (aside from Treasury Secretary Paulson) actions reflected the aura of desperation enough to utilize their last ace; the shifting role of the US Federal Reserve from a lender of last resort to a BUYER of last resort or the socialization of the important aspects of the US financial markets, which was once the embodiment of modern capitalism!

Many have argued that the socialization of the financial sector is needed to save the system. We aren’t so sure.

Why?

-Prohibition of short sales has temporal effects. As we argued in our recent post Will The Proposed Ban of Short Sales Support Global Markets?, a ban of short sales is a form of price control which inhibits price discovery and leads to even more inefficient and volatile markets. Instead, since socialization seems to be the thrust why not simply ban the stock market altogether?

-It is unlikely for the US to save the entire banking industry or let alone the $47 trillion debt markets.

-Government will essentially compete with private funds for financing affected or bailed out or “nationalized” institutions. Aside from the risk of driving up interest rates, it could lead to more inefficiency in capital allocation within the economy resulting to a loss of productivity.

-Since the US government is entirely reliant on foreign financing (about $2 billion per day), it may be at the risk of having difficulty to borrow or raise money for its funding requirements.

As an example, just last week even when US treasury yields where at historic lows from the credit seizure, credit default swaps (CDS) on US treasuries rose to its highest level! From Reuters, ``Credit default swaps on 10-year Treasury debt widened to a fresh high of 27.9 basis points from 27.7 basis points late on Thursday, according to CMA, a specialised data provider.”

Figure 4: Casey Research: Foreigners Pull Plug on Dollar Recycling?

The Fannie and Freddie debacle led to an outflow or significant sales in agency holdings by major foreign public and private institutions last July (CBS marketwatch). Although some portion of the sales had been offset by inflows into US treasuries, which seemed as the only asset the foreigners were willing to buy, aside from the reduced net purchases of foreign assets by US residents, which equally reflected the forcible liquidations abroad, it wasn’t enough to account for to reverse the net outflows.

Overall, in times of heightened risk aversion, state owned Sovereign Wealth Funds or central banks don’t seem to be totally immune to the previous conventional pursuit of the acquiring US dollar assets (or recycling dollars) for political objectives as seen in Figure 4.

What this means?

It raises the risk of the skepticism over the viability of the “full faith and credit” upon which the US dollar and the world’s monetary system has been founded upon.

While we are seeing some participation of forex currency reserve rich countries as China in the ongoing negotiation to acquire distressed US financial companies as the brewing CIC-Wachovia- Morgan Stanley deal (newsdaily.com), it isn’t clear that the previous incentives for foreign financing will always remain the same.

Besides, it would necessitate a substantial portion of the US assets to be acquired by foreign investors, if the present system is to be maintained, which implies a shift in the balance of geopolitical power.

Yet, we appear to be seeing some signs of cracks on the seemingly inexorable faith over the US dollar system…

From the New York Times (highlight mine),

``The nonstop deluge of bad publicity for American investments seems to be seeping into the consciousnesses of the rich and middle class across Asia.

“I do not believe in U.S. financial institutions anymore; I don’t think any U.S. bank is safe anymore,” said Wang Xiao-ning, a Hong Kong homemaker. Even after the Federal Reserve had taken control of A.I.G., she waited in line with dozens of other anxious policyholders at one of the insurer’s customer service centers for the chance to close her investment account….

``Changing Asian sentiments have not yet eroded the value of the dollar — although market reaction to the A.I.G. bailout seemed to be doing that Wednesday. Asian skittishness has coincided with heavy selling by Americans of their holdings of stocks and bonds in foreign markets.

``“It’s almost a case of everyone bringing money back home,” Americans and Asians, said Ben Simpfendorfer, an economist in the Hong Kong office of Royal Bank of Scotland.”

This implies that the US has been more at the urgency to bring home its currency enough to have prompted for the recent US dollar rally, which evidently had been indications of the deleveraging process.

However, as Asians may become more skeptical, they could begin entertain the idea of possibly reallocating more of their investments to ex-US dollar denominated investments or tangible assets, albeit the alternatives aren’t large and liquid enough.

For Asians to withhold if not abandon the US markets in exchange for other potential markets would be a disaster for the US.

And it is not just in the financial world but also seen in migration flows.

From AsianInvestor.net, “We are seeing not only ethnic Asians seeking to return to Asia from Europe and the US, but also professionals without any personal link to Asia,” says Executive Access’ Eisenbeiss. “Asian markets still offer more opportunities than elsewhere for selected, experienced professionals.”

Does this represent an unwarranted concern? Not if you ask New York Mayor Michael Bloomberg, from Hedgeco.net, ``"Who’s buying our debt? It’s these overseas funds, these sovereign-wealth funds, these overseas hedge funds. They are in trouble now. So it’s not clear who is going to be buying" US Treasury bills, he said.”

Some Mises Moment Scenario

So what do we see from the Mises moment?

More US assets will probably be acquired by foreign institutions unless the US government resorts to increased financial protectionism. Yet there is could be a political policy dilemma over the prospective crossborder acquisitions of key US industries, as Brad Setser rightly points out ``Bailing out US banks is one thing. Bailout out a Chinese-government-owned US bank is another.” With more of the foreign buying of US distressed assets, the balance of geopolitical power would have clearly shifted. Yet if state owned institutions were to take such a lead role then, we could be seeing nationalization of US assets from governments abroad.

It is likely too that on the account of massive dosages of central bank money for rescue programs, the prospects of “higher inflation” could be signaled by the continued rise in gold and precious metals.

Furthermore, the US dollar may be pressured from government instituted policies that is likely to weigh on the fiscal equation. We cannot compare the past experience of nationalizations simply because the scale of government intervention will likely be the largest the world has ever seen.

With government weighing in heavily on the markets, the rules have been changing almost daily to the point of triggering credit events for CDS, which means even more losses.

Now, if the degree of US financials systemic losses are much more than anticipated by the regulators, then I think the appropriate question to ask is, who will then bail out the US treasury and the US Federal Reserve?