Wednesday, July 30, 2008

Further comments and corrections on yesterday’s post

As expected yesterday’s post drew more reaction (and visitors) than any previous post on this blog. There are a few corrections to make (mostly minor). But I should also share with my readers a taste of the comments that came through the mail.

The only really substantive comment – which came both on the blog and through the mail – was that I underestimated the importance of lending in Euro (rather than Lats) in Latvia (and presumably the other Baltic states).

That is fair enough. Consumers can have a high price loan in Lats or a low price loan in Euro. They take the low price loan in Euro.

However if the currency suddenly halves a lot of distressed borrowers (and I will prove over the next few days that they are distressed) will suddenly owe twice as much as they previously owed. Hansa Bank will then implode in credit risk. Credit risk, currency risk – you pick your poison…

It all reminds me of a flight I was once on between Singapore and Sydney where I sat next to the regional head of credit for Citigroup. He was the perfect upper-mid-level executive – and would only talk about the distant past. However he pointed out that many risks that banks face are equivalent in extrema. For instance if you have lent to people in a currency where interest rates suddenly go to 50 percent (as happens in some devaluation crises), your funding cost (deposits) will rapidly go to 50%. However if you pass that on to your borrowers they will fail. You will suffer credit risk and possibly go insolvent. If however you have offered fixed loans to your borrowers you will wind up with huge funding mismatches – and possibly go insolvent. For small moves there is a difference between credit risk and interest rate risk. For large moves there is no effective difference. The same analysis applies to currency and credit risks.

The second set of comments came down to whether it was possible for Swedbank to go insolvent even if Hansa were a complete disaster. Swedbank has about 40 billion Swedish Kroner in Hansa (including both debt and equity stakes). Swedbank has tangible capital closer to 50 billion Swedish Kroner. If everything goes to zero (which it won’t) then Swedbank still has tangible equity they would argue. And Hansa – no matter what happens – will get some recoveries.

That may be right. Swedbank will look considerably worse than Washington Mutual does now but it may be solvent. Indeed WaMu has blown up considerably less capital than Swedbank does under any variant of that model. But then I think WaMu is solvent. (Regular readers know I own the subordinated debt.)

I used to think – and I made it clear in the post – that Swedbank probably survived. After their conference call and the lack of indication that they will ever pull the plug – I now think they probably fold. However if they pulled the plug now and were straightforward with the risks they were taking the stock would almost certainly stay above zero. [Memo to Swedbank management – now is your time.]

Thirdly there was some objection to my characterisation of the Latvian economy as being driven by sex tourism. Thailand would have a similar objection. But there was a more politically correct way of saying it. One reader wrote:

“A pint of lager costs the same in Tallin as it does in Mayfair, despite earnings power being 4-10x higher in the latter.”

You could argue similar about property prices...

Some noted that I got the currency crises confused when I talked about the fall in the Thai Baht. I did. The Thai Baht only fell by about 60%. The Rupiah fell something between 80 and 90. I never traded anything in Thailand – but I did buy HM Sampoerna near the base of the currency crisis in Indonesia – so I remembered the good side of this (buying really cheap assets). The exact fall is a detail lost in my memory. And I wish all my stocks could be Sampoernas...

Several noted that there was little new in my post. One sell side stock analyst from Scandinavia said that there was nothing new in my post – quibbled about minor errors – and said that it was what he believed but he wasn’t allowed to be so blunt. Several pointed out that the uber-bear Roubini has been saying the same thing. He has – albeit less with less colour!

There were several comments from people who had lived through the Argentine crisis who thought that I had the character of crises spot on. There were a few people from the Baltic republics who didn’t feel it was inaccurate though quibbled about minor details.

Some people noted that the biggest risk to a short position was the geo-political significance of the Baltic States. Simple question: if there is a crisis do you think Putin will take advantage?

And that I think is the real reason this situation is allowed to go on. Nobody thinks the economy of the Baltics will collapse without Western bailout. They are watching the geopolitics. And maybe they are right. I don’t do politics very well.

Further comments much appreciated.

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