Showing posts with label bankrupt. Show all posts
Showing posts with label bankrupt. Show all posts
Tuesday 13 June 2023
Monday 10 April 2023
Does winning the lottery actually ruin your life?
Contrary to popular belief, not everyone loses their friends and goes bankrupt writes Tim Harford in The FT
At the start of the graphic novel Bloke’s Progress, our everyday hero Darren Bloke isn’t coping with the everyday stresses of life. He has a tedious job, a grinding commute, squalling children and too many bills to pay. Then he wins the lottery — and his troubles truly begin.
First, Darren becomes estranged from his friends, who keep pestering him for money. He hangs out with a richer crowd but feels out of place. He divorces his wife and marries a new woman. Then she divorces him. His money is soon gone, and so, too, are his family and friends.
In Bloke’s Progress, Darren is saved by conversations with the spirit of the Victorian sage John Ruskin. (Of course!) Ruskin’s insights deserve a separate column — or a book. But Darren’s tale made me wonder: is this what happens to people who win the lottery?
A glance at the newspapers suggests that it is. The Courier Journal tells the tale of David Lee Edwards from Ashland, Kentucky. He won $27mn in 2001, spent it on drugs, fast cars and a Learjet. He was living in a storage unit within five years, and died penniless. The Guardian explains that Michael Carroll, self-proclaimed “king of chavs”, was declared bankrupt just eight years after winning nearly £10mn — while Lee Ryan ended up sleeping rough, and spending time in jail for handling stolen cars, despite winning £6.5mn. If only the spirit of John Ruskin had been there to save them all.
But while these cautionary tales offer us a moralistic narrative arc that sticks in the memory, they aren’t necessarily typical. A lot of people win big prizes on the lottery, enough to allow us to draw more subtle — and less tragic — conclusions.
First, do lottery wins estrange us from our friends? Darren Bloke’s fate seems plausible: his friends kept asking him for money, leading him to feel exploited and them to accuse him of meanness. Yet a study by Joan Costa Font of the London School of Economics and Nattavudh Powdthavee of Warwick Business School finds that people who win more than £10,000 on the lottery spend more time socialising with their friends, although less time talking to neighbours.
This result won’t come as a shock to those who read a 2016 study by Emily Bianchi and Kathleen Vohs, which found that richer Americans tended to spend less time with neighbours and family, and more with friends. The simplest explanation is that money makes it easy to socialise for pure pleasure, while reducing the need to maintain relationships for practical reasons, such as sharing childcare.
Second, do lottery winners blow their winnings and lapse into poverty? Here, myths abound; the National Endowment for Financial Education is often cited as the source for a claim that 70 per cent of lottery winners go bankrupt. The NEFE has issued a press release explaining that it has not made that claim and has no reason to believe the claim is true.
A study by the economists Scott Hankins, Mark Hoekstra and Paige Marta Skiba looked at 35,000 lottery winners in Florida, of whom 2,000 later filed for bankruptcy (that’s less than 6 per cent, not 70 per cent). The researchers did find that lottery winners were more likely to file for bankruptcy than non-winners. Perhaps that is not surprising, since lottery enthusiasts tend to be low-income, and most of them don’t win much. Hankins, Hoekstra and Skiba found that bankruptcy struck with equal likelihood whether people won less than $10,000 or more than $50,000.
These Floridian winners, then, were more likely to face bankruptcy than non-winners, but bankruptcy was still an unusual outcome. Nor did it make any difference how much they won.
Third, do lottery winners quit their jobs, as Darren Bloke did? Not according to a study of Swedish lottery winners who had won an average of 2mn Swedish kronor — roughly £200,000 — at some stage between the mid-1990s and 2005. This was about eight times the annual salary of a nurse or police officer in Sweden at the time. The researchers, Bengt Furaker and Anna Hedenus, found that some of these winners reduced their hours or took some unpaid leave, but 62 per cent carried on working exactly as before, and only 12 per cent quit their jobs completely. Either people felt that the jackpot wasn’t quite large enough to make it sensible to quit, or — perhaps more likely — they rather enjoyed their jobs. John Ruskin, who celebrated the value of honest labour, would surely have approved.
Thus far we’ve seen that lottery winners spend more time hanging out with friends, are not notably at risk of bankruptcy and often keep working in their old jobs. The big question remaining is: are they happy?
Yes, say Erik Lindqvist, Robert Östling and David Cesarini, who studied lottery winners in (again) Sweden. They find that winners of large prizes were significantly more satisfied with their lives — and in particular were significantly more satisfied with their finances. There is little sign in this data of the feckless or reckless lottery winners who squander their winnings.
The overall impression I get from these studies is that lottery winners are . . . well, rather sensible. “I won’t let it change my life,” goes the cliché, and perhaps the cliché is true.
Lottery winners typically use their money to increase their financial security and to spend more time with friends. They rarely quit their jobs. Some squander the money; most do not. Ruskin argued that money had no value unless it was wisely used. Lottery winners don’t do as badly as we might have feared.
Saturday 18 March 2023
Tuesday 12 May 2020
Why the coming emerging markets debt crisis will be messy
Colby Smith and Robin Wigglesworth in The Financial Times
The Maldives’ coral-encrusted islands have long been irresistible to tourists. But today its secluded luxury resorts are deserted, except those converted into makeshift quarantine facilities for stranded coronavirus patients.
The virus has shattered global tourism and devastated the Maldivian economy. The IMF has gone from projecting a 6 per cent expansion in gross domestic product this year to an 8 per cent contraction. The risk is that this brutal, abrupt recession could translate into the Maldives becoming the latest country to sink into sovereign bankruptcy.
Zambia, Ecuador and Rwanda have all announced in recent weeks that they are struggling to repay their debts. Lebanon has already kicked off its restructuring process, while Argentina, which was already battling its creditors even before the pandemic struck, appears to be heading for its ninth sovereign default since independence in 1816. Investors believe many other developing countries are not too far behind.
The Maldives is hardly the biggest country likely to succumb, but given its debt burden to creditors such as China and the severity of its recession, it is the “poster child of how easily the dominoes will fall”, warns Mitu Gulati, a sovereign debt expert at Duke University.
The IMF has already lent the country $29m to tide it over, but warned that the loss of tourism has “severely weakened” the economy and that additional financial support would be needed. The country’s $250m bond due in 2022 has tumbled to trade at just 81 cents on the dollar, indicating that investors are increasingly concerned about the Maldives’ capacity to make good on its obligations.
The kindling for another big emerging markets debt crisis has been accumulating for years. The investor thirst for higher returns has allowed smaller, lesser-developed and more vulnerable “frontier” countries to tap bond markets (Editor's note - this refers to bond markets not denominated in the country's own currency) at a record pace in the past decade. Their debt burden has climbed from less than $1tn in 2005 to $3.2tn, according to the Institute of International Finance, equal to 114 per cent of gross domestic product for frontier markets. Emerging markets as a whole owe a total of $71tn.
“The challenge is enormous,” says Ramin Toloui, a former head of emerging market debt at bond manager Pimco and assistant secretary for international finance at the US Treasury, who now teaches at Stanford University. “The withdrawal of money [from EM funds] is greater and more sudden than in 2008, the economic shock is huge and the path to recovery more uncertain than it was after the last crisis.”
The G20 has agreed to temporarily freeze about $20bn-worth of bilateral loan repayments for 76 poorer countries. It has urged private sector creditors to do the same, but few analysts believe that is feasible, and predict the result will probably instead be a series of ad hoc debt standstills and restructurings for swaths of the developing world.
Resolving the coming debt crises may be even tougher than in the past, however. Rather than the banks and governments — the primary creditors in the mammoth debt crisis that racked the developing world in the 1980s and 1990s — creditors are nowadays largely a multitude of bond funds. They are trickier to co-ordinate and corral into restructuring agreements.
Although the need for financial relief is stark in many cases, there are indications that some investment groups may break with the custom of reluctantly accepting financially painful compromises to achieve a restructuring, and instead fight for a better deal.
“Normally these guys would get out of Dodge City at the first sign of trouble in the debtor country. They're not set up to deal with prolonged debt restructurings and don't like the reputational risk that would result from an aggressive campaign against a country in deep economic and social distress,” says Lee Buchheit, a prominent lawyer in the field. “But having watched some holdout creditors extract rich payouts, even some of the traditional institutional investors appear to be reconsidering the virtues of passivity.”
Holdout strategy
In the past, such aggression has been the preserve of what critics call “vulture funds” — investors who seek to profit from government debt crises through obstinacy and legal threats.
Their basic strategy is to act as a “holdout”. Sovereign debt restructurings amount to exchanging a country’s old bonds for new ones, often worth less, with a lower interest rate or longer repayment times. Holdouts refuse to join in, and instead threaten to sue for the full amount. As long as the number of holdouts is tiny, countries have often elected to simply pay them off rather than deal with the nuisance of a potentially lengthy courtroom battle.
For example, when Greece restructured most of its debts in 2012, it grudgingly chose to repay in full a smattering of overseas bonds where hedge funds had congregated. Others, like Argentina, have chosen to fight. The uncertainty of the outcome — and how hard it can be to compel a country to pay through legal means — long ensured a delicate but functional balance to the sovereign debt restructuring process.
However, in 2016 Elliott Management’s Jay Newman etched his name in the annals of big hedge fund hauls by extracting $2.4bn from Argentina for the firm after a decade-long legal battle.
“[Holding out] long seemed like a cat-and-mouse game that was costly and uncertain, but now it has shifted to a more promising strategy,” says Christoph Trebesch, an academic at the Kiel Institute for the World Economy in Germany. Although still daunting, Elliott’s success could inspire more copycats and complicate the looming spate of EM debt crises, some experts fear.
Moreover, there are signs that traditional investment groups are also toughening up, which could turn a difficult process into a more protracted nightmare for government lenders and borrowers alike.
One lawyer who has worked with creditors points out that many investment funds have piled into EM bonds in recent years, and the prospect of deep and broad losses could be ruinous to some heavily-exposed funds. “Before, the holdouts were the main problem, but now it could be the traditional funds,” he says. “If your back is against the wall, you’re going to fight.”
After the IMF’s failed attempt to set up a quasi-sovereign bankruptcy court in the early 2000s, the main response by governments has been to introduce “collective action clauses” into their bonds. These dictate that if a large majority of bondholders vote for a restructuring, typically 75 per cent, the agreement is imposed on all holders.
But investors have wised up, buying bigger chunks of specific bonds in an attempt to amass such a large position that they enjoy a de facto veto over the restructuring terms of the instruments. And some older bonds have no such clauses.
So far there are only a few examples of larger investment firms taking a tougher stance, but they are notable for how successful they have been. The first was Franklin Templeton, which managed to extract what some analysts say were surprisingly favourable terms in Ukraine’s 2015 debt restructuring, having snapped up enough bonds to become the country’s largest private creditor.
More recently, Ashmore has built up a huge stake in Lebanon’s debt that in practice gives it a veto over how the country will restructure some of its bonds. And this year, Fidelity successfully played hardball with Buenos Aires, calling the Argentine province’s bluff that it was unable to make a $250m payment due in January. Buenos Aires ended up paying in full.
Fidelity is also part of a larger creditor group that has pushed back on Argentina’s plans to restructure its $65bn foreign debt burden. The group includes some of the world’s largest institutional investors, including BlackRock and T Rowe Price, and together with the two other main bondholder groups, wields enough power to make or break any deal.
Franklin Templeton and Ashmore declined to comment. Fidelity declined to comment on its Argentine bust-up, but said in a statement that its policies on sovereign restructurings had not changed.
“When it becomes necessary to negotiate with those who have borrowed our investors’ money, we do so in good faith and in a reasonable, professional manner,” the investment group said. “The interests we represent are those of the millions of individuals, and thousands of financial advisers and institutions who have entrusted their money to us to invest on their behalf.”
Debtor advantage
Fidelity’s nod to the fiduciary duty money managers owe clients is telling. Traditional asset managers are unlikely to be quite as stubborn or litigious as Elliott. But with a spate of examples that a tougher approach can be successful, more may feel compelled to follow suit — no matter how severe the coronavirus crisis proves for many countries.
“They don’t want to be Elliott, but they have a fiduciary duty and for some of them it will be existential, so they might as well fight to the death,” says the creditor lawyer. “It doesn’t take many of them to change their attitudes and this will become very difficult.”
Clinching a victory, however, is another story, says one holdout investor. Amassing a blocking stake “gets you a seat at the table, but it doesn’t tell you when you will be eating”, the person adds.
These dynamics are why many investors believe the G20’s call for private-sector creditors to copy their blanket debt “standstill” will probably prove futile. Absent some kind of extraordinary legal mechanism — such as the UN Security Council resolution that shielded Iraq’s assets from seizure from creditors after the US invasion in 2003 — investors warn it will be challenging to come to a collective and voluntary agreement. Instead, they say the coming wave of debt crises will have to be handled on a case-by-case basis.
For the investment funds looking to take an aggressive stance in any default talks, the obstacle might not be the potentially bad PR but the perception among some governments that the pandemic gives them more leverage. Given that bond prices have plummeted to distressed levels, countries will probably harden their stance and seek more favourable terms in forthcoming restructurings.
Bill Rhodes, a former top Citi executive who was one of the key figures in the Latin American debt crisis of the 1980s, argues that the threat of fresh outbreaks of coronavirus will strengthen the hand of debtor countries when negotiating repayment terms. “We are looking at just the first wave of Covid-19, so some of these finance ministers are going to feel like they really have to drive a tough bargain,” he says. “The IMF will be very firm on pushing for the countries to get discounts.”
Institutional deal
A group of sovereign debt experts, including Mr Gulati and Mr Buchheit, has come up with a pandemic debt relief proposal. Countries should strike an agreement with creditors to funnel debt payments into credit facilities set up by the World Bank or a regional development bank, which would then be lent back to the countries to pay for essential spending.
Its backers hope this would avoid a technical default and impose a de facto debt standstill. The carrot of the legal protection enjoyed by organisations such as the World Bank — which are considered “super-senior” in debt restructurings — might help sweeten the deal. Once the crisis has faded a decision can then be taken on whether a full but orderly debt restructuring is needed, and any money deposited in the facility would be protected.
It is unclear whether the World Bank, which has not publicly commented on the idea, would go for this proposal, and some heavy-handed coercion from the likes of the US would probably be needed to get many creditors to agree. But Mr Trebesch says the proposal may be acceptable to China, which has edged out the IMF and the World Bank as the largest official creditor to developing economies via its Belt and Road Initiative, according to data he compiled with Harvard’s Carmen Reinhart and economist Sebastian Horn. “If things really blow up, China might prefer this option to an outright default,” he says.
Whatever avenue is eventually taken, it is essential that policymakers start grappling more forcefully with emerging market travails, given the danger that their severity is likely to reverberate across the international financial system, according to Scott Minerd, chief investment officer at investment firm Guggenheim Partners.
“This pandemic will quickly escalate from a health crisis to a humanitarian crisis, and ultimately to a solvency crisis,” Mr Minerd wrote in a recent note to clients. “Political stability will be the last domino to fall. But my biggest concern is that this crisis will be much deeper and more prolonged than people anticipate, which leaves a lot of space for another shoe to drop in the global financial crisis.”
The Maldives’ coral-encrusted islands have long been irresistible to tourists. But today its secluded luxury resorts are deserted, except those converted into makeshift quarantine facilities for stranded coronavirus patients.
The virus has shattered global tourism and devastated the Maldivian economy. The IMF has gone from projecting a 6 per cent expansion in gross domestic product this year to an 8 per cent contraction. The risk is that this brutal, abrupt recession could translate into the Maldives becoming the latest country to sink into sovereign bankruptcy.
Zambia, Ecuador and Rwanda have all announced in recent weeks that they are struggling to repay their debts. Lebanon has already kicked off its restructuring process, while Argentina, which was already battling its creditors even before the pandemic struck, appears to be heading for its ninth sovereign default since independence in 1816. Investors believe many other developing countries are not too far behind.
The Maldives is hardly the biggest country likely to succumb, but given its debt burden to creditors such as China and the severity of its recession, it is the “poster child of how easily the dominoes will fall”, warns Mitu Gulati, a sovereign debt expert at Duke University.
The IMF has already lent the country $29m to tide it over, but warned that the loss of tourism has “severely weakened” the economy and that additional financial support would be needed. The country’s $250m bond due in 2022 has tumbled to trade at just 81 cents on the dollar, indicating that investors are increasingly concerned about the Maldives’ capacity to make good on its obligations.
The kindling for another big emerging markets debt crisis has been accumulating for years. The investor thirst for higher returns has allowed smaller, lesser-developed and more vulnerable “frontier” countries to tap bond markets (Editor's note - this refers to bond markets not denominated in the country's own currency) at a record pace in the past decade. Their debt burden has climbed from less than $1tn in 2005 to $3.2tn, according to the Institute of International Finance, equal to 114 per cent of gross domestic product for frontier markets. Emerging markets as a whole owe a total of $71tn.
“The challenge is enormous,” says Ramin Toloui, a former head of emerging market debt at bond manager Pimco and assistant secretary for international finance at the US Treasury, who now teaches at Stanford University. “The withdrawal of money [from EM funds] is greater and more sudden than in 2008, the economic shock is huge and the path to recovery more uncertain than it was after the last crisis.”
The G20 has agreed to temporarily freeze about $20bn-worth of bilateral loan repayments for 76 poorer countries. It has urged private sector creditors to do the same, but few analysts believe that is feasible, and predict the result will probably instead be a series of ad hoc debt standstills and restructurings for swaths of the developing world.
Resolving the coming debt crises may be even tougher than in the past, however. Rather than the banks and governments — the primary creditors in the mammoth debt crisis that racked the developing world in the 1980s and 1990s — creditors are nowadays largely a multitude of bond funds. They are trickier to co-ordinate and corral into restructuring agreements.
Although the need for financial relief is stark in many cases, there are indications that some investment groups may break with the custom of reluctantly accepting financially painful compromises to achieve a restructuring, and instead fight for a better deal.
“Normally these guys would get out of Dodge City at the first sign of trouble in the debtor country. They're not set up to deal with prolonged debt restructurings and don't like the reputational risk that would result from an aggressive campaign against a country in deep economic and social distress,” says Lee Buchheit, a prominent lawyer in the field. “But having watched some holdout creditors extract rich payouts, even some of the traditional institutional investors appear to be reconsidering the virtues of passivity.”
Holdout strategy
In the past, such aggression has been the preserve of what critics call “vulture funds” — investors who seek to profit from government debt crises through obstinacy and legal threats.
Their basic strategy is to act as a “holdout”. Sovereign debt restructurings amount to exchanging a country’s old bonds for new ones, often worth less, with a lower interest rate or longer repayment times. Holdouts refuse to join in, and instead threaten to sue for the full amount. As long as the number of holdouts is tiny, countries have often elected to simply pay them off rather than deal with the nuisance of a potentially lengthy courtroom battle.
For example, when Greece restructured most of its debts in 2012, it grudgingly chose to repay in full a smattering of overseas bonds where hedge funds had congregated. Others, like Argentina, have chosen to fight. The uncertainty of the outcome — and how hard it can be to compel a country to pay through legal means — long ensured a delicate but functional balance to the sovereign debt restructuring process.
However, in 2016 Elliott Management’s Jay Newman etched his name in the annals of big hedge fund hauls by extracting $2.4bn from Argentina for the firm after a decade-long legal battle.
“[Holding out] long seemed like a cat-and-mouse game that was costly and uncertain, but now it has shifted to a more promising strategy,” says Christoph Trebesch, an academic at the Kiel Institute for the World Economy in Germany. Although still daunting, Elliott’s success could inspire more copycats and complicate the looming spate of EM debt crises, some experts fear.
Moreover, there are signs that traditional investment groups are also toughening up, which could turn a difficult process into a more protracted nightmare for government lenders and borrowers alike.
One lawyer who has worked with creditors points out that many investment funds have piled into EM bonds in recent years, and the prospect of deep and broad losses could be ruinous to some heavily-exposed funds. “Before, the holdouts were the main problem, but now it could be the traditional funds,” he says. “If your back is against the wall, you’re going to fight.”
After the IMF’s failed attempt to set up a quasi-sovereign bankruptcy court in the early 2000s, the main response by governments has been to introduce “collective action clauses” into their bonds. These dictate that if a large majority of bondholders vote for a restructuring, typically 75 per cent, the agreement is imposed on all holders.
But investors have wised up, buying bigger chunks of specific bonds in an attempt to amass such a large position that they enjoy a de facto veto over the restructuring terms of the instruments. And some older bonds have no such clauses.
So far there are only a few examples of larger investment firms taking a tougher stance, but they are notable for how successful they have been. The first was Franklin Templeton, which managed to extract what some analysts say were surprisingly favourable terms in Ukraine’s 2015 debt restructuring, having snapped up enough bonds to become the country’s largest private creditor.
More recently, Ashmore has built up a huge stake in Lebanon’s debt that in practice gives it a veto over how the country will restructure some of its bonds. And this year, Fidelity successfully played hardball with Buenos Aires, calling the Argentine province’s bluff that it was unable to make a $250m payment due in January. Buenos Aires ended up paying in full.
Fidelity is also part of a larger creditor group that has pushed back on Argentina’s plans to restructure its $65bn foreign debt burden. The group includes some of the world’s largest institutional investors, including BlackRock and T Rowe Price, and together with the two other main bondholder groups, wields enough power to make or break any deal.
Franklin Templeton and Ashmore declined to comment. Fidelity declined to comment on its Argentine bust-up, but said in a statement that its policies on sovereign restructurings had not changed.
“When it becomes necessary to negotiate with those who have borrowed our investors’ money, we do so in good faith and in a reasonable, professional manner,” the investment group said. “The interests we represent are those of the millions of individuals, and thousands of financial advisers and institutions who have entrusted their money to us to invest on their behalf.”
Debtor advantage
Fidelity’s nod to the fiduciary duty money managers owe clients is telling. Traditional asset managers are unlikely to be quite as stubborn or litigious as Elliott. But with a spate of examples that a tougher approach can be successful, more may feel compelled to follow suit — no matter how severe the coronavirus crisis proves for many countries.
“They don’t want to be Elliott, but they have a fiduciary duty and for some of them it will be existential, so they might as well fight to the death,” says the creditor lawyer. “It doesn’t take many of them to change their attitudes and this will become very difficult.”
Clinching a victory, however, is another story, says one holdout investor. Amassing a blocking stake “gets you a seat at the table, but it doesn’t tell you when you will be eating”, the person adds.
These dynamics are why many investors believe the G20’s call for private-sector creditors to copy their blanket debt “standstill” will probably prove futile. Absent some kind of extraordinary legal mechanism — such as the UN Security Council resolution that shielded Iraq’s assets from seizure from creditors after the US invasion in 2003 — investors warn it will be challenging to come to a collective and voluntary agreement. Instead, they say the coming wave of debt crises will have to be handled on a case-by-case basis.
For the investment funds looking to take an aggressive stance in any default talks, the obstacle might not be the potentially bad PR but the perception among some governments that the pandemic gives them more leverage. Given that bond prices have plummeted to distressed levels, countries will probably harden their stance and seek more favourable terms in forthcoming restructurings.
Bill Rhodes, a former top Citi executive who was one of the key figures in the Latin American debt crisis of the 1980s, argues that the threat of fresh outbreaks of coronavirus will strengthen the hand of debtor countries when negotiating repayment terms. “We are looking at just the first wave of Covid-19, so some of these finance ministers are going to feel like they really have to drive a tough bargain,” he says. “The IMF will be very firm on pushing for the countries to get discounts.”
Institutional deal
A group of sovereign debt experts, including Mr Gulati and Mr Buchheit, has come up with a pandemic debt relief proposal. Countries should strike an agreement with creditors to funnel debt payments into credit facilities set up by the World Bank or a regional development bank, which would then be lent back to the countries to pay for essential spending.
Its backers hope this would avoid a technical default and impose a de facto debt standstill. The carrot of the legal protection enjoyed by organisations such as the World Bank — which are considered “super-senior” in debt restructurings — might help sweeten the deal. Once the crisis has faded a decision can then be taken on whether a full but orderly debt restructuring is needed, and any money deposited in the facility would be protected.
It is unclear whether the World Bank, which has not publicly commented on the idea, would go for this proposal, and some heavy-handed coercion from the likes of the US would probably be needed to get many creditors to agree. But Mr Trebesch says the proposal may be acceptable to China, which has edged out the IMF and the World Bank as the largest official creditor to developing economies via its Belt and Road Initiative, according to data he compiled with Harvard’s Carmen Reinhart and economist Sebastian Horn. “If things really blow up, China might prefer this option to an outright default,” he says.
Whatever avenue is eventually taken, it is essential that policymakers start grappling more forcefully with emerging market travails, given the danger that their severity is likely to reverberate across the international financial system, according to Scott Minerd, chief investment officer at investment firm Guggenheim Partners.
“This pandemic will quickly escalate from a health crisis to a humanitarian crisis, and ultimately to a solvency crisis,” Mr Minerd wrote in a recent note to clients. “Political stability will be the last domino to fall. But my biggest concern is that this crisis will be much deeper and more prolonged than people anticipate, which leaves a lot of space for another shoe to drop in the global financial crisis.”
Monday 13 April 2020
Auditors clash with firm directors over the question of 'firms that can survive'
Businesses are under pressure to give full account of how pandemic has affected trade writes Tabby Kinder in The FT
UK companies in the retail, hospitality and construction industries are locked in a battle with auditors to prevent their accounts carrying warnings that risk making the fight to survive the coronavirus crisis harder.
The country’s accounting watchdog is pushing auditors to be tougher when judging whether a company can continue trading as a going concern for the next 12 months. The going concern test is one that companies must pass to secure a clean bill of health from their auditors.
The increased pressure from the Financial Reporting Council is stoking tensions between audit firms and company directors, who are worried that an official question mark in their accounts over whether they can keep trading — known as a qualified audit — would automatically trigger a breach of lending agreements with banks or bondholders.
Several of the UK’s six largest accounting firms, which include KPMG, Deloitte, PwC and EY, have put additional steps in place to review signing off companies as a going concern.
PwC has introduced a panel to sign off on its audit opinions, while Grant Thornton is sending every one of its audits through its technical review team, which is usually reserved for its riskiest or complex audit judgments, according to people familiar with the matter. Both firms declined to comment.
“If any of us are accused of not challenging management after all this is over, that will be hideously unfair,” said one senior auditor. “We are having challenging conversations [with company directors] at colossal scale.”
The pressure on auditors from the FRC comes after a series of accounting scandals led to criticism that the regulator has been too slow to act, lenient and too close to the audit firms it supervises.
“We don’t want boilerplate, we want specific circumstances and disclosure about judgments on going concern,” said a senior official close to the FRC. “For corporates that means the trading environment, and now the audit environment is tougher than ever. It is creating tensions in the system.”
With the government expected to extend the lockdown, senior auditors at a number of the UK’s largest firms said they were asking companies in the hospitality, retail and construction sectors to stress test whether they could survive “zero revenues” for six months or longer.
“It’s not an impossible prospect,” the head of audit at a major accounting firm said of the scenario. “We’re saying you’ll breach covenants in that situation and you need to tell the world that. Directors are pushing back and telling us that’s not realistic. The issue is any consensus on how long this will last is quickly meaningless.”
The economic turmoil unleashed by the government’s effort to contain the virus has already upended the reporting calendar for companies. The Financial Reporting Council and the Financial Conduct Authority have given listed companies two extra months to file their accounts in order to better assess the impact of Covid-19 on their profitability.
The FRC is also urging lenders and investors to react sensibly if the accounts of some large listed companies end up being qualified. “[There is a worry that] markets will overreact to what is a statement of the blindingly obvious,” the senior official close to the watchdog said.
The watchdog is holding talks with banks, shareholder groups and bondholders to warn them to prepare for a flood of going concern warnings in the companies they own or have lent to.
The Institute of Chartered Accountants in England and Wales, the profession’s trade body, is expected to put out guidance this week that will “remind” accountants working in the finance departments of listed companies of their disclosure obligations on going concern, according to a person familiar with the matter.
“Many boards are going to have to come to conclusions today that would have seemed absurd three months ago, and they are obliged to consider that in their results,” the person said.
UK companies in the retail, hospitality and construction industries are locked in a battle with auditors to prevent their accounts carrying warnings that risk making the fight to survive the coronavirus crisis harder.
The country’s accounting watchdog is pushing auditors to be tougher when judging whether a company can continue trading as a going concern for the next 12 months. The going concern test is one that companies must pass to secure a clean bill of health from their auditors.
The increased pressure from the Financial Reporting Council is stoking tensions between audit firms and company directors, who are worried that an official question mark in their accounts over whether they can keep trading — known as a qualified audit — would automatically trigger a breach of lending agreements with banks or bondholders.
Several of the UK’s six largest accounting firms, which include KPMG, Deloitte, PwC and EY, have put additional steps in place to review signing off companies as a going concern.
PwC has introduced a panel to sign off on its audit opinions, while Grant Thornton is sending every one of its audits through its technical review team, which is usually reserved for its riskiest or complex audit judgments, according to people familiar with the matter. Both firms declined to comment.
“If any of us are accused of not challenging management after all this is over, that will be hideously unfair,” said one senior auditor. “We are having challenging conversations [with company directors] at colossal scale.”
The pressure on auditors from the FRC comes after a series of accounting scandals led to criticism that the regulator has been too slow to act, lenient and too close to the audit firms it supervises.
“We don’t want boilerplate, we want specific circumstances and disclosure about judgments on going concern,” said a senior official close to the FRC. “For corporates that means the trading environment, and now the audit environment is tougher than ever. It is creating tensions in the system.”
With the government expected to extend the lockdown, senior auditors at a number of the UK’s largest firms said they were asking companies in the hospitality, retail and construction sectors to stress test whether they could survive “zero revenues” for six months or longer.
“It’s not an impossible prospect,” the head of audit at a major accounting firm said of the scenario. “We’re saying you’ll breach covenants in that situation and you need to tell the world that. Directors are pushing back and telling us that’s not realistic. The issue is any consensus on how long this will last is quickly meaningless.”
The economic turmoil unleashed by the government’s effort to contain the virus has already upended the reporting calendar for companies. The Financial Reporting Council and the Financial Conduct Authority have given listed companies two extra months to file their accounts in order to better assess the impact of Covid-19 on their profitability.
The FRC is also urging lenders and investors to react sensibly if the accounts of some large listed companies end up being qualified. “[There is a worry that] markets will overreact to what is a statement of the blindingly obvious,” the senior official close to the watchdog said.
The watchdog is holding talks with banks, shareholder groups and bondholders to warn them to prepare for a flood of going concern warnings in the companies they own or have lent to.
The Institute of Chartered Accountants in England and Wales, the profession’s trade body, is expected to put out guidance this week that will “remind” accountants working in the finance departments of listed companies of their disclosure obligations on going concern, according to a person familiar with the matter.
“Many boards are going to have to come to conclusions today that would have seemed absurd three months ago, and they are obliged to consider that in their results,” the person said.
Sunday 14 October 2018
What price the wisdom of Luke Johnson, when his own company Patisserie Valerie tanks?
Catherine Bennett in The Guardian
The Patisserie Valerie chief should look to himself before lecturing others again
The Patisserie Valerie chief should look to himself before lecturing others again
Self-styled ‘risk-taker’ Luke Johnson at a branch of Patisserie Valerie in London.
‘Unfortunately,” Luke Johnson wrote recently, “financial illiteracy permeates society from top to bottom. Too many ordinary people do not understand mortgages, pensions, insurance, loans or investing.”
Johnson, the entrepreneur whose biggest asset, Patisserie Valerie, now needs bailing out, was being generous. Even after the 2008 financial crisis confirmed that corporate incompetence warranted unwavering public scrutiny, too many ordinary people remain equally ignorant about the operations and capabilities of business leaders, even those, like Mr Johnson, whose influence extends far beyond his imperilled patisserie company.
Some of us, inexcusably, even struggle with the basic jargon of “black hole”. As in: “The owner of Patisserie Valerie has been plunged into financial crisis after it revealed a multimillion pound accounting black hole.” Is it the same sort of black hole that astonished managers at Carillion, following a “deterioration in cashflows”? Or an industry synonym for the “material shortfall” disclosed by the Patisserie Valerie board, “between the reported financial status and the current financial status of the business”.
Either way, does the black hole’s existence mean that Mr Johnson must also be financially illiterate? Or is that question better addressed to Patisserie Valerie’s finance chief, Chris Marsh, with whom Johnson has worked since 2006? Marsh was arrested by the police, then released on bail.
Regrettably, at the very moment when an ordinary person struggles to comprehend how £28m in May became minus £10m by October, and why one creditor, the HMRC, should be pursuing an unpaid tax bill of £1.4m – and what that tells us about the company’s leadership – it appears that Mr Johnson is taking a break from his weekly newspaper column. Its absence is the more acute, now that its author, expert on subjects such as red tape, Brexit and other people’s incompetence, has also fallen silent on Twitter; and his popular personal website seems, at the time of writing, to have vanished. With luck, it won’t be too long before he is sharing details of his mercy dash on Evan Davis’s The Bottom Line: “Providing insight into business from the people at the top.”
‘Unfortunately,” Luke Johnson wrote recently, “financial illiteracy permeates society from top to bottom. Too many ordinary people do not understand mortgages, pensions, insurance, loans or investing.”
Johnson, the entrepreneur whose biggest asset, Patisserie Valerie, now needs bailing out, was being generous. Even after the 2008 financial crisis confirmed that corporate incompetence warranted unwavering public scrutiny, too many ordinary people remain equally ignorant about the operations and capabilities of business leaders, even those, like Mr Johnson, whose influence extends far beyond his imperilled patisserie company.
Some of us, inexcusably, even struggle with the basic jargon of “black hole”. As in: “The owner of Patisserie Valerie has been plunged into financial crisis after it revealed a multimillion pound accounting black hole.” Is it the same sort of black hole that astonished managers at Carillion, following a “deterioration in cashflows”? Or an industry synonym for the “material shortfall” disclosed by the Patisserie Valerie board, “between the reported financial status and the current financial status of the business”.
Either way, does the black hole’s existence mean that Mr Johnson must also be financially illiterate? Or is that question better addressed to Patisserie Valerie’s finance chief, Chris Marsh, with whom Johnson has worked since 2006? Marsh was arrested by the police, then released on bail.
Regrettably, at the very moment when an ordinary person struggles to comprehend how £28m in May became minus £10m by October, and why one creditor, the HMRC, should be pursuing an unpaid tax bill of £1.4m – and what that tells us about the company’s leadership – it appears that Mr Johnson is taking a break from his weekly newspaper column. Its absence is the more acute, now that its author, expert on subjects such as red tape, Brexit and other people’s incompetence, has also fallen silent on Twitter; and his popular personal website seems, at the time of writing, to have vanished. With luck, it won’t be too long before he is sharing details of his mercy dash on Evan Davis’s The Bottom Line: “Providing insight into business from the people at the top.”
Happily, as others have noted, some of Mr Johnson’s earlier columns have addressed related issues such as, recently, “a business beginner’s guide to tried and tested swindles”. Watch out, he warns, for non-payment of creditors, dodgy advisers and attempts to overcomplicate things, so as to baffle the many people – unlike himself – who “do not understand the technicalities of investing or accounting”.
Inevitably, that widespread ignorance makes it hard to judge how much of Johnson’s wide-ranging, pre-existing advice, which has recently focused on Brexit, we can safely discard as, if not consistently hilarious, worthless. His chairmanship of Patisserie Valerie has, after all, repeatedly been cited, in the same way as Dyson’s profits and Tim Martin’s pubs, as the main reason to listen to him deprecate the EU, with his own achievements (pre-black hole), proving that “this is a great country in which to do business and prosper”.
Although Johnson is no different from other business celebrities, such as Dyson, Branson and Trump, in having parlayed business success into guru status, he has, more unusually, further set himself up as a kind of entrepreneur-moralist, with a biblical line in rebukes. Here he is, against – I think – overpaid government regulators: “Political leaders who want to foster world-beating companies must act decisively and, as with any transformation, slash off the gangrenous limbs without mercy.” Critics of rich people are warned: “Envy is a ruinous trait – as well as one of the deadly sins – and a sordid national characteristic.”
Inevitably, that widespread ignorance makes it hard to judge how much of Johnson’s wide-ranging, pre-existing advice, which has recently focused on Brexit, we can safely discard as, if not consistently hilarious, worthless. His chairmanship of Patisserie Valerie has, after all, repeatedly been cited, in the same way as Dyson’s profits and Tim Martin’s pubs, as the main reason to listen to him deprecate the EU, with his own achievements (pre-black hole), proving that “this is a great country in which to do business and prosper”.
Although Johnson is no different from other business celebrities, such as Dyson, Branson and Trump, in having parlayed business success into guru status, he has, more unusually, further set himself up as a kind of entrepreneur-moralist, with a biblical line in rebukes. Here he is, against – I think – overpaid government regulators: “Political leaders who want to foster world-beating companies must act decisively and, as with any transformation, slash off the gangrenous limbs without mercy.” Critics of rich people are warned: “Envy is a ruinous trait – as well as one of the deadly sins – and a sordid national characteristic.”
Like any half-decent moralist, he alternates rants with hints for personal salvation, through thrift, reliability and, again, financial literacy: “I am surprised how many senior managers I meet cannot read a cashflow statement.”
By way of authority, even Johnson’s less scorching capitalist homilies are littered with references to the usual suspects – Napoleon, Samuel Smiles and Marcus Aurelius – less usually, the scriptures and “the 19th-century philosopher Herbert Spencer”, not forgetting, shamelessly, Ayn Rand. “Those who possess willpower,” Johnson echoes, “seize the day and actively control their destiny.” Less gifted individuals are dismissed as lazy idiots, fools, inferiors who will never get the chance to close down a chain of well-regarded bookshops or, as now, bail out their own patisseries.
That Johnson should, on the back of this stuff, and the cake shops, have risen to yet greater prominence as a notable Vote Leave backer, his blessing sought by Theresa May, is perhaps no more absurd than, earlier, was David Cameron’s promotion of the Topshop brute, Philip Green, or elevation of JCB’s Anthony Bamford (previously fined by the EU). The myth of the disinterested entrepreneur-consultant seems ineradicable.
In Brexit, Johnson and his like-minded entrepreneurs have, however, discovered a yet more rewarding platform on which to portray their regulation-averse interests as a purely patriotic project.
Entrepreneurs, Johnson has written, on this favourite subject, are “the anarchists of the business world. Their mission is to overthrow the existing order.” Every entrepreneur is “a disruptor and a libertarian”, or would be “if the state sets a sensible framework and gets out of the way”. He explains that the word “chancer” properly describes risk-takers like him, who are willing to make mistakes, probably through excessive impetuosity, or as others might think of it, recklessness. “Probably the most common and devastating mistake I’ve made,” he wrote, “is to choose the wrong business partners.” As for abiding by the rules of the game: “It is the nature of risk-takers to be in a ferocious hurry to become successful, which frequently means cutting corners.”
Thus, even before last week’s disclosures about Patisserie Valerie, Johnson’s own columns amounted to the best possible case for ignoring the entrepreneur lobby on Brexit – indeed, on every subject other than their own, risk-taking genius.
By way of authority, even Johnson’s less scorching capitalist homilies are littered with references to the usual suspects – Napoleon, Samuel Smiles and Marcus Aurelius – less usually, the scriptures and “the 19th-century philosopher Herbert Spencer”, not forgetting, shamelessly, Ayn Rand. “Those who possess willpower,” Johnson echoes, “seize the day and actively control their destiny.” Less gifted individuals are dismissed as lazy idiots, fools, inferiors who will never get the chance to close down a chain of well-regarded bookshops or, as now, bail out their own patisseries.
That Johnson should, on the back of this stuff, and the cake shops, have risen to yet greater prominence as a notable Vote Leave backer, his blessing sought by Theresa May, is perhaps no more absurd than, earlier, was David Cameron’s promotion of the Topshop brute, Philip Green, or elevation of JCB’s Anthony Bamford (previously fined by the EU). The myth of the disinterested entrepreneur-consultant seems ineradicable.
In Brexit, Johnson and his like-minded entrepreneurs have, however, discovered a yet more rewarding platform on which to portray their regulation-averse interests as a purely patriotic project.
Entrepreneurs, Johnson has written, on this favourite subject, are “the anarchists of the business world. Their mission is to overthrow the existing order.” Every entrepreneur is “a disruptor and a libertarian”, or would be “if the state sets a sensible framework and gets out of the way”. He explains that the word “chancer” properly describes risk-takers like him, who are willing to make mistakes, probably through excessive impetuosity, or as others might think of it, recklessness. “Probably the most common and devastating mistake I’ve made,” he wrote, “is to choose the wrong business partners.” As for abiding by the rules of the game: “It is the nature of risk-takers to be in a ferocious hurry to become successful, which frequently means cutting corners.”
Thus, even before last week’s disclosures about Patisserie Valerie, Johnson’s own columns amounted to the best possible case for ignoring the entrepreneur lobby on Brexit – indeed, on every subject other than their own, risk-taking genius.
Friday 23 February 2018
Zombie companies walk among us
Tim Harford in The Financial Times
For vampires, the weakness is garlic. For werewolves, it’s a silver bullet. And for zombies? Perhaps a rise in interest rates will do the trick.
For vampires, the weakness is garlic. For werewolves, it’s a silver bullet. And for zombies? Perhaps a rise in interest rates will do the trick.
Economists have worried about “zombie companies” for decades. Timothy Taylor, editor of the Journal of Economic Perspectives, has followed a trail of references back to 1989, noting sightings of these zombies in Japan from the 1990s, and more recently in China. The fundamental concern is that there are companies which should be dead, yet continue to lumber on, ruining things for everyone.
It’s a vivid metaphor — perhaps a little too vivid — and it is likely to be tested over the months and years to come if, as almost everyone expects, central banks continue to raise interest rates back to what veterans might describe as “normal”.
Claudio Borio of the Bank for International Settlements recently gave a speech in which he worried about the tendency of low interest rates to sustain zombie companies. Mr Borio has consistently been concerned about the distorting effects of low interest rates, but the zombie element of his argument adds a new twist.
Researchers at both the BIS and the OECD, the club of wealthy nations, have found evidence that low interest rates seem conducive to the existence of zombies, which they define as older companies that don’t make enough money to service their debts. As interest rates have fallen around the world, such zombies have become more prevalent and have also shown more endurance.
On average, across the US, Japan, Australia and western Europe, the proportion of firms that are zombies has risen fivefold since 1987, from 2 to 10 per cent. The zombies walk among us.
Why should we worry? One obvious answer is that zombies absorb resources. If a zombie retailer occupies a space on the high street, that makes it harder and more expensive for a start-up or a successful competitor to move in. The same goes for any resource from advertising space to electricity, and of course it goes for staff, too.
We would usually expect a thriving company to be able to outbid the walking dead for anything necessary, from a finance director to a unit in an industrial estate. But the status quo always has a certain power, and in some cases, the zombie might be at an unfair advantage.
Consider a zombie bank, propped up by a government guarantee but basically insolvent. Gambling on resurrection, it tries to expand by offering high rates to depositors and cheap loans to creditors. In the late 1980s, Joseph Stiglitz — later to win a Nobel memorial prize in economics — proposed a “Gresham’s law” of savings-and-loan associations based on this tendency: bad associations crowd out good ones.
More recently, the collapse of Carillion, a large British outsourcing and construction firm, showed a similar dynamic. The more Carillion struggled, the more desperate it became to win new business — which meant aggressive bids in competitive auctions, dooming Carillion while starving competitors of business.
Having written an entire book about the importance of failure, I am naturally sympathetic to Mr Borio’s argument. Modern economies have a low failure rate — probably too low. Still, one should not be too cavalier about this point. To ordinary ears, bankruptcy sounds unambiguously bad. If you spend too much time thinking about zombie firms and economic dynamism, bankruptcy starts to sound unambiguously good.
Cut down those zombies and let highly productive new firms grow in the rich soil, fertilised by those zombie corpses, sounds like — forgive the play on words — a no-brainer. But should we really be so pleased that so many of the UK’s coal mines, or the auto suppliers of Detroit, have been successfully killed off? If nothing has replaced them, there is nothing to celebrate.
One of the lessons of recent economic research by economists David Autor, David Dorn and Gordon Hanson has been that productive new firms do not necessarily spring up as we might have hoped. Mr Autor and his colleagues have, in a series of influential papers, tracked local areas subject to the sudden shock of competition from imported Chinese products. Their conclusion: recovery is neither quick nor automatic.
Nor is it always easy for laid-off workers to stroll into fresh jobs: if you have worked for several years stitching soft toys, then the obvious next step when the toy factory lays you off is to start stitching shirts or trousers instead. Unfortunately, that is also the obvious next move for the importers, or the robots.
We can make a long list of policies that might help new productive firms to get started and expand: education, infrastructure, flexible regulations, small-business finance and so on. There is some evidence in favour of these policies, but no checklist can guarantee results.
Still, that is where to focus our attention as the zombies start to expire. The easier it is to start a new idea, the more hard-nosed we can be about killing off the old ones. It is necessary that the zombies must die, but that cannot be where the story ends.
Wednesday 30 August 2017
PFI is bankrupting Britain's public services
The plight of my local hospital trust in Walthamstow shows just how debt is holding our country back. Could this be the time for a windfall tax?
Stella Creasey in The Guardian
Next time you have an appointment cancelled at hospital, or a headteacher tells you their school will be losing staff because of budget cuts, ask how much PFI debt they have – the answer may surprise you. My hospital trust, in north-east London, spends nearly £150m a year repaying its PFI debt – nearly half of which is on interest payments. If Theresa May is serious about taking on the unacceptable face of capitalism, she could save Britain a fortune if she goes after the legal loan sharks of the public sector.
New research from the Centre for Health and the Public Interest (CHPI) shows just how much these debts are hurting our NHS. Over the next five years, almost £1bn of taxpayer funds will go to PFI companies in the form of pre-tax profits. That’s 22% of the extra £4.5bn given to the Department of Health in the 2015 spending review, and money that would otherwise have been available for patient care.
The company that holds the contract for University College London hospital has made pre-tax profits of £190m over the past decade, out of the £725m the NHS has paid out. This alone could have built a whole new hospital as 80% of PFI hospitals cost less than this to construct. This is not just about poor financial control in the NHS – UK PFI debt now stands at over £300bn for projects with an original capital cost of £55bn.
It’s time to grasp the nettle and get Britain a better line of credit
Private finance initiatives are like hire-purchase agreements – superficially a cheap way to buy something, but the costs quickly add up, and before you know it the debt is crippling.
For decades, governments of both main parties have used them for the simple but ultimately short-sighted view that it keeps borrowing off the books – helping reduce the amount of debt the country appears to have, but at great longer-term expense. Its now painfully clear that the intended benefits of private sector skills to help manage projects have been subsumed in the one-sided nature of these contracts, to devastating effect on budgets.
No political party can claim the moral high ground. The Tories conveniently ignore the fact that these contracts started under the John Major government – and are expanding again under Theresa May, with the PF2 scheme. Labour veers between defensive rhetoric that PFI was the best way to fund the investment our public sector so desperately needed during its last government, and angrily demanding such contracts be cancelled outright, wilfully ignoring what damage this would do to any government’s ability to ever borrow again.
It’s time to grasp the nettle and get Britain a better line of credit. That requires both tough action on the existing contracts to protect taxpayers’ interests, and getting a better deal on future borrowing. Some have already bought out contracts – Northumbria council took out a loan to buy out Hexham hospital’s PFI, and in doing so saved £3.5m every year over the remaining 19-year term. But as the National Audit Office has shown, gains from renegotiating individual contracts are likely to be minimal – what is saved in costs is paid out in fees to arrange.
However, the CHPI research also shows up another interesting facet of PFI. Just eight companies own or appear to have equity stakes in 92% of all the PFI companies in the NHS. Renegotiating not the individual deals done for hospitals or schools, but across the portfolios of the companies themselves could realise substantial gains. Innisfree, which manages my local hospital’s PFI and others across the country and has just 25 staff, stands to make £18bn alone over the coming years. If these companies are resistant to consolidating these loans into a more realistic cost, then it’s time to look again at their tax reliefs, or – given the evidence of excessive profits in this industry that shareholders have received – resurrect one of New Labour’s early hits with a windfall tax on the returns made.
Longer term, we need to ensure there is much more competition for the business of the state. Despite interest rates being low for over a decade, these loans have stayed stubbornly expensive. The lack of viable alternatives – whether public borrowing or bonds – gives these companies a captive market. If the government wants better rates, it needs to ensure there are more options to choose between, whether by allowing local authorities to issue bonds, or reforming Treasury rules that penalise public sector borrowing in the first place.
As our public services struggle under the pressure of PFI, Labour must lead this debate to show how we can not only learn from our past, but also provide answers for the future too. The government has already spent £100bn buying the debt of banks through quantitative easing. With Brexit expected not only to add £60bn to our country’s debt but also affect our access to European central bank funds, taking on our expensive creditors is a battle no prime minister can ignore in the fight to stop Britain going bust.
Stella Creasey in The Guardian
Next time you have an appointment cancelled at hospital, or a headteacher tells you their school will be losing staff because of budget cuts, ask how much PFI debt they have – the answer may surprise you. My hospital trust, in north-east London, spends nearly £150m a year repaying its PFI debt – nearly half of which is on interest payments. If Theresa May is serious about taking on the unacceptable face of capitalism, she could save Britain a fortune if she goes after the legal loan sharks of the public sector.
New research from the Centre for Health and the Public Interest (CHPI) shows just how much these debts are hurting our NHS. Over the next five years, almost £1bn of taxpayer funds will go to PFI companies in the form of pre-tax profits. That’s 22% of the extra £4.5bn given to the Department of Health in the 2015 spending review, and money that would otherwise have been available for patient care.
The company that holds the contract for University College London hospital has made pre-tax profits of £190m over the past decade, out of the £725m the NHS has paid out. This alone could have built a whole new hospital as 80% of PFI hospitals cost less than this to construct. This is not just about poor financial control in the NHS – UK PFI debt now stands at over £300bn for projects with an original capital cost of £55bn.
It’s time to grasp the nettle and get Britain a better line of credit
Private finance initiatives are like hire-purchase agreements – superficially a cheap way to buy something, but the costs quickly add up, and before you know it the debt is crippling.
For decades, governments of both main parties have used them for the simple but ultimately short-sighted view that it keeps borrowing off the books – helping reduce the amount of debt the country appears to have, but at great longer-term expense. Its now painfully clear that the intended benefits of private sector skills to help manage projects have been subsumed in the one-sided nature of these contracts, to devastating effect on budgets.
No political party can claim the moral high ground. The Tories conveniently ignore the fact that these contracts started under the John Major government – and are expanding again under Theresa May, with the PF2 scheme. Labour veers between defensive rhetoric that PFI was the best way to fund the investment our public sector so desperately needed during its last government, and angrily demanding such contracts be cancelled outright, wilfully ignoring what damage this would do to any government’s ability to ever borrow again.
It’s time to grasp the nettle and get Britain a better line of credit. That requires both tough action on the existing contracts to protect taxpayers’ interests, and getting a better deal on future borrowing. Some have already bought out contracts – Northumbria council took out a loan to buy out Hexham hospital’s PFI, and in doing so saved £3.5m every year over the remaining 19-year term. But as the National Audit Office has shown, gains from renegotiating individual contracts are likely to be minimal – what is saved in costs is paid out in fees to arrange.
However, the CHPI research also shows up another interesting facet of PFI. Just eight companies own or appear to have equity stakes in 92% of all the PFI companies in the NHS. Renegotiating not the individual deals done for hospitals or schools, but across the portfolios of the companies themselves could realise substantial gains. Innisfree, which manages my local hospital’s PFI and others across the country and has just 25 staff, stands to make £18bn alone over the coming years. If these companies are resistant to consolidating these loans into a more realistic cost, then it’s time to look again at their tax reliefs, or – given the evidence of excessive profits in this industry that shareholders have received – resurrect one of New Labour’s early hits with a windfall tax on the returns made.
Longer term, we need to ensure there is much more competition for the business of the state. Despite interest rates being low for over a decade, these loans have stayed stubbornly expensive. The lack of viable alternatives – whether public borrowing or bonds – gives these companies a captive market. If the government wants better rates, it needs to ensure there are more options to choose between, whether by allowing local authorities to issue bonds, or reforming Treasury rules that penalise public sector borrowing in the first place.
As our public services struggle under the pressure of PFI, Labour must lead this debate to show how we can not only learn from our past, but also provide answers for the future too. The government has already spent £100bn buying the debt of banks through quantitative easing. With Brexit expected not only to add £60bn to our country’s debt but also affect our access to European central bank funds, taking on our expensive creditors is a battle no prime minister can ignore in the fight to stop Britain going bust.
Wednesday 30 December 2015
Recession, retrenchment, revolution? Impact of low crude prices on oil powers
Guardian writers: Shaun Walker in Moscow Dominic Rushe in New YorkChris Stein in Lagos Chris Stephen in Tunis Sibylla Brodzinsky in Caracas Hugh Miles in Cairo and Saeed Kamali Dehghan
A glut of oil, the demise of Opec and weakening global demand combined to make 2015 the year of crashing oil prices. The cost of crude fell to levels not seen for 11 years – and the decline may have further to go.
There have been four sharp increases in the price of oil in the past four decades – in 1973, 1979, 1990 and 2008 – and each has led to a global recession. By that measure, a lower oil price should be positive for the world economy, with lower fuel costs for consumers and businesses in those countries that import crude outweighing the losses to producing nations.
But the evidence since oil prices started falling from their peak of $115 a barrel in August 2014 has not supported that thesis – or not yet. Oil producers have certainly felt the impact of the lower prices on their growth rates, their trade figures and their public finances but there has been no surge in consumer spending or business investment elsewhere.
Economist still reckon there will be a boost from a lower oil price particularly if it looks as if the lower cost of crude will be sustained.
Dhaval Joshi, an economist at BCA, a London-based research company, said: “A commodity bubble has deflated three times in the past 100 years: the first was after world war one; the second was after the 1980s oil shock; the third is happening right now.”
For the big producer countries, this is a major headache, the ramifications of which are only starting to be felt. Oil powers base their spending plans on an assumed crude price. The graphic below shows just how far below water their budgets are.
Joshi says crude prices may fall by a further 35% to reach its long-term trend. That would mean an oil price closer to $25 a barrel - and fiscal crises in some of the world’s most pivotal economies.
Saudi Arabia
The Ras Tanura oil production plant in Saudi Arabia’s eastern province. Photograph: Bilal Qabalan/AFP/Getty Images
Low oil prices are not just squeezing Saudi Arabia’s domestic budget, imposing austerity on a kingdom not used to it: it is taking its toll on Saudi support for foreign projects too.
The kingdom this week announced swingeing budget cuts for 2016 to address an alarming deficit of 15% of GDP run up this year. Subsidies for water, electricity and petroleum products are likely to be cut, and government projects reined in.
But overseas beneficiaries will face some austerity too. For years, Saudi Arabia has used its oil wealth to support friends and allies around the world, including media organisations, thinktanks, academic institutions, religious schools and charities. Countries that have traditionally benefited from Saudi largesse include Jordan, Lebanon, Bahrain, Palestine and Egypt.
But now the IMF has raised the prospect that Saudi Arabia could go bankrupt in five years without changes to its economic policy, cuts in support to foreign allies seem inevitable.
Egypt’s black-hole economy is potentially the kingdom’s most expensive foreign policy commitment. In recent years, Saudi Arabia has donated billions in cash and oil products but, despite this, the Egyptian economy, battered by war, terrorism and political instability, is facing an acute foreign currency shortage.
Speculation is mounting that Saudi financial support to Egypt is starting to dry up – something the Egyptian authorities have denied – and that this is damaging the bilateral relationship.
There have been some signs of tension. In July, Egypt’s oil minister said he had no objections to importing crude oil from Iran, a move sure to ruffle the Saudis. In September, the Saudi journalist Jamal Khashoggi – known for his closeness to the Saudi state – raised eyebrows when he said the new Egyptian culture minister, Hilmi al-Namnam, who is well known for his secularism and dislike of Wahhabi Islam, should never have been appointed.
So far, the Saudi authorities have given few clear signs about how they are planning to respond to the oil price crisis, let alone lay out a long-term plan for a post-oil Saudi Arabia.
Options under consideration are thought to include cutting construction projects, energy subsidies and public sector wages, introducing new taxes and privatisations, and issuing debt.
Another possibility foreign observers have posited is that the Saudis will be forced to unpeg the riyal from the dollar, although given the potential this would have for uncontrollable knock-on effects on the rest of the economy, this seems likely to be a last resort.
Cuts impacting on ordinary Saudis are something the government will be keen to avoid to maintain political stability, so industry, the public sector and foreign allies are likely to bear the brunt of the economic burden.
Nigeria
Nigeria’s president, Muhammadu Buhari, swears in his cabinet in November. Photograph: Afolabi Sotunde/Reuters
The oil price slump has not prevented Nigeria’s new government from unveiling big spending plans – but analysts warn that the generosity is misplaced at a time when oil prices languish below $40 a barrel.
Nigeria is Africa’s top oil producer and the World Bank estimates crude sales fund about 75% of the country’s budget.
In its £19.8bn budget proposal, the government plans to increase spending by about one quarter over last year’s budget, and to pay for it by improving tax collection and cutting the cost of government.
The budget includes £1.65bn for cash transfers to poor Nigerians. The programme was a campaign promise of the president, Muhammadu Buhari, who was elected in March on a platform of cutting corruption and weaning Nigeria’s economy off its dependence on oil revenue.
But some analysts think the proposed budget is unrealistic during times of $40 oil.
“This brings a dose of reality to a people who have extremely high expectations,” said Bismarck Rewane, the chief executive of Financial Derivatives Co. He predicted the government would have to back down on some of its promises.
Nigeria is Africa’s largest economy, but most of the money is concentrated in the hands of a wealthy elite and about two-thirds of Nigerians live in poverty, according to the United Nations development programme.
Analysis Nigeria overtakes South Africa to become Africa's largest economy. Complicated statistical recalculation adds $240bn to the economy - the equivalent of finding six Ghanas within Nigeria, says Tolu Ogunlesi
Unemployment has climbed this year, hitting 9.9% in the third quarter, according to the National Bureau of Statistics.
Chuba Ezekwesili, research analyst at Nigerian Economic Summit Group, says despite the falling price of crude, the country has been able to avoid a jump in inflation by imposing limits on the availability of foreign currency.
While other major oil producing economies have let their currencies lose value along with oil prices, Nigeria has spent its reserves to prop up the value of the naira. But Ezekwesili says they can only do that for so long.
“They’re sort of delaying the inevitable,” he said. “I feel like eventually it has to give way, and by the time it does I feel the economy is going to be hurt because a lot of businesses can’t work under those conditions.”
Ezekwesili was also sceptical of the government’s ability to generate the revenue necessary to pay for programmes such as cash transfers to the poor. He doubts the government can accomplish its goals of streamlining its costs and generating more revenue by next year.
“One thing I’ve learned about policies in Nigeria is we tend to be very optimistic but it never really works out exactly as we want it to,” Ezekwesili said.
Russia
Oil extraction at a Gazprom field in Khanty-Mansiysk, Russia. Photograph: TASS/Barcroft Media
Vladimir Putin goes into 2016 with record approval ratings but the shakiest economic outlook since he took charge. In the 15 years he has been at the helm, 2015 was the first year that real wages registered a decline, something that did not happen even during the 2008-09 financial crisis.
Oil and gas exports make up about half of the Russian budget, and the rouble rate has been strongly linked to the price of oil.
Sanctions against Russia, particularly the ban on Russian banks seeking western credit, combined with falling oil prices in late 2014 to create a perfect storm that demolished the rouble, with the currency losing half of its value against the dollar, reviving memories of previous crashes. The currency regained some of its value by spring, but falling oil prices in autumn have caused it to fall back to lows similar to those it experienced in late 2014.
Rouble in freefall despite rate hike
Falling oil prices were one of the principal reasons for the collapse in the Soviet economy, and some economists are warning of history repeating itself. Riding on a wave of high oil prices for most of his presidency, the Russian president did not expect such a sharp downturn. Last October, Putin said that if the price of oil fell below $80 a barrel, the world economy would crash. A range of other top Russian officials made similar statements, in effect ruling out the possibility that oil could fall below $70.
Some analysts say the rouble is still overvalued, and the current oil price should theoretically push the rouble down further. This is necessary to balance the budget: the fewer dollars Russia receives for the oil it sells, the higher the exchange rate needs to be for the budget to receive the requisite amount of roubles. For the budget to balance at 65 roubles, not far off the current rate, the price of oil should be $70, a recent Bank of America Merrill Lynch report found.
For ordinary Russians, it could be a tough year ahead. Those who were used to travelling abroad have already had to scale back as the rouble made the cost of visiting foreign cities prohibitive; and rising food prices have made it harder to balance the books for many families.
The 2016 budget, fixed in October, requires oil to be at $50 in order to run a 3% deficit within “acceptable” rouble rate limits, meaning if the price does not rise soon, cuts will need to be made or reserves spent. The war in Syria is an extra cost, and the announced increases in military spending are not likely to be reversed.
US
Belridge, California, is one of the oldest and largest oilfields in the US containing tens of thousands of wells, many of which are being fracked. Photograph: Les Stone/Corbis
Filling up at the gas station hasn’t been this cheap in the US since the recession. The nationwide average price of a gallon of regular is now $2.02 (£1.36), down 58 cents from this time last year, according to auto club AAA, and expected to fall further.
Scared that North America’s oil boom threatens its grip, Opec, the oil cartel, stepped up production and forced a price war that has driven oil prices down to below $35 a barrel. US consumers have benefited from lower petrol prices to the tune of about $700 a year, according to the US government, and that money is fuelling consumer spending. According to a recent report from JP Morgan, 80% of that saving is being spent on goods and services.
But the collapsing price of oil has also cast a shadow over the US energy industry – formerly one of the country’s fastest growing employers. Fracking – the controversial process of extracting oil and gas from shale rock – has become less attractive to investors as the oil price has fallen, and tens of thousands of jobs have been lost as a result. This year, the International Energy Agency said low oil prices would “slam the brakes” on the US shale industry and the impact is already being felt across the country’s oil producing areas.
The US energy sector has cut more than 90,000 jobs this year, according to outplacement company Challenger, Gray & Christmas. And while the overall US unemployment rate has continued to fall, in Texas unemployment has risen since August, according to the Bureau of Labour Statistics. In North Dakota, home of the Bakken shale oil field, more than 17% of the mining jobs – which include oil and natural gas – have disappeared in the past year. More jobs look certain to be lost in the coming months.
North of the border in Canada, things are even worse. In Alberta, “the Texas of the north”, job layoffs and the downturn of the economy have been blamed for a 30% rise in suicides between January and June, compared with 2014. In Saskatchewan, another energy-dependent region, there have been 19% more suicides this year.
Daniel Pavilonis, senior commodity broker with RJO Futures, said the situation was only likely to get worse for those employed in the US energy sector. “There are oil tankers just sitting off the coast because we don’t need more supply. We have too much,” he said. “There’s oversupply and a lack of anybody trying to tighten production because they don’t want to lose market share.”
As a result he predicts oil prices will go lower, taking more jobs with it. But for most consumers, it’s a win. Unlike other global economic trends, the oil price fall actually benefits average Americans, said Pavilonis. “This is our money,” he said. “For most people, it’s a good thing.”
Venezuela
A mural depicts President Nicolás Maduro, who, having lost the Venezuelan National Assembly, has a battle to keep economy and his leadership afloat. Photograph: Luis Robayo/AFP/Getty Images
In most of the world, falling oil prices have caused significant reductions in petrol prices. But in the country with the world’s largest oil reserves, the oil glut could force a price rise.
“It’s probably the only place in the world where with oil prices so low, they may raise gasoline prices,” says Pedro Méndez, an informal taxi driver in Caracas, the Venezuelan capital, who fills the tank of his Ford Laser for less than a dollar.
But the lower the price of oil goes, the deeper Venezuela’s economy sinks. It’s near total dependence on crude exports for hard currency has seen the government of president Nicolás Maduro struggling to try keep the economy afloat.
The political effect is already being felt. Gripped by spiraling inflation, chronic shortages of basic goods and a quickly depreciating currency, Venezuelan voters this month gave the opposition an overwhelming majority in the new legislature, which takes office in January.
Each $1 drop in oil prices results in more than $685m in lost yearly oil income for PDVSA, the state-owned oil company, according to analysts.
And every drop in crude prices means less funding for the health, education and housing and other social welfare programmes that won Maduro’s predecessor, Hugo Chávez, widespread support for his self-styled “Bolivarian revolution”.
While dwindling oil revenue hurts the social programmes, Antonio Azpurua, a financial consultant with CFS Partners/LA Group, says it could be a blessing in disguise, allowing Venezuela to wean itself of its dependence on crude. “Venezuela needs to take advantage of low oil prices to build its industrial base,” he says.
With a super-majority in the National Assembly, the opposition could reverse some of Maduro’s populist measures, which have contributed to the current economic crisis. They could also choose to raise petrol prices.
Iran
Libya
Fuel depots and tankers have been targets for years in the struggle for control of Libya and its oil resources. Photograph: EPA
Plunging oil prices are threatening disaster in Libya, where civil war has left the population depending on fast-dwindling oil revenues to survive.
Libya has Africa’s largest oil reserves and in normal times this provides 95% of the country’s export revenues, keeping the economy afloat. But civil war between rival governments at either end of the country has shattered the economy, leaving the population almost wholly dependent on revenue generated overseas.
The crash in oil prices has halved revenues, and shortages of foodstuffs and medicines – even petrol – are starting to be felt.
This cash squeeze has triggered a three-way battle for control of what remains of the country’s oil wealth. Much of Libya’s largest group of oil fields, the Sirte Basin, is now held by Islamic State, which has interposed itself between forces of the rival governments. Most of what remains is in eastern Libya, held by the elected parliament based in Tobruk.
Tobruk is using its status as the internationally recognised government to battle in foreign courts for the right to income from other producing fields, opposing the state-owned National Oil Corporation, whose headquarters remains in Tripoli, held by a rival parliament.
Tobruk has set up a second National Oil Corporation, based in eastern Libya, and last month demanded international oil companies switch payments that currently go to Tripoli.
Countering that, Tripoli’s NOC chief, Mustafa Sanallah, convened a conference in London in October calling on oil buyers to stick with him. Two of the world’s largest oil buyers, Glencore and Vitol, have agreed, but the eastern government has vowed legal action.
London courts are likely to be the proving ground for this test of wills, with both governments already gearing up for a precedent-setting high court battle, due early next year, for control of the Libya Investment Authority, the country’s £65bn sovereign wealth fund.
But whoever wins control of what remains of the oil industry may find it a pyrrhic victory. John Hamilton, director of London’s Cross-border Information, says the glut of oil on world markets and turbulence around the few remaining oil ports means Libyan oil has already been “priced out” by many buyers.
A glut of oil, the demise of Opec and weakening global demand combined to make 2015 the year of crashing oil prices. The cost of crude fell to levels not seen for 11 years – and the decline may have further to go.
There have been four sharp increases in the price of oil in the past four decades – in 1973, 1979, 1990 and 2008 – and each has led to a global recession. By that measure, a lower oil price should be positive for the world economy, with lower fuel costs for consumers and businesses in those countries that import crude outweighing the losses to producing nations.
But the evidence since oil prices started falling from their peak of $115 a barrel in August 2014 has not supported that thesis – or not yet. Oil producers have certainly felt the impact of the lower prices on their growth rates, their trade figures and their public finances but there has been no surge in consumer spending or business investment elsewhere.
Economist still reckon there will be a boost from a lower oil price particularly if it looks as if the lower cost of crude will be sustained.
Dhaval Joshi, an economist at BCA, a London-based research company, said: “A commodity bubble has deflated three times in the past 100 years: the first was after world war one; the second was after the 1980s oil shock; the third is happening right now.”
For the big producer countries, this is a major headache, the ramifications of which are only starting to be felt. Oil powers base their spending plans on an assumed crude price. The graphic below shows just how far below water their budgets are.
Joshi says crude prices may fall by a further 35% to reach its long-term trend. That would mean an oil price closer to $25 a barrel - and fiscal crises in some of the world’s most pivotal economies.
Saudi Arabia
The Ras Tanura oil production plant in Saudi Arabia’s eastern province. Photograph: Bilal Qabalan/AFP/Getty Images
Low oil prices are not just squeezing Saudi Arabia’s domestic budget, imposing austerity on a kingdom not used to it: it is taking its toll on Saudi support for foreign projects too.
The kingdom this week announced swingeing budget cuts for 2016 to address an alarming deficit of 15% of GDP run up this year. Subsidies for water, electricity and petroleum products are likely to be cut, and government projects reined in.
But overseas beneficiaries will face some austerity too. For years, Saudi Arabia has used its oil wealth to support friends and allies around the world, including media organisations, thinktanks, academic institutions, religious schools and charities. Countries that have traditionally benefited from Saudi largesse include Jordan, Lebanon, Bahrain, Palestine and Egypt.
But now the IMF has raised the prospect that Saudi Arabia could go bankrupt in five years without changes to its economic policy, cuts in support to foreign allies seem inevitable.
Egypt’s black-hole economy is potentially the kingdom’s most expensive foreign policy commitment. In recent years, Saudi Arabia has donated billions in cash and oil products but, despite this, the Egyptian economy, battered by war, terrorism and political instability, is facing an acute foreign currency shortage.
Speculation is mounting that Saudi financial support to Egypt is starting to dry up – something the Egyptian authorities have denied – and that this is damaging the bilateral relationship.
There have been some signs of tension. In July, Egypt’s oil minister said he had no objections to importing crude oil from Iran, a move sure to ruffle the Saudis. In September, the Saudi journalist Jamal Khashoggi – known for his closeness to the Saudi state – raised eyebrows when he said the new Egyptian culture minister, Hilmi al-Namnam, who is well known for his secularism and dislike of Wahhabi Islam, should never have been appointed.
So far, the Saudi authorities have given few clear signs about how they are planning to respond to the oil price crisis, let alone lay out a long-term plan for a post-oil Saudi Arabia.
Options under consideration are thought to include cutting construction projects, energy subsidies and public sector wages, introducing new taxes and privatisations, and issuing debt.
Another possibility foreign observers have posited is that the Saudis will be forced to unpeg the riyal from the dollar, although given the potential this would have for uncontrollable knock-on effects on the rest of the economy, this seems likely to be a last resort.
Cuts impacting on ordinary Saudis are something the government will be keen to avoid to maintain political stability, so industry, the public sector and foreign allies are likely to bear the brunt of the economic burden.
Nigeria
Nigeria’s president, Muhammadu Buhari, swears in his cabinet in November. Photograph: Afolabi Sotunde/Reuters
The oil price slump has not prevented Nigeria’s new government from unveiling big spending plans – but analysts warn that the generosity is misplaced at a time when oil prices languish below $40 a barrel.
Nigeria is Africa’s top oil producer and the World Bank estimates crude sales fund about 75% of the country’s budget.
In its £19.8bn budget proposal, the government plans to increase spending by about one quarter over last year’s budget, and to pay for it by improving tax collection and cutting the cost of government.
The budget includes £1.65bn for cash transfers to poor Nigerians. The programme was a campaign promise of the president, Muhammadu Buhari, who was elected in March on a platform of cutting corruption and weaning Nigeria’s economy off its dependence on oil revenue.
But some analysts think the proposed budget is unrealistic during times of $40 oil.
“This brings a dose of reality to a people who have extremely high expectations,” said Bismarck Rewane, the chief executive of Financial Derivatives Co. He predicted the government would have to back down on some of its promises.
Nigeria is Africa’s largest economy, but most of the money is concentrated in the hands of a wealthy elite and about two-thirds of Nigerians live in poverty, according to the United Nations development programme.
Analysis Nigeria overtakes South Africa to become Africa's largest economy. Complicated statistical recalculation adds $240bn to the economy - the equivalent of finding six Ghanas within Nigeria, says Tolu Ogunlesi
Unemployment has climbed this year, hitting 9.9% in the third quarter, according to the National Bureau of Statistics.
Chuba Ezekwesili, research analyst at Nigerian Economic Summit Group, says despite the falling price of crude, the country has been able to avoid a jump in inflation by imposing limits on the availability of foreign currency.
While other major oil producing economies have let their currencies lose value along with oil prices, Nigeria has spent its reserves to prop up the value of the naira. But Ezekwesili says they can only do that for so long.
“They’re sort of delaying the inevitable,” he said. “I feel like eventually it has to give way, and by the time it does I feel the economy is going to be hurt because a lot of businesses can’t work under those conditions.”
Ezekwesili was also sceptical of the government’s ability to generate the revenue necessary to pay for programmes such as cash transfers to the poor. He doubts the government can accomplish its goals of streamlining its costs and generating more revenue by next year.
“One thing I’ve learned about policies in Nigeria is we tend to be very optimistic but it never really works out exactly as we want it to,” Ezekwesili said.
Russia
Oil extraction at a Gazprom field in Khanty-Mansiysk, Russia. Photograph: TASS/Barcroft Media
Vladimir Putin goes into 2016 with record approval ratings but the shakiest economic outlook since he took charge. In the 15 years he has been at the helm, 2015 was the first year that real wages registered a decline, something that did not happen even during the 2008-09 financial crisis.
Oil and gas exports make up about half of the Russian budget, and the rouble rate has been strongly linked to the price of oil.
Sanctions against Russia, particularly the ban on Russian banks seeking western credit, combined with falling oil prices in late 2014 to create a perfect storm that demolished the rouble, with the currency losing half of its value against the dollar, reviving memories of previous crashes. The currency regained some of its value by spring, but falling oil prices in autumn have caused it to fall back to lows similar to those it experienced in late 2014.
Rouble in freefall despite rate hike
Falling oil prices were one of the principal reasons for the collapse in the Soviet economy, and some economists are warning of history repeating itself. Riding on a wave of high oil prices for most of his presidency, the Russian president did not expect such a sharp downturn. Last October, Putin said that if the price of oil fell below $80 a barrel, the world economy would crash. A range of other top Russian officials made similar statements, in effect ruling out the possibility that oil could fall below $70.
Some analysts say the rouble is still overvalued, and the current oil price should theoretically push the rouble down further. This is necessary to balance the budget: the fewer dollars Russia receives for the oil it sells, the higher the exchange rate needs to be for the budget to receive the requisite amount of roubles. For the budget to balance at 65 roubles, not far off the current rate, the price of oil should be $70, a recent Bank of America Merrill Lynch report found.
For ordinary Russians, it could be a tough year ahead. Those who were used to travelling abroad have already had to scale back as the rouble made the cost of visiting foreign cities prohibitive; and rising food prices have made it harder to balance the books for many families.
The 2016 budget, fixed in October, requires oil to be at $50 in order to run a 3% deficit within “acceptable” rouble rate limits, meaning if the price does not rise soon, cuts will need to be made or reserves spent. The war in Syria is an extra cost, and the announced increases in military spending are not likely to be reversed.
US
Belridge, California, is one of the oldest and largest oilfields in the US containing tens of thousands of wells, many of which are being fracked. Photograph: Les Stone/Corbis
Filling up at the gas station hasn’t been this cheap in the US since the recession. The nationwide average price of a gallon of regular is now $2.02 (£1.36), down 58 cents from this time last year, according to auto club AAA, and expected to fall further.
Scared that North America’s oil boom threatens its grip, Opec, the oil cartel, stepped up production and forced a price war that has driven oil prices down to below $35 a barrel. US consumers have benefited from lower petrol prices to the tune of about $700 a year, according to the US government, and that money is fuelling consumer spending. According to a recent report from JP Morgan, 80% of that saving is being spent on goods and services.
But the collapsing price of oil has also cast a shadow over the US energy industry – formerly one of the country’s fastest growing employers. Fracking – the controversial process of extracting oil and gas from shale rock – has become less attractive to investors as the oil price has fallen, and tens of thousands of jobs have been lost as a result. This year, the International Energy Agency said low oil prices would “slam the brakes” on the US shale industry and the impact is already being felt across the country’s oil producing areas.
The US energy sector has cut more than 90,000 jobs this year, according to outplacement company Challenger, Gray & Christmas. And while the overall US unemployment rate has continued to fall, in Texas unemployment has risen since August, according to the Bureau of Labour Statistics. In North Dakota, home of the Bakken shale oil field, more than 17% of the mining jobs – which include oil and natural gas – have disappeared in the past year. More jobs look certain to be lost in the coming months.
North of the border in Canada, things are even worse. In Alberta, “the Texas of the north”, job layoffs and the downturn of the economy have been blamed for a 30% rise in suicides between January and June, compared with 2014. In Saskatchewan, another energy-dependent region, there have been 19% more suicides this year.
Daniel Pavilonis, senior commodity broker with RJO Futures, said the situation was only likely to get worse for those employed in the US energy sector. “There are oil tankers just sitting off the coast because we don’t need more supply. We have too much,” he said. “There’s oversupply and a lack of anybody trying to tighten production because they don’t want to lose market share.”
As a result he predicts oil prices will go lower, taking more jobs with it. But for most consumers, it’s a win. Unlike other global economic trends, the oil price fall actually benefits average Americans, said Pavilonis. “This is our money,” he said. “For most people, it’s a good thing.”
Venezuela
A mural depicts President Nicolás Maduro, who, having lost the Venezuelan National Assembly, has a battle to keep economy and his leadership afloat. Photograph: Luis Robayo/AFP/Getty Images
In most of the world, falling oil prices have caused significant reductions in petrol prices. But in the country with the world’s largest oil reserves, the oil glut could force a price rise.
“It’s probably the only place in the world where with oil prices so low, they may raise gasoline prices,” says Pedro Méndez, an informal taxi driver in Caracas, the Venezuelan capital, who fills the tank of his Ford Laser for less than a dollar.
But the lower the price of oil goes, the deeper Venezuela’s economy sinks. It’s near total dependence on crude exports for hard currency has seen the government of president Nicolás Maduro struggling to try keep the economy afloat.
The political effect is already being felt. Gripped by spiraling inflation, chronic shortages of basic goods and a quickly depreciating currency, Venezuelan voters this month gave the opposition an overwhelming majority in the new legislature, which takes office in January.
Each $1 drop in oil prices results in more than $685m in lost yearly oil income for PDVSA, the state-owned oil company, according to analysts.
And every drop in crude prices means less funding for the health, education and housing and other social welfare programmes that won Maduro’s predecessor, Hugo Chávez, widespread support for his self-styled “Bolivarian revolution”.
While dwindling oil revenue hurts the social programmes, Antonio Azpurua, a financial consultant with CFS Partners/LA Group, says it could be a blessing in disguise, allowing Venezuela to wean itself of its dependence on crude. “Venezuela needs to take advantage of low oil prices to build its industrial base,” he says.
With a super-majority in the National Assembly, the opposition could reverse some of Maduro’s populist measures, which have contributed to the current economic crisis. They could also choose to raise petrol prices.
Iran
Iranians took to the streets to celebrate the nuclear deal which will mean they can more freely trade their oil. Photograph: Abedin Taherkenareh/EPA
Iran is rushing to implement the landmark nuclear accord in order to cash in on sanctions relief as early as next month, but the plummeting price of oil is tempering its expectations even though its economy has become less dependent on crude sales.
Tehran currently exports 1.1m barrels of oil per a but the Iranian oil minister, Bijan Zanganeh, has announced that the country is aiming to double that amount within six months of sanctions being lifted, hoping it will return to the pre-sanctions level of 2.2m.
Although the EU lifted Iranian sanctions in October after the Vienna nuclear agreement, the measures will only come into effect after what has become known as “implementation day”, the unknown date when the UN nuclear watchdog, IAEA, will verify that Iran has taken the necessary steps as outlined under the nuclear deal. Iran is expediting whatever it can to bring this date forward to as early as January.
In an effort to woo foreign investment in the post-sanctions era, Iran put a set of new lucrative oil and gas contracts, worth more than $30bn, on the market this month. But all these efforts have come at a time when global oil prices are falling as a result of a crude surplus of 2m barrels a day, a phenomenon Tehran blames on the Saudis.
“The drop in oil prices hurts all oil producers, not just Iran,” said Amir Handjani, president of PG International commodities trading services and a member of the board directors of RAK Petroleum.
“Saudi Arabia is very aware that Iran will be able to sell its crude unencumbered by sanctions on the international market very soon and will use all means at its disposal to make sure Iran doesn’t recapture the market share it lost over the past four years,” he said.
“Basically, Riyadh’s message to Tehran is simple: we can endure low oil prices for a while; can you?”
But the experience of years under sanctions has made the Iranian economy “incredibly resilient”, according to Handjani. Iran’s economy faced huge economic problems in recent years due to international sanctions imposed over Tehran’s nuclear programme. Plummeting oil prices only added to economic woes in a country with the world’s fourth-largest oil reserves.
“To be sure, low oil prices deny Tehran much needed revenue but unlike the Saudis, Iran’s economy is not solely dependent on oil exports. Oil revenue accounts for about 15% of Iran’s GDP,” Handjani told the Guardian. Sanctions have forced Iran to diversify its economy, he said. It has a large manufacturing base, IT sector, and robust agro-industries, which make its economy on the whole “much more balanced” than Saudi Arabia.
“The Iranian economy has absorbed so many shocks over the past 36 years, from war to sanctions, that the pain of low oil prices now, as it breaks from international isolation, pales in comparison.”
Without naming Saudi Arabia, Zanganeh said last week that it was clear which country had an excess of supply and that there was “no ambiguity about who they are”. On the occasion of unveiling new oil contracts, the Iranian minister said last month that his country was willing to play a major role in oil supply and was even ready to work with American companies. “The way for the presence of these companies in Iran’s oil industry is open,” he said at the Iran Petroleum Contracts Conference in Tehran.
The deputy managing director of the national Iranian oil company (NIOC) told the Guardian in September that the Iranian government was earning more from tax than oil for the first time in almost half a century as the country shifts its traditional reliance on crude to taxation revenues in the face of falling oil prices. Critics say Iran is unlikely to maintain that equation when the lifting of sanctions allows it to export more oil.
According to Opec, Iran on average was selling oil at $38.92 a barrel in November, $5.63 less than the average in October, which is the worst drop among the group’s members.
Iran is rushing to implement the landmark nuclear accord in order to cash in on sanctions relief as early as next month, but the plummeting price of oil is tempering its expectations even though its economy has become less dependent on crude sales.
Tehran currently exports 1.1m barrels of oil per a but the Iranian oil minister, Bijan Zanganeh, has announced that the country is aiming to double that amount within six months of sanctions being lifted, hoping it will return to the pre-sanctions level of 2.2m.
Although the EU lifted Iranian sanctions in October after the Vienna nuclear agreement, the measures will only come into effect after what has become known as “implementation day”, the unknown date when the UN nuclear watchdog, IAEA, will verify that Iran has taken the necessary steps as outlined under the nuclear deal. Iran is expediting whatever it can to bring this date forward to as early as January.
In an effort to woo foreign investment in the post-sanctions era, Iran put a set of new lucrative oil and gas contracts, worth more than $30bn, on the market this month. But all these efforts have come at a time when global oil prices are falling as a result of a crude surplus of 2m barrels a day, a phenomenon Tehran blames on the Saudis.
“The drop in oil prices hurts all oil producers, not just Iran,” said Amir Handjani, president of PG International commodities trading services and a member of the board directors of RAK Petroleum.
“Saudi Arabia is very aware that Iran will be able to sell its crude unencumbered by sanctions on the international market very soon and will use all means at its disposal to make sure Iran doesn’t recapture the market share it lost over the past four years,” he said.
“Basically, Riyadh’s message to Tehran is simple: we can endure low oil prices for a while; can you?”
But the experience of years under sanctions has made the Iranian economy “incredibly resilient”, according to Handjani. Iran’s economy faced huge economic problems in recent years due to international sanctions imposed over Tehran’s nuclear programme. Plummeting oil prices only added to economic woes in a country with the world’s fourth-largest oil reserves.
“To be sure, low oil prices deny Tehran much needed revenue but unlike the Saudis, Iran’s economy is not solely dependent on oil exports. Oil revenue accounts for about 15% of Iran’s GDP,” Handjani told the Guardian. Sanctions have forced Iran to diversify its economy, he said. It has a large manufacturing base, IT sector, and robust agro-industries, which make its economy on the whole “much more balanced” than Saudi Arabia.
“The Iranian economy has absorbed so many shocks over the past 36 years, from war to sanctions, that the pain of low oil prices now, as it breaks from international isolation, pales in comparison.”
Without naming Saudi Arabia, Zanganeh said last week that it was clear which country had an excess of supply and that there was “no ambiguity about who they are”. On the occasion of unveiling new oil contracts, the Iranian minister said last month that his country was willing to play a major role in oil supply and was even ready to work with American companies. “The way for the presence of these companies in Iran’s oil industry is open,” he said at the Iran Petroleum Contracts Conference in Tehran.
The deputy managing director of the national Iranian oil company (NIOC) told the Guardian in September that the Iranian government was earning more from tax than oil for the first time in almost half a century as the country shifts its traditional reliance on crude to taxation revenues in the face of falling oil prices. Critics say Iran is unlikely to maintain that equation when the lifting of sanctions allows it to export more oil.
According to Opec, Iran on average was selling oil at $38.92 a barrel in November, $5.63 less than the average in October, which is the worst drop among the group’s members.
Libya
Fuel depots and tankers have been targets for years in the struggle for control of Libya and its oil resources. Photograph: EPA
Plunging oil prices are threatening disaster in Libya, where civil war has left the population depending on fast-dwindling oil revenues to survive.
Libya has Africa’s largest oil reserves and in normal times this provides 95% of the country’s export revenues, keeping the economy afloat. But civil war between rival governments at either end of the country has shattered the economy, leaving the population almost wholly dependent on revenue generated overseas.
The crash in oil prices has halved revenues, and shortages of foodstuffs and medicines – even petrol – are starting to be felt.
This cash squeeze has triggered a three-way battle for control of what remains of the country’s oil wealth. Much of Libya’s largest group of oil fields, the Sirte Basin, is now held by Islamic State, which has interposed itself between forces of the rival governments. Most of what remains is in eastern Libya, held by the elected parliament based in Tobruk.
Tobruk is using its status as the internationally recognised government to battle in foreign courts for the right to income from other producing fields, opposing the state-owned National Oil Corporation, whose headquarters remains in Tripoli, held by a rival parliament.
Tobruk has set up a second National Oil Corporation, based in eastern Libya, and last month demanded international oil companies switch payments that currently go to Tripoli.
Countering that, Tripoli’s NOC chief, Mustafa Sanallah, convened a conference in London in October calling on oil buyers to stick with him. Two of the world’s largest oil buyers, Glencore and Vitol, have agreed, but the eastern government has vowed legal action.
London courts are likely to be the proving ground for this test of wills, with both governments already gearing up for a precedent-setting high court battle, due early next year, for control of the Libya Investment Authority, the country’s £65bn sovereign wealth fund.
But whoever wins control of what remains of the oil industry may find it a pyrrhic victory. John Hamilton, director of London’s Cross-border Information, says the glut of oil on world markets and turbulence around the few remaining oil ports means Libyan oil has already been “priced out” by many buyers.
Sunday 6 January 2013
Needed: An exit policy for bad businessmen
S A Aiyer
Vijay Mallya has not paid employees of Kingfisher Airlines for months, and has defaulted on thousands of crores due to suppliers and creditors. Yet he has just donated three kilos of gold, worth almost one crore, to the Tirupathi temple. In August, he offered 80-kilo gold plated doors to the Kukke Subramanya temple in Karnataka. Possibly he believes that the gods can be bought off in ways that employees and creditors cannot.
How can a man who owes enormous sums to employees and creditors be free to throw gold around like small change? If there were any justice, surely the gold and golden doors should be seized from the temples and handed over to the employees and creditors. Surely they should have first right to Mallya’s assets.
After two decades of economic reform , we have not yet evolved rules that facilitate the exit of poor managements before they ruin a company beyond redemption. Kingfisher Airlines has been ground to the dust by Mallya, a liquor baron who should never have entered this space.
A free-market economy is not just a device giving owners the freedom to sack employees. It is one where creditors and employees have the right to seize a company defaulting on dues, and sack the management. The managing shareholder or promoter is only one of many stakeholders. If he cannot meet his obligations to other stakeholders , they should oust him in a true free market economy. In India, alas, our unreformed regulations and procedures leave promoters in control no matter how big a mess they make.
In the US, creditors can quickly seize a company that defaults on dues, and reorganize or sell it to a new owner . The owner can get temporary protection from creditors through Chapter 11 proceedings. In this, a judge determines whether the company is so far gone that it must be liquidated, or whether it can be saved through mutual sacrifices by creditors, employees and owners. In the process, the judge can change the owner. So, often workers survive bankruptcy proceedings , but the owner does not. That is what we should aim for in India too: an exit policy for incompetent, defaulting owners.
Kingfisher Airlines never made a profit, not even in the boom years when its rival airlines were profitable. Creditors should have moved in years ago when it became clear that the skills of a liquor baron were irrelevant for an airline. But in India creditors cannot quickly seize a company, least of all when the owner has political clout (as in Mallya’s case).
In the old licence permit raj, banks and financial institutions had to support existing managements and keep rescuing them. This has not changed despite the 1991 reforms. Banks have to keep throwing good money after bad.
Today Kingfisher is so worthless that it no longer makes sense to seize it and find a buyer. SBI Chairman Pratip Chaudhuri estimates that rehabilitating Kingfisher will cost a billion dollars. Nobody will do so — a new airline can be started for maybe just $100 million. Kingfisher has just lost its flying licence. Mallya’s hopes of being rescued by Etihad Airways of Abu Dhabi look like pure fantasy.
Even if it makes no sense to seize the airline today, why not seize his liquor business? Why not seize his prize luxury possessions, ranging from paintings to yachts or jets? Why not take over his cricket team, Royal Challengers ? Why not take over his football team Mohun Bagan, and his Formula 1 racing team Force India? Why is he allowed to keep all these, along with gold that he donates to temples, when he says he doesn’t have enough to pay employees or suppliers? He has given personal guarantees to banks: why are these not being enforced?
Mallya can be congratulated on one thing. Service was top-class in Kingfisher , and the airline gained a good reputation for quality. Had the airline been seized early on, it could definitely have been sold to a new owner. However , its reputation has steadily fallen with its continuing financial crisis, leading to cancelled flights and official grounding.
I constantly hear that India has gone in for neo-liberal policies. That’s pure rubbish. Neo-liberalism would have given employees and creditors the right to quickly seize and sell a company that cannot meet its obligations. The problem is not liberalism but the continuing old illiberalism that keeps promoters in charge, forcing other stakeholders to take a hit. Temples and religious trusts can keep enormous donations from defaulters instead of handing them over to others who, in all justice, should have the first right to such money or gold. This area desperately needs reform.
Vijay Mallya has not paid employees of Kingfisher Airlines for months, and has defaulted on thousands of crores due to suppliers and creditors. Yet he has just donated three kilos of gold, worth almost one crore, to the Tirupathi temple. In August, he offered 80-kilo gold plated doors to the Kukke Subramanya temple in Karnataka. Possibly he believes that the gods can be bought off in ways that employees and creditors cannot.
How can a man who owes enormous sums to employees and creditors be free to throw gold around like small change? If there were any justice, surely the gold and golden doors should be seized from the temples and handed over to the employees and creditors. Surely they should have first right to Mallya’s assets.
After two decades of economic reform , we have not yet evolved rules that facilitate the exit of poor managements before they ruin a company beyond redemption. Kingfisher Airlines has been ground to the dust by Mallya, a liquor baron who should never have entered this space.
A free-market economy is not just a device giving owners the freedom to sack employees. It is one where creditors and employees have the right to seize a company defaulting on dues, and sack the management. The managing shareholder or promoter is only one of many stakeholders. If he cannot meet his obligations to other stakeholders , they should oust him in a true free market economy. In India, alas, our unreformed regulations and procedures leave promoters in control no matter how big a mess they make.
In the US, creditors can quickly seize a company that defaults on dues, and reorganize or sell it to a new owner . The owner can get temporary protection from creditors through Chapter 11 proceedings. In this, a judge determines whether the company is so far gone that it must be liquidated, or whether it can be saved through mutual sacrifices by creditors, employees and owners. In the process, the judge can change the owner. So, often workers survive bankruptcy proceedings , but the owner does not. That is what we should aim for in India too: an exit policy for incompetent, defaulting owners.
Kingfisher Airlines never made a profit, not even in the boom years when its rival airlines were profitable. Creditors should have moved in years ago when it became clear that the skills of a liquor baron were irrelevant for an airline. But in India creditors cannot quickly seize a company, least of all when the owner has political clout (as in Mallya’s case).
In the old licence permit raj, banks and financial institutions had to support existing managements and keep rescuing them. This has not changed despite the 1991 reforms. Banks have to keep throwing good money after bad.
Today Kingfisher is so worthless that it no longer makes sense to seize it and find a buyer. SBI Chairman Pratip Chaudhuri estimates that rehabilitating Kingfisher will cost a billion dollars. Nobody will do so — a new airline can be started for maybe just $100 million. Kingfisher has just lost its flying licence. Mallya’s hopes of being rescued by Etihad Airways of Abu Dhabi look like pure fantasy.
Even if it makes no sense to seize the airline today, why not seize his liquor business? Why not seize his prize luxury possessions, ranging from paintings to yachts or jets? Why not take over his cricket team, Royal Challengers ? Why not take over his football team Mohun Bagan, and his Formula 1 racing team Force India? Why is he allowed to keep all these, along with gold that he donates to temples, when he says he doesn’t have enough to pay employees or suppliers? He has given personal guarantees to banks: why are these not being enforced?
Mallya can be congratulated on one thing. Service was top-class in Kingfisher , and the airline gained a good reputation for quality. Had the airline been seized early on, it could definitely have been sold to a new owner. However , its reputation has steadily fallen with its continuing financial crisis, leading to cancelled flights and official grounding.
I constantly hear that India has gone in for neo-liberal policies. That’s pure rubbish. Neo-liberalism would have given employees and creditors the right to quickly seize and sell a company that cannot meet its obligations. The problem is not liberalism but the continuing old illiberalism that keeps promoters in charge, forcing other stakeholders to take a hit. Temples and religious trusts can keep enormous donations from defaulters instead of handing them over to others who, in all justice, should have the first right to such money or gold. This area desperately needs reform.
Monday 26 November 2012
How could Greece and Argentina – the new 'debt colonies' – be set free?
Protesters wear chains in a protest against Greece's austerity measures. The burden of debt falls mostly on the weaker members of society. Photograph: Aris Messinis/AFP/Getty Images
Colonialism is back. Well, at least according to leading politicians of the two most famous debtor nations. Commenting on the EU's inability to deliver its end of the bargain despite the savage spending cuts Greece had delivered, Alexis Tsipras, the leader of the opposition Syriza party, said last week that his country was becoming a "debt colony". A couple of days later, Hernán Lorenzino, Argentina's economy minister, used the term "judicial colonialism" to denounce the US court ruling that his country has to pay in full a group of "vulture funds" that had held out from the debt restructuring that followed the country's 2002 default.
While their language was deliberately incendiary, these two politicians were making extremely important points. Tsipras was asking why most burdens of adjustment for bad loans have to fall on the debtor country and, within them, mostly on its weaker members. And he is right. As they say, it takes two to tango, so those who condemn Greece for imprudent borrowing should also condemn the imprudent lenders that made it possible.
Lorenzino was asking how we can let one court ruling in a foreign country in favour of one small group of creditors (who bought the debt in the secondary market) derail a painfully engineered process of national recovery. The absurdity of this situation becomes clear when we recall that, partly thanks to the default and subsequent debt restructuring,Argentina, expanding at close to 7% per year, has been the fastest growing Latin American economy between 2003 and 2011.
But there is far more at stake here than the national welfares of Greece and Argentina, important though they are. The Greek debt problem has dragged down not just Greece but the whole eurozone, and with it the world economy. Had the Greek debt been quickly reduced to a manageable level through restructuring, the eurozone would be in a much better shape today. In the Argentinian case, we are risking not just an end to Argentina's recovery but a fresh round of turmoil in the global financial market because of one questionable US court ruling.
Many people argue that, regrettable as they may be, such situations are unavoidable. However, when it comes to debt problems within our borders, we actually don't let the same situation develop. All national bankruptcy laws allow companies with too big a debt problem to declare themselves bankrupt. Once bankruptcy is declared, the debtor company and its creditors are forced to work together to reorganise the company's affairs, under clear rules.
First, a standstill is imposed on debt repayments – for as long as six months in the case of the debtor-friendly American bankruptcy law. Second, subject to the majority (or in some countries a super-majority of two thirds) of them agreeing, creditors are required to accept a debt reduction programme in return for a new company management strategy. This programme could involve outright reduction (or even cancellation) of debts, lowering of interest rates, and extension of the repayment period. Third, lawsuits by individual creditors are banned until there is an agreement, so that individual creditors cannot disrupt the restructuring process. Fourth, the claims of other stakeholders on the company are also taken into account, with wages being typically given "seniority" over debts.
Unfortunately, no mechanism like this exists for countries, which is what has made sovereign debt crises so difficult to manage. Because they don't have any legal protection from creditors in times of trouble, countries typically postpone the necessary restructuring of their economies by piling on more debts in the (usually unfulfilled) hope that the situation will somehow resolve itself. This makes the debt problem bigger than necessary.
What's more, because they cannot officially go bankrupt, countries face a stark choice. Either they default and risk exclusion in the international financial market (although countries can overcome it quickly, as Russia and Malaysia did in the late 1990s) or they have to opt for a de facto default, in which they pretend that they have not defaulted by making full repayments on their existing loans with money borrowed from public bodies, like the International Monetary Fund and the EU, while trying to negotiate debt restructuring.
The problem with this solution is that, in the absence of clear rules, the debt renegotiation process becomes lengthy, and can push the economy into a downward spiral. We have seen this in many Latin American countries in the 1980s, and we are seeing it today in Greece and other eurozone periphery economies.
Meanwhile, the absence of rules equivalent to the protection of wage claims in corporate bankruptcy law means that claims by weaker stakeholders – pensions, unemployment insurance, income supports – are the first to go. This creates social unrest, which then threatens recovery by discouraging investment.
It is not because people condoned defaulting per se that they came to introduce the corporate bankruptcy law. It was because they recognised that in the long run, creditors – and the broader economy, too – are likely to benefit more from reducing the debt burdens of companies in trouble, so that they can get a fresh start, than by letting them disintegrate in a disorderly way.
It is high time that we applied the same principles to countries and introduced a sovereign bankruptcy law.
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