For details, read Posner and Becker's blog on this. 

source: WSJ

Little Island That Could

Singapore Aims to Stand Out
In Capital-Rich Asia
By Helping U.S. Firms

The tiny city-state of Singapore is trying to confirm its reputation as a global financial heavyweight by pumping its money into ailing Wall Street firms.

The latest indication: News that state-owned investment company Temasek Holdings Pte. Ltd. is in advanced talks to invest as much as $5 billion in Merrill Lynch & Co.

The financial district of Singapore.

Around the world, government-controlled investment companies like these — also known as "sovereign-wealth" funds — have been investing billions of dollars in the West's struggling financial institutions. Morgan Stanley recently announced a $5 billion investment from China Investment Corp., a Chinese-government-led fund. And Citigroup recently sold a stake in itself to an Abu Dhabi fund. A few months ago Chinese-controlled Citic Securities agreed to invest in Bear Stearns Cos.

Temasek's investment would be that fund's first major foray into U.S. assets. But a sister fund has already been shopping: The Government of Singapore Investment Corp., about two weeks ago said it will team up with an unnamed Middle Eastern investor to inject $11.5 billion into Swiss bank UBS AG, with the Singaporeans putting up around $9.6 billion of the total.

Significantly, many investments like these are in the form of minority stakes, rather than controlling stakes, presumably to diminish possible political fallout.

"I'm sure in their deliberations, they are thinking about how they will be received by their host countries and the public at large," says Mark Mobius, who manages emerging-markets portfolios for Franklin Templeton Investments.

Temasek itself learned a lesson about political risk recently after buying control of a Thai telecommunications company from the family of former Prime Minister Thaksin Shinawatra. Under terms of that deal, Mr. Thaksin's family avoided paying taxes on its profit. Public outrage over the incident in Thailand fueled antigovernment protests that ultimately led to Mr. Thaksin's ouster.

Both Temasek and GIC say they will be passive investors in Merrill and UBS. Yet their rapid-fire investments in recent weeks seem at least partly calculated to send the message that Singapore is a sophisticated financial player capable of deploying capital quickly.

In addition, with its investment in UBS — one of the biggest managers of wealth globally — GIC appears to push Singapore closer to its goal of establishing itself as a private banking hub.

The investments are part of a longstanding strategy by Singapore — a speck on the map near Malaysia, Thailand and Indonesia — to build its reputation as a global financial center as it struggles for influence with emerging regional powerhouses like China and India.

The island-state has long tried to woo regional financiers from Hong Kong by touting the city-state's cleaner air and more affordable housing. And whereas, in the past, Hong Kong has sometimes seemed to view a rising number of hedge funds in Asia with wariness, Singapore has offered seed capital to start-up managers.

Singapore has also sought to attract "knowledge" industries such as technology and biotech by offering tax breaks and a hands-off regulatory environment to global companies. And it promotes itself as a center of Islamic finance — significant given its proximity to Malaysia and Indonesia — as well as a financial stepping-stone for doing deals in India.

Singapore derives its financial muscle in part from decades of trade surpluses with the rest of the world, and a government-led investment strategy dating back to 1974, when Temasek was established as a holding company consisting mainly of stakes of state-owned Singaporean companies.

Starting with a portfolio of 354 million Singapore dollars (about US$243 million at current exchange rates) in 1974, Temasek's assets now total about S$164 billion, reflecting the city-state's own transformation from sleepy tropical port into a thriving hub of global finance and transport.

GIC, set up in 1981 to manage the country's foreign reserves, oversees "well above" US$100 billion in assets, according to its Web site.

Traditionally, it has shied away from taking large stakes in publicly traded companies. The recent UBS deal represents a major break with that policy.

Temasek's chief executive, Ho Ching, is an engineer by training with a graduate degree from Stanford University. She previously worked in the Ministry of Defense, later becoming CEO of Singapore Technologies Group. Ms. Ho also is the wife of Singapore's Prime Minister, Lee Hsien Loong, and daughter-in-law of its founding former prime minister, Lee Kuan Yew.

Under Ms. Ho, who took over Temasek in 2002, the company has pushed aggressively to diversify away from Singaporean assets into overseas markets, particularly financial services. It sank billions of dollars into state-owned Chinese banks before they sold shares to the public. Those deals have yielded spectacular profits amid a boom in Chinese shares.

Singapore Responds To Investment Article

Your article "Little Island That Could — Singapore Aims to Stand Out in Capital-Rich Asia by Helping U.S. Firms " (Money & Investing, Dec. 22) claims that Singapore is trying to confirm its reputation as a global financial heavyweight by having Government of Singapore Investment Corp. invest in UBS AG, and Temasek Holdings Pte. Ltd. in Merrill Lynch & Co. Both GIC and Temasek Holdings invest with the sole objective of maximizing long-term financial returns. They make investment decisions independent of Government and of each other. They do not invest to "send the message that Singapore is a sophisticated financial player capable of deploying capital quickly." Neither is it their job to "push Singapore closer to its goal of establishing itself as a private banking hub." The Government would, in fact, be concerned if either were "pumping its money into ailing Wall Street firms" for any non-commercial reasons.

Laurence Lien
Director of Governance & Investment for Permanent Secretary
Ministry of Finance
Singapore

The unintended consequence of Fed’s rate cuts

Mr. Ranson argues that market expectations of further Fed’s rate cuts may be the reason that has been stalling the real economy, as evidenced by corporate bond spreads between Baa vs. Aaa bond yields. I certainly see the merits of such argument in home purchases: potential home buyers will wait longer, and wisely so, in anticipation of more price falls in the future, thus further beating down the housing market.

However, I am not convinced on the causal relationship, i.e. it’s Fed’s rate cuts that made matter worse…maybe the real reason is the delay of the subprime’s spillover effect.

Last word, if we look at the corporate bond spread over a longer period, you may find it less scared. In fact in 2003, when we were completely out of recession of 2001, the spread was much higher than today.

The Fed’s Predicament

By DAVID RANSON

Day by day forecasters, already pessimistic, lose further confidence in the economy. I too must plead guilty to being drawn in, although I had argued for months that the economy would come through the subprime mess more or less unscathed.

However, the indicator on which we at my firm rely most — the tightness of spreads in the quality end of the corporate bond market — has abruptly changed. As recently as a couple of weeks ago, these spreads were tighter than they had been all year. Now it seems that the corporate bond market has begun to corroborate the general panic.

If enough people in a crowded theater stand up and cry fire (when there isn’t one), they can set off an unnecessary catastrophe. I believe that what is happening now is a classic example of this mechanism, and that the Federal Reserve is the central player in the drama.

Market-based forecasting of the economy is not a new idea; theoretically, the stock market should be a harbinger of the future economy. But the credibility of market-based forecasting has long been compromised by the stock market’s abysmal record as a forecaster.

During turbulent periods, as we have been experiencing since late July, the market is hurled to and fro daily by alternating fear and relief. But spreads in the corporate bond market have an excellent record of forecasting the economy and don’t seem to suffer from this vulnerability. And, until recently, they have remained aloof.

Far better than the stock market, the spread between corporate Baa and Aaa bond yields tracks the immediate future of the overall economy closely and consistently. The logic of his very sensitive indicator is simple. Spreads between yields of slightly different grade reflect the market’s perception of risk. A slower economy simply means more risk.

The necessary data are published on a daily basis, though not necessarily watched closely, by the Fed. Our research suggests that the timeliness of the spread signal, and its lack of volatility, make it a better indicator than even the GDP estimates themselves on a short-term basis. Better still, it is a leading indicator, providing a forward picture of what GDP data can only show us in the rearview mirror.

Throughout the mortgage-market panic, spreads remained tight, allowing us to predict (correctly) that there would be no significant slowdown in the economy until now. This remains true as far as the rest of 2007 is concerned.

But just in the last couple of weeks, the Baa/Aaa spread has broken through 100 basis points for the first time in several years. Having traded in a range between 85 and 95 basis points all year, it had widened to nearly 120 basis points by mid-December, suggesting a hit to GDP and consumer spending by the first quarter of 2008. According to the most recent data, it has fallen back a bit and the estimated slowdown still looks moderate in severity. But if spreads were to widen further, it could be more acute.

It looks to me unlikely that the unraveling of the subprime mortgage boom is directly responsible for this change. Bond yield spreads should have widened months ago, if that had been the economic threat so many forecasters thought it was. Bond-market data indicate that the economy was weathering the credit crunch perfectly well until this most recent jump in the Baa/Aaa yield indicator.

But there could be a connection between the threat to the economy and Washington’s misplaced efforts to address the turmoil. The Fed’s policy is quite naturally based on the universally accepted notion that prices affect economic activity. It assumes that an interest-rate cut will promote borrowing and that, in turn, will boost the economy. But there is one aspect of this theory that it has missed: the role of expectations.

In this space, 16 years ago, I argued that “economic activity is often free to migrate from unfavorable to favorable climates,” and that one of the less-recognized examples is “the migration of GNP from one time period to another,” motivated by “an urge to exploit expectations about the future.”

Consider the following thought experiment. The Fed is in the position of an industrial company that fears a shortfall in the demand for its product. The simple solution is to cut the price. The firm does so, but what if its customers are unimpressed and lobby for a deeper one?

The company is uncertain and opts to “wait and see” whether an additional price cut is necessary. The board of directors, which meets every six weeks, promises to announce its decision at the next meeting. In the meantime, pressure for more cuts intensifies and customers postpone their purchases in the expectation of getting a lower price.

Imagine the predicament in which that company now finds itself. Whether or not the first price cut was sufficient, further cuts are widely expected, and sales continue to slump. That induces the disappointed directors at their next meeting to cut again. Now every additional price cut creates expectations that cause sales to slump further. This chain of events repeats itself — until something breaks. This occurs when the firm wakes up to what is happening, and manages to convince its customers that there will be no more price cuts. At that point, finally, sales bounce back and stability returns.

So, ironically, when the Fed cuts interest rates to support the economy, it can actually create a slump — by cutting rates slowly and reluctantly enough to encourage more and more aggressive hopes of further cuts. Fortunately, the downward spiral cannot last forever and, when it stops, the economy will snap back. But in the meantime, the Fed has been tripped up by another instance of the law of unintended consequences. It looks to be in the process of precipitating the very recession it is trying to head off.

Mr. Ranson is head of research at H.C. Wainwright Economics Inc.

—
**************************************
Paul D. Deng
Department of Economics
Brandeis University
IBS, MS 032
Waltham, MA 02454
http://www.pauldeng.com/

Wisdom, Folly in Turmoil

The kingdom of heaven will be like 10 virgins who took their lamps and went out to meet the bridegroom. Five of them were foolish and five were wise. The foolish took their lamps but did not take any oil with them. The wise, however, took oil in jars along with their lamps.

The foolish ones said to the wise: "Give us some of your oil; our lamps are going out." "No," they replied. "There may not be enough for both us and you."

–Matthew 25, abridged

The biblical parable of the 10 virgins is sometimes used to make a financial moral: Those who don't take precautions have to face the consequences. "Wise" ones end up paying the price. Here's a retelling of the story for modern times:

All Invited: Left, Citigroup ex-CEO Charles Prince; at right, former Merrill Lynch CEO Stan O'Neal.

The first virgin was Stan O'Neal. He ran Merrill Lynch, an investment bank. He took big bets with its cash. For a few years, he made good profits. But then the bets turned sour and the firm took an $8.4 billion hit. Luckily, Stan had a nice board. It said he could take all his stock awards and benefits from previous years — without any deduction for the new losses. Stan retired with $161 million in his back pocket.

The second virgin was Rock, also known as Northern Rock. The British bank borrowed lots of money short-term because it was cheap and lent it out for long-term mortgages. It pocketed the spread. That was very profitable for a few years. But then funding dried up. Fortunately, when Rock ran out of money, a charming man from the British government named Alistair Darling provided £56 billion ($111 billion) through loans and guarantees, an offering of almost £1,000 from every man, woman and child in the land.

The third virgin was Charles Prince of Citigroup. He played a clever game of lending money without it appearing on the bank's balance sheet. Better still, he copied Rock's trick of borrowing cheap short-term money and investing it in better-yielding long-term assets. Chuck was so happy he couldn't stop dancing. But then the music stopped. Chuck lost his job but not the fat bonuses he'd collected in previous years.

The fourth virgin was Fannie Mae. She was in the business of lending people money to buy houses. But she was imprudent with her sums. She didn't put aside enough cash to back those loans. She's not too worried, though. If worst comes to worst, Fannie's rich uncle, Sam, will be sure to come to bail her out.

The fifth virgin was called Hedge. It was a nickname from his favorite game: "Hedge I win, tails you lose." He ran a fund. The deal with investors was that every year he made them money, he'd keep 20% of the profits. For several years, Hedge made a packet. But then, in one big bet, he lost much of his investors' money. Of course, he didn't refund them 20% of the losses.

There were five other virgins. They worked hard in industry rather than finance, saved rather than borrowed, paid their taxes, didn't speculate on subprime mortgages and didn't run hedge funds. They didn't get fat bonuses, either, during the bubble or during the crunch. They weren't running risks — or, at least, that's what they thought. The snag is that, after the Federal Reserve's Ben Bernanke and his French cousin, Jean-Claude Trichet started spraying around cheap cash to bail out Stan, Chuck, Fannie and the like, inflation started seeping into the economy. That eroded the real value of the "wise" virgins' savings.

In the Bible, the bridegroom allows only the wise virgins to come to the wedding feast. The foolish ones are shut out. In this financial version, all 10 virgins are invited. The bridegroom looks around the room and scratches his head. Which are the real fools?

BEIJING — China is cracking open the door for foreign investment banks seeking entry into China's booming stock market — but just barely, at least for now.

In coming days, China's securities regulator is expected to outline rules for global investment banks looking to set up joint ventures to tap the country's domestic exchanges. Morgan Stanley and Credit Suisse Group have already signed preliminary agreements for joint ventures that will be governed by these rules.

Foreign investment banks will be able to take a maximum 33% stake in new local underwriting joint-ventures, a cap that could be raised to 49% over time, according to a person briefed by Chinese regulators on the plans. These joint ventures initially will be limited to securities-underwriting activity, for an unspecified "seasoning period" after which regulators can decide whether to grant other licenses that extend their range of business to include proprietary trading (bets with the firm's own money), brokerage services and money management, the person said.

At the same time, foreign investors will be allowed to invest in established Chinese brokerages with smaller stakes and less control. The new rules for foreign investment in existing brokerages are likely to be modeled on control limits for investors in Chinese commercial banks, the person briefed by regulators said.

In China, individual foreign investors are allowed to own as much as 20% of a domestic commercial bank. Total foreign investment in a single domestic bank is capped at 25%.

The China Securities Regulatory Commission didn't reply to a request for comment. In a statement earlier this month, it said the new rules would "relax restrictions" on foreign equity participation in domestic securities firms and "clearly define the conditions and sequence for progressively expanding the scope of securities joint-ventures."

The new rules give future entrants into the onshore market less access than what the two major foreign players that currently manage securities joint-ventures in China — Goldman Sachs Group Inc. and UBS AG — have. Both won key approvals for local joint ventures before regulators shut the door on other applicants in late 2005. Other smaller joint-venture securities firms exist in China but don't have the profile of those run by Goldman and UBS.

Global investment banks without a domestic joint-venture have long courted Chinese business from outposts in Hong Kong, connecting Chinese firms to the international capital flowing through the Hong Kong or U.S. exchanges.

With the Chinese government pushing the development of the domestic markets in Shanghai and Shenzhen, global investment banks haven't been able to reap the rewards of China's domestic stock boom.

—
**************************************
Paul D. Deng
Department of Economics
Brandeis University
IBS, MS 032
Waltham, MA 02454
www.pauldeng.com

States’ Shifting Populations

12/27/07, WSJ