Tag Archives: Lehman Brothers

Europe: A Lehman Collapse in Slow Motion, Former Lehman Banker Says

Former derivative trader at Lehman Brothers and founder of Re-Define, Sony Kapoor, has been trying for years to explain to European governments how they can handle the financial crisis and create a new sustainable economy – on both national and international level. But  sadly they don’t seem to have been listening to the experienced financial expert. In a recent published article it seems like Mr. Kapoor is about to give up on the whole euro zone and its politicians.

“Instead of reacting decisively to reduce uncertainty, our political leaders have done the exact opposite.”

Sony Kapoor


“When Lehman Brothers collapsed, no one knew which bank would be next. Counter-parties lost faith in all measures of the soundness of banks. Under such a scenario, the only course of action that made sense was to hold one’s money close to the chest. This individually rational response was collectively disastrous. The uncertainty around the size and distribution of potential losses led to systemic collapse. Something similar has been unfolding in the euro zone banking and sovereign debt crisis albeit in slow motion,” Mr. Kapoor writes.

I first met Sony Kapoor about three years ago, a few months after the historical bankruptcy at Lehman Brothers, as he was working on setting up the headquarter for his international think-tank, Re-Define, in Oslo, Norway.

Kapoor had left Lehman Brothers in 2005, because, he said, felt uncomfortable with the things he was doing at Lehman.

Sony Kapoor has been the Director of Policy & Advocacy with Stamp out Poverty (UK), Strategy Advisor to Oxfam Novib (Netherlands), Senior Advisor to Christian Aid (UK) & the Jubilee Network (USA).

He is also a former Member of the Boards of Directors of Eurodad (European Network on Debt and Development) and the International Tax Justice Network which he also helped set up.

He played a leading policy and advocacy role in the multilateral debt cancellation deal reached in 2005, recently he has been an influential voice in shaping the discussion on innovative sources of financing, and helped driving the international agenda on tackling capital flight and tax havens.

As I introduced him to leading Norwegian market participants, we both agreed that a new global financial and monetary system is urgently needed. Mr. Kapoor had already been acting as a consultant for several European governments, and seemed optimistic about future.

(You may want to read his comprehensive – 112 pages – analysis of the financial crisis; “The Financial Crisis – Causes & Cures”)

It is therefore with some sadness I publish his recent commentary, in which he points out that the politicians of Europe have done exactly the opposite of what they should have done, and completely dismissed his advise.

He says it’s like watching the collapse of his former employer all over again – only this time in slow motion.

Anyway – here’s the full post, called:

The Shadow Fiscal Union

The failure to draw a line under the crisis has meant that the continuing uncertainty around the size and distribution of losses in the euro zone is hemorrhaging our economy.

The size of this deadweight economic loss, with all its human cost, is increasing with every additional day of inaction.

Political dithering and mixed messages have ensured that no one knows how, when or where these losses will materialize.

Under these circumstances, it is rational for investors to keep their distance.

They are penalizing both sovereigns exposed to weak financial institutions and financial institutions exposed to troubled sovereigns.

They assume the worst for both, but this collective fear is far in excess of the worst possible realistic economic outcome.

Increased Human Costs

States and banks with healthier balance sheets have got caught in the crossfire.

Instead of reacting decisively to reduce uncertainty, our political leaders have done the exact opposite.

Their continuing dithering has increased the absolute economic and human cost of the crisis.

“Mixed messages, a seeming lack of competence and a decision to focus on issues such as competitiveness that at best tangential to crisis resolution today have increased uncertainty with grave economic consequences.”

This is bad economics.

Euro-federalists have suggested everything from minimalist E-bonds to a complete fiscal union. At the other end, some skeptics have even called for kicking troubled countries out of the euro zone.

Political expediency and economic logic rules out any break-up of the euro zone, and political stalemate and public opinion stand in the way of a fully fledged fiscal union.

Our political leaders have instead chosen to gamble taxpayer funds with abandon.

They are taking on ever-increasing amounts of liabilities on public balance sheets in the EU.

This happened not just when countries rescued their banks the first time round and again when a deteriorating situation in Greece led to a ‘rescue package’ for Greece. This was less a bailout of the Greek sovereign but more an indirect bailout of banks in Germany and France exposed to Greek bonds.

Ireland, having foolishly issued guarantees for its financial sector, was forced by the ECB and the EU to honor these with the consequence that an otherwise sound Irish sovereign was dragged down by its hemorrhaging banking system. Bondholders have been made whole.

Taxpayers are being made to pay.

A Shadow Fiscal Union

The loans provided to Greece, the ECB’s purchase of Euro zone sovereign bonds, and the creation of the European Financial Stability Mechanism (EFSM), have all shifted the risk of losses from creditors to the taxpayers of troubled member states underwritten by the taxpayers of member states with more sound finances.

An opaque “shadow fiscal union” has been created but no one bothered asking the voters.

“The official discourse is that both creditors and taxpayers from countries such as Germany will be fully repaid in time. Since this is not possible, this public stance is irresponsible and probably dishonest.#

With debt burdens bigger than their economies, and growth rates below or close to zero and skyrocketing borrowing costs, the only choice for Greece and Ireland will be to restructure outstanding debts by rescheduling or imposing significant haircuts on creditors.

“Creditor losses are likely to run into tens of billions (hundreds if Spain and Portugal also seek aid) of Euros.”

When they hit taxpayers in Germany and France, it will be a serious body blow to the eroding trust that EU citizens have in their leaders.

Bad Economics – Bad Politics

Even more important, it would also poison member states’ relations with each other, perhaps irreparably.

“Losses at the ECB will damage its credibility inflicting additional damage to the Euro project.”

This is bad politics.

Delaying this inevitable restructuring of Greek and Irish will simply increase the losses to EU taxpayers.

Too much has already been given away to creditors and too much has already been taken away from taxpayers.

Let the March summit signal the end of the era of bad economics and bad politics.

By Sony Kapoor

Managing Director

Re-Define

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IMF Update: The Recovery Continues (We Hope…)

The International Monetary Fund (IMF) is out with its first update on the global economy this year. Reading through the report, it seems like the IMF is trying to convince, primary themselves, that an economic recovery is just around the corner. The cold facts, however, don’t give any conclusive answer – the charts looks more like a flat-line on an EKG monitor.

“Financial stresses, however, are expected to remain elevated in the periphery of the euro area, where market participants are still concerned about sovereign and banking risk, the political feasibility of current and envisioned austerity measures, and the lack of a comprehensive solution.”

International Monetary Fund


Well, I don’t think anyone can blame the IMF for being uncertain about the world economic outlook. Most experts, including the US Federal Reserve, is. In its latest update, the IMF points to the fact that it is substantial differences in the economic conditions from region to region, and from nation to nation. The main message, however, seems to that the downside risks has increased since the last report in October 2010.

The report “World Economic Outlook Update – January 2011” was released at 3 AM (EDT) this morning.

At the moment it’s being dissected by economist and analysts, hunting for clues to what may be in store for them in the months to come.

I don’t think they will find much, thou. Looking at the projected development of the global economy in 2011 and 2012, it shows an almost totally flat line.

Here’s the report’s executive summary:

“The two-speed recovery continues. In advanced economies, activity has moderated less than expected, but growth remains subdued, unemployment is still high, and renewed stresses in the euro area periphery are contributing to downside risks. In many emerging economies, activity remains buoyant, inflation pressures are emerging, and there are now some signs of overheating, driven in part by strong capital inflows. Most developing countries, particularly in sub-Saharan Africa, are also growing strongly. Global output is projected to expand by 4½ percent in 2011 (Table 1 and Figure 1), an upward revision of about ¼ percentage point relative to the October 2010 World Economic Outlook (WEO). This reflects stronger-than-expected activity in the second half of 2010 as well as new policy initiatives in the United States that will boost activity this year. But downside risks to the recovery remain elevated. The most urgent requirements for robust recovery are comprehensive and rapid actions to overcome sovereign and financial troubles in the euro area and policies to redress fiscal imbalances and to repair and reform financial systems in advanced economies more generally. These need to be complemented with policies that keep overheating pressures in check and facilitate external re-balancing in key emerging economies.”

Now, let’s see:

  • “comprehensive and rapid actions”
  • “policies to redress fiscal imbalances”
  • “reform financial systems”
  • “keep overheating pressures in check”
  • “facilitate external re-balancing in key emerging economies”

I’m afraid the IMF is severely overestimating the European governments ability come up with, and agree on, common solutions.

And these recent economic indicators seems to be pointing in the wrong direction.

So, we better have a closer look at the IMF’s alternative scenario, which is pretty much the same as decried in their last report – WEO October 2010.

“The scenario—which is broadly similar to the one presented in the July 2010 WEO Update— assumes that a large shock followed by insufficiently rapid and strong policy action results in significant losses on securities and credit in the euro area periphery. This causes capital ratios to fall substantially in several countries, both in the periphery and the core.”

“Under such a scenario, European banks tighten lending conditions by a similar magnitude as during the collapse of Lehman Brothers in 2008. As a result, euro area growth is reduced by about 2½ percentage points relative to the baseline. Assuming that financial spillovers to the rest of the world are limited – with the increase in bank-lending tightness in the United States about half that in Europe – global growth in 2011 is lower by about 1 percentage point than in the baseline. But if financial contagion to the rest of the world is more severe – resulting in a spike in generalized risk aversion, a drying up of liquidity, and sharp falls in equity markets – the impact on global growth would be substantially larger, amplified by balance sheet weaknesses in other major advanced economies.”

Another Lehman-shock, hu?

Personally, I would not be surprised. Even the IMF has figured out that the financial sector is still in deep trouble, in spite of what the big-bank CEO’s might say.

“The risk of financial turmoil spreading from the periphery to the core of Europe is a by-product of continuing weakness among financial institutions in many of the region’s advanced economies, and a lack of transparency about their exposures. As a result, financial institutions and sovereigns are closely linked, with spillovers between the two sectors occurring in both directions. Although the periphery accounts for only a small portion of the euro area’s overall output and trade, substantial financial linkages with countries in the core, as well as financial spillovers through higher risk aversion and lower equity prices, could generate a slowdown in growth and demand that would hinder the global recovery. In particular, continued market pressures could result in serious funding pressures for major banks and sovereigns, increasing the likelihood that problems spill over to core countries. Figure 4 presents an alternative scenario that illustrates how larger spillovers can subtract from growth.”

Jepp, we can see that….the banks will – under IMF’s alternative scenario – completely stop lending money.

Hey, Ben! May we have another QE, please?

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Here’s a copy of the report.

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European Debt Chaos Sends Chills Through Credit Markets

A bundle of negative news caused the sovereigns to continue to underperform on Monday, compared to the broader market. The difference between the Markit iTraxx SovX Western Europe and the Markit iTraxx Europe is now over 60bp, a new record. Ireland’s CDS spreads are back up above the 500bp level, close to an all-time-high.

“Bondholders could now face interest holidays and haircuts on their sovereign holdings.”

Gavan Nolan


Heightened concerns over the peripheral euro zone sovereigns helped temper any gains from better than expected economic leading indicators. The EU agreement last Friday, driven by Germany, which “bails-in” bondholders has shaken the sovereign debt markets.

“Bondholders could now face interest holidays and haircuts on their sovereign holdings,” credit analyst Gavan Nolan writes in today’s Markit Intraday Alert.

“The consensus in the market seems to be that the permanent restructuring mechanism will be implemented after the EFSF expires in three years time,” Gavan points out.

Adding that this was not the only factor pushing sovereign spreads wider.

“A plethora of stories emerged over the weekend that did nothing to help sentiment.”

The negative news flow ranged from peripheral banks increased dependence on ECB funding; an article in the Irish Independent suggesting that Ireland could be forced in the hands of the IMF if the upcoming budget isn’t approved.

Greece’s deputy prime minister made another hilarious attempt to reassure the world that “everything is fine” ny  stating that “demonizing debt restructuring is wrong”.

“The swathe of negative news led to sovereigns continuing to underperform the broader market; even Portugal‘s two main parties reaching a compromise on the budget had negligible positive effect,” Gavan Nolan at Markit comments.

The basis between the Markit iTraxx SovX Western Europe and the Markit iTraxx Europe is now over 60bp, a new record.

Ireland’s spreads are  back above the 500bp level, close to a historic all-time-high.

“The sovereign situation had a dampening effect on a market becalmed by European holidays,” Nolan notes.

Leading indicators produced by Markit and the ISM pointed towards a global economy in recovery.

The Markit/HSBC China Manufacturing PMI came in better than expected, and the expansion was driven by domestic demand rather than the usual exports.

Here’s a copy of the report.

In contrast, however, the consensus beating Markit/CIPS UK Manufacturing PMI was underpinned by growth in exports.

According to Markit is this an “encouraging sign” for the British coalition government.

Monday afternoon day the ISM manufacturing survey came in higher than expectations, but with little impact on the credit markets in Europe.

The Ghost of Crisis Past

Remember the monoliner Ambac?

One of the worlds largest isurers of corporate debt (including financial companies) that was on the edge of collapse in the middle of the 2008-turmoil – an event that could have caused even greater pain than Lehman Brothers did.

Well, now Ambac seems to be in trouble again.

The insurance company reportedly skipped a $2.8 million bond payment today in contemplation of a potential bankruptcy filing; the company believes the move will provide leverage in negotiation with creditors towards a prepack filing; the payment has a 30 day grace period.

Complicating a potential restructuring are: $7 billion in earlier operating losses which has a tax benefit for future income as long as there is not a change of control and Ambac’s operating subsidiary which is under the auspices of the Wisconsin courts and the Wisconsin insurance regulator.

According to Markit, Ambac’s 5-years CDS is now at 75 basis points ($7.5 million upfront + $500,000 running per annum on $10 million notional).

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