Breakingviews

Pricey Chesapeake medicine highlights its sickness

By Christopher Swann and Robert Cyran

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Pricey medicine can help. But in Chesapeake Energy’s case, it shows how sick the company is. The embattled energy firm is borrowing $3 billion at 8.5 percent to repay a loan whose terms might otherwise prevent asset sales. This buys time. But it makes even more obvious Chesapeake’s unsustainable reliance on selling assets to fund its persistent cash drain.

Chesapeake, America’s second-largest natural gas producer, has been cash-flow negative for a decade. Fitch Ratings reckons it faces a $10 billion shortfall this year. Aubrey McClendon, the chief executive now beset by questions over financial conflicts of interest, recently sounded characteristically confident that the gap could be bridged by asset sales. The company is targeting up to $14 billion of them this year.

But the firm’s quarterly filing with regulators on Friday – curiously delayed – painted a less optimistic picture. Chesapeake said it might have to delay and rejig asset sales to avoid flogging off assets needed as collateral or cutting cash flow below the level required by its debt covenants. The shares slumped 14 percent, and have lost about half their value in the past year.

The main stumbling block appeared to be the firm’s $4 billion revolving credit facility. The new, much more expensive loan from Goldman Sachs and Jefferies unveiled later on Friday will repay that, easing concerns that a cash flow squeeze could force more asset sales only to have lenders demand repayment, creating a fresh cash deficit.

But it’s a temporary reprieve. Chesapeake still needs to reduce its debt and wring more dollars from its wells. Selling choice oil assets while gas properties suffer with ultra-low prices only whittles away further at the company’s long-term earning power.

Dimonfreude is irresistible, but may be dangerous

By Rob Cox

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

It’s easy to sympathize with the collective glee that greeted JPMorgan’s shock revelation of some $2 billion of trading losses. The bank and its chief executive Jamie Dimon have received their long-awaited comeuppance. But this emotion – Dimonfreude, if you will – is dangerous. If one of the few big banks that managed to sidestep most of the credit crisis is proven fallible, confidence in the system itself will be shaken.

Dimon and JPMorgan deserve a good knocking, to be sure. After all, this is the firm widely credited, if somewhat unfairly, with hammering the final nail into the coffins of not just Bear Stearns – which it bought for a pittance in 2008 – but also of Lehman Brothers and later MF Global, mainly through collateral calls. Rivals on Wall Street and in financial centres across the world may take some satisfaction from seeing JPMorgan stumble.

And Dimon has not taken kindly to the march of new regulation of the financial industry. He has called tough capital standards proposed by the Basel Committee “anti-American.” A little over a year ago he publicly carpeted Ben Bernanke over whether the Fed had properly analyzed the costs and benefits of the Dodd-Frank Act. Regulators everywhere may find succor in JPMorgan’s failed whaling voyage.

All this may prove salutary if it serves as a reminder to Dimon and his managers that they, too, are human, and like all humans prone to err. As a consequence, the bank should toughen up its controls, take its lumps, stamp down its rhetoric and conduct a more rigorous and honest appraisal of its businesses. It might even soften Dimon’s stance on accepting new capital standards, and perhaps lead to some comity with regulators over interpreting and implementing admittedly complicated rules like the one named after Paul Volcker.

By all means, those who have been on the receiving end of JPMorgan’s arrogance or flexing of financial power – be they rivals, regulators, politicians, customers or even journalists – may savor this moment. But they must be careful what they wish for. A swift but humbling lesson in fallibility would do some good. A prolonged loss of confidence in the financial system could bring back some pretty dark days.

Jamie Dimon’s Ahab meets his Moby Dick

By Antony Currie

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

JPMorgan’s Ahab has met his Moby Dick. Chief Executive Jamie Dimon has toiled at length to build a bank strong enough to withstand the greatest of storms. The $2 billion hedging hit the bank disclosed late on Thursday will put JPMorgan to the test. Its capital buffers may be safe for now, but the ramifications are apt to be broader.

The losses come from the bank’s chief investment office. That’s part of the core treasury function at JPMorgan, responsible for managing the entire firm’s balance sheet. That it was being “poorly monitored,” as Dimon conceded, is even more worrying than the discovery of a random rogue trader.

The CIO has made news of late because of reports that one of its overseas traders, Bruno Iksil, was taking such large positions in a credit index to hedge JPMorgan’s risk that he was distorting the market. Rivals labeled him the London whale. Dimon declined to discuss specifics.

But just last month, on the bank’s first-quarter earnings call, executives defended the CIO. Finance chief Doug Braunstein said the bank was “very comfortable” with its positions. Now, Dimon admits a revised hedging strategy was “flawed,” there was “sloppiness” and that “egregious mistakes” were made.

Investors have come to expect such disarming honesty from Dimon. But the mess is reminiscent of similar failings at JPMorgan before his time. In fall 2001, the bank was adamant that its overall exposure to Enron was around $900 million, before later revealing the amount was almost triple that figure. A year later, executives hosted an emergency call with investors – like the one hastily assembled on Thursday afternoon – to announce that all its trading desks had lost money even though all had remained within their risk limits.

U.S. mortgage lessons lost in student debt policy

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The lessons of the U.S. mortgage crisis seem to be lost on policymakers tackling student debt. A decade ago, government subsidies and guarantees helped expand the “dream” of homeownership to many Americans who would have been better off renting. Today, it’s college education being made more accessible with cheap funding provided by Uncle Sam.

The U.S. Congress, which rarely agrees on anything these days, is achieving quick consensus on the matter. Without action, interest rates on student loans, which are unsecured, are set to double in July. But lawmakers have been scrambling all April to find a way to collect more revenue or cut spending to maintain subsidies and keep the rates down.

The effort is all too familiar. Government mortgage guarantees, accompanied by encouragement to make the American Dream available to lower income and less creditworthy borrowers, sent home prices soaring at an inflation-adjusted annual rate of 8 percent over the decade ending when they peaked in late 2006, according to Yale economist Robert Shiller, whose name adorns a closely watched home price index.

The price of college has been growing near that rate for even longer, according to College Board data. Over the past 30 years, private nonprofit college tuition and fees, after adjusting for inflation, have increased 6 percent annually. Public university prices have grown at 9 percent.

Like homeownership, college education has been exploited as a moral good. Anyone aspiring to earn decent wages needs a degree these days. Even jobs that haven’t traditionally required such academic training, like police work, now do. This shift has pushed the average student loan balance up by 25 percent annually over the last decade, according to finaid.org. These debts now exceed $1 trillion, more than even enthusiastic U.S. consumers have accumulated on their credit cards.

Ultra-cheap loans too often encourage young adults to start their working lives with excessive debt. And it’s the federal guarantees that prime the pump. To curb the unsustainable growth in higher education costs requires scaling back the government’s involvement. There’s still some time to keep student debt from turning into a mortgage-like crisis, but probably not much.

The rupee looks vulnerable

By Jeff Glekin The author is a Reuters Breakingviews columnist. The opinions expressed are his own. India’s ballooning trade deficit means it has to run just to stand still. Without steady capital inflows, the currency will collapse. But without a steady currency, it is hard to attract foreign capital. The rupee’s 19 percent fall against the dollar over the past year is worrying.

During most of the last decade, the current account deficit has been funded without great difficulty. Foreign direct investment, portfolio investments and about $60 billion a year of remittances have usually exceeded the shortfall in trade. India has accumulated around $300 billion of foreign currency reserves, equivalent to 17 percent of GDP.

But the annual trade gap has widened from $104 billion to $185 billion. At 3.7 percent of GDP, the current account deficit is the highest since 1980, when the International Monetary Fund starting collecting data. High energy prices are the main culprit for the recent deterioration – oil accounts for two-thirds of the country’s import bill. Of course, the blow would have been less painful if India had a stronger export sector.

The support of foreign investors is more necessary than ever, but New Delhi’s mismanagement has discouraged them. Foreigners bought an average of $3 billion dollars a month of Indian debt and equities in the first three months of 2012, according to the Securities and Exchange Board of India’s website. So far in April, they have been net sellers of $403 million.

The currency’s fall threatens to create a negative spiral. More expensive imports are inflationary and put pressure on corporate profits. Government subsidies of domestic fuel prices become more costly, adding to the fiscal deficit, which swelled to 5.9 percent of GDP in the fiscal year that ended in March. Furthermore, the rupee’s slide creates financial stress for Indian companies that have borrowed in dollars.

India’s currency reserves provide a buffer. But if capital flows turn sharply negative the reserves could melt away quickly. And if investors start to believe that the rupee is a one-way downwards bet, they will race for the exit. Predictions of a declining currency – UBS suggested a further 6 percent fall last week – could prove self-fulfilling.

TARP success doesn’t make it good finance

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The dramatic $700 billion bailout of U.S. banks calmed markets and helped stabilize the financial system, but that doesn’t mean taxpayers will see any direct returns from the investment. The Treasury says the Troubled Asset Relief Program might turn a profit. But the agency’s fuzzy math wouldn’t fly with any sensible portfolio manager. What it calls a gain looks more like a loss of at least $230 billion.

Treasury’s rosy projections aren’t half as bad as its methodology. The government declares a return when an investment’s payments exceed the initial cash outlay. That boldly disregards the cost of money and its value over time.

By contrast, consider Warren Buffett’s bet on Goldman Sachs. In the thick of the crisis, he loaned the bank $5 billion in exchange for 10 percent annual interest and stock warrants. Goldman paid back the Oracle of Omaha a few years later. Though hanging on to the warrants may cost him in the end, even without them he booked an annualized return of 14 percent.

Compare that to TARP, which had seven broad components. Start with the banks. Treasury estimates an ultimate profit of $22 billion. Even if that’s achieved by year’s end, taxpayers will have earned a paltry annualized return of 2 percent. Simply investing in the S&P 500 index would have earned 14 percent a year. Worse, applying Buffett’s Goldman return as the risk-based cost of capital turns the net present value of the bank rescue into a loss exceeding $15 billion.

Then there’s Fannie Mae and Freddie Mac. Treasury says its “loss” may shrink to $28 billion in a decade, generously assuming that profits from the giant mortgage backers will exceed housing-bubble era averages. Even using that questionable projection generates a net present value loss of $88 billion. Tabulate automakers and AIG similarly, figure a $28 billion loss on mortgage backed securities Treasury bought and sold, and accept Treasury’s estimated $46 billion loss on foreclosure programs and its $3 billion gain on its flop of a public-private toxic asset scheme – and it all adds up to a whopping $230 billion loss, adjusting for the cost of capital.

Even using a more conservative discount rate of 10 percent would still leave the loss at over $190 billion. The U.S. Treasury isn’t a hedge fund, so was willing to invest poorly for the bigger, unquantifiable return delivered by stability. But rather than try and obscure the painful price tag of its rescue, it should be emphasizing that avoiding a global meltdown was worth the cost.

Frannie generosity could cost taxpayers $128 bln

By Daniel Indiviglio 

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.  

The holy grail of foreclosure prevention looks near struggling homeowners’ grasp – but its contents may taste bitter to taxpayers. The Federal Housing Finance Agency appears close to caving on letting Fannie Mae and Freddie Mac cut mortgage balances for underwater borrowers. A new Breakingviews calculator shows that this policy shift would not cost too much more at the margins. But it introduces another layer of moral hazard: if it encourages enough borrowers to sip from the cup, Frannie’s already gargantuan $150 billion bailout tab could almost double.

If properly targeted, forgiving lump sums from borrowers’ mortgages isn’t overly expensive. FHFA Acting Director Edward DeMarco revealed last week that 700,000-odd government-backed, underwater borrowers already in default might qualify. Their balances could be cut by an average of $51,000 a pop.

Plug those numbers into Breakingviews’ calculator, along with Barclays’ assumption that redefaults may hit 40 percent, and it shows that principal forgiveness costs $9 billion more than the projected cost of Treasury’s original Home Affordable Modification Program. That initiative shrinks a borrower’s monthly payment without reducing balances. Forgiveness is more expensive – while it usually pushes redefault rates down by five to 10 percentage points, according to Barclays, it cuts mortgage principal and interest revenue.

Frannie would, though, get a boost from the Obama administration, which has offered to use leftover bailout money to pay an incentive of up to 63 cents for each dollar of principal cut. The firms say that makes reducing loan balances $1.7 billion cheaper than traditional HAMP modification. That’s bogus math for taxpayers, of course – they provide the funds either way.

The real problems start if borrowers who are deeply underwater but still paying their mortgage demand principal relief. Some 2 million homeowners fall into this category, the FHFA says. Factoring those in and assuming none of them defaults, the calculator shows that slashing loan amounts would cost taxpayers a whopping $128 billion more than just rejigging payments.

Growth is the least of China’s three big worries

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China’s present condition can’t be summed up in a few tenths of a percentage point. True, judged by the headlines, GDP growth of 8.1 percent in the first quarter of 2012 was a miss. Economists polled by Reuters expected 8.3 percent. Investors shouldn’t overthink it: growth is the least of China’s three big worries.

The slowdown is real, but well flagged. Premier Wen Jiabao set a target of 7.5 percent GDP growth for 2012, compared with last year’s realised 9.2 percent. Against that, the current reading is hardly shabby, and may improve. Getting banks to lend more is one recourse that has already begun, with loans reaching 1 trillion yuan in March. There are signs things are already ticking up – such as the inching up of electrical production in March, often touted as a “more reliable” measure of growth than GDP.

If investors want to worry about something, they should start with politics. The mysterious ouster of high-profile Chongqing party chief Bo Xilai, and the arrest of his wife on murder charges, suggests a rising political risk premium as China nears next year’s leadership change. There’s no sign of a political breakdown, but increased anxiety at the top could slow big reforms on major issues such as opening up restricted investment sectors or liberalising interest rates.

Fretters should also have an eye on the financial system. As with GDP, numbers mislead. China’s banks reported non-performing loans of just over 1 percent of their total books in 2011. But that’s unsustainable, even if accurate. The banking system is built on distortions that promote misallocation of capital, with lending guided more by policy, collateral levels and implicit government guarantees than by considerations of risk and return.

Not that GDP growth won’t present China with some thorny issues in 2012. Policymakers will soon have to decide, for example, whether they are happy to tolerate the inflationary pressures that come with using bank lending to stimulate the economy. And a political or financial shock would quickly make itself felt in the GDP figures. But the more complex China’s situation gets, the less useful one big number becomes.

Wobbly markets face second-quarter correction

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Markets are wobbling on renewed fears about global growth. Rising yields on Italian and Spanish bonds add to the alarm. And it would be wrong to assume that central bankers will ride to markets’ rescue this time – because oil prices and inflation are part of the global gloom.

Risk assets face a second-quarter correction as central banks – rightly – hold back on further stimulus. Many investors assume that central banks will help because falling stock prices are bad for consumer confidence and growth. But rising oil prices and inflation are also bad for growth. And central bankers may be realising that excess monetary stimulus is behind soaring global oil prices.

“Current conditions do not warrant further accommodation,” said Charles Plosser, the admittedly hawkish president of the Philadelphia Fed, at the end of last month. His fears are shared by other Fed governors. Yet the real risks go much deeper. With ultra-loose money policies the central banks are not just facilitating the spread of inflation, they are creating it at source – via commodity prices. Andrew Sentance, recently of the Bank of England’s monetary policy committee, warned in March that central banks need to rethink, and that further money loosening could recreate the inflation of the 1970s.

Rising Spanish and Italian bond yields and weak euro-zone growth are a further worry for markets. But the European Central Bank, having controversially supplied a fresh trillion euros to banks in what may prove to be a short-term palliative, is ill-placed to intervene again.

Global investors must therefore weigh an ugly mix of risks: the possibility of renewed, intense, euro-zone crisis; middling global growth; and oil prices compatible with recession. And yet U.S. equities have just enjoyed their best first quarter in 14 years after a strong run-up in global equities since 2009. Something has to give.

World Bank wackiness explains odd U.S. choice

By Rob Cox

This column appears in the April 9 issue of Newsweek. The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

If the competition to become the World Bank’s next president were a normal process, Jim Yong Kim wouldn’t stand a chance. The Dartmouth College president lacks two of the traditional qualifications for running an international lending body: financial savvy and diplomatic experience. But the race to lead the World Bank is everything but ordinary – particularly this time.

Americans have always helmed the bank, which doled out some $57 billion in loans and grants to poor and middle-income countries last year alone. Except for a congressman (Barber Conable) and a Ford Motor boss (Robert McNamara), all 11 chiefs hailed from Wall Street firms like Lazard Freres, First Boston and Chase Bank. Even outgoing president Robert Zoellick spent some time on the payroll of Goldman Sachs.

Not so the Korean-born physician Kim. At 52, he has spent the past three years in bucolic Hanover, New Hampshire, where his biggest diplomatic challenge appears to have been quelling -with mixed success, according to a recent Rolling Stone exposé -a fondness among its fraternities for painting their pledges in puke and even forcing them to eat it in omelets. But there’s logic to the Obama administration’s choice for the job.

Though it was decreed at the 1944 Bretton Woods confab that the United States would name the bank’s president, it has 186 other stakeholders. And for the first time ever, they’re making their voices heard. When the World Bank board meets this week in Washington, it will have two other candidates to interview: Ngozi Okonjo-Iweala and José Antonio Ocampo, the former finance ministers of Nigeria and Colombia, respectively.

In another contest, their backgrounds would give them an edge. But here’s why Kim may be an inspired choice: if poverty’s insidious bedfellow is disease, it knows few enemies like Kim. He has a superhero’s resume of fighting the dark forces of illness. Kim was a co-founder of Partners in Health, which is seeking to eradicate infectious diseases like tuberculosis in the poorest nations on the planet. He chaired the Department of Global Health and Social Medicine at Harvard Medical School. In 2003, he moved to the World Health Organization and directed its efforts in fighting HIV and AIDS.