Thursday, August 30, 2007

Philippine economic growth surges in Q2 2007

From the Financial Times this morning:

Philippine economic growth surges in Q2

By Roel Landingin in Manila

Published: August 30 2007 04:25 | Last updated: August 30 2007 06:17

The Philippine economy grew at its fastest pace in two decades in the second quarter, spurred by a surge in government outlays for the elections in May and infrastructure projects, and higher overseas remittances that boosted household spending.

Officials said gross domestic product expanded 7.5 per cent in the three months to June 30 from the same period last year. Analysts’ forecasts had ranged from 6.3 to 6.9 per cent.

The economy grew by a revised 7.1 per cent in the first quarter, bringing growth for the first half of the year to 7.3 per cent. Last year, GDP expanded by 5.5 per cent.

The stock market was up 3.4 per cent as of noon on the news, while the peso rose to 46.66 per US dollar against Wednesday’s close of 46.83.

Economic planners said the economy was poised to exceed the government’s full-year growth target of 6.1-6.7 per cent. “Hitting seven per cent is not impossible,” said Augusto Santos, the temporary economic planning secretary.

The strong growth figures are a big boost to president Gloria Macapagal Arroyo, who has vowed to create one million jobs a year and cut the poverty rate from 33 per cent in 2003 to below 20 per cent when her term ends in 2010. She is battling low popularity ratings and continuing doubts about the transparency of her May 2004 poll victory.

She said the latest numbers showed that growth can be sustained over the next three years. “We’re the only administration that has not experienced negative growth in any quarter. The regular boom and bust cycle is three years, but it has not happened to us,” she said.

Government spending surged 13.5 per cent in the second quarter, compared with just 3.3 per cent in the same period last year. Officials cited fund outlays in preparation for May’s legislative and local government polls.

Spending on public construction soared 39.6 per cent, versus 11.8 per cent a year ago, as the government stepped up implementation of infrastructure projects that had stalled due to lack of money. The imposition of new and higher taxes in 2006 boosted government revenues by more than a fifth last year and slashed the budget deficit.

Remittances from the more than 8m Filipinos living and working abroad rose 7.8 per cent from a year ago in the second quarter, compared to only 4.8 per cent the previous year. That helped boost household spending, which makes up 70 per cent of GDP

Analysts said the robust first-half growth may encourage the central bank to refrain from adjusting policy rates. Frederic Neumann, regional economist as HSBC, said: “Today’s data on balance reduces the chance of imminent easing by the Bangko Sentral ng Pilipinas as strong domestic demand growth raises the risk that inflation will pick up more quickly than expected.”

Wednesday, August 29, 2007

Currency Charts

Czech Koruna - US Dollar Cross

Romania Leu- US Dollar Cross

Forint-US Dollar Cross

Polish Zloty-US Dollar Cross

Turkish Lira-US Dollar Cross

House prices in Bulgaria “set to rocket”

From the BBJ today:

House prices in Bulgaria “set to rocket”

House prices in Bulgaria have risen by 27% in the past 12 months and are set to rocket further, according to the latest issue of Quest Bulgaria magazine.

The September issue of the leading independent English language magazine for people living or buying in Bulgaria, says the latest forecast shows price increases of 20% this year. A steady stream of investors has made sure the Bulgarian property market is maintaining it's dynamic position. The country's National Statistics authority says that prices rose 15% in the first six months of 2007 with a 27% increase in the past year. And Address Real Estate, the country’s largest agency, forecast a further increase of 10-15% for the rest of the year.

The cheapest homes, said Chris Goodall, managing director of Quest Bulgaria, are in the region around Sofia where prices are £152 ($306) per square meter - well behind the national average of £347 ($700) per square meter. “This makes the area round Sofia a good bet for investment,” said Goodall. "Demand is moving away from the beach toward both urban and rural properties and is being driven by four factors: the level of foreign investment; the emerging Bulgarian middle classes who want modern apartments; increasing local affluence; and the supply of capital from mortgages. “Those buying property in the countryside are buying attractive village homes. Most of them are foreigners, in general early retirees and families who want to own property and enjoy the low cost of living, along with affluent Bulgarians from Sofia and other cities who are looking for weekend or holiday homes in the best rural areas.” One of the biggest factors affecting affordability is the availability of mortgages and home loans. The Credit Centre, a loans consultancy, says that home loans this year are up by 25% with June mortgage lending outpacing even the historically high December loans.

Bulgaria’s soaring property prices, says Quest Bulgaria, follow the pattern of what has traditionally occurred in other countries following EU accession. But despite this, they remain up to 40% lower than Poland, the Czech Republic and Slovakia.

So where are the hot spots?
Quest Bulgaria says that Sofia is still good - but be wary were you buy in the city; the countryside, in and near the prettiest villages; spa towns for the tourism potential; and Varna, the most western European city in Bulgaria. It warns that Bansko is going down in value with too much development and parts of the coastal belt where there is also over development. But, says Goodall, the top tip for home buyers is to invest in a period property in protected areas such as museum towns and villages. (

Five facts about structured investment vehicles

Structured investment vehicles (SIVs) are the latest investment entities to be hit by the double whammy of declining asset prices and squeezed short-term funding.

On Wednesday, Cheyne Finance, an SIV managed by British hedge fund Cheyne Capital Management, said it was seeking to restructure after it was forced to start selling assets to pay down debt. On Tuesday, Rhinebridge Plc, an SIV managed by Germany's IKB, said it had sold assets and did not expect further liquidity support from IKB or its owners. Following are some facts about SIVs:


SIVs issue commercial paper, medium-term notes and capital and invest the proceeds in a portfolio of diversified assets, aiming to generate returns from the spread between the yield on the portfolio and the cost of funding.


The first SIV was Alpha Finance Corporation, launched by Citibank in 1988. Since then a host of specialised asset managers and banks have set up SIVs. As of July, Moody's Investors Service rated 36 SIVs or SIV hybrids managing assets of $395 billion.


SIVs achieve very high ratings for senior debt, typically at the triple-A level for long-term debt and Prime-1 or A-1+ for short-term debt, in order to benefit from low funding costs; they then invest in a range of mostly investment-grade securities. To do so they are bound by a set of limits on the assets they invest in and their liquidity; there are also tests on the value of the portfolios; and SIVs must report regularly -- at least weekly -- to the ratings agencies.


According to Moody's, as of the end of March the average SIV portfolio was 57.5 percent structured finance, 41 percent financial-sector debt, with the remainder made up of corporate and government securities. Of the exposure, 62.4 percent was Aaa rated, 27.9 percent double-A rated, 8.9 percent single-A rated and just 0.2 percent in the Baa or Ba categories.


If an SIV breaches its major capital loss test, defaults on its debt or becomes insolvent, it enters a mandatory wind-down process whereby assets are sold to pay down debt. SIVs typically have a partial liquidity facility to help achieve an orderly sale process, with cash drawn down to cover near-term liabilities.

Philippine Economic Growth Seen Slowing on Remittances, Exports

In Bloomberg this morning:

Philippine Economic Growth Seen Slowing on Remittances, Exports

Philippine economic growth probably slowed in the second quarter as nationals working abroad sent home less money and exports waned.

The $117 billion Southeast Asian economy grew 6.5 percent from a year earlier, down from 6.9 percent in the first quarter, according to the median estimate of 15 economists in a Bloomberg News survey. The figures are due tomorrow at 10 a.m. in Manila.

``Remittance growth has started slowing down,'' said Frederic Neumann, an economist at HSBC Holdings Plc in Hong Kong. ``Economic growth for the full year won't be as high as expected'' as gains in the peso curb exports.

The government is relying on cash sent home from the one- in-ten Filipinos who work overseas to boost economic growth to as much as 6.7 percent this year, easing poverty in a nation with an average income of $1.66 a day. President Gloria Arroyo has boosted taxes to fund infrastructure needed to attract investors and lessen the nation's reliance on remittances.

The amount of money sent home by overseas nationals, equivalent to a 10th of the economy, grew 13 percent to $3.54 billion in the second quarter from a 24 percent pace in the first three months of the year. Shipments of Philippine-made disk drives, mobile phone chips and other electronics increased 4.2 percent to $12.4 billion, easing from a 9.2 percent gain in the first quarter.

Lower Spending

The pace of economic expansion may have also eased as the government held second-quarter spending at 262 billion pesos ($5.6 billion), 9.3 percent less than in the previous three months. Spending was ``frontloaded'' into the first quarter before restrictions related to elections in May took effect and capped in the second quarter to help contain the budget deficit as revenue growth slowed, Neumann said.

``The Philippines is in a position to cut rates to cushion the domestic economy,'' said Vishnu Varathan, an economist at Forecast Singapore Pte. ``Inflation pressures are not overwhelming and with the slowdown in the U.S., price pressures are easing off.''

Consumer prices rose an average 2.3 percent in the second quarter, close to the lowest pace in seven years. The central bank cut its benchmark interest rate to 6 percent in July, its first reduction in four years.

Borrowing costs may need to be lowered further for the government to meet its growth target as demand cools in the U.S., the Philippines' largest export market.

``Electronics exports are very sensitive'' to currency movements, Neumann said. ``We see increasing migration of electronics production to China.''

Peso Gains

The peso rose 4.3 percent against the dollar in the second quarter, the second-biggest gain among Asia's 10 most-traded currencies. While the peso's climb hurt exports, it curtailed inflation by lowering the cost of imports.

Still, second-quarter growth may have been as high as 6.9 percent, central bank Deputy Governor Diwa Guinigundo said Aug. 23. Campaign spending by politicians and parties for elections in May may have helped the economy, said Jojo Gonzales, managing director at Philippine Equity Partners Inc. in Manila.

``Single-digit growth in remittances may have been compensated by the resilience of the domestic economy; the election, housing and construction, and the markets,'' said Song Seng-Wun, an economist at CIMB-GK Research in Singapore.

Following is a table of economists' estimates for year-on- year and seasonally-adjusted quarter-on-quarter economic growth.

Philippine GDP Estimates
Firm YoY QoQ SA YoY 2007 2008
Median 6.5% 1.0% 6.1% 6.2% 5.8%
Average 6.3% 0.9% 6.1% 6.2% 5.7%
High 6.8% 1.3% 7.0% 6.7% 6.8%
Low 5.4% 0.2% 5.2% 5.1% 4.5%
Number of Estimates 15 10 10 13 12
Action Economics 6.5% 1.0% 6.4% 6.0% 5.0%
ANZ Banking Group 6.7% 1.1% 6.0% 6.3% 4.5%
ATR-Kim Eng Capital Partners 6.4% -- 6.0% 6.5% 6.8%
BDO Unibank 6.0% -- 5.9% 5.9% 6.1%
CIMB-GK Research 6.8% 1.3% 7.0% 6.7% 6.2%
Citi 6.2% 0.7% -- 6.3% --
Economist Intelligence Unit -- -- -- 6.0% 5.5%
Forecast Singapore 6.2% -- 6.1% 5.9% 5.8%
HSBC 6.2% -- 6.1% 6.2% 5.8%
Ideaglobal 6.5% 1.0% -- -- --
ING Groep NV 6.5% 1.0% -- -- --
Lehman Brothers 6.5% -- -- 6.4% 6.5%
Standard Chartered 5.4% 0.2% 5.2% 5.1% 4.5%
Thomson IFR 6.6% 1.1% 6.7% 6.7% 6.0%
UBS 5.7% 0.6% -- -- --
UOB Group 6.6% 1.1% 5.4% 6.0% 5.6%

Tuesday, August 28, 2007

Slovak Central Bank Keeps Rates on Hold

From Bloomberg this morning:

Slovak Central Bank Keeps Rates on Hold for 4th Month

By Radoslav Tomek and Andrea Dudikova

Aug. 28 (Bloomberg) -- The Slovak central bank kept its benchmark interest rate unchanged for a fourth month to cap inflation as the nation prepares to adopt the euro in 2009.

The bank refrained from lowering the 4.25 percent two-week repurchase rate at its monthly meeting today, spokesman Ivan Jurko announced in a conference call with journalists. The decision was predicted by all 18 economists surveyed by Bloomberg. The central bank will hold a press conference at 1:30 p.m. in Bratislava, Slovakia.

Slovakia plans to be the second former communist nation to adopt the euro after Slovenia did so in January. The central bank must keep borrowing costs unchanged in the coming months, following two cuts this year, as risks remain that inflation may spike, economists said.

``The economy is growing at the fastest pace and this will fuel labor-market tensions,'' said Robert Prega, an economist at Tatra Banka AS in Bratislava. ``Inflation is set to rise next year, so there are no reasons for another rate cut.''

An improving inflation outlook prompted the National Bank of Slovakia to trim its benchmark rate by a half-point this year, as policy makers sought to halt the appreciation of the koruna by making money market yields less attractive for foreign investors. The recent weakening of the koruna has removed an argument for another rate cut, Prega said.

Koruna Rate

The koruna was trading at 33.743 against the euro at 12:37 p.m., little changed from the yesterday's close of 33.764. The currency has pared some gains since reaching a record in March, although it is still about 12 percent higher on the year, helping to cut the annual inflation rate.

The central bank expects to meet the inflation test for euro adoption as early as this year, though it needs to maintain a ``very cautious'' monetary policy, board member Peter Sevcovic said after the previous monetary-policy meeting on July 31.

The central bank forecasts the inflation rate will rise to 2 percent next year and 2.5 percent in 2009 from 1.5 percent estimated for December 2007 as price growth will no longer be tamed by koruna's appreciation.

The bank will therefore keep its benchmark rate steady throughout this year and may raise borrowing costs next year, should the ECB lift its two-week rate above the Slovak level, economists said.

Wednesday, August 22, 2007

Migrant workers choosy about jobs

From the FT this morning:

Migrant workers choosy about jobs

By Andrew Taylor, Employment Correspondent

Published: August 22 2007 01:59 | Last updated: August 22 2007 01:59

Further signs that the rising tide of Poles coming to work in Britain may have peaked emerged on Wednesday.

According to the Home Office, the number of workers applying to work in the UK from the A8 countries – the eight eastern and central European nations of the European Union – dipped to 49,500 during the three months to the end of June.

This was almost 2,400 fewer than in the previous three months and almost 7,000 fewer than in the corresponding period last year. The figures record only those registering to work in the UK and do not take account of migrants who have returned home.

Krzysztof Trepczynski, minister-counsellor at the Polish embassy in London, argued last month that many Poles worked for only a short time in the UK before returning. Two-thirds of the 683,000 workers who have applied to work in the UK from A8 countries have come from Poland.

Latest figures showed that eastern and central European migrants had started to move up the jobs chain and were occupying more professional positions.

Some 41 per cent of registered workers applied to work in administration, business or management posts during the latest quarter. This compared with 25 per cent three years ago when Britain opened its job market to A8 workers.

Fruit and vegetable growers warned this week that they were facing a struggle to attract sufficient eastern and central Europeans to harvest their crops because A8 workers had become more choosy about the work they undertook.

According to the Home Office the hospitality industry has accounted for 19 per cent of jobs filled by A8 workers, and agriculture 11 per cent, since 2004.

David Davis, shadow home secretary, claimed the latest figures showed the immigration system was “out of control”. He said numbers of migrants arriving from eastern and central Europe had risen by almost 60,000 in the latest quarter, if Bulgarian and Romanian workers were included.

Bulgarians and Romanians, unlike other EU members, have been given only limited access to British jobs. Mr Davis said the latest figures reinforced Conservative arguments that even tougher restrictions should have been imposed.

He said the government’s original estimate that only 13,000 migrants a year would come from A8 countries had been blown out of the water.

Housing market threatens to hit eurozone growth

From the Financial Times today:

Housing market threatens to hit eurozone growth

By Ralph Atkins and Ivar Simensen in Frankfurt

Published: August 20 2007 03:00 | Last updated: August 20 2007 03:00

Eurozone house price growth is slowing and threatening to act as a brake on the region's economies.

Average house prices in the 13-country eurozone will rise by just 4.3 per cent this year - the slowest pace since the launch of the euro in 1999 - according to forecasts by Barclays Capital, the London-based finance house.

As elsewhere in the world, house prices have soared in many eurozone countries in recent years, driven higher by exceptionally low interest rates that have in turn boosted economic growth. But Spain and France are seeing a striking deceleration. In Ireland, annual growth is likely to grind to a near-standstill this year.

The latest data suggest that the European Central Bank may have underestimated the extent of the housing market slowdown, as well as its implications for future economic growth and interest rate decisions.

This month, the ECB noted that the rate at which house prices were increasing "remains at high levels on average in the euro area", in spite of "some moderation".

But Julian Callow, European economist at Barclays Capital, said higher ECB interest rates - which have risen from 2 per cent at the end of 2005 to 4 per cent - "have had a dramatic impact, just as beforehand cuts in interest rates had a dramatic [positive] impact". Spain and Ireland have proved especially sensitive to changes in borrowing costs, as in both countries variable rate mortgages are widespread.

Clear signs of cooling house markets would weaken the case for further interest rate rises. Mr Callow said the spill-over effects of recent financial market turmoil, which has driven up borrowing costs in Europe, meant that the eurozone housing market "could face further weakness".

But there is little sign of average eurozone house prices crashing and the region's economies are not seen as prone to the difficulties that have struck the US subprime mortgage market.

Barclays Capital's analysis fits with results of the ECB's bank lending survey, released this month, which showed demand for housing loans continuing to deteriorate. Although the weakening in net demand in the second quarter of the year was not as great as in the previous quarter, it remained "significantly negative", the ECB reported. A further deterioration was expected in the third quarter.

The forecasts mirrored anecdotal evidence pointing to a loss of investor enthusiasm for continental European residential property.

"Investments in German residential property portfolios will probably peak this year, after rising steadily from 2004. We expect prices to fall, but not by very much," said Thomas Beyerle, chief strategist at Degi, the property investment management subsidiary of Allianz.

The marked cooling of eurozone housing markets could feed through into slower economic growth through several channels. A decline in residential house building could hit economies such as Spain's, which have boomed on the back of strong construction activity. The number of eurozone construction jobs rose by 400,000 last year and accounted for about a fifth of total employment growth.

Fewer housing market transactions would depress demand for consumer durables - fewer people would be kitting out new homes - and the boost to consumer confidence felt when house prices are rising strongly would disappear.

Eurozone housing markets vary from region to region, and some places may continue to see significant growth. But the long-awaited recovery in Germany still appears some way off, according to the Barclays Capital forecasts. It expects house prices in Europe's largest economy to grow just 0.7 per cent this year, after 0.5 per cent in 2006.

Spain builds inroads into eastern Europe

In the FT today:

Spain builds inroads into eastern Europe

By Leslie Crawford in Madrid

Published: August 22 2007 03:00 | Last updated: August 22 2007 03:00

On the banks of the Danube in Bulgaria, Spanish engineers have begun work on a two-kilometre bridge linking the resort of Vidin to Calafat, its sister town on the Romanian side of the river.

FCC, a Spanish building and infrastructure services group, won the €100m (£68m, $135m) project, to be part-financed by the European Union, against stiff competition from German and French construction groups.

Spanish groups have be-come specialists in big infrastructure projects thanks to 20 years of generous EU support. Since Spain joined the EU in 1986, it has received more than €90bn in European aid to build high-speed train links, dams, bridges, wind parks, sewerage plants and 11,000km of motorways.

But now that the EU bonanza is shifting to east and central Europe - with Spain set to become a net contributor to the EU budget in 2010 - Spanish companies are following the money.

As a result, the bridge over the Danube is not just another project for a budding Spanish multinational; it has become a symbol of what Spain can teach new member states about making the most of EU funds to modernise their economies.

"When I travel to eastern Europe, and see the huge need for infrastructure pro-jects, it reminds me of where Spain was 20 years ago," says José Mayor Oreja, FCC's construction chief.

José Luis de la Torre, who directs FCC's environmental and municipal services division, adds: "Spanish companies are experts at tapping EU funds. We can teach the new member states how to do it. We want them to . . . put the funds available to the best possible use."

Spanish companies are going about this in two ways. Some have established a foothold in the region by acquiring local construction groups. Ferrovial, a big infrastructure conglomerate, was the pioneer, acquiring control of Budimex, Poland's largest listed builder, in 2000. "We saw a country that was similar to ours in size, in population, and with the same huge infrastructure deficit that Spain had prior to joining the EU," says one Ferrovial executive.

FCC, for its part, acquired Alpine, an Austrian builder with a lot of business in eastern Europe, four years ago.

Spanish direct investment in the region has soared since the accession of new EU member states in 2004. Ferrovial has €1.2bn worth of assets in Poland. Telefónica, the Spanish telecommunications group, bought Cesky Telecom in the Czech Republic in 2005. In Hungary, Spaniards have invested €3.5bn since 2004.

Other Spanish groups have set up consultancies that are teaching east European bureaucrats how to navigate the EU labyrinth.

"East Europeans don't think we're arrogant," says one Spanish executive. "Spain doesn't have the historical baggage that Germany has in the region."

In Poland, where Ferrovial has just completed a €200m terminal for Warsaw airport, Spanish groups are concerned by what they regard as a lack of forward planning. Poland is slated to receive €67bn in EU money between 2007 and 2013, but the Warsaw government has yet to publish a master plan that sets out its infrastructure priorities for the period.

"There is a wall of money coming towards Poland," says one Spanish executive. "But without a master plan, much of it will go to waste, or not be tapped at all."

Spanish executives also hope that Warsaw will overcome its suspicion of infrastructure concessions - an area in which Spanish companies have built considerable expertise.

Last year, Ferrovial acquired BAA, the world's biggest airports operator. It also owns toll roads in the US, Spain and Latin America. "Building airport terminals is fine," says one Ferrovial executive, "but we'd much rather be operating concessions."

Tuesday, August 21, 2007

The Lessons Learned from the Asian Financial Crisis

The events that led up to the financial crisis in Asian economies are far too similar to what has been happening in the world’s largest economy, the US. During the 90s, capital was flowing into the region as investors and speculators saw vast opportunity in countries like Thailand, Indonesia, South Korea and the Philippines. For the record, private capital flow amounted close to $100 billion in 1996, equivalent to almost one third of worldwide money, as portfolio equity investment quadrupled within a year. The resulting investment was so enormous that it was comparable to percentages in total gross domestic product.

At the time, the boost in foreign capital subsequently supported expansion in the Asian Tiger economies as the countries were able to attract massive amounts of direct investment, spurred by higher interest rates in order to curb corresponding inflationary pressures. Once again investors turned to credit markets and instruments in boosting up speculation for assets in the region. This helped to support elevated levels in respective stock markets and housing sectors as investors sought rates of return at a cost of a forming bubble. Incidentally, demand was so great speculation led the Philippine stock index to advance by 60 percent in 1995-96 while boosting the Jakarta benchmark higher by 58.5 percent during the same period.

Completely overleveraged and over invested, the region was ripe for disaster as the unthinkable occurred on July 2nd 1997. On that day, the Thai government, a central body who relentlessly promised not to revalue its currency, allowed the Thai baht to float. Now with speculation constituting a majority of the market, sellers were moving faster as buying demand dried up leaving some in the market holding massive losses. The tragedy didn’t stop there as the effects were far reaching. Beginning in Southeast Asia, the contagion effect spread throughout the global markets as regional and benchmark indexes went down like dominoes. Although the effect was reduced to a more mild “Asian flu” by the time it landed in America, the damage could also seen in the Dow Industrials, which was severely hit by a 554 point plunge on October 27th. The loss equated to 7.2 percent as the New York Stock Exchange briefly halted trading amidst the panic. In the currency markets, no currency pair can capture the visual display as perfectly as shown in the downturn in USDJPY. Shortly after the contagion effect and impending exodus of risky loving speculators, the pair was rocked lower on grounds of a carry trade exit. In a matter of a week and a half, the USDJPY fell almost 1500 pips to a hard landing at 114.00.

Turkish Lira Leads Eastern Europe's Currencies Lower on Risk

From Bloomberg today:

Turkish Lira Leads Eastern Europe's Currencies Lower on Risk

By Yon Pulkrabek

Aug. 21 (Bloomberg) -- Central and eastern Europe's currencies dropped as further evidence the U.S. subprime crisis is spreading deterred investors from riskier assets.

The Turkish lira led Poland's zloty and Hungary's forint lower against the dollar and euro as the NTX Index of stocks in the region's 30 biggest companies fell, alongside bourses in Istanbul, Warsaw and Budapest. The currencies rebounded Aug. 17 after the Federal Reserve cut the rate at which it lends directly to banks.

``What the Fed did on Friday is not going to alleviate the situation,'' said Nigel Rendell, an emerging-market currency strategist in London at Calyon, the investment banking arm of Credit Agricole SA. ``People are reassessing their positions.''

Turkey's lira snapped two days of gains against the dollar, falling to 1.3613 by 5:26 p.m. in Istanbul, from 1.3507 yesterday.

Turkish government bonds declined along with the currency, with ABN Amro NV's yield index rising for the first day in three. Yields move inversely to bond prices. JPMorgan Securities Inc. said it sold Turkish bonds and lowered its recommendation on the debt, according to a note to clients.

The Fed unexpectedly cut its so-called discount rate by half a percentage point to 5.75 percent to calm fears the credit turmoil is infecting the wider economy.

Against the euro, the zloty dropped to a more than two-month low and recently traded at 3.8508, from 3.8359 yesterday. The forint slid to 261.45 per euro from 259.04.

The Romanian leu dropped to 3.2843 against the single European currency, touching a two-month low, from 3.2566 Aug. 20.

The Czech koruna fell to 27.648 versus the euro, from 27.562. Lawmakers today approved a plan to restructure the tax system and cut spending to rein in the budget deficit.

In the region's bond market, the yield on the 6 percent Hungarian note due October 2011 rose 6 basis points to 7.23 percent, while the yield on Poland's 4.25 percent security due May 2011 rose 5 basis points to 5.67 percent.

Russia's July Unemployment Rate Falls to Record-Low 5.8 Percent

In Bloomberg today:

Russia's July Unemployment Rate Falls to Record-Low 5.8 Percent

By Maria Levitov

Aug. 21 (Bloomberg) -- Russia's unemployment rate fell in July to a record-low 5.8 percent as economic growth fuels the need for new workers.

The unemployment rate fell from 6.7 percent in June, the Moscow-based Federal Statistics Service said in an e-mailed statement today. The median forecast of 11 economists surveyed by Bloomberg was for a 6.7 percent rate.

Russia's economy, the world's 10th biggest, is expanding for a ninth consecutive year, boosted by revenue from oil and gas sales. The economy will probably expand at least 7 percent this year, compared with 6.7 percent in 2006, government officials have said.

The average monthly wage increased an annual 15.4 percent in July to reach a monthly average of 13,575 rubles ($523.81), the statistics office said. Real disposable income increased 15.5 percent, it said.

Russian Inflation Rate Rises to 8.7% in July

In Bloomberg This Morning:

Russian Inflation Rate Rises to 8.7% in July, Highest This Year

By Maria Levitov

Aug. 21 (Bloomberg) -- Russia's annual inflation rate rose in July to 8.7 percent, the highest level since December.

The rate rose from 8.5 percent in June, the Moscow-based Federal Statistics Service said in an e-mailed statement today. The median forecast of 14 economists surveyed by Bloomberg was for an 8.9 percent rate. Consumer prices rose a monthly 0.9 percent.

Russia, the world's largest energy exporter, has the highest inflation rate of any Group of Eight nation and is struggling to bring inflation down to Western European levels. The government aims to contain inflation at 8 percent this year, below the 9 percent rate in 2006.

German skills gap costs €20bn

From the FT today:

German skills gap costs €20bn

By Bertrand Benoit in Berlin

Published: August 20 2007 19:06 | Last updated: August 20 2007 19:06

Germany’s chronic skills shortage is costing its economy up to €20bn ($27bn, £13.6bn) a year, or one percentage point of gross domestic product, according to a study commissioned by the economics ministry.

The failure of Germany’s education system to foster skills required by its fast-growing export industry could inflict “long-term damage” to Europe’s largest economy, Michael Glos, economics minister, said on Monday.

The publication, the first attempt at putting a price on Germany’s skills bottleneck, comes as the cabinet of chancellor Angela Merkel is preparing to meet at Meseberg, north of Berlin, on Thursday for its two-day mid-term conclave.

Government officials said the “grand coalition” of Christian and Social Democrats had agreed on a “national qualification offensive” aimed at addressing the skills problem.

This matched proposals unveiled by Mr Glos on Monday, including more public and private spending on education and closer co-operation between business and academia. He also urged universities to adapt to the market’s requirements and companies to hire more women, older workers and foreigners living in Germany.

The minister was cautious in advocating more immigration, however, reflecting concern among the ruling parties about the vote-losing potential of opening Germany’s tight borders.

Currently, non-EU residents who wish to work in Germany must have a yearly income of €80,000. Germany also has the toughest restrictions in the European Union on citizens from new member states.

The skills shortage has become a source of tension between business and politics. While the large industry federations have called for a relaxation of Germany’s immigration laws, politicians have accused companies of preferring cheap foreign labour over costly in-house training.

“There is no short-term solution to this problem,” said Oliver Koppel, economist a the IW Institute on the German Economy and author of the study. “The eastern European graduates who would have come a few years ago are all in the UK and the US now.”

Even there, there is little the federal government can do directly to boost university budgets since education falls within the remit of 16 state governments.

Mr Koppel’s study was based on a survey of 2,400 companies, about 85 per cent of which have returned their questionnaires. The cost of the skills shortage was calculated by multiplying the number of unfilled vacancies by a worker’s average contribution to Germany’s GDP.

Though the estimate of €20bn might appear high, he said, the figure reflected only direct costs. “There are a range of indirect costs too that we did not take into account.”

The survey showed the drought of engineers, natural scientists and programmers was acute in sectors with high research and development budgets.

Carmakers, capital goods manufacturers and electronics companies, some of Germany’s best export sectors, were among the most affected.

Berlin Cracks Immigrant Door


BERLIN -- Germany is taking baby steps to relax its tough restrictions on immigration as growing shortages of skilled labor force many European countries to compete for migrant workers.

Complaints from businesses that they can't find enough qualified staff -- especially in the engineering sector -- are pushing Europe's largest economy to rethink its reluctance to admit foreign workers. Chancellor Angela Merkel said Friday that her cabinet had agreed to let companies hire more engineers from European Union countries in Eastern Europe.

But Germany plans to keep a lid on the number of Eastern European migrants in other sectors, maintaining restrictions that have been in place since Poland and seven other ex-communist countries joined the EU in 2004. In contrast, other established EU countries such as the United Kingdom and Ireland opened their doors to workers from the East. The influx of workers is widely judged to have boosted their economies.

Germany, like many European countries, is torn between the economic case for more immigration and an attachment to the traditional idea of an ethnically homogeneous nation-state. For years, German politicians on the left and right have assured voters that Germany wasn't a country of mass immigration -- even though the country has gone through periods of letting in millions of foreigners. Even when large numbers of Turks settled in postwar West Germany, most Germans assumed these "guest workers" would return home.

"Germany is struggling to accept the idea of diversity in society," says David Audretsch, an American who heads the Max Planck Institute of Economics in Jena, Germany. But countries that open up to people with different backgrounds and experiences are likely to fare better in the global economy than countries that try to stay homogeneous, he says.

During the 1990s, Germany had Europe's highest immigration rate, partly because it opened its doors to asylum seekers and ethnic Germans from Eastern Europe. About 13% of today's German population was born abroad -- the same proportion as in the U.S., according to the Organization for Economic Cooperation and Development.

But in recent years, immigration has slowed amid bureaucratic restrictions, while an increasing number of Germans are moving abroad. Net immigration in Germany fell to 80,000 in 2005, compared with 270,000 in 2001.

In contrast, countries including the U.K., Ireland and Spain have absorbed huge numbers of immigrants in recent years, which many economists credit with boosting growth and living standards for the native population.

Others contend competition from immigrants depresses wages of lower-skilled workers. In the past few years, much of the debate over immigration in Europe has focused on how to better integrate immigrants and their children into society. Riots in France and the U.K. and problems at German schools have highlighted social exclusion among ethnic minorities.

Terrorism by militant Islamists, including the Hamburg students who took part in the Sept. 11, 2001, attacks on the U.S., have made many Europeans mistrustful of their Muslim minorities, adding to the unpopularity of allowing more immigration.

European policy makers also must address illegal immigration. Boatloads of destitute migrants -- often smuggled by criminal gangs to Europe's Mediterranean shoreline -- are common. On the other hand, many Europeans see immigration as one of the steps needed to ease future labor shortages that will afflict Europe's aging societies, together with improving low employment rates in certain parts of the native population.

"By 2015 at the latest, our replacement needs will be bigger than our domestic supply of newly qualified workers," says Volker Treier, skills adviser at the German Chambers of Industry and Commerce.

Pressure for more immigration is compounded by an unexpectedly strong boom in German manufacturing, fueled by surging global demand for capital goods. A survey for Germany's Economics Ministry by the Cologne Institute for Economic Research found that last year German firms were unable to fill about 110,000 job vacancies for lack of qualified candidates. The study's author, Oliver Koppel, estimates the skills shortage, concentrated in engineering and information technology, cost the economy €20 billion, or about $27 billion.

Yet German Economics Minister Michael Glos, who unveiled the study last week, stopped short of calling for more immigration. Instead, the government focused on the need to train citizens better for the labor market, which Ms. Merkel said on Friday was a higher priority than immigration.

Among the members of Ms. Merkel's cabinet, only Education Minister Annette Schavan recently has called for further relaxation of immigration rules. "Improving education and strengthening immigration aren't alternatives," she said in June. "We need both."

Ms. Schavan called for Germany to relax one particularly onerous rule that German business chafes at: Firms can recruit highly skilled workers from abroad only if they pay them at least €85,000 a year. But other ministers overruled her, and last week the cabinet agreed to only one change: Beginning in November, companies hiring mechanical and electrical engineers from new EU countries in Eastern Europe will no longer have to go through a long bureaucratic process to prove there is no suitable German candidate for the job.

"Minimal steps are not enough," says Hartfrid Wolff, immigration spokesman for Germany's pro-business Free Democratic Party. Under EU law, Germany will have to drop its restrictions on East European EU citizens by 2011 at the latest -- so it might as well do so now and reap the benefits, he says.

In another measure to protect Germany against unwanted foreign intrusion, Ms. Merkel reiterated Friday that her government is working on ways to stop investors backed by foreign governments from taking over German companies in sensitive sectors -- a concern Germany has expressed in recent months against a background of the growing influence of state-backed investment funds from emerging economic powers such as Russia and China.

Germany eases restrictions on skilled workers from Eastern EU

BERLIN: In a major shift in policy, the German government announced Friday that it would ease labor restrictions for skilled workers from East European members of the EU in an effort to overcome serious shortages in its own key economic sectors.

The announcement, made by Chancellor Angela Merkel after a two-day closed session of her cabinet that set out the government's agenda for the remaining two years of its four-year term, reflects the potential crisis faced by German industry.

That industry, the world leader in exports, has repeatedly complained about the lack of skilled labor, outdated training programs, high labor costs and the falling birth rate. Universities are short of professors and other senior teaching professionals in a country where college education is largely free but hampered by undergraduate terms that last up to six years.

Merkel said the new plan would meet the concerns of industry and help to maintain Germany's competitive edge despite the immense competition coming from China.

The decision to open up the labor market to the EU's Eastern countries represents a turnaround by the German government. In 2004, just before 10 new countries from Eastern Europe were about to join the EU, Berlin imposed restrictions, lasting up to seven years, on allowing citizens from the new member states to work in Germany.

This is despite the fact that the free movement of labor is one of the fundamental rights enshrined in EU law. Germany argued at the time that a big influx of labor from the new member states would destabilize the labor market.

The reality is that German industry, hotels and services have faced immense pressure from the lower labor costs in Poland. The German Finance Ministry said there was a thriving black economy in Germany while at the same time German companies used Polish services in Poland so as to keep costs down.

The labor plan, agreed to by the coalition of conservatives and Social Democrats, means that in the short term, electrical and mechanical engineers from the East European and Balkan countries that joined the EU over the past three years will be able to start working in Germany as early as next November.

With so many skilled workers already having left Eastern Europe, however, the new measure is not expected to open the floodgates to large number of immigrants. Given the labor shortage in Germany, those who will be hired by industry here are not expected to undermine local wages.

The countries involved include the three Baltic States of Estonia, Latvia and Lithuania, as well as Poland, Slovakia, Hungary, the Czech Republic, Slovenia, Bulgaria and Romania. Malta and Cyprus are also on the list.

While the news was welcomed by German industry, experts remain skeptical that Germany would in fact have much access to skilled workers from its Eastern neighbors. A report issued last month by the Vienna Institute for International Economic Studies showed that the new member states of the EU were facing their own labor shortages.

The report said: "Lack of labor is reported for most of these countries, not only in the automotive industry in the Czech Republic and Slovakia in particular, but also in segments of the high-skilled service sector such as health care personnel, architects, civil engineers and IT experts."

The shortage of skilled labor in these countries was attributed partly to the large inflow of foreign direct investment, which has demanded more skilled labor, and also to the huge emigration of young and highly educated people to the old EU member states.

At the same time, the German government agreed to restructure the way apprentice training programs were organized so that the programs reflected the needs of industry and that they would be constantly monitored.

On another issue, the government agreed on an ambitious but controversial plan to reduce greenhouse gases by 40 percent by 2020 compared with 1990 levels. The government failed to address the future role of nuclear energy. Merkel's conservatives favor retaining nuclear power while the Social Democrats are committed to phasing out the nuclear power stations.

Merkel to Tackle Skills Shortage in Einstein's Home

Aug. 22 (Bloomberg) -- German Chancellor Angela Merkel, a physicist by training, convenes a special Cabinet meeting tomorrow to tackle a growing skills shortage in the country that spawned scientists like Albert Einstein and engineers such as Rudolf Diesel.

The issue tops the agenda for the Aug. 23-24 Cabinet conclave in Meseberg, a government retreat northeast of Berlin. With almost 100,000 engineering positions forecast to remain vacant through 2014, economists and industry leaders warn the shortfall may dash the economic upswing, not to mention derail attempts to promote Germany as the ``land of ideas.''

``We're struggling with the effects of staff shortages every day,'' said Hans-Georg Haerter, chief executive officer of ZF Friedrichshafen AG, a German maker of gearboxes for the automotive industry. The company plans to hire 250 engineers through the end of next year, though ``if we could, we'd rather take them on now,'' Haerter said.

The shortage is particularly hard-felt in Germany, Europe's biggest economy, where demand and supply are mismatched through a combination of growth near a six-year high and a stagnant birth rate. Unlike the U.K., Sweden and Ireland, Germany blocked free movement of workers from the new European Union states that joined from 2004, shutting off a supply of fresh talent. Merkel faces calls to review that position.

``We may have to open our borders if we want our companies to continue operating at full capacity,'' said Martin Wansleben, executive director of Germany's DIHK industry and trade chambers representing about 3 million companies.

Policy Planning

The issue joins climate change and steps to shield German companies from takeovers by sovereign wealth funds on tomorrow's agenda as the 16-member Cabinet draws up its policy plans for the second half of the coalition's four-year term.

Merkel's room for maneuver on skills shortages is limited by Germans' traditional concern for job security and the sensitivities arising from three state elections due in early 2008, said Oliver Koppel, a labor expert at the Cologne-based IW economic institute. Merkel's Christian Democrats and her Social Democrat coalition partners are likely to consider ``a mix of steps'' at Meseberg, he said.

They may include greater incentives for skilled foreign workers to migrate to Germany, along with better job training for apprentices and graduates and rewards for companies prepared to locate in areas with higher populations of skilled workers, Koppel said.

Tax Incentives

The DIHK is pressing for tax incentives for companies that hire research and development staff, and for lowering the annual pay threshold of 85,000 euros ($115,000) that a foreign worker must earn to be entitled to stay in Germany.

Otherwise, ``the imminent shortage of scientists could become a real problem for growth,'' DIHK chief economist Axel Nitschke said in an interview today.

``We will need foreign experts,'' Merkel said in an interview with ARD television on July 22. ``But we must also say we're prepared to take steps at home.''

The coalition faces pressure for action from Germany's biggest companies. Siemens AG, Europe's largest engineering company, awards each employee a 3,000-euro bonus for proposing a new hire at its power-plant engineering unit, where it currently lacks 600 experts. Lufthansa AG, the continent's second-largest airline, is turning away orders at its maintenance division, where aircraft systems are tested and plane body shells overhauled. It wants to hire 400 technical engineers by 2009.

`Rejecting Orders'

``We barely know how to process the workload'' with existing staff, said Bernd Habbel, spokesman for Lufthansa Technik AG. ``We're already rejecting orders.''

Each engineering post supports the equivalent of 2.3 jobs in research, development and trade, according to Eike Lehmann, head of Germany's VDI engineers' association -- positions that cannot be filled as long as the engineering vacancies persist.

The dearth of skilled staff -- most pronounced among engineers, physicists, other scientists and computer specialists -- may cost Germany's economy more than 20 billion euros this year, slicing as much as 1 percent off gross domestic product, the IW institute said in a government-commissioned study, part of which was released yesterday.

By contrast, immigration to the U.K. from new EU states such as Poland and the Czech Republic, both of which border Germany, will boost Britain's aggregate GDP by 0.67 percent in the ``medium term,'' according to a March report by the National Institute of Economic and Social Research.

Party Differences

The Social Democrats want to tackle Germany's skills shortage by scrapping restrictions keeping eastern European workers out of Germany until at least 2009 in return for the introduction of minimum pay levels -- a measure the chancellor's Christian Democrats have rejected as hostile to job creation.

Merkel's party favors targeting highly qualified foreign workers through measures such as lowering the minimum wage threshold for migrant workers, said Maria Boehmer, Merkel's envoy for immigration matters.

``Given global competition for the best minds, Germany must become more attractive for the highly qualified from abroad,'' Boehmer, a Christian Democrat lawmaker, said in an interview.

Yet with almost 3.8 million Germans unemployed, Merkel's coalition ``may shun any radical steps'' in favor of incremental changes to immigration rules, said Uwe Andersen, a professor of political science at the University of Bochum in western Germany.

``Ultimately, immigration matters are highly sensitive,'' Andersen said, meaning it's likely the issue is ``tackled in small rather than big steps.''

Turkish Lira Advances From Five Month Low

In Bloomberg today:

Turkish Lira Advances as Fed's Rate Cut Encourages Carry Trade

The Turkish lira rose for a second day against the dollar after the Federal Reserve's decision to cut its discount rate prompted investors to return to the so- called carry trade.

The lira rebounded from a five-month low as investors, attracted by the highest interest rates in Europe, bought the currency in trades funded by borrowing the Japanese yen or Swiss franc more cheaply. Turkey's currency was also buoyed as traders returned to the country's government debt, according to an ABN Amro NV index of bond yields.

``It's down to the Fed,'' said Agata Urbanska, European emerging market economist at ING Bank NV in London. ``There should be some relief'' for the lira.

Against the dollar, the lira rose to 1.3507 by 5:45 p.m. in Istanbul, from 1.3667 on Aug. 17, when it touched the lowest since March 14. The Turkish currency also rose for a second day versus the euro, to 1.8226 from 1.8440 at the end of last week.

The Fed unexpectedly lowered the rate at which it lends directly to banks by 50 basis points to 5.75 percent on Aug. 17, and said it's ready to do more to ``mitigate'' the effects of the credit-market turmoil on the wider economy.

Turkish government debt advanced for a second day, with ABN Amro's index of bond yields dropping from near a three-month high. Yields move inversely to bond prices.

The lira fell more than 5 percent against the U.S. currency last week, the most in more than a year, as a rout in global credit markets sparked a sell-off in equities and riskier assets such as emerging-market bonds and carry trades.

With a main lending rate of 17.5 percent, the lira is an attractive purchase for investors seeking higher-yielding assets.

Presidential Elections

Turkish Foreign Minister Abdullah Gul, a devout Muslim, failed to secure parliament's support to be elected the country's next president today, and another round of voting will take place on Aug. 24. A clash between the army -- traditionally the guardian of secularism in Turkey -- and the government over Gul's candidacy led to early elections on July 22.

In other markets, the Slovak koruna fell to 33.712 per euro from 33.676 on Aug. 17, while Poland's zloty dropped to 3.8384 from 3.8298 versus the single European currency. The Hungarian forint dropped to 258.85 per euro from 257.76 on Aug. 17.

The Czech koruna gained to 27.649 versus the euro, from 27.755 on Friday, with Romania's leu advancing to 3.2563, from 3.2622 per euro.

The NTX Index of stocks in the 30 biggest companies in central and eastern Europe rose more than 1 percent today, rebounding from near the lowest since March.

The yield on the 4.25 percent Polish bond due May 2011 rose 4 basis points to 5.62 percent, while the yield on the 4.6 percent Czech bond due August 2018 rose 4 basis points to 4.51 percent.

Monday, August 20, 2007

Sub Prime Risk and Collateralized Debt Obligations

This very lengthy piece in Bloomberg today is fascinating for the detailed insight it offers into how and why the sub-prime mortgage issue is unwinding the way it is:

Subprime Infects $300 Billion of Money Market Funds, Hikes Risk

Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.

Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail.

Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans.

CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service.

U.S. money market funds run by Bank of America Corp., Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6 billion of CDOs with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission. Money market funds with total assets of $300 billion have invested in subprime debt this year.

The danger of owning even highly rated CDOs containing subprime loans was thrown into sharp relief in June, when two Bear Stearns Cos. hedge funds that were holding subprime CDOs collapsed.

Bear Stearns Manager

At the center of that storm was Ralph Cioffi, a senior managing director at Bear Stearns who ran the hedge funds. Cioffi, 51, wore another, less publicized hat. He managed more than $13 billion of CDOs, according to Fitch Ratings -- and money market funds and other investors bought all of it.

Cioffi-managed CDOs filled with subprime debt have been purchased by money market funds run by Invesco Plc's AIM Investment Service, Marsh & McLennan Cos.' Putnam Investments and Wells Fargo & Co.

In August, New York-based Bear Stearns fired Warren Spector, the firm's co-president for fixed income and asset management. Cioffi stayed with the bank. Bear Stearns spokesman Russell Sherman says Cioffi's stewardship of the bank's CDOs ended in late June.

``There is a team of portfolio managers running them now,'' Sherman says. ``Ralph still serves as an adviser.'' Cioffi didn't respond to telephone and e-mail requests for comment.

Under SEC rules, money market managers must invest in securities with ``minimal credit risks.'' Joseph Mason, a finance professor at Drexel University in Philadelphia and a former economist at the U.S. Treasury Department, says subprime debt in money market funds is far from safe.

`Tremendous Risk'

``This creates tremendous risk for today's money market investors,'' says Mason, who wrote an 84-page report on CDOs this year. ``Right now, I'm not comfortable investing anything in CDOs.''

Global financial markets were rocked in July and August, first by the collapse of the Bear Stearns hedge funds and then when banks and insurance companies worldwide disclosed their U.S. subprime debt holdings.

On Aug. 9, BNP Paribas SA, France's biggest bank by market value, froze withdrawals on three investment funds with assets of 2 billion euros because the bank couldn't find a way to value its U.S. subprime bonds and other assets. CDOs aren't bought and sold on exchanges and their trading has little transparency.

During the first two weeks in August, central banks in Europe, Japan and Australia and the U.S. Federal Reserve lent more than $300 billion to banks to stem a collapse in credit markets.

On Friday, the Federal Reserve lowered the interest rate it charges to banks to 5.75 percent from 6.25 percent in an attempt to contain the subprime mortgage collapse.

`It's Inappropriate'

Money market funds have become a staple for investors. There are 38.4 million money market fund accounts in the U.S., according to the Investment Company Institute.

People use a money market both to hold savings and serve as an account to buy securities and place the proceeds of sales. Bruce Bent, who in 1970 created the first money market fund, The Reserve Fund, says no money market fund should invest in subprime debt.

``It's inappropriate,'' Bent, 70, says. ``It doesn't have a place in money market funds. When I created the first money market fund, I said you have to have immediate liquidity, safety and a reasonable rate of return. You also have to have a situation where you're not giving people headline risk.''

Seeking Safety

Investors have sought safety during the subprime meltdown by moving their holdings to U.S. Treasuries and money market funds. On Aug. 8, just after the Bear Stearns hedge funds filed for bankruptcy protection, U.S. money market fund total assets reached a record high of $2.66 trillion, with investors pouring $49 billion into such funds in one week, according to the ICI.

As a sign of stability, money market funds never allow their share price to rise above or fall under $1 for each dollar invested.

A money market fund that invests in subprime debt increases the risk that its share price could drop below $1. If 5 percent of a fund's holding is subprime debt, and in a worst-case situation that asset collapses, then the value of the fund could drop to 95 cents.

Even if a fund's value dropped below a dollar, banks and fund companies wouldn't allow investors to lose money, says Peter Crane, founder of Crane Data LLC, the Westborough, Massachusetts-based publisher of the Money Fund Intelligence Newsletter.

`Virtually Nil'

``Fund companies will support the funds,'' he says. ``They won't let them break $1 a share. The odds of money market funds breaking the buck are virtually nil.''

Just once has a money market fund failed. In 1994, a fund run by Community Bankers Mutual Fund of Denver invested in securities that defaulted. Investors were paid 96 cents a share, and the fund was liquidated.

The fund had invested 27.5 percent of its assets in adjustable-rate securities, whose values were tied to interest rate changes, the SEC found. The fund lost money as interest rates increased.

Until recently, CDOs had been the fasted-growing debt market -- outpacing corporate and municipal bond sales by dollar total -- with about $500 billion sold in 2006, up from $99 billion in 2003, according to Morgan Stanley.

CDO Slump

About a quarter of the content of all CDOs sold last year in the U.S. was made up of securitized subprime mortgage loans. CDO sales slumped to $11.9 billion in July from $36.9 billion in June, according to JPMorgan Chase & Co.

SEC Chairman Christopher Cox told Congress in June his agency was conducting about a dozen probes related to the marketing of subprime CDOs to investors.

Lynn Turner, chief accountant of the SEC from 1998 to 2001, says the SEC will likely look into money market funds investing in CDOs, particularly because the value of subprime collateral of CDOs can collapse suddenly.

``I'm betting some people at the SEC will be concerned,'' he says. ``And they'll be more concerned in six months. How quickly did the Bear Stearns hedge fund evaporate?''

Each time a bank or financial firm creates a CDO, it forms a free-standing company incorporated offshore, usually in the Cayman Islands, which doesn't tax corporations. All CDOs have a trustee, usually a bank, that prepares monthly reports on the changing contents of the debt package.

From Mortgage to Fund

The trail that connects subprime debt to money market funds usually starts with a mortgage broker who makes a loan to a homebuyer with poor credit. A middleman then bundles hundreds of these subprime mortgages into so-called asset-backed securities.

Next, a CDO manager buys hundreds of these securities for collateral for a CDO. Some CDOs issue commercial paper, and brokers can then sell that paper to money market funds. Commercial paper, which is typically issued by banks and large companies, is debt maturing in less than 270 days.

Commercial paper pays relatively low interest rates, which averaged about 5.3 percent in June and July, because it rarely defaults. There have been occasional exceptions, such as paper issued by Enron Corp. and WorldCom Inc., both of which filed for bankruptcy earlier in this decade.

CDO commercial paper, often loaded with subprime debt, pays higher returns than corporate paper, and it paid as much as 6.5 percent in August.

This year, CDOs have sold more than $11 billion in the form of investment-grade commercial paper to money market funds, SEC filings show. The paper has the highest credit rating because Fitch Ratings, Moody's and S&P give AAA or Aaa ratings to the top portions of CDOs, which are the source of all CDO commercial paper.

`An Unpleasant Surprise'

Satyajit Das, a former Citigroup Inc. banker and author of 10 books on debt analysis, says those ratings are very misleading. ``I don't think the typical money market investor, in his wildest dreams, would assume he has exposure to the risk of subprime CDOs,'' he says. ``They may be in for an unpleasant surprise.''

Money market managers buy CDO commercial paper even when prospectuses warn of the risks.

Zurich-based Credit Suisse, Morgan Stanley in New York and San Francisco-based Wells Fargo are among money market managers that poured more than $1 billion into commercial paper issued by the Buckingham series of CDOs managed by Chicago-based Deerfield Capital Management LLC.

`Do Not Exist'

``Reliable sources of statistical information do not exist with respect to the default rates for many of the types of collateral debt securities eligible to be purchased by the Issuer,'' say both the 2005 and 2006 CDO prospectuses backing commercial paper held in the funds.

Deerfield's three Buckingham CDOs have directed $1.5 billion, or 40 percent of their $3.8 billion in assets, into subprime debt, according to their trustee reports. Billionaire Nelson Peltz's Triarc Cos. agreed to sell Deerfield in April.

Morgan Stanley spokesman Mark Lake and Wells Fargo's John Roehm declined to comment.

Tim Wilson, head of Credit Suisse's cash management portfolio desk, says he's comfortable with CDO commercial paper because it has the highest credit ratings and because his funds hold the debt for only one to three months.

`We're Watching'

``We don't have any concerns these are going to have any defaults in 90 days,'' he says. ``We're obviously watching.'' The paper matures within three months, and after that the fund doesn't hold any subprime debt, unless Wilson decides to buy more.

Vanguard Group Inc., the second-largest mutual fund company in the U.S., has a policy of never buying CDO commercial paper for its $90 billion in money market funds or $325 billion in fixed-income mutual funds.

``It really gets down to transparency questions,'' says John Hollyer, risk management director at Valley Forge, Pennsylvania-based Vanguard. ``Can you understand what you have? And can you measure it appropriately? We haven't been comfortable that we could.''

Bank of New York Mellon Corp.'s Dreyfus unit has banned CDO commercial paper from its $110 billion in money market funds because it has found that analyzing subprime holdings in CDOs is too difficult.

The firm's money market investment committee decided in 2005 that such paper was too risky, Dreyfus spokeswoman Patrice Kozlowski says. ``The committee questioned the fundamental structure of commercial paper of CDOs,'' she says. Dreyfus has never purchased CDO commercial paper, she says.

`Refuse to Fund'

CDOs create what is supposed to be a safety net for buyers of their commercial paper. CDO managers reach agreements with banks to purchase their paper when nobody else will, so the CDO can pay off debt when it's due.

Some fund companies, including Dreyfus, say those contracts don't reassure them because they're conditional and they aren't guarantees. ``The banks can refuse to fund,'' Kozlowski says.

CDO paper has other risks, former banker Das says. ``CDO commercial paper has a lot more moving parts than other kinds of commercial paper,'' says Das, who wrote ``Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives'' (FT Prentice Hall, 2006).

``There's a lot more that can go wrong,'' he says. Das says that because so much subprime debt is held by CDOs, there is constant risk that the value of the investment can drop or collapse.

The Credit Suisse Group Institutional Money Market Fund Prime Portfolio held 8 percent of its $22.8 billion of assets in commercial paper secured by subprime home loans as of June 30.

`It's There'

Fund manager Wilson says he's not worried about the $1.8 billion in subprime content because the term of the debt is so short. ``Lots of clients are uncomfortable owning commercial paper with `CDO' in the name,'' Wilson says.

He monitors his CDO holdings by analyzing the monthly reports that CDO trustees publish, listing all holdings. ``I think there are some investors not doing the work and relying on ratings,'' Wilson says. ``If you're willing to do the work, it's there.''

Credit rating companies don't just rate CDOs; they play an active role in assembling them, says Charles Calomiris, the Henry Kaufman professor of financial institutions at Columbia University in New York. Fitch, Moody's and S&P participate in every level of packaging a CDO, says Calomiris, who has worked as a consultant for UBS AG, Bank of America and Citigroup.

A CDO manager gathers hundreds of loan securitizations or bonds to use as collateral for the CDO. The debt supports an assortment of CDO sections, ranging from the riskiest non- investment grade to AAA or Aaa rated. CDO managers consult with analysts from the rating companies when creating a CDO, negotiating the highest credit ratings for each level, or tranche.

The Credit Raters

Most of the dollar value of all CDOs, as much as 90 percent, gets a credit rating of AAA or Aaa. The higher the credit rating, the lower the return that's demanded by investors. The CDO commercial paper bought by money market funds always has a top credit rating, even when it's backed by subprime debt.

In the past three years, Fitch, Moody's and S&P have made more money from evaluating structured finance -- which includes CDOs and asset-backed securities -- than from rating anything else, including corporate or municipal bonds, according to their financial reports.

The companies charge as much as three times more to rate CDOs than to analyze bonds, their cost listings show. The three rating companies say these fees are higher because CDOs are so complex.

Close Relationship

The close working relationships between CDO managers and rating companies -- and the fees that change hands -- mean money market funds shouldn't rely on ratings to evaluate CDOs, says Harvey Pitt, who was SEC chairman from 2001 to 2003.

Pitt says fund managers should do their own research on CDOs by reading the hundreds of pages of prospectuses and the monthly trustee reports. Some managers may not have been doing their homework.

``Relying on rating agencies for investment advice is dicey,'' he says. ``Their reliance on rating agencies left them a day late and several dollars short.''

Two money market funds run by AIM have gotten the message. They stopped buying CDO commercial paper. ``In today's market, you really can't trust any ratings,'' says Lu Ann Katz, AIM's director of cash management research.

As recently as June, two AIM money market funds owned $2.64 billion of CDO commercial paper that was invested in subprime debt. The debt made up 10.2 percent of the AIM STIT-Liquid Assets Portfolio and 4.5 percent of AIM STIT-STIC Prime Portfolio.

Mistrust of Ratings

Katz says she's stopped buying CDO investments because she doesn't trust credit ratings and she thinks CDO paper in money market funds is too risky. AIM's funds had included more than $1 billion of CDO commercial paper issued by CDOs managed by Bear Stearns before its hedge funds collapsed.

Fidelity Investments, the world's biggest mutual fund company, owned $2.3 billion in CDO-issued commercial paper in two money market funds as of May 31, according to spokeswoman Sophie Launay. The biggest money market fund in the U.S., Fidelity Cash Reserves Fund, had 1.5 percent of its $98.2 billion assets invested in CDO commercial paper backed by subprime debt.

The Fidelity Institutional Money Market Portfolio had 2.3 percent of its $32.3 billion in assets in such commercial paper. Boston-based Fidelity fund manager Kim Miller says he's holding off on buying more CDO debt.

`Dust to Settle'

``There's been a lot of volatility,'' he says. ``I think people are waiting for the dust to settle, and we're doing the same.''

Money market managers are required to determine that their investments are safe and have high credit ratings, according to Rule 2a-7, a 1997 addition to the Investment Company Act of 1940.

``The money market fund shall limit its portfolio investments to those United States dollar-denominated securities that the fund's board of directors determines present minimal credit risks,'' the rule says.

Money market managers buy CDO commercial paper to boost returns and make their fund more attractive to investors, which in turn increases their income, money market fund inventor Bent says. ``The higher rates sell more easily,'' he says. ``They're doing it to suck the people in.''

Fund managers are paid based on the total dollar amount invested in their funds, so more assets mean higher pay for managers.

``Trying to outguess the market makes no sense at all,'' Bent says about money market funds. ``That's not the risk you're looking for.''

Higher Yields

The subprime-backed commercial paper in money market funds offers some of the highest yields managers can include in their investments because such funds are prohibited by SEC rules from buying junk-rated debt.

The Bear Stearns hedge fund implosion demonstrated how misleading credit ratings of CDOs can be. The two funds had avoided buying the riskiest CDOs, sticking with tranches awarded AAA and AA grades, or the highest available, from Fitch, Moody's and S&P.

In July, the funds filed for bankruptcy protection as the investment bank halted withdrawals from a third fund, Bear Stearns Asset-Backed Securities Fund, after investors sought to extract their money.

Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd. and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. lost a combined total of about $1.5 billion in the second quarter as home prices slumped and subprime loan foreclosures jumped 62 percent from a year earlier because borrowers stopped making mortgage payments.


Cioffi had total control of Bear Stearns CDOs, according to a Fitch report dated Aug. 3. ``In lieu of a formal committee process, ultimate decision making lies with Ralph Cioffi,'' Fitch wrote.

Cioffi joined the bank as a bond salesman in 1985, seven years after earning a bachelor's degree in business administration at Saint Michael's College in Colchester, Vermont. Apart from his job managing funds, Cioffi also ran the Klio and High-Grade Structured Credit CDOs, which are rated mostly AAA.

AIM, Putnam, Wells Fargo and other fund managers bought more than $4 billion of Klio and High-Grade commercial paper backed by subprime home loans.

In June, the three Klio CDOs held 37-41 percent in subprime mortgage securities, according to trustee reports. The original $5 billion in collateral for Klio II's CDOs, purchased in 2004 and 2005, came from a source very close to home: Cioffi's own High-Grade Structured Credit Strategies Fund.

Low Risk?

AIM's Liquid Assets Portfolio held almost $900 million in Klio commercial paper on May 31, SEC filings show. Putnam Money Market Fund owned $119 million of Cioffi-managed paper on March 31, amounting to 3.5 percent of the Putnam fund's $3.41 billion in holdings.

``By investing in high-quality, short-term money market instruments for which there are deep and liquid markets, the fund's risk of losing principal is very low,'' Putnam wrote in its first-quarter report to shareholders.

``Putnam Money Market Fund holds a much smaller amount of CDOs than it did in March,'' Putnam spokeswoman Laura McNamara says. ``Putnam is comfortable with the structures we currently own.''

Seven money market funds run by Federated Investors Inc., the third-largest U.S. manager of money market funds, owned more than $1 billion of commercial paper issued by Bear Stearns- managed CDOs at the end of June, according to Federated's Web Site.

Not `Comfortable'

``We were never real comfortable with the whole program to begin with,'' says Deborah Cunningham, chief investment officer of Pittsburgh-based Federated's money market funds. ``We wanted to monitor it more and keep a little tighter rein on it.''

She says that's why Federated has never held Klio paper for more than 90 days.

Bank of America's Columbia Cash Reserves and Columbia Money Market Reserves funds owned more than $600 million of Bear Stearns's Klio CDO paper on June 30, according to Boston-based Columbia Management, the investment division of Bank of America, which is based in Charlotte, North Carolina.

``The funds are permitted to invest in asset-backed securities,'' Bank of America spokeswoman Faith Yando says.

Three Wells Fargo money market funds held $886 million in Bear Stearns-managed CDO commercial paper on June 30. The funds held a total of $1.5 billion in CDO commercial paper on that day, according to Wells Fargo spokesman John Roehm.

Trimming CDO Holdings

The Wells Fargo Advantage, Advantage Cash Investment and Advantage Liquidity Reserve funds held the subprime-backed debt. The funds' holdings of all CDO commercial paper ranged from 4.1 percent to 6.9 percent of their assets, Roehm says.

Wells Fargo trimmed its money market funds' CDO holdings to $680 million by July 31, Roehm says. He declined to comment further.

Wells Fargo money market funds also held more than $120 million of commercial paper issued by CDOs managed by Deerfield Capital Management on June 30. That CDO firm was controlled by billionaire Peltz, 65, who owns the Arby's fast-food chain and sold Snapple Beverage Corp. to Cadbury Schweppes Plc for $1.45 billion in 2000.

Peltz agreed on April 20 to sell Deerfield to an affiliate, Deerfield Triarc Capital Corp., a publicly traded real estate investment trust with no employees, for $290 million, SEC filings show.

Deerfield Triarc hired Bear Stearns in March for $2.4 million to provide a so-called fairness opinion, which concluded that the acquisition price was acceptable. Bear Stearns spokesman Sherman declined to comment on the fairness opinion.

SEC Inquiry

Deerfield Triarc disclosed in a July 13 regulatory filing that the SEC was conducting an informal inquiry into collateralized mortgage obligations and had made two information requests to Deerfield as part of its probe.

That filing was made more than two months after Triarc announced the sale of Deerfield Capital Management. Triarc noted the federal probe on page 21 of the filing as part of a list of risks for investors.

Peltz didn't respond to e-mail and telephone requests for comment.

Commercial paper from CDOs, laced with subprime home loan securitizations, made up 5.1 percent of the $11.4 billion Wells Fargo Advantage Money Market Fund as of June 30. The holdings included $96 million of Buckingham CDOs.

Morgan Stanley

Morgan Stanley money market funds held more than $330 million of Deerfield's Buckingham commercial paper on June 30, according to the bank's Web site. Credit Suisse money market funds owned more than $700 million in April, according to SEC filings.

The Morgan Stanley Institutional Liquidity Funds Prime Portfolio held $235 million of Buckingham commercial paper on June 30. Morgan Stanley spokesman Lake declined to comment.

Deerfield's CDO track record isn't reassuring. Since 2000, six of the 14 CDOs Deerfield manages have had tranches downgraded from investment grade to junk. Valeo Investment Grade I and II, Mid Ocean 2000 and 2001, Ocean View and North Lake include sections that lost their investment-grade ratings.

In May, Fitch said 39 percent of Mid Ocean CDO collateral was distressed, and it expected all of a $44 million Mid Ocean tranche to be a total loss. Moody's still rates Mid Ocean investment grade, or Baa3, one notch above junk.

Deerfield Capital Senior Managing Director John Brinckerhoff and Bear Stearns spokesman Sherman declined to comment.


While CDOs aren't regulated by the SEC, mutual funds -- including money markets -- are. The SEC disclosed in June it's begun looking at some CDO investments, without releasing further details.

Former SEC Chief Accountant Turner says investors have cause to be concerned about money market funds' holding subprime debt. ``It doesn't make you feel real good in the gut,'' Turner says. ``This stuff takes on a life of its own when it starts going south.''

Investors are accustomed to treating money market funds as if they were bank savings accounts. The last thing they expect is that the subprime debt turmoil would enter their safe cash havens. And now it has.

European central banks on stand-by

From the FT this morning:

European central banks on stand-by

European central banks are standing ready this week to take further steps to ease the credit squeeze following the US Federal Reserve’s unexpected move on Friday to stem the turmoil in money and credit markets.

Financial markets rallied after the Fed made direct loans available to banks on favourable terms and hinted at an interest rate cut. If the move calms US nerves this week, European central bankers are likely to follow to ensure a similar effect is achieved across the Atlantic.

One policy lever the Europeans are considering is the extension of more credit to banks for longer periods than are normally available in an attempt to bring market interest rates closer to the central banks’ main interest rates.

Fed officials do not expect a quick recovery in credit market conditions, and another volatile week on the stock markets is thought to be in prospect.

Mohammed El-Erian, chief executive of Harvard Investment Management, said the Fed’s action had helped but more volatility probably lies ahead. The question was no longer whether the Fed was prepared to counter market disorder, he said, but “whether it is able to do so”.

The world’s central bankers are also nervous that their powers to stem this crisis of confidence are limited, as even good quality credit cannot find ready purchasers. One noted the veracity of a comment by a market observer who said in these circumstances, any action by a central bank “doesn’t affect s***”.

At the weekend, the fear of continued small financial bombs going off was heightened as Sachsen LB, a second German state-owned bank, was bailed out after Ormond Quay, its off balance sheet investment vehicle, failed to secure finance in the commercial paper market.

Also late on Friday, Sentinel, the US cash management group, filed for Chapter 11 bankruptcy protection after freezing its clients’ accounts last week.

Signs of banks’ difficulties in raising credit were evident at the end of last week when European three-month interbank rates were much higher, at 4.65 per cent, than the European Central Bank’s 4 per cent policy rate. The ECB’s actions so far only stabilised the very short-term overnight market.

In London, where the Bank of England has so far avoided any intervention, interbank rates were 6.3 per cent overnight and 6.7 per cent at a three-month maturity, well above the central bank’s 5.75 per cent main rate of interest.

Although the Bank of England is trying to avoid being the first port of call for banks, if unusual market rates persist, it would act to secure its objective for “overnight market interest rates to be in line with the Bank’s official rate”.

Slovenia’s annual inflation highest in Eurozone

Slovenia’s inflation rate on the annual level was 4%, the highest rate among the euro area countries, while the eurozone annual inflation rate stood at 1.8%, according to latest data provided by Eurostat, the EU's statistics office.

Both the eurozone and the EU in July recorded a slight disinflation in comparison to June, as monthly inflation rate was -0.2% in the euro area, and -0.3% in the 27-nation bloc. Slovenia’s 12-month average rate in July (2.8%) was second only to Greece (3%) among the eurozone countries. In July, the lowest annual rates in the EU were recorded in Malta (0.7%), Finland (1.3%), and France (1.4%), and the highest rates in Latvia (7.5%), Hungary (7.5%), and Bulgaria (5.5%).

According to Eurostat, sectors with the highest annual rates in the eurozone were education (9.1%) and catering (3.4%), while the lowest annual rates were posted in telecommunications (-1.7%), clothing (0.1%) and recreation and culture (0.3%).

Polish July Industrial Output Increases 10.4% on Year in July

This in Bloomberg today:

Polish July Industrial Output Increases 10.4% on Year (Update1)

By Dorota Bartyzel and Katya Andrusz

Aug. 20 (Bloomberg) -- Polish industrial output rose at a faster annual pace in July than corporate wages, easing concern that an increase in borrowing costs will be necessary to prevent labor expenses from outpacing productivity.

Industrial output rose 10.4 percent on the year and declined 2 percent from June, the Warsaw-based Central Statistical Office said today. The annual rate exceeded the 10.1 percent median estimate of 17 economists surveyed by Bloomberg. The monthly rate was as predicted in the same survey.

The annual pace of growth almost doubled from last month and for the first time in three months outpaced wage growth. This may indicate that manufacturers will finance higher labor costs with revenue from growing production instead of boosting prices, which could spur inflation and force the central bank to raise interest rates.

``An interest-rate increase in August is less possible, mainly because of a better relation between productivity and wage growth,'' said Jaroslaw Janecki, an economist at Societe Generale in Warsaw.

The central bank-led Monetary Policy Council, which sets interest rates for the country will meet on Aug. 28-29.

The council has raised the benchmark seven-day reference rate by a quarter of a percentage point twice this year, to 4.5 percent, to combat inflation, which reached the bank's mid-range target of 2.5 percent in May for the first time in two years.

In a separate report, the office said July producer prices grew 0.4 percent on the month and increased 1.5 percent on the year.

The zloty traded at 3.837 per euro at 2:45 p.m. in Warsaw, unchanged on the report and down from 3.82 on Friday. The yield on the five-year government bond rose 3 basis points in the morning from Friday and remained at the same level after the statistics reports.

Sunday, August 19, 2007

Fitch downgrades Latvia to BBB+

From Danske Bank:

Fitch downgrades Latvia to BBB+
Fitch ratings agency has downgraded Latvia’s foreign currency issuer default rating (IDR) to ‘BBB+’ from ‘A- and it also downgraded the country’s local currency IDR to ‘BBB+‘ from A –‘ both with a stable outlook. Fitch says, “The Latvian economy is severely overheating and Fitch considers the policy reaction of the government to be insufficient to restore the economy to a sustainable growth path”. It is hard to disagree and the downgrade should as such not be a surprise. The ratings agency, Standard & Poor’s, earlier this year also downgraded Latvia. Even though this is hardly surprising, Fitch’s downgrade of Latvia is nonetheless not good news and it is becoming increasingly obvious to everybody that urgent policy action is needed to address the major imbalances in the Latvian economy. We, however, find it encouraging that the Latvian Finance Minister, Oskars Spurdzins, in a comment on the downgrade said that it was “a clear and unmistakable signal to Latvia for an even stricter fiscal policy and for all involved parties to more actively carry out measures against inflation". We certainly hope that the Latvian government will follow up on the Finance Minister’s wise statement.