‘Pimping’ your car

It sure looks good but does it enhance value?

By EUGENE MAHALINGAM
eugenicz@thestar.com.my

THROUGHOUT history, man has always taken pride in customising his mode of transport.

The earliest form of “vehicle mod” can be traced back to probably when horses were domesticated and individualised in every way imaginable.

Native Americans painted them, knights donned them with colourful linen and cowboys saddled them with studded silver.

Fast forward to the era of the automobile and vehicle customisation has become a huge fad – a platform for artistic automotive expression.

Rims or customised wheels are among the most popular upgrades that can help boost your vehicle’s resale value, says a tyre agent.

 

But let’s talk about resale value. The common automobile, like almost everything else on this planet, starts to depreciate in value as time goes by.

Car modifications, as pleasing as they may seem in the eye of the beholder, generally tend to knock down the value of one’s car even further when compared to a non-customised or “stock” vehicle.

Used Autos Sdn Bhd owner Peter Wong, a Segamat-based used car dealer, explains: “The idea of vehicle modifications screams personalisation, meaning that the car is meant to suit the owner’s individual needs and no one else.

“Because the vehicle will now end up looking totally different from what the manufacturer intended, the range of buyers you can attract will be limited.”

Still, there are vehicle customisations that can actually help increase, if not retain (rather than decrease) the resale value of your car.

All souped up

Rims, or customised wheels, are among the most popular upgrades that could help boost your vehicle’s resale value, says Klang Valley-based tyre agent Vincent Pang.

“Customised wheels not only positively impact the performance and handling of any vehicle, but they can help improve its value as well. Plus, they enhance your vehicle’s appearance,” Pang says.

He, however, advises that customers should go for rims that are identical in size to the vehicle’s original wheels.

“A larger rim means more weight, meaning more effort is needed to spin the wheel and this could result in worse fuel economy. If you must go with a bigger wheel, choose alloy rims, which are lighter, as opposed to (heavier) steel ones.”

Another trick is to compensate for the larger wheel with a lower profile tyre. This is to ensure that the diameter of the new wheel and tyre is the same as the original.

“Keeping the diameter of the new wheel and tyre package equal to the vehicle’s original wheel size should result in very little impact on fuel economy,” says Pang.

“Getting wider rims are also great for handling and stability, something that a lot of buyers look for in a car. However, these wheels will require wider tyres, which can cost more,” he adds.

Jeremy Yeoh, a Kuala Lumpur-based used car dealer, says many vehicle owners are spending more on mobile electronics that help increase their car’s resale value.

“Aftermarket GPS navigation systems are quite popular with today’s drivers because they provide flexibility and mobility compared with systems installed by the car manufacturers.

“These units, which can be stuck on practically anywhere within the vehicle cabin, come with added features such as UBS and Bluetooth connectivity, which are easier to update and use,” he says.

Aftermarket stereo systems are also popular, provided the installation is professionally done and does not interfere with the vehicle’s electrical system, says Wong.

“I’ve known of car owners that installed crazy sound systems into their vehicles and the wiring job was poorly done. This caused an overload and the car caught fire.

“DVD entertainment systems are also quite popular, but it depends on the types of vehicle. These are ideal SUVs (sports-utility vehicles) and MPVs (multipurpose vehicles), which are great for carrying five to seven passengers during long trips.”

According to Yeoh, certain visual upgrades can also increase the resale value of a car if they are “not over the top” and legal.

“Given our hot climate, adding a sun-roof or window tinting, as long as it is legal, can help garner a higher resale value.”

At the crossroads

Will the 10th Malaysia Plan put us on track to high income status?

By JAGDEV SINGH SIDHU
jagdev@thestar.com.my

ON paper, it seems promising. But will it fall short on execution?

That question may seem like a cynic’s oft-quoted critique, but it resonates with the sentiments of the general Malaysian populace who were over the week given large doses of information on how the Government plans to steer the country towards a high income nation. All of that – and some – were encapsulated in the 420-page 10th Malaysia Plan.

For starters, the broad plan sets a target growth rate of 6% per annum over the span of 2011-2015 to bring the country closer to its aspiration to turn into a high income nation by 2020. The Government will fork out some RM230bil on development, just as it did in the Ninth Malaysia Plan (9MP).

Prime Minister Datuk Seri Najib Tun Razak tabling the 10th Malaysia Plan in parliament on Wednesday.

 

Essentially, it echoes the salient targets of the New Economic Model that was revealed in March as well as transformation efforts under the Government’s Transformation Programme.

Views seem mixed; while some economists opine that the growth target may be ambitious, others say it’s achievable but the Government needs to pull out all the stops to get there.

“10MP makes the right soundbytes,” says Maybank IB Research. But “the market wants to see action,” says Citigroup, referring to past delays and false starts in project and policy implementation.

The main approach

A higher sum of money will be devoted to soft infrastructure (40%) such as skills training and human capital development in contrast to hard infrastructure (60%) such as roads, power stations and ports. That marks a shift from the past plans and is very much in keeping with the main thrust of the 10MP – change.

Second Finance Minister Tan Sri Nor Mohamed Yakcop elaborates: “The world has changed and countries have become more liberalised and we have to get the 10MP right to get to Vision 2020. We want to be driven by productivity and innovation and no longer by factor accumulation.’’

Tan Sri Nor Mohamed Yakcop ... ‘Progress is going to come from skills.’

 

No doubt. There’s wide room for improvement in this area. The number of people getting technical and vocational knowledge in more developed nations far outweighs those in Malaysia. Toss in the fact that presently, over 77% of secondary school leavers are entering the workforce armed with merely SPM qualification and the push to get this plan on high gear becomes imperative.

“We don’t need more brick and mortar. Progress is going to come from skills and now is the time to do it,’’ says Nor Mohamed.

The plan further expounds the Government’s repeated calls for the private sector to take the driver’s seat to build the economy. Towards this end, the Government is looking for businesses to invest some RM115bil a year to achieve a growth rate of 12.8% per year in private investment as opposed to a paltry 2% in the 9MP.

In line with this, the Government will gradually scale back its pump priming strategy whereby in 2015, it intends to slash the deficit to 2.8% of GDP from a projected 5.3% in 2010.

Apart from the ambitious target of private investments to pick up speed dramatically, the plan also sees household spending growing by 7.7% per annum, much more than it has been. There are concerns if this can happen given the debt levels of households.

Do people have the appetite to take on more debt? Is it wise to expect a rising spend policy when subsidies are expected to be slashed leading to higher inflation?

Aspiration vs achievement

Some will argue that the plan repackaged many of the previous objectives. One example is efforts to improve human capital levels which have been spelt out in the past.

“We need a transformation in the planning approach. There must be a major change,’’ says economist Datuk Dr Zainal Aznam Yusof.

He argues that economies are getting lighter on their feet and reacting faster than they did 40 or 50 years ago.
“It must be beyond a rolling plan and there must be continuous planning and we should not wait for the mid-term review to change things,’’ he says.

A more nimble approach in planning is painfully obvious based on the aspirations of the past five-year plans and its actual achievements.

The past 10 years has seen Malaysia traverse a bumpy path – two recessions and a world that has grown smaller on the back of globalisation which also makes it more vulnerable to external factors. Understandably, it would be difficult to take into consideration economic cycles when formulating policies as rarely, downside risks are taken into account when setting targets.

Suffice to say that many key indicators set have not met their mark not just in the 9MP, but also in the previous two plans.]

In fact, among the major economic targets contained in the 9MP, the only one that was met was inflation.
In comparison, key targets such as GDP growth, private investment, exports and consumption, both public and private, were pleasantly surpassed in the Fifth and Sixth Malaysia Plans. Noteworthy is that these two plans – between 1986 and 1995 – were unveiled when Malaysia was being transformed into a manufacturing-led economy and when foreign investors viewed Malaysia as a darling investment destination in Asia.

On the other hand, the last three plans coincided with the Asian Financial Crisis and the financial sector crisis in the United States and Europe that plunged the world into a recession. But analysts say the culprits could also be private sector withdrawal and weak implementation.

The private path

A central feature of the 10MP is to crank up private spending but as history has proven, that is no walk in the park.

“The private sector has lost dynamism, with private investment languishing due to external and internal constraints,’’ says CIMB Research head of economics Lee Heng Guie in a recent report.
The constraints include the weak government bureaucracy where approvals take far too long and that the private sector is being crowded out by government linked companies (GLCs).

Zainal says that to have more effective implementation, what is needed is a more realistic and forceful approach, akin to what is being done in Singapore. While consultation and engaging the public on key policies are fine, it ought to be employed with discretion. Otherwise, it could come at a cost. “What you will lose is leadership strength in the timeliness and aggressiveness in implementation,’’ he cautions.

To address the infamous red tape and bureaucracy and government hindrance to private investment, several measures have already been put in motion.

Pemudah and Pemandu are two government agencies that have been entrusted in bringing about on-the-ground change that is needed for Malaysia to remain competitive in the world.

And progress has been made.
Via Pemudah, the time taken for a number of government services have been cut. It now takes three days to start a business compared with 11 previously.

A vast improvement has also been made in registering standard property titles and getting tax refunds but there is a lot more left to be done before the country can meet its aim of breaking into the top 10 in the World Bank’s Doing Business survey where Malaysia was ranked 23rd in the 2010 report.

Improving approval process is one step. Eventually, it still boils down to wooing domestic businesses and foreigners to invest more in the country.

Centre for Public Policy Studies chairman Tan Sri Ramon Navaratnam says it will be difficult for the Government to see private investments grow by 12.8% a year during the duration of the plan.

“How do you do it when there is really nothing attractive enough to attract FDI in a significant quantity and to prevent domestic investments from going abroad to more attractive pastures?’’ he asks.

He feels that unless there is change to the policy of allocating 30% of wealth to just one race, corruption eradicated and a more merit-based and liberal environment promoted, the task is difficult if not impossible.
“There must be a holistic improvement to the environment,’’ he says.

Backing the sector

The concept of the Public Private Partnership would be backed with a RM20bil facilitation fund and this is seen as a major kicker in getting the private sector to open up their wallets.

Nor says the Government would give private companies a grant of up to 10% of the cost of the project.
“The rules are simple and the Government will give a cheque,’’ he says.

The Facilitation Fund is expected to attract private sector investments worth RM200bil during the 10MP.
“If those are government initiated projects, then it is pretty much government driven. But the private sector will bite into the money made available and take advantage of the facilitation fund,’’ says an economist from RHB.

Other measures proposed is a timely focus on SMEs and trying to get their contribution to GDP up to a level enjoyed by other more developed countries. To do so, funding and market access issues would have to be ironed out.

Malaysian Investment Development Authority (Mida) would also be reformed to make it more effective as a one-stop centre in bringing in FDI into the country.

On its part, the Government has proposed to establish a Talent Corp to inject more professionalism and capability into the service.

Even so, at this point, sweet talking the Malaysian diaspora into coming back to Malaysia and keeping the next wave of talent from moving abroad to greener pastures is a mountain of a challenge as the brain drain over the years has built up tremendous momentum.

Much of the same?

The 10MP contained excerpts of what the proposed New Economic Model but not the more controversial changes proposed, such as the doing away with affirmative action and cutting foreign labour, and that took some by surprise.

The current 30% bumiputra equity ownership remains one of the key thrusts of government policy and while the equity number stands, the Government has broadened it to non-financial indicators such as professional employment and real estate ownership.

The Government felt there was a need to transform the bumiputra development agenda to enhance participation among competitive and resilient bumiputra companies.

Such an approach will be based on four key principles – market-friendly, needs-based, merit-based and transparency.

“I am encouraged by some of the announcements and confused by others. Are they going to have quotas for employment and properties?’’ asks Navaratnam.

Whether that would deter foreigners or even domestic investors from investing into the country is up in the air but while the Government spoke about maintaining affirmative action, it also sent a strong signal that it was moving ahead with its international obligations to liberalise more sectors of the economy, especially in the growing and important services sector by 2015.

Liberalisation will bring about more competition and allow companies to benefit and prosper in a more open business atmosphere. In addition, the Government will enact the Competition Act next year.

“That’s a good development but at the moment many people are unaware of what the Competition Act will do,’’ says an analyst.

He feels once the ramifications of the Act is assessed, there could very well be lobbyists who might put pressure on the Government to repeal or change the legislation.

The changes to the bankruptcy law is lauded as it will encourage risk taking among entrepreneurs, which is essential, especially in the high-tech businesses, in building a more dynamic business community.

“Banks will have to be more cautious and they will eventually have to learn to price in such new risk elements,’’ he says.

That, coupled with the removal of distorted price controls and subsidies should help improve the competitiveness of the economy.

The leeway for mistakes is getting slim. There is just 10 short years that stand between now and the time the country achieves its big objective of becoming a high-income nation. Considerable work needs to be done.
CIMB Research sums up the task ahead pretty well.

“If the reform programmes and high-impact projects under the 10MP are properly executed, it will be positive for both the economy and the capital market in the short-to-medium term. But if the reform moves are stalled and implementation of the planned projects and programmes is delayed, it could hamper growth and investment prospects,’’ it says.

The broker says there should be more openness in government expenditure including significant acceleration of enforcement and prosecution for misappropriation and mismanagement of resources within the Government.

It points out that expenditure leakage and wastage is a pervasive problem and has an impact on the overall economy.

“Unless the Government means business, this is our last chance,’’ says Navaratnam.

Related Stories:

Private sector needsto play bigger role

Tackling human resource issues

Promoting competition

Asia’s alternative path to economic growth

Review by DAVID TAN
davidtan@thestar.com.my

Nowhere to Hide: The Great Financial Crisis and Challenges for Asia
Authors: Dr Lim Mah Hui and Dr Lim Chin
Publisher: Institute of Southeast Asian Studies

ASIAN countries must not depend solely on being export-driven to generate growth but should instead focus on increasing domestic consumption.

Authors Dr Lim Mah Hui and Dr Lim Chin present a cogent argument why Asia should move away from being an export-oriented region in their book titled Nowhere to Hide: The Great Financial Crisis and Challenges for Asia. The authors say that the United States and Europe are no longer reliable markets for Asia.

“The US cannot go on accumulating international debt at the present rate without triggering another financial crisis. It has to narrow its chronic current deficit by either increasing its gross savings or reducing its gross investments,” the authors say.

The US is already buying less, as reflected by its improving savings rate, which rose from zero percent in April 2008 to 6.9% in May 2009. It is currently hovering around 4% at present.

Its current account deficit has also narrowed to about 3% of gross domestic product (GDP) in 2009 from 6.5% in 2006.

Neither can the European economy be relied upon as an export market for Asia, given the financial crisis in Greece, Spain, and Portugal.

This leaves the Asian domestic markets as the alternative for economic growth. But the authors point out that the ability of Asian economies to spend is capped by the people’s purchasing power.

In China, the population’s capacity to spend is restraint by the need to save for precautionary reasons.
“For instance, the poor are forced to save because of deterioration in access to health care, education, and social security,” the authors say.

Thus, if China wants to increase consumption as a driver of economic growth, it has to reduce income equality, improve social services, and provide social safety nets for the population.

Mah Hui and Chin argue that wages should increase to keep up with rising productivity to ensure adequate purchasing power.

Corporate savings in China can be taxed to help improve healthcare and social security services, reducing the need for excessive precautionary savings. This will also boost private and household consumption.

Asian economies with large foreign reserves should invest more in the region to raise growth, income, and consumption, and reduce dependency on the West.

To drive domestic consumption, Asian economies should not follow the Anglo-Saxon model, which is to turn to debt creation.

In Malaysia, there is reliance on increasing household debt to fuel consumption. About 55% of the country’s total bank loans are for private consumption and household such as residential and non-residential property loans (36%), passenger car loans (10%), credit cards and personal loans (7%).

In view that some 60% of the Malaysian population makes a monthly wage of about US$900, increasing consumption through debt creation could take it down the same path as the US, the authors say. “In fact, this is a policy challenge for most Asian countries, particularly China, which is attempting to turn to domestic consumption as an engine of growth,” they say.

Nowhere to Hide: The Great Financial Crisis and Challenges for Asia examines the origin of the crisis in the early eighties when US financial regulators were financially intoxicated.

This resulted in the removal of the Glass-Steagall Act, which separated commercial and investment activities in banks, prohibiting interstate banking so that banks do not become too big and take too much risks, and regulating the activities of commercial banks.

The deregulation led to the appearance of asset-backed securities (ABS) and collaterised debt obligations, which repacked and sold ABS with credit ratings, creating a category of subprime mortgages.

Subprime mortgages formed about 15%, or US$1.5 trillion, of total US housing loans from 2004 to 2006. These subprime loans, distributed worldwide, were fine as long as the US housing market continued to boom and interest rates did not rise.

When these conditions disappeared and the borrowers defaulted in 2007, the subprime crisis erupted in the US, leading inevitably to the global economic crisis.

The book also examines how long-term causes such as the imbalance between the financial sector and the real economy turned the US into the world’s largest debtor nation, with a current account deficit reaching more than US$800bil, or 6.5% of its 2006 GDP.

The US financial sector’s contribution to GDP from 1960 to 2006 rose from 14% to 20%, while the manufacturing sector more than halved from 27% to 11% of GDP.

From 1960 and 2007 the size of domestic debt grew 64 times from US$781bil in 1960 to US$49.9 trillion in 2007, while the GDP rose 27 times from US$526bil to US$14 trillion during the same period.

Mah Hui and Chin concludes the book with a call for capital controls to be reconsidered, as the free movement of capital results in the volatility of exchange rates, which in turn can undermine small economies and a country’s ability to pursue independent monetary policies.

The book also proposes that a Special Drawing Rights note, not pegged to any other sovereign state, be used as the international currency, which is one way of restoring global stability and equity.

The argument for government intervention in the economy, which the authors’ present in the book, occupy a middle-ground between two competing analyses of capitalism that were advanced in the first half of twentieth-century by two Austrian economists Friedrich Hayek and Karl Polanyi.

Hayek holds the view that depressions are cycles in a capitalist economy, which should be allowed to run its course without any intervention from the government, while Polanyi argues that the free market system needs to be regulated by a global governing financial authority, as it is prone to failure, which would lead to dystopia.
But how much government intervention should there be and in what areas should it intervene?

For example, should the Chinese government just play a role in improving healthcare and social security services to reduce precautionary savings and boost domestic spending?

Or should it also ensure that there is always full employment even during periods of depression to ensure that the working class have the power to consume?

Prior to the financial deregulation of the 1980s, government intervention in the UK’s economy to create jobs kept wages and inflation high, leading eventually to unemployment, deficits, and high interest rates. Should the government also intervene to create employment? These are some questions which the book leaves unanswered.

Nowhere to Hide: The Great Financial Crisis and Challenges for Asia is a reliable guide for the layman to understand the origins of the global economic crisis and how Asia should respond to the challenges.

Euro Company Spreads Rise to Record Versus U.S.: Credit Markets

By Bryan Keogh and John Detrixhe

 

June 11 (Bloomberg) -- The risk of owning Europe’s corporate bonds is the highest on record relative to U.S. company debt as investors lose confidence lawmakers and central bankers can tame the region’s worsening fiscal crisis.

Yields on investment-grade bonds in euros rose to a 10- month high of 239 basis points, or 2.39 percentage points, more than government debt, according to Barclays Capital index data. That’s 41 basis points more than the spread for U.S. company notes, near the record 44 basis points reached May 27. European bond spreads were below those on dollar debt as recently as February, the indexes show.

Yields suggest debt investors are concerned Europe’s sovereign debt crisis will stifle growth and curb profits even after European Union President Herman Van Rompuy said yesterday a 750 billion-euro ($908 billion) rescue package will be increased if it fails to quell volatility. About 75 percent of investors and analysts expect some governments in the region to default or the 16-nation euro area to break up, according to a quarterly poll of Bloomberg subscribers.

“It’s largely fear driven,” said John Milne, chief executive officer of JKMilne Asset Management, who oversees about $1.8 billion in Fort Myers, Florida, and favors U.S. corporate bonds. “People like ourselves are holding onto positions, watching the market like a hawk.”

Standard & Poor’s raised the ratings on 201 U.S. companies and cut 183 this quarter, a ratio of 1.1 to 1, according to data compiled by Bloomberg. That compares with 51 upgrades and 127 downgrades in Western Europe, a ratio of 0.4 to 1.

Selling Buyout Debt

“Deficits in Europe remain massive and are going to weigh down the economic recovery,” said Juan Esteban Valencia, a London-based credit strategist at Societe Generale SA. He predicts Europe’s corporate bonds will continue to underperform their U.S. counterparts.

Elsewhere in credit markets, Emerging-market bonds rallied the most in two weeks. JPMorgan Chase & Co. sold $716.3 million of bonds backed by commercial mortgages in the second offering of the debt this year, according to a person familiar with the transaction.

The largest top-rated portion, maturing in 4.53 years, yields 140 basis points more than the benchmark swap rate, said the person, who declined to be identified because the terms aren’t public. The AAA rated slice maturing in about 9.53 years yields 165 basis points over the benchmark, the person said. A basis point is 0.01 percentage point.

Bank of New York

Bank of New York Mellon Corp. is marketing $500 million of five-year notes, according to a person familiar with the offering. The debt may yield as much as 97 basis points more than similar-maturity Treasuries, said the person, who declined to be identified because terms aren’t set. A basis point is 0.01 percentage point.

Bank of New York Mellon may issue the notes as soon as today, the person said. Barclays Plc and UBS AG are managing the sale for the New York-based bank.

The extra yield investors demand to own corporate bonds instead of government debt rose 1 basis point to 200 basis points, the highest since Oct. 16, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Average yields were 4.158 percent.

An indicator of corporate credit risk in the U.S. fell for a second day. Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 0.3 basis point to a mid-price of 125.3 basis points as of 1:46 p.m. in New York, according to Markit Group Ltd.

European Credit Risk

The index, which typically falls when investor confidence improves and rises when it deteriorates, is down 6.8 basis points since reaching an 11-month high on June 9.

The cost of protecting European corporate bonds from default plunged the most in more than two weeks, with credit- default swaps on the Markit iTraxx Crossover Index of 50 mostly junk-rated companies dropping as much as 21.3 basis points to 581, according to Markit Group Ltd. The index was at 597.8 basis points as of 1:53 p.m. New York time, up 8.6 basis points for the week.

The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan fell 9 to 142 in Singapore, its biggest daily decline since May 27, according to Royal Bank of Scotland Group Plc and CMA DataVision.

BP Credit Swaps

The cost of insuring BP Plc’s bonds using credit-default swaps fell from a record, with contracts on the company declining 34.5 basis points to 443.5, according to CMA. Credit swaps on the company have surged since the April 20 explosion of the Deepwater Horizon rig that killed 11 people and triggered an oil spill.

BP’s $3 billion of 5.25 percent notes due in 2013 rose 3.125 cents to 95.375 cents on the dollar yesterday, after declining to as little as 89.94 cents the day before, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield declined to 6.8 percent, a premium of 534 basis points over similar-maturity Treasuries, down from 655 basis points.

Credit-default swaps tied to Spain’s two largest banks fell today, with Banco Santander SA dropping 18.5 basis points to 195.5 and Banco Bilbao Vizcaya Argentaria SA declining 24 basis points to 362, CMA prices show.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Emerging-Market Bonds

In emerging markets, yield spreads widened 9 basis points to 327 basis points, the biggest jump in a week, according to a JPMorgan index. The spread has ranged from this year’s low of 230 on April 15 to a high of 346 on May 20.

Spreads on European company bonds traded at an average of 64 basis points tighter than the yield premiums on U.S. debt before this year, according to Barclays Capital’s U.S. and euro aggregate corporate bond indexes dating back to 1998.

The debt in Europe has traded at or above U.S. bonds since Feb. 23, the data show. European notes, which carry an average maturity of five years, half that in the U.S., traded wider for the first time in December.

Banks in the U.S. are better bets than those in Europe because of their deposit bases, plenty of near-term liquidity and improving balance sheets, said Mark Kiesel, global head of corporate bond portfolio management at Pacific Investment Management Co. in Newport Beach, California.

“The U.S. banks look very compelling on a global basis relative to other banks,” said Kiesel, who oversees about $300 billion of credit investments for the firm, which also manages the world’s biggest bond fund. “In contrast, Europe looks like the sick patient.”

Companies sold 14 billion euros of bonds in Europe last month, an 89 percent decline compared with the same month last year, according to data compiled by Bloomberg. U.S. issuance totaled $35 billion last month, a 75 percent drop from the same period in 2009, Bloomberg data show.

Europe’s rescue fund for nations struggling with spiraling budget deficits, which is backed by 440 billion euros-worth of national guarantees, has had a “muted impact,” according to Jamie Stuttard, head of European and U.K. fixed income at Schroders Plc in London.

Stuttard, who oversees the equivalent of about 25 billion pounds ($37 billion), cited rising European government bond yields, led by Greece and including so-called Club Med nations such as Italy and Spain.

‘No Meaningful Impact’

“If the bailout was formed to prevent contagion to larger and more serious peripheral economies such as Spain, then the package seems to have had no meaningful impact,” Stuttard said. Lenders are being affected and “the market perceives that European banks are riskier than at any point in 2008,” he said.

Van Rompuy, a former Belgian prime minister who became the EU’s first full-time president in January, was the first European official to say the rescue fund may be expanded. He voiced confidence Greece won’t default and that no country will be forced to quit the euro.

Sovereign bond spreads have surged. The 10-year Greek bond yield reached 12.46 percent on May 7, the highest since the common currency was introduced in 1999. The yield plunged to 6.3 percent on May 10 after the rescue program was announced, before rising to 7.68 percent. It was 8.14 percent today.

‘Incomprehensible’

Skepticism about euro-area rescue funds is “incomprehensible” and they are “significant programs,” European Central Bank Governing Council member Axel Weber said at a conference this week in Berlin. The Frankfurt-based ECB kept its main refinancing rate at a record-low 1 percent at yesterday’s monthly policy meeting to avoid stamping out the fragile economic recovery.

Spreads on company bonds in Europe and the U.S. are widening even as the World Bank raised its forecast for global economic growth this year and next, while acknowledging the risks posed by strained government budgets.

The world economy will expand 3.3 percent this year and by the same amount in 2011, up from January predictions of 2.7 percent for 2010 and 3.2 percent next year, the Washington-based World Bank said in a June 9 report. The bank said it saw a “high probability” of a “more muted recovery” because of accelerated efforts to trim deficits.

Risks to the global economic outlook have “risen significantly” and policy makers have limited room to provide support to growth, International Monetary Fund Deputy Managing Director Naoyuki Shinohara said.

--With assistance from Sonja Cheung, Caroline Hyde, Abigail Moses, John Glover in London, Sandrine Rastello and Timothy R. Homan in Washington and Margaret Brennan, Sarah Mulholland, Craig Trudell, Emre Peker and Shannon D. Harrington in New York, Drew Benson in Buenos Aires and Ed Johnson and Sarah McDonald in Sydney. Editors: Paul Armstrong, Charles W. Stevens

The global regulatory reforms

THINK ASIAN
BY ANDREW SHENG

JUST as the US appears to have reached an agreement on their banking financial sector reforms, the Euro-Greek crisis broke out.

In April, two important consultations on the Basel Committee on Banking Supervision’s proposals for the reform of bank capital and liquidity requirements ended, just as the banking lobby around the world furiously pushed back the suggested reforms in different ways.

After having carefully read the proposals, I have formed two conclusions. Firstly, I am not sure that the global proposals will prevent the next crisis. Secondly, I do not think that all the proposals fit the needs of the emerging markets.

Everyone is waiting for the World Cup Football matches in South Africa. What you are seeing in the rule changes can be likened to a football referee, who after witnessing a collapse of the game where everyone has broken the rules, asks that the goalpost be shifted.

Insufficient enforcement

This crisis did not happen because the rules were defective (some were), but because there was insufficient enforcement of the existing rules.

If you say that Basel II rules were good enough to prevent a major crisis in Japan, which had implemented the rules, then why didn’t it also prevent the crisis in the US, UK and Europe?

The answer is that no one there enforced Basel II. The whole basis for Basel II was capital efficiency, not capital adequacy.

After the crisis, people were shocked that all the complex rules boiled down to was 2% core capital against markets that moved more than 5% a day and a liquidity of 1% of total assets.

When the crisis came, the central bankers became lenders of first resort, not lenders of last resort. The emperor had no clothes and the banking system, as Alan Greenspan reminded Asia in 1999, had no spare tire.

Why is the banking industry in the West so much against such rules? The answer is that the low capital adequacy (in fact high leverage) was exactly the reason why bankers were getting such large salaries – the more short-term profits they appeared to get, the higher the bonuses and the larger the bailout that the taxpayers have to fork out.

We now agree that banks should not be too large to fail. But the Greek rescue means that for countries that are members of larger unions are also “too small to fail”.

So we have a situation that under the present system, no one is allowed to fail. The issue is very simple. Everyone who eats a pound of delicious French fries knows that it is “short-term gain, long-term pain.” If you become overweight, you will pay through weak health and more hospital bills.

Anyone who tries to diet will understand that it is all about “short-term pain, long-term gain.”
Financial regulation and supervision means that you prevent crisis by taking small steps all the time by enforcing the rules. Small and immediate enforcement can help to prevent big crisis.

Big problems have small origins. If the football referee does not enforce the rules, are we surprised that the game becomes totally uncontrollable?

The second issue is moral hazard. The first basis of financial regulation is that it must be easy to understand, learn, use and enforce. This is why we have principles–based regulation.
However, those who are regulated prefer to have rules-based regulation. This means that rules are made more and more complex, as the market demands that this and that are exempted from the rule or the calculation.
For example, the 8% capital adequacy rule is diluted through many gimmicks. First, the capital adequacy ratio is calculated as the numerator (capital) divided by the denominator (the asset or liability).

The numerator can be changed or diluted in many ways, such as Tier 2 capital, using subordinated debt or unrealised profit from unsold stocks held by the bank.

The core capital (paid-in capital plus retained earnings) is weakened from 8% to less than 2% by these classifications.

The second gimmick is to change the denominator. Instead of strict and simple calculation like total assets or liabilities (including contingent liabilities or those below the line), banks were permitted to use risk-weighted assets.
 
For example, sovereign bonds were given zero weighting if they had investment grade rating by the rating agencies. Look what has happened with Greek bonds, which can be downgraded overnight to junk bond status. Even mortgages were given very low risk ratings.

The third gimmick is the shifting of liabilities off-balance sheet so that they do not require capital. This is the main effect of creating derivatives so that liabilities become contingent.
Now we know that in a systemic crisis, contingent liabilities have a habit of getting back into the balance sheet.

The fourth gimmick is to persuade regulators that sophisticated investment bankers can rely on their internal risk models to measure risks.

The fifth gimmick is to move liabilities offshore completely beyond the regulation of the home regulator.
This was the creation of the shadow banking system, where one is lightly or not regulated at all. These gimmicks mean that for every rule, there are at least five ways of going around the rules.

Moral hazard

However, the more complex the rule, the easier it is to escape them and the greater the moral hazard that the state would have to end up paying for.

When people do not understand the rules, they blame the rule maker, not the rule breaker.
The Basel Committee has decided that there are five major areas of reform:

·The quality, consistency and transparency of the capital base will be raised;

·The risk coverage of the capital will be strengthened, avoiding the arbitrage which I had earlier mentioned;

·An overall leverage ratio will be used as a supplementary measure to the minimum risk-based framework. This is a limit to the leverage that became also infinite just before the crisis;

·There should be an element of anti-cyclical or dynamic provisioning, in the sense that the higher the risks, the higher the provisions or capital; and

·A global minimum liquidity standard for internationally active banks will be introduced.
All the rule changes look very sensible, but will they stop banks making more mistakes? I shall discuss this in the next article.

Datuk Seri Panglima Andrew Sheng is adjunct professor at Universiti Malaya, Kuala Lumpur, and Tsinghua University, Beijing. He has served in key positions at Bank Negara, the Hong Kong Monetary Authority and the Hong Kong Securities and Futures Commission, and is currently a member of Malaysia’s National Economic Advisory Council. He is the author of the book From Asian to Global Financial Crisis