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NOVEMBER 2013
changes in the analyzing abe- real estate re- detroits danthe chinese
janet yellens
energy industry
nomics
covery
gerous decision
economy
rise
Vincent Criscuolo
Graham Jordan
Kunal Kochar
William Helmold Kartik Bharnidipati
Brendan Tsai
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aBenoMiCs so far
however, there are also worries that the policy by the bank of
japan could be seen as a form of debt monetization. this is
scaring investors away from japanese bonds.
the second arrow, government stimulus measures, is currently in play. What makes government spending difficult in
japan is that japan is currently the most indebted country in
the world with, according to the imF, a public debt to gdP
ratio of 238% at the end of 2012. to put that into perspective,
at the end of 2012 the us had debt to gdP ratio of around
106.5% and greece one of 158%. Fortunately for japan, the
ultra-low interest rates provided by an aging population which
primarily invests in government bonds have allowed the country to maintain payments on this debt. however, japan is toeing a very fine line and the repercussions would be huge if this
line were crossed. Fortunately, the government is currently experiencing higher than expected tax revenues. abe plans to use
this windfall to finance his stimulus plan. however, it will be
difficult to make a meaningfully-sized stimulus plan without
issuing more debt.
abe has also been proactive in pursuing an olympics bid
and is looking to the 2022 games as potentially being a source
of stimulus for the economy. at the same time, olympic
games are often associated with high government debt levels
in the construction of a venue for the games. Furthermore,
there is a question as to how impactful securing the olympic
games will be on the current situation, given that they arent
for another nine years.
the third arrow of abes plan, addressing structural reforms in the labor market, has only been partially addressed so
far. japan has some of the most restrictive labor laws in the
world. there are various laws in place that lead to the labor
market being incredibly rigid in that it is both difficult for people to find new jobs and it is also difficult for employers to
fire people.
although the december 2012 elections to the upper house
in japan considerably consolidated abes power, there is still
stiff resistance to changing the labor laws. as such, many of
the proposed reforms have been put on hold. these original
labor reforms, which were seen as not very ambitious, are now
having trouble being enacted. this questions the extent to
which abe will be able to push larger reforms later.
so far, these three arrows have only started to be felt by
japans economy. on the one hand, inflation is at its highest
level in five years at 0.3%. While this may seem small, it is
substantial for a country that has been facing deflation consistently for decades. this success is primarily due to the fact
that abe has had the most success in being able to implement
radically new monetary policy. similarly, exports have begun
Story continued on page 5, See Japan
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passu with all other liabilities with regards to the citys priority
of claims. under orrs plan, the city may only pay bondholders
pennies on the dollar. if this plan is adopted and ruled legal by
bankruptcy court, a very disturbing precedent would be set. the
underlying notion of security, and safety regarding unlimited tax
general obligation bonds would be fundamentally challenged,
ultimately causing yields for future municipal issuances to rise
significantly. this would cause significant fallout not only for
michigan, but potentially for the rest of the country. credit rating
agency Fitch noted that should a bankruptcy court approve detroit's treatment of these bonds as unsecured debt, Fitch will reassess its ratings of tax-supported debt ratings within michigan
and perhaps the rest of the country. a large scale credit rating
recalibration, as threatened by Fitch, could significantly drive
up borrowing costs for municipalities across the country, thus
stalling needed capital improvement projects, and could potentially force other municipalities into financial distress.
though detroits handling of its bankruptcy may challenge
fundamental market beliefs regarding general obligation security
pledges, current holders of detroits debt are unlikely to see
much of an effect. of the citys outstanding debt, approximately
80% is insured; this means investors should get significant (if
not perfect) recovery rates, assuming the insurers stay out of
bankruptcy themselves. in the coming months, detroits proceedings will answer the question about the sanctity of the general obligation pledge. as investors watch the actions of detroit,
the city would be wise to remember that the capital markets generally have a good memory welching on bonds today may
make securing future funding at reasonable yields all but impossible.
Japan, story continued from page 3
rise too; this is also a consequence of the weaker yen.
on the other hand, many less financial metrics dont
paint as rosy a picture. For the most part, income and unemployment have remained unchanged throughout the implementation of abenomics. While surveys such as business
confidence have started to rise to very positive levels, this confidence has not yet translated into effects for the population as
a whole.
in conclusion, while a lot has been done by abe in pursuing his goal of fighting inflation and revitalizing growth,
there is still a lot left to do. While significant progress has been
made combatting deflation, there are still a host of structural
issues in japan that need to be addressed before the effects of
growth can be felt. at the same time, japan needs to implement all of these policies while bearing in mind the fact that it
is near bursting with debt as a country. a lot has been done, but
the jury is still out on whether abenomics will be successful.
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Separation, story continued from page 1
to raise very inexpensive funds from investors that view
these banks as a comparably safe harbor for their investments. moreover, these banks run considerable retail banking operations so that they can acquire vast amounts of
deposits insured by the Federal deposit insurance corporation. this advantage in terms of funding can lead to severe
moral hazard issues as banks are not reluctant to use these
cheap funds to make risky bets on the capital markets. this
became apparent when citigroup had to be supported by the
us government with $25 billion emergency aid during the
crisis.
From this point of view, a separation of retail and commercial banking from investment banking would increase the
safety of deposits and reduce the liabilities states have to
incur for tbtF financial institutions. given this scenario,
investment banks would be forced to entirely absorb the
losses they generate, which could provide incentives to decrease the riskiness of their transactions and therefore stabilize the financial sector.
however, reality has proved the contrary. lehman brothers was a pure investment bank that nevertheless encouraged
risky transactions. the absence of deposits caused the bankruptcy as so-called broker-dealers like goldman sachs,
morgan stanley and at that time lehman brothers entirely
relied on the capital markets to raise liquidity issuing commercial papers. the danger of such a financing structure was
also shown by lehman brothers: if the bank had had access
to liquidity, e.g. in form of deposits, it would not have been
forced to file for bankruptcy because it was struggling initially with illiquidity problems instead of insolvency.
the refinancing costs of banks and therefore the riskiness of its operations can be estimated by means of credit
default swap spread. the higher the risk investors evaluate
the higher is the cds spread - i.e. the price investors have
to pay in order to hedge the credit line they offer banks.
the market data reveal that the more diversified a financial institution is, the lower the cds spread, which means
that investors consider pure investment banks like morgan
stanley as much more unstable than financial supermarkets
like ubs that operate profitable Private Wealth management
and other divisions in addition to their investment banks.
the fact that large, well-diversified banks have access to
deposits and provide various financial services (including investment banking) contributes to their apparently high level
of stability because they are much more likely to be able to
absorb losses in one division in comparison to focused
banks. For instance, j.P. morgan chase was able to cover gigantic trading losses of about $7 billion incurred by the london-based chief investment office division in 2012 with
profits from other operations, which would not have been
possible for specialized banks. the us government even
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