Finance in Asia

Pots and kettles

The credit crisis has cooled Asia’s ardour towards Western banks

WHEN China’s three leading state-run banks finally felt confident enough to list their shares in 2006 and 2007, after years of losses from bad lending, the initial public offerings contained two common elements: big Western banks acting as underwriters and as strategic investors. The government wanted an endorsement of quality from the cream of global banking.

The offer of minority stakes was accompanied by a slight crack in the Great Wall that China has built around its highly sensitive securities markets. Last year Credit Suisse, Citigroup and Morgan Stanley all received enough encouragement from regulators to announce agreements with domestic securities firms for some form of tie-up. Meanwhile, China’s new sovereign-wealth fund spent $3 billion on a direct stake in Blackstone, an American buy-out fund, hoping, in part, to learn lessons in finance from an acknowledged master of the craft.

This came before the credit crisis sideswiped Western financial firms, costing a reputation for prudent risk management. Optimists in Europe and America say that acknowledging these losses is all part of the healing process. But in parts of Asia there is a chillier interpretation: the belief that Western banks have failed an important test and their regulatory model is not to be trusted.

Western bankers say that they are greeted more coolly than a year ago—in China, Japan and South Korea. They point to Seoul’s reluctance to endorse HSBC’s acquisition of Korea Exchange Bank. In China none of Credit Suisse, Citi, nor Morgan Stanley have had their deals approved, and other banks now wonder if the approval process has been quietly shelved.

A rejection in China often comes in the maddening form of absolute silence. And strong clues are emerging from some pervasive criticisms. A senior Chinese regulator recently described to this newspaper his view of big global investment banks in one graphic word: “shit”.

There is particular concern about whether any of the large Western banks, or their regulators, truly understand the risks associated with the mountain of derivatives on their balance sheets. Liu Mingkang, chairman of the China Banking Regulatory Commission (and a leading reformer), explains his concerns about bank regulation in America—and how flat-footed it was. “After the death, the doctor came,” he observes dryly, indicating that China is likely to open up to international banks even more slowly than it has already.

Jiang Jianqing, chairman of ICBC, the world’s largest bank by stockmarket value, recently talked down the merits of future investment in American bonds and banks. ICBC has refused invitations to take stakes in global firms. Instead it has bought a large part of Standard Bank of South Africa and controlling shares in banks in Macau and Indonesia.

Some of the reaction is an understandable response to genuine failures. China’s sovereign-wealth fund has lost plenty of money on its stakes in Blackstone and Morgan Stanley. But rather than viewing this as an education in how an unrigged market works it considers the investments an embarrassment.

But a rise in protectionism could hurt many. Hank Paulson, America’s treasury secretary, says that opening the Chinese financial system is “absolutely necessary” for China’s own long-term economic success. It would not only provide greater equilibrium to global capital flows, it would also bring more efficiency to China’s industry. Already, manufacturing firms in southern China are struggling to cope with the rising yuan, because there is no currency-futures market to lock in revenues and costs.

Similarly, Chinese firms are forced into inefficient financing arrangements. They can borrow from state-controlled banks at rising rates that may have little to do with their own creditworthiness, let alone what they plan to do with the money. Alternatively, they can join a long, bureaucratic queue to issue shares. Even the largest ones still rely on the state for permission to raise capital; Ping An, the second-largest insurer, recently pulled a vast secondary share offering after what was believed to be a quiet word from the authorities.

A state-driven financial market means state firms tend to do best. Financing for start-ups remains largely informal. Worst of all, today’s system provides a rotten deal for Chinese citizens trying to save. They are given a bleak choice of deposits yielding less than inflation or speculating on highly volatile shares.

China’s financial firms are not model institutions either. A banking crisis, which began in the late 1990s and is still not fully resolved, cost $428 billion, according to the World Bank. In addition, billions of dollars were lost by state-controlled securities firms through unfunded “guaranteed” investment products and inept proprietary trading funded by money absconded from client accounts. China has never revealed the full cost of this disaster. It gives some perspective to the $335 billion or so of write-downs and credit losses thus far from the subprime crisis.

Western banks have every reason to regret their losses. That may be why they are not defending their methods more vigorously. Having got so far with China, however, bankers would be remiss if they let the misapprehensions fester. Western finance may be prone to cyclical excess, but the state-sponsored model is even more so. At least when troubles hit Western banks, the recognition—and the healing—come far quicker.

Fed Adds Liquidity and Economy Avoids Recession: John M. Berry

Commentary by John M. Berry

May 15 (Bloomberg) -- The Federal Reserve is supplying the financial system with more than $150 billion in cash, a liquidity cushion that has helped keep enough credit flowing to ensure the economy's growth.

After another auction of term funds on May 19, the amount of cash from the Fed will probably top $175 billion. And if the system needs still more, Fed Chairman Ben S. Bernanke said in a May 13 speech, the Fed stands ready to supply it.

The financial turmoil stemming from the subprime mortgage debacle has caused most banks to tighten their standards for lending to households and businesses. The 325-basis-point reduction in the Fed's target for the overnight lending rate and the unprecedented amount of cash pumped into the system have helped the economy defy predictions of a recession.

Recent data suggest the economy grew at about a 1 percent annual rate in the first quarter, slightly more than the 0.6 percent estimate released by the Bureau of Economic Analysis on April 30.

And on May 13, Macroeconomic Advisers predicted that the tax-rebate checks now being sent to many households would spur consumer spending this quarter, boosting growth to 2.5 percent. Third-quarter growth would exceed 3 percent, the forecast said.

If those predictions turn out to be correct, then the fourth quarter's 0.6 percent growth rate would be the weakest of this period. That makes it doubtful that the National Bureau of Economic Research -- the accepted arbiter for business-cycle turning points -- would declare a recession. There has never been a recession without at least two quarters of declining real gross domestic product.

Central Banks

The Fed has been criticized for its decision to extend loans to major securities firms rather than just to banks, and for accepting collateral other than securities either issued or guaranteed at least indirectly by the federal government.

However, Bernanke said in his speech that supplying liquidity during a banking crisis is what central banking is all about.

Larger financial institutions don't depend primarily on customers' deposits as a source of funds for lending. Instead, they manage other liabilities according to what they need to finance their assets such as loans, and that often means borrowing from other banks.

The freeze in the market for asset-backed securities last year cut off a key source of bank funding. Not surprisingly, the interbank market for term funds, which mature within one to 90 days, was disrupted as well.

No Choice

Meanwhile, many borrowers who had financed investments with commercial and asset-backed paper had to turn to banks instead.

The Fed had no choice except to supply the liquidity that was no longer available in the market. Otherwise, even creditworthy households and businesses wouldn't have been able to borrow, and a recession would have been inevitable.

Instead, over the 12 months ended in April, commercial and industrial loans rose 20.9 percent at banks, while home-equity loans climbed 9.9 percent and consumer loans increased 9.3 percent. Even other types of real-estate loans were up 6.7 percent over the period.

It wasn't easy at first to persuade banks to borrow from the Fed because, as Bernanke explained in his speech, institutions were concerned that investors might find out about the borrowing and question a bank's financial soundness. That has always been a problem with borrowing from one of the 12 Federal Reserve banks' discount windows, and it limited the Fed's first efforts to provide liquidity late last year.

Bank in the Crowd

So in December the Fed created the Term Auction Facility that provided some of the anonymity of a crowd. Instead of just a few banks borrowing at a discount window, the auctions, which began at $20 billion twice a month and are now up to $75 billion each, have drawn scores of bidders. On May 5, for example, 71 institutions sought some of the money, which must be repaid in 28 days.

Perhaps encouraged by the wide acceptance of borrowing via the TAF, more banks are utilizing the discount window as well. As of May 7, $11.7 billion of such loans was outstanding.

After the near-collapse of Bear Stearns Cos. in March, the Fed began lending to the 20 primary dealers -- the counterparties in the New York Federal Reserve Bank's daily interventions to keep the overnight lending rate close to its target level, now at 2 percent. As of May 7, $16.5 billion had been borrowed through the Primary Dealers Credit Facility.

Sense of Urgency

In effect, institutions and primary dealers have turned a broad range of collateral, some of it quite illiquid, into cash that they then lend to customers.

Bernanke acknowledged that all this lending might lead financial institutions and their creditors to be lax in the future in managing their liquidity risk -- the so-called moral- hazard issue.

So, he said, the Fed and other financial supervisors ``are reviewing their policies and guidance regarding liquidity risk management to determine what improvements can be made. In particular, future liquidity planning will have to take into account the possibility of a sudden loss of substantial amounts of secured lending.''

Right now, that review is just about as urgent as putting all that cash into the financial system.

Paulson Should Act to Stop Dollar Slump, Americans Say in Poll

May 15 (Bloomberg) -- Americans want Treasury Secretary Henry Paulson to act to stop the dollar's decline, which has stoked the inflation eroding their household incomes.

A Bloomberg/Los Angeles Times poll found that 76 percent of Americans think the government should do something to halt the falling dollar. Among those with incomes of $100,000 or more, seven in 10 favored aiding the currency, putting pressure on Paulson, who's charged with setting the policy, to match his ``strong dollar'' rhetoric with action.

The U.S. currency has slumped 41 percent against the euro since 2002 and 13 percent in the past 12 months alone. That has contributed to a surge in energy and commodity prices to record levels, and prompted central banks to reduce their share of foreign exchange reserves in dollars.

``It's not just the economic impact,'' said Paul Burt, who heads Westlake Financial Group, an employee benefits consulting firm, in Lake Forest, Illinois. ``The perception of the decline in the dollar is as important as the decline itself. The dollar needs to be respected in the world, and the government needs to realize that.''

Burt, 47, had few specific prescriptions for the Bush administration beyond trimming the federal budget and U.S. trade deficits. ``I don't think it can be addressed very easily,'' he said, referring to halting the dollar's drop.

The nationwide poll of 2,208 adults was conducted May 1 to May 8. The sampling error is plus or minus 3 percentage points. There were 650 respondents who earned at least $100,000. The survey noted that economists say a weaker dollar both adds to the cost of imported goods and helps American exports.

No Intervention

Five consecutive Treasury secretaries in the Clinton and Bush administrations have maintained the so-called strong-dollar policy since 1995. Bush's Treasury chiefs have refrained from intervening in markets to buy the currency. The last time the U.S. bought dollars to influence its value was 13 years ago.

Paulson did help strengthen the language used by Group of Seven officials to address the dollar's decline last month. Central bankers and finance ministers from the G-7 denounced ``sharp fluctuations in major currencies'' that could have ``implications for economic and financial stability.''

The statement was aimed at persuading investors to look past the short-term U.S. economic slowdown and financial-market turmoil, a Treasury official said last week.

``The long-term fundamentals of the U.S. economy will be reflected in our currency,'' Paulson said in Kansas City, Missouri, last week, responding to a question from the audience. The Treasury chief has been asked by reporters or members of the public about the dollar repeatedly since its slide accelerated in September.

`Steadfastly' Opposed

Though the poll results indicate Americans want stronger action, analysts said it's still unlikely Paulson would abandon his opposition to intervention. That means popular discontent with the currency's decline may deepen. A new administration will take office in January after elections in November.

``The U.S. view is we'll take care of our economy and the currency will take care of itself,'' said Robert Sinche, head of global currency strategy at Bank of America Corp. ``The administration is steadfastly against any kind of intervention.''

Even without stronger government action, market watchers said the U.S. currency may extend its rally.

The dollar will strengthen against most major currencies in the next six months as the Federal Reserve stops reducing interest rates, a separate survey of Bloomberg customers showed.

Rising Rates of Return

The end of Fed rate cuts will boost the allure of American assets for international investors, according to U.S. respondents in the monthly Bloomberg Professional Global Confidence Index, which questioned 3,447 users from Chicago to London to Hong Kong.

After declining 15 percent in the previous 12 months to a record low 70.698 on March 17, the Dollar Index traded on ICE Futures in New York that compares the currency to those of six trading partners has risen 3.9 percent to 73.473.

``In order for the dollar to bottom out, investors have to change their behavior, and they seem to be doing so,'' said Marc Chandler, global head of currency strategy in New York at Brown Brothers Harriman Inc. ``But Bush is going to leave office without ever intervening,'' he forecast.

Christina Griffin, who remembers her reaction to the euro's introduction a decade ago, won't be pleased with inaction. Married to a State Department officer and living in Italy, she was sure the new currency could never challenge the dollar's global supremacy.

``I thought, `this will never get off the ground,''' Griffin, a 63-year-old resident of Washington, said of the euro's 1999 debut. ``The dollar used to be everybody's benchmark. Now it's not. Something should be done.''

Recovery From Worst Housing Slump Since 1930s Comes With Angel

May 15 (Bloomberg) -- The way out of the worst U.S. housing slump since the 1930s goes through Angel Gutierrez.

Gutierrez buys bad mortgages a dozen at a time for a fraction of their face value from lenders overwhelmed by the highest number of defaults in 23 years. When he goes door to door to negotiate lower payments for homeowners or pay them to move so he can sell the house, he's speeding up the recovery by establishing a price for the homes and flushing out the least reliable borrowers.

``You buy the mortgage for pennies on the dollar, carry the big stick, tell the homeowner how it's going to be, then double your money very easily,'' Gutierrez said.

Gutierrez and his wife Brenda, based in San Diego, are a two- person shop in an industry that is attracting deep-pocketed investors such as BlackRock Inc., which manages $1.36 trillion in assets. While Gutierrez said he can buy up to $300,000 of bad loans with his own money and has funding sources for about $1 million, New York-based BlackRock plans to raise $2 billion to invest in discount mortgages.

``At this stage of the game they're playing a very small role, but I expect that that role will accelerate as more people are willing to accept reality,'' said Sam Zell, the billionaire real estate investor who's called ``the grave dancer'' for buying distressed assets. ``The single-family market has to be cleared. No market works unless it clears. If banks can't clear, they can't make new loans. Anything you do to keep people who can't afford it in their houses is another way of delaying the market clearing.''

Eyeballing Properties

In San Diego's Encanto neighborhood, where median home prices slid 38 percent in March from a year earlier, according to La Jolla, California-based DataQuick Information Systems Inc., Gutierrez, 42, pulled up in front of an L-shaped, one-story stucco house. The grass was tall enough to hide a broken child's swing in the front yard. A dented Budweiser can lay next to the walkway.

Gutierrez, who was eyeballing the property to see if he wanted to bid on the mortgage, checked the gas meter mounted on the garage. It was spinning, a sign the home was probably occupied.

The homeowner was $365,000 under water after buying the house with no money down in June 2005, according to a spreadsheet listing about 30 loans for sale by a national mortgage servicer that Gutierrez referred to in his truck. If Gutierrez bought the note for 20 cents on the dollar, or $73,000, he could probably get the owner to leave by giving her $5,000 for moving expenses, then sell the home for about $150,000, well below even the neighborhood's declining market value, he said. That would leave him a profit of about $70,000.

`Buy Cheap, Sell Fast'

``I like the fast nickel,'' he said. ``You buy them cheap, you sell them fast and you get paid.''

Gutierrez said he didn't want to buy the house before he owned the mortgage because then he'd have to settle with the company that did own the note. That could be expensive. Negotiating a new mortgage for the homeowner could be tough, too, he said, because most of the lenders he used have gone out of business.

Still, when there was no answer at the front door, Gutierrez slipped a bright orange sheet of paper into the jamb. It gave the homeowner Gutierrez's phone number to call if he was interested in selling.

``That's so I can feel them out, see what they're thinking,'' Gutierrez said.

Gutierrez hailed a neighbor two doors down who was unloading groceries from her car. She explained that the woman who lived in the house was probably at work and her children were at school. The woman's husband and brother were both ``nowhere to be found,'' she said.

`Bottom Feeder'

``You hear all kinds of stories,'' Gutierrez said later.

Gutierrez said he'll probably offer the homeowner enough cash to pay for a mover and a couple of months in a rented apartment because, he said, many of them want to get out but don't have the money.

``I'm considered a bottom feeder,'' Gutierrez said. ``That's the way bankers see me. They only want the best loans, the loans that are paying. That's nice, but there's no money in it.''

Gutierrez has no shortage of defaulting borrowers close to home. One in every 74 homes, or 15,315, in the San Diego area was in the foreclosure process in the first three months of 2008, compared with one in every 194 homes nationally, according to RealtyTrac Inc. Foreclosure filings in the San Diego area rose 252 percent in the first quarter from a year earlier, compared with a 112 percent increase in the U.S., the Irvine, California-based real estate data provider said.

Unsold Homes

The number of unsold new homes on the national market is the highest since 1980, according to the U.S. Census Bureau. More homeowners are late on their monthly payments than at any time in the last 23 years, the Mortgage Bankers Association said.

The number of home loans for sale is rising, said Marshall Whalen, managing member of Stockbridge Capital LLC in Albany, New York, which bought 19 bad, or nonperforming, mortgages from the Federal Deposit Insurance Corp. in March for 38 cents on the dollar.

``We went from seeing a couple deals a quarter to now we're seeing 20 big deals a quarter,'' Whalen said. ``You really had to beat the bushes to find product before and now you don't have to do that.''

Gutierrez said smaller operators like him are getting ``knocked out of the game'' because of the volume of mortgages that banks want to dump. With Wall Street giants like New York- based BlackRock, Goldman Sachs Group Inc. and Morgan Stanley getting into the business by bidding on thousands of mortgages at a time, Gutierrez said it will be increasingly difficult for ``bottom feeders'' like himself to make a living.

Getting Squeezed

``The banks want to get rid of the loans, and they want to get rid of them to one company, not 20 or 30 companies,'' Gutierrez said. ``It makes sense. I would do the same thing.''

A nonperforming loan that went for 70 cents on the dollar two years ago will generally go for about 50 cents today, and 60 cents if payments are still being made, said Jeffrey Kirsch, chief executive officer of Miami-based American Residential Equities LLC, which trades and services mortgages.

Prices will ``jump dramatically when bigger players get in and start buying nonperforming loans,'' Kirsch said.

BlackRock, the biggest publicly traded U.S. asset manager, announced in March it was backing a new company called Private National Mortgage Acceptance Co. LLC, also known as PennyMac, that will buy mortgages at a discount and renegotiate borrowing terms with homeowners. The Calabasas, California-based company will then service the loans, meaning it will collect monthly payments.

Highfields Capital Management LP, a Boston hedge fund that manages about $10 billion, also has a stake in the new firm.

PennyMac

PennyMac is headed by Stanford Kurland, former president of Countrywide Financial Corp., the largest U.S. home lender and mortgage servicer. Kurland was the one-time heir apparent to Countrywide CEO Angelo Mozilo.

The new company will avoid foreclosing on borrowers, said Mark Suter, PennyMac's chief portfolio strategy officer. Aside from the social cost of foreclosure -- vacant homes are eyesores and magnets for vandals, and they can bring down home values in the area -- Suter said it was more expensive to take over ownership of a home than it was to get a borrower to start paying the mortgage again.

``We don't want to provide a Band-Aid that will fall off,'' Suter said in an interview. ``We want to create permanent solutions to borrowers to stay in their homes.''

Foreclosure Costs

Foreclosure can cost lenders 35 percent of the value of the home, according to a study by the Association of Community Organizations for Reform Now, or ACORN, a non-profit homeowner advocacy group.

``Banks don't want to hold on to a nonperforming asset for the length of time it takes to get people out of the house,'' said Morris Davis, a real estate professor at the University of Wisconsin in Madison.

Lenders also sell loans so they can avoid the hassle of dealing with problematic borrowers, said Eric Fitzwater, senior analyst with SNL Financial LC in Charlottesville, Virginia.

``There are horror stories of people getting kicked out of their houses and because they were pissed off, totally destroying the house,'' Fitzwater said. ``Getting 60 cents on the dollar is better than getting nothing.''

On a sunny day last month, Gutierrez knocked on doors in Imperial Beach, an arid, hilly town just south of San Diego. There were three Imperial Beach houses on the spreadsheet provided by the mortgage servicer that was selling them; none of the borrowers had made a payment in months. Gutierrez was ``driving'' the neighborhood, as he calls it, to determine what he would bid on the pool.

Imperial Beach

In Imperial Beach, 15 homeowners lost their properties to foreclosure in the first three months of 2008, compared with four in the same period last year, according to DataQuick. The town's population is about 26,000, according to the U.S. Census Bureau. The median single-family resale price in town fell 19 percent in the first quarter compared with a year earlier, DataQuick said.

Gutierrez said that because of the legal fees, he avoids foreclosing except when he has to ``clean'' the title of liens or other legal judgments. He said he never collects borrowers' monthly payments because he doesn't want his life to get too ``complicated.''

At a one-story, L-shaped stucco house in Imperial Beach with four-foot-tall rose bushes and an American flag hanging from the garage, 62-year-old Armida Leos answered the door. Her 73-year-old husband, Gilberto, a former U.S. Border Patrol officer, had to quit retirement and get a job as a security guard when their monthly mortgage payments jumped to $3,200 from $2,400, she said.

`We're Losing It'

``I feel really bad for my husband because he worked his heart out to get us into this house and now we're losing it,'' Leos said.

Gutierrez's spreadsheet said the Leos family owed $455,000 on their mortgage. Leos said she and her husband spent $50,000 fixing up the house when they moved in three years ago. They had just received notice from San Diego County that their property tax was being reduced because the house had been assessed for $193,000.

Back in his pickup truck, Gutierrez said he was prepared to offer Leos and her husband $5,000 to move out. He made note of the town's falling home prices and how the house didn't seem to be that big.

``That's not a real selling point,'' he said.