Monday, October 13, 2008

When nations go belly up

Iceland, a tiny economy with a population of just 320,000 and GDP of £14 billion ($ 23.85 billion) has liabilities in excess of $100 billion against annual GDP of just $14 billion. Clearly, a case of a nation going bankrupt. It is starting to adopt extreme measures by forcing Icelandic institutions such as pension funds to repatriate funds to bolster its reserves in defense of the collapsing currency.

As the Economist puts it –

"Iceland’s rapid rise and even faster fall has been viewed from afar as a parable of greed and hubris, in which a nation of farmers and fishermen borrowed too much and are paying the price. But that is to draw false comfort. Although Iceland represents an extreme case of a huge financial system towering over a small economy, other states suffer from similar imbalances. They differ only in scale, but not substance. Kreppa (“in a pinch”) may be an Icelandic term, but it translates."

The only avenue open to Iceland to function economically on a day to day basis i.e. so as to enable Iceland to import resources such as food and fuel is by long-term loans and guarantees from the IMF and other countries such as Russia which has loaned Iceland euros 4 billion. The net effect is that Iceland is likely to experience a severe and prolonged economic recession and will be forced to develop cash generating commercial industries such as fishing to finance the increased debt burden. The expectation is that over time governments will cancel the Icelandic bad debts in exchange for geopolitical influence.

The fact is, in the flat world in which we live in, Kreppa will more likely translate. Not all may have the EU umbrella above their heads...

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Monday, October 06, 2008

What is Paulson’s Plan B, sorry X (by now?)

Quoting Newsweek

“In the best-case scenario for Paulson's plan, there is real, unrecognized value in the mortgage-backed securities sitting on financial institutions' balance sheets. He hopes that the government, by serving as a committed buyer, will be able to jump-start trading in those securities. Once it's clear to the marketplace that the disdained securities have considerable value, Paulson hopes, the uncertainty over financial institutions' net worth will be dispelled and they will be able to raise capital privately and resume normal lending.

If instead the Treasury purchase plan reveals that the securities really are as worthless as many fear, Paulson and Bernanke will need an urgent Plan B (or are we up to Plan X by now?). Super-low sales prices will force financial institutions to acknowledge they have been carrying assets on their books for more than they're worth. They'll have to write them down, which could leave many undercapitalized. At that point, the government will be forced to take them over and then close them or merge them into healthier institutions.”