For months, I have been confident that Europe would suffer a financial crisis and a depression, as in a real economy catastrophe accompanied by a market crash. It might not be as severe and lasting as 1929, but the breadth would mean there would not be 1987 quick bounceback nor a 2008 derivatives crisis concentrated at the heart of the banking system. Even though that looked like financial near-death experience, the same factors that made it more acute in many respects also made it easier for the officialdom to identify and shore up the key institutions that took hits below the water line.
That view was based simply on the level of damage Europe seemed determined to suffer via the effect of sanctions blowback on supplies of Russian gas. There are additional de facto and self restrictions on Russian commodities via sanctions on Russian banks and warniness about dealing with Russian ships and counterparties. For instance, Russian fertilizer is not sanctioned; indeed, the US made a point of clearing its throat a couple of months back to say so. Yet that does not solve the problem African (and likely other) buyers suffer They had accounts with now-sanctioned Russian banks and have been unable to come up with good replacement arrangements.
Another major stressor is the dollar’s moon shot. It increased the cost of oil in local currency terms, making inflation even worse. It also will produce pressure, and potentially defaults, in any foreign dollar debtor because he local currency cost of interest payments will rise. Given the generally high state of nervousness in financial markets, anyone who had been expected to roll maturing debt will be in a world of hurt (Satyajit Das in a recent post pointed out that investors typically don’t expect emerging market borrowers to repay).
Yet another big concern is hidden leverage, particularly from derivatives. A sudden rise in short term interest rates and increased volatility can blow up derivative counterparties. It’s already happening with European utility companies, many of whom are so badly impaired as to need bailouts.
And the failure of regulators to get tough with banks in the post-crisis period is coming home to roost. Nick Corbishley wrote about how Credit Suisse went from being a supposedly savvy risk manage to more wobbly than Deutsche Bank due to getting itself overly-enmeshed in the Archegos “family office” meltdown and then the Greensill “supply chain finance” scam. Archegos demonstrated a lack of regulatory interest in “total return swaps” which in simple terms allow speculators to create highly leveraged equity exposures. Highly leveraged equity exposures was what gave the world the 1929 crash. The very existence of this product shows the degree to which the officialdom has unlearned big and costly lessons.
“This is surely unworkable – a carve out for Hungary, which allows its refineries to enjoy sky rocketing margins on sales elsewhere in the EU because of their access to Russian crude. It’s almost laughable,” said Jeremy Warner.
It seems the carve out for Hungary was “workable” after all, with predictable results.
Russia, China, Hungary, and energy producers are the beneficiaries of these terribly counterproductive sanctions.
This is my “Hoot of the Day” but it’s early. I may easily need bonus hoots.
Despite strong rhetoric from Gov. J.B. Pritzker and other top state officials demanding public pension funds divest more than $100 million in Russia-based assets, state lawmakers now say they won’t act until the Fall veto session.
A key legislative proposal to force the pullout in the wake of the Russian invasion of Ukraine died in a Senate committee awaiting a vote.
Senate President Don Harmon, D-Oak Park, declined to be interviewed for this report, but his staff suggested the Senate had too little time before the session closed on April 9. The House bill — which passed by a vote of 114-0 on April 5 — was never taken up in the Senate chamber.
Using pension investment decisions as a way to prompt social change has long been controversial. In the past, Illinois funds have divested from companies and funds related to Sudan, Iran and businesses that boycott Israel following direction from lawmakers.
The Illinois State Board of Investments creates a prohibited list of companies for the funds to consider. The most recent list does not contain companies or funds connected to the Russian invasion.
“How, as a society, should we think about our pension systems assets?” Amanda Kass, Associate Director of the Government Finance Research Center at the University of Illinois – Chicago, asked. “I also see this kind of scrutiny of investing in Russian assets as part of this larger movement.”
As economic sanctions against Russia for its invasion of Ukraine spread, state and local public pension plans are looking at selling off their Russian-related assets and some are already doing so.
Lawmakers in at least a dozen states are pressuring their pension funds to divest from Russian-related investments. Divestment isn’t likely to have much impact on the funds themselves as Russian-domiciled investments make up less than 1% of most (if not all) state portfolios. But collectively, it sends a message. For example, California’s CalPERS is the largest pension fund in the world and it alone holds nearly $1 billion in Russian assets.
However, it’s likely that at least some (if not all of) these funds will be selling at a loss. Here is a snapshot of what’s happening across the U.S.
New York employees and taxpayers are unwittingly financing Russian companies and the oligarch pals of Vladimir Putin with at least $519 million invested in assets now frozen by the war-mongering dictator, The Post has learned.
City and state pension systems have pledged to sell off the holdings in protest of Russia’s assault on Ukraine, but Moscow has prohibited foreign investors from dumping the stocks.
“Putin is a thug and he’s holding our money hostage,” said Gregory Floyd, a Teamsters union leader and trustee of the New York City Employee Retirement System, NYCERS.
New York City’s five pension systems – covering teachers, cops, firefighters and other city employees – have invested a total $284.5 million in 33 publicly traded Russian stocks, according to records released to The Post by city Comptroller Brad Lander’s office.
On Feb. 25, the market value of the Russian assets was $185.9 million, nearly $100 million less than the purchase price, the latest available records show.
Arguably, trustees and investment teams need a serious conversation with portfolio managers who are overweight in companies and countries that could foreseeably lose favor and stock exchange value. To ground that dialog, some form of risk analysis is required. One protocol could be as primitive as routinely identifying which major corporate equity and debt holdings in a system’s portfolio have cost and revenue exposure of more than 10 or 15 percent in such potentially at-risk regimes, and prodding managers to trim down those geopolitically vulnerable positions unless there is a clearly compelling undervaluation thesis. Another sensible approach would be to require underweighting of major companies relative to a benchmark index, based on their percentages of autocrat-nation revenues.
Ultimately at a fiduciary level, if a pension fund’s total worst-case exposure to all earnings and income derived from autocratic nations is an insignificant fraction of its total portfolio, the composite risk is probably not worth losing sleep over, on purely financial grounds. But politics could still enter the theater stage for pension boards that ignore this issue.
Pension consultants and risk advisers have a new role to play in this dialog. ESG investing is now under fire, so a healthy ESG+Gdiscussion is especially timely. If nothing else, informed advisers can help investment teams and trustees identify where their portfolios might contain a blind-side risk that hasn’t received enough attention.
Total Russian and Ukraine sovereign and corporate debt was $813.3 million at year-end 2021, representing 97% of total exposure; the remainder comprised $28.8 million in stocks (see Table 2). While life companies accounted for the majority of the bond exposure at $683.9 million (or 84% of total Russia and Ukraine bonds), property/casualty (P/C) companies accounted for almost all the Russia and Ukraine stock exposure at $28 million. About 90% of U.S. insurers’ exposure to Russia and Ukraine bonds and stocks was held by large companies, or those with more than $10 billion assets under management.
Author(s): Jennifer Johnson, Michele Wong, Jean-Baptiste Carelus
Publication Date: 14 Apr 2022
Publication Site: NAIC Capital Markets Special Reports
The decision to boot Russian lenders from the global bank messaging system as punishment for its invasion of Ukraine is a very bad idea that could boomerang and hurt the West, Credit Suisse admonishes.
“Exclusions from SWIFT will lead to missed payments and giant overdrafts similar to the missed payments and giant overdrafts that we saw in March 2020,” wrote Credit Suisse strategist Zoltan Pozsar, in a research note.
“Exclusions from SWIFT will lead to missed payments everywhere,” Pozsar wrote. Two years ago, “the virus froze the flow of goods and services that led to missed payments.” Aside from the financial panic at the outset of the pandemic, the world ran into a similar problem in 2008, when Lehman Brothers collapsed, he said.
Pozsar wrote: “Banks’ inability to make payments due to their exclusion from SWIFT is the same as Lehman’s inability to make payments due to its clearing bank’s unwillingness to send payments on its behalf. History does not repeat itself, but it rhymes.”
America’s state and local government pensions invest as much as 40 percent of their assets in secretive, offshore “alternative” hedge, private equity, real estate and venture funds which warn that certain unidentified “mystery investors” pay lower fees, are provided greater information about investment strategies and portfolio holdings, have been granted liquidity preferences and receive superior net performance—all at the expense of America’s public sector workers. How many wealthy Russians are “mystery investors” in these pension deals which, according to an internal FBI document leaked last year, criminals and foreign adversaries regularly use to launder money? Wall Street refuses to say and public pensions have promised not to ask. Ironically, the invasion of Ukraine and calls to dump Russian investments to punish the country are drawing attention to the ugly fact that America’s public pensions have long consented to being kept in the dark by Wall Street, abrogating their duty to monitor and safeguard workers’ retirement savings.
For example, my second investigation of the Rhode Island state pension revealed in 2015 that contrary to the pension’s financial reports, 40 percent of the pension’s investments—not the 25 percent disclosed—had been allocated to secretive alternative investments.
It’s no secret that the FBI suspects that many alternative investment vehicles are widely utilized for money laundering. In 2019, the FBI compiled a report titled “Financial Crime Threat Actors Very Likely Laundering Illicit Proceeds Through Fraudulent Hedge Funds and Private Equity Firms to Obfuscate Illicit Proceeds.” Then, a leaked May 1, 2020 internal FBI report similarly titled “Threat Actors Likely Use Private Investment Funds to Launder Money, Circumventing Regulatory Tripwires” purported to supplement the January 2019 report “by providing recent reporting of hedge funds and private equity firms used to launder illicit proceeds, and expands the threat context beyond financial threat actors to include foreign adversaries.”
The news immediately following the removal of some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network has been a moment of victory for the international community in condemning Russia’s invasion of Ukraine. Soon after the sanctions took effect, the ruble sunk 21 percent compared to the U.S. Dollar (USD). Russia’s central bank is in damage control mode, raising interest rates to 20 percent. At a glance it might seem like these punishing sanctions could force Russia to change course, but any optimistic takes should be tempered by a review of the effect of sanctions after Russia’s annexation of Crimea in 2014.
Unlike the United States and other western nations where oil and gas production are controlled by private companies, Russia’s oil and gas production is managed by state-owned enterprises. Oil and gas production in Russia directly finances Russia’s budget, including its military budget, and in 2019 oil and gas exports accounted for 39 percent of Russia’s federal budget revenue. Part of the reason oil and gas is such a lifeline to the Russian budget can be attributed to the effect of the sanctions. In January of 2014, the ruble was $0.03 USD, and by December 2014 it fell to $0.019 USD. In that same year, Russia was the largest producer of crude oil and exported 4.7 million barrels per day. The price of oil in January 2014 was $108/barrel, and by December had fallen to $62/barrel—thanks to high U.S. production. The value of Russian oil exports went from 16.9 billion rubles per day in January to 15.4 billion rubles per day in December, as the sharp decline of oil prices was counteracted by the rising ruble value of oil from the sanctions. If oil prices had remained constant, then the effect of the sanctions would have been to increase Russian export value in the local currency to 26.7 billion rubles per day. In plain English, the harder the sanctions hit, the more valuable Russian energy exports become and the better they are able to sustain the Russian budget.
It may not be fair to throw Finland in there, but if the excuse is hard-drinking and being northerly, Finland has that in excess, and they are beating all those other countries in life expectancy. So that’s not the difference.
Note that all the ex-Soviet states except Russia and Ukraine also had the post-USSR fall from 1989-1994… but started their mortality improvement in 1994, as opposed to a decade later.
Poland started doing well the moment communism went away. Isn’t that interesting?
But I want to note that Ukraine and Russia are lagging the comparable countries hugely. To be sure, Russia is huge, and includes Siberia, which is not the most congenial of locations. But Ukraine doesn’t have the excuse of Siberia.
Both places, in short, suck when it comes to mortality.
The war in Ukraine and subsequent international sanctions have triggered a bank run in Russia. But this is no ordinary run—it may become a run on the central bank itself, one that holds important lessons for introducing central bank digital currencies.
Reports show Russians lining up at ATMs to withdraw their cash. For now, the run is largely driven by fears of withdrawal limits and the anticipation that credit cards and electronic means of payments will cease to function. If that happens, cash at hand is the better alternative. For that scenario, central banks know what to do: provide solvent banks with plenty of liquidity against good collateral, as Walter Bagehot recommended.
But will that be all? As Western countries freeze the Russian central bank’s reserves and limit the ability of banks to transact internationally, the exchange rate of the ruble has collapsed, falling by more than 40 percent. Prices for ordinary goods may begin to rise, perhaps dramatically so. If that happens, then rubles would no longer be a good store of value. Russians may seek to convert them into foreign currency, but that’s hard to do with the current sanctions. Consequently, they may start to hoard goods instead, dumping their cash as they go along. The situation would no longer be a run on specific goods, but a run away from fiat money and toward goods—a run, in other words, on the central bank.
Author(s): Linda Schilling, Jesús Fernández-Villaverde, Harald Uhlig