An ever-increasing emphasis on rewarding entrepreneurial skill could increase global wealth disparities and generate discontent over the medium-term, according to Oxford Analytica. This is despite the fact that, in the past, entrepreneurialism has driven social mobility.
In a new analysis, An ‘entrepreneurial society’ has costs OxAn concludes that innovation and entrepreneurialism will continue to be the main generators of wealth and prosperity in the global knowledge-based economy. “Entrepreneurialism is fundamental to capitalist development, economic growth and renewal. However, some innovations created by entrepreneurial activity can have destructive consequences, as the financial engineering that contributed to the global credit crunch demonstrated.”
The period of intense financial innovation that accelerated in the present decade — fostered by entrepreneurial employees at all levels in the financial industry — ultimately generated vast profits. Yet many of these gains have been at least partially swallowed by the pernicious counterparty risk they created.
Some social scientists now believe that an ‘entrepreneurial society’ is essential to long-term economic development along Western-style free market capitalist lines.
“However, there is a dark side to entrepreneurial innovation. It facilitates ‘creative destruction’ in the marketplace, which an influential school of economists deems essential to long-term growth. Yet this disruption can, over the short-term, lead to volatility and hinder economic expansion.”
According to OxAn, entrepreneurial society looks well-entrenched in the developed world, but certain aspects could change:
1. Exaggerated entrepreneurialism?. It may be that this picture of a vastly intensified entrepreneurialism and spread of innovation will ultimately be seen to exaggerate relatively modest developments. Most work, even in high technology sectors, requires what amounts to routine clerical labour. Mundane work is mundane work whatever the industrial sector, and the experience of entrepreneurial innovation may still pass most workers by.
2. New value chain. However, even with this caveat it is the case that ideas and those with the ability to use them will increasingly dominate society in the West. ‘Knowledge products’ now sit at the top of the global value chain, and continued growth may depend on exploiting them.
3. Debate over entrepreneurial value. Yet some innovations, such as the system of distributed financial risk that developed over the past two decades, are bound to be attacked for destroying more value than they create.
US regional banks were top-of-mind at Research Recap this week. Last week’s popular post from Oxford Analytica, Regional US Banks May Need Rescuing, was the most-read post this week, while S&P “Very Cautious” on US Regional Bank Credit Quality made the top five as well. Standard & Poors also nabbed the second spot with Distressed Finance Sector Junk Bonds at Stratospheric Level while Audit Integrity’s Forensic Analysis Gives Clues to Lehman Problems came in at number three.
Monoline Stock Price Rally Overdone, from CreditSights, was also popular, and has since been followed up wiith MBIA Takes the Best, Leaves FGIC with the Rest. CreditSights sees the reinsurance transaction involving MBIA and FGIC as a positive credit development for MBIA, but says it does little to solve FGIC’s longer term solvency issues.
Outside the credit markets, Forrester Research’s provocative prediction “Serious Gaming” to Take Off in Coming Years was also well read.
Elsewhere, the surprising upward revision in second quarter US GDP growth to 3.3% was a hot topic. Felix Salmon at Portfolio.com laments what he sees as the decline of the quality of government economic statistics. FT Alphaville, goes further calling the number “laughable.” Yves Smith at Naked Capitalism smells “manipulation for political purposes.” There’s no clear evidence of this: there do not appear to have been any cahnges in which the caluclations are made. But you don’t need to agree to wonder about the discrepancy between the implicit priced deflator used to measure inflation in the GDP calculation (1.2%) and the much higher CPI and PPI numbers.
Research Recap Quote of The Week:
In other words, there would be only two persons of working age for every person aged 65 or more in 2060, compared with four persons to one today. – Eurostat – commenting on demographic projections for the 27 European Community nations.
The latest issue of the International Monetary Fund’s Finance & Development includes a useful primer on securitization, tracing its origins and growth.
The subprime mortgage crisis that began in 2007 has given the decades-old concept of securitization a bad name, IMF Economist Andreas Jobst writes. Securitization is the process in which certain types of assets are pooled so that they can be repackaged into interest-bearing securities.
The landscape of securitization has changed dramatically in the last decade, Jobst notes. “No longer is it wed to traditional assets with specific terms such as mortgages, bank loans, or consumer loans (called self-liquidating assets). Improved modeling and risk quantification as well as greater data availability have encouraged issuers to consider a wider variety of asset types, including home equity loans, lease receivables, and small business loans, to name a few.”
Although most issuance is concentrated in mature markets, securitization has also registered significant growth in emerging markets, where large and highly rated corporate entities and banks have used securitization to turn future cash flow from hard-currency export receivables or remittances into current cash.
In the future, securitized products are likely to become simpler.
After years of posting virtually no capital reserves against highly rated securitized debt, issuers will soon be faced with regulatory changes that will require higher capital charges and more comprehensive valuation, Jobst concludes.
“Reviving securitization transactions and restoring investor confidence might also require issuers to retain interest in the performance of securitized assets at each level of seniority, not just the junior tranche.”
The Economist has an interesting analysis of the prospects of private equity riding to the rescue of beleaguered financial institutions.
“Buy-out firms are unlikely saviours, but private equity’s $450 billion war chest is big enough to fill Western banks’ capital shortfall,” the magazine notes. “There are few other sources of ready capital. Sovereign-wealth funds have been badly burnt; banks cannot easily raise equity in public markets; and the atrophy in many of the biggest lenders leaves them in a poor state to buy the weakest.”
“On one side of the financial system are buy-out firms with ambition, long-term capital, discretion about how to invest it, and a dearth of opportunities to invest in industrial companies. On the other are banks, desperately short of capital and liquidity.”
It does not take a billionaire buy-out barbarian to put two and two together.
Most buy-out firms have started by buying the distressed loans that banks issued to fund LBOs, many of which trade at 70-80% of face value. Only a few big deals have been made public: Citigroup’s sale of $12 billion of debt to TPG, Blackstone and Apollo, for instance. But behind the scenes the activity has been frenzied.
One alternative to buying banks’ loans is to buy their holdings of the securities at the heart of the crisis—structured-credit products backed by mortgages. Blackstone is talking to “several institutions” about buying mortgages. Last month Merrill Lynch offloaded a pile of collateralised debt obligations at a knock-down price of $7 billion, or 22% of their face value, to Lone Star, a private-equity firm.
But Lone Star has a history of specialising in finance and such deals are unusual. When UBS auctioned a portfolio of securities backed by “Alt-A” mortgages in May, it received little interest from private-equity firms. This may be because these securities are highly technical. In addition, they are passive investments that do not call for the operational management where private equity thinks its skills lie.
For mainstream private-equity firms, the promising business may lie elsewhere: buying into banks themselves.
The Economist recognizes that “before private equity takes the plunge, the rules may need to be tweaked. As early as next month, the Fed is expected to offer more guidance on the grey area of the ownership thresholds, probably relaxing its stance.”
The Bank Holding Company Act, which governs most big deposit-taking institutions (although not broker-dealers), stipulates that a voting stake in a bank of 25% or above constitutes control, whereas a holding of less than 5% does not. “Between these two thresholds is a grey area that the Federal Reserve has interpreted conservatively, taking into account, for example, whether the owner can appoint directors or owns non-voting capital too.”
The Securities and Exchange Commission’s embrace of International Financial Reporting Standards should provide plenty of opportunity for accounting consultants in the coming months and years as firms consider when and how to make the proposed transition from Generally Accepted Accounting Principles.
Critics such as 24/7 Wall Street’s Doug McIntyre say that the SEC is backing the wrong horse . He argues that the IASB’s guidelines are less rigorous than rule-based US standards. “If the world wants one set of accounting standards, let them come to GAAP. It is the mountain and Muhammad can do a little traveling.”
However, the SEC says IFRS rules are tougher in forcing companies to keep on their balance sheets assets in so-called special purpose entities. And the move should benefit multinationals in the long run.
Some useful resources for getting up to speed on IFRS include:
Deloitte’s guide IFRS in your pocket 2008
PricewaterhouseCoopers IFRS Pocket Guide
The AICPA’s dedicated IFRS web pages.
KPMG’s How the IFRS movement is expected to affect financial reporting in the U.S.
Ernst & Young’s US GAAP vs IFRS – The Basics
The IASB’s website.
Standard & Poor’s delinquency index for U.K. nonconforming residential mortgage-backed securities (RMBS) increased to a record level of 23.31% in the second quarter, from 22.17% in the previous quarter and 90+ day delinquencies now stand at 12.12%.
The 2005 vintage of transactions continues to show the highest cumulative losses to date, but the 2007 vintage is trending above all others in relative terms, meaning that higher losses are appearing earlier in the life of some transactions, S&P said in a new report.
Rising numbers of foreclosures and declining house prices are likely to cause an acceleration in losses over the coming quarters.
Delinquencies on prime RMBS also continued to rise in Q2 2008. In a separate report S&P said 90+-day delinquencies have now hit 1.00% from 0.92% last quarter, and total delinquencies have increased to 2.94% from 2.33%. “These are the highest values seen in this index, exceeding 2006 levels.”
Eurostat has released some startling projections about the aging of the European Community’s population.
According to the Statistical Office of the European Communities, by 2060, 30% of the population of the 27 EU countries will be over 65. This means that the ratio of “old age” people to the working population will rise to 53% from 25% currently.
In other words, there would be only two persons of working age for every person aged 65 or more in 2060, compared with four persons to one today.
The old age dependency ratio is projected to be more than 60% in Bulgaria, the Czech Republic, Latvia, Lithuania, Poland, Romania, Slovenia and Slovakia, and less than 45% in Denmark, Ireland, Cyprus, Luxembourg and the United Kingdom.
The UK, projected to have the highest EU population, has a higher fertility rate and has been more open to immigration than many other EU countries.
From 2015 onwards deaths in the EU would outnumber births, and hence population growth due to natural increase would cease, EuroStat projects. From this point onwards, positive net migration would be the only population growth factor. However, from 2035 this positive net migration would no longer counterbalance the negative natural change, and the population is projected to begin to fall.
Commenting on the report, the New York Times blog The Lede notes that the trend could lead to “geriatric peace” in which arms spending is reduced in order to support a larger aging population.
Could the trend lead to a more welcoming attitude to immigrants, who tend to be younger? A new survey from Harvard finds that effects of immigration in Northern European countries has been more positive than generally perceived.
The general view on immigration overstates the adverse effects of immigration on natives of the host country.
Within the large empirical literature looking at the effects of immigration on native employment and wages, most studies find only minor displacement effects even after very large immigrant flows.
US home prices continued to decline in June, though at a slowing pace.
The S&P/Case-Shiller Home Price Indices showed continued broad-based declines in the prices of existing single family homes across the country through June.
The decline in the National Home Price Index – which covers all nine census divisions – remained in double digits, recording a record 15.4% decline in the second quarter of 2008 versus the second quarter of 2007. This is larger than the decline of 14.2% reported in the first quarter of the year. The 10-City and 20-City Composites also set new records, with annual declines of 17.0% and 15.9%, respectively. However, it should be noted that the acceleration in decline was only moderate in June. The May numbers reported annual declines of 16.9% and 15.8%, respectively.
At the national level, the housing market peaked around June/July of 2006. As of June 2008, two years later, the 10-City Composite has fallen by 20.3% and the 20-City Composite is down 18.8%.
“Record year-over-year declines were reported in both the 10-City and 20-City Composites in June; however, they are very close to the values reported for May. The rate of home price decline may be slowing. For the month, the 10-City Composite was down 0.6% and the 20-City Composite was down 0.5%. While still falling, these are far less than the 2-2.5% monthly drops seen earlier in 2008.”
In June, nine of the 20 cities were up month-to-month compared with seven in May. Nevertheless, not one market is showing a positive return over the past 12 months and seven of the metro areas are reporting declines in excess of 20.
Further signs of weakness in the US car loan sector are evident in Moody’s latest auto loan indexes.
Prime auto loan credit performance deteriorated in June 2008 as net loss and delinquency rates increased compared to year-ago levels. Moody’s prime auto loan net loss rate rose to 1.24% in June 2008, an increase of 87% from the level of 0.66% during June 2008, a 18% increase from its year-ago level of 0.46%.
The Manheim Used Vehicle Value Index, an indicator of recovery values on repossessed vehicles, dropped 4% during June 2008 from the year-prior level. Lower prices for used vehicles lead to lower recovery rates on repossessed autos, thus increase loss severities.
Led by a “stratospheric” finance sector, distressed junk bond issues have risen to their highest level in more than five years, according to Standard & Poor’s.
Distressed credits are speculative-grade rated issues that have option-adjusted spreads of more than 1,000 basis points (bps) relative to Treasuries.
Following on the heels of last month’s 10% increase, the Standard & Poor’s distress ratio has advanced again to 24.8%. In the year to date, the distress ratio has expanded nearly 19% from December’s level. The distress ratio is at its highest level since March 2003, and the 12-month moving average has hit 13.8%. This increase runs alongside the recent rise in speculative-grade spreads, which were at 780 bps on Aug. 15 from 763 bps a month earlier.
By debt volume, the finance companies and media and entertainment sectors take the lead, each accounting for just under $100 billion (60.4%) of the total. When looking at the distress ratio based on outstanding debt however, the finance savings and loan sector is at a stratospheric high of 91.8%.
This means that nearly 92% of the speculative-grade debt in this sector is attributable to companies trading at distressed levels.
S&P noted that only five issues attributable to three firms within this sector possess speculative-grade ratings.
Alongside the recent expansion within the corporate universe, distress in leveraged loans has also increased, with the S&P/LSTA Leveraged-Loan Index distress ratio moving to 15.1% in July from 12.7% in June. Distress within leveraged loans had been declining for the previous three months but now is comfortably in the double-digit range after a 20-month period ending as recently as July 2007 where distress was below 1%.