Collateral Transformation, or Doing the Laundry

By J.D. Neeson, President, Marine Parts Express

In will-they-never learn and where-the-heck-are-the-regulators department, J.P. Morgan, Bank of America, Barclays, Deutsche Bank, and State Bank are all setting up collateral-transformation trading desks. Due to the new financial rules that will begin in 2013, banks, hedge funds, and other traders have to increase the percentage of collateral they post when trading in the $648 trillion (yes, trillion, or 10 times the world GDP!) derivatives market.

Congress changed the law requiring most privately negotiated derivatives trades (called over-the-counter trades) to go through established trading houses and ruled that the collateral collected must not only be a bigger percentage of the trade, but of better quality and relatively easily convertible into cash. The theory being that if a derivatives trade went south, the clearing house would be able to cash in the collateral to cover the default and not require government help.

Herein lies the challenge for the poor derivatives trader. It is difficult to find enough high-quality rated debt to meet the new rules. The United States has about $11 trillion of high-quality treasuries out in the market, and if you add in the Japanese and European high-quality debt there is another $25 trillion available. There is a tremendous demand for these types of instruments from central banks, governments, and big institutional investors.

So the banks came up with collateral-transformation that allows the derivatives trader to “borrow” high-quality securities (mostly treasuries) from the banks by putting up as collateral for the loan of these high-quality securities, inferior or non-complying securities. At some point, the trader is supposed to return these good treasuries.

The derivatives traders take these loaned (or maybe rented is a better word) high-quality securities (mostly treasuries) to the clearing houses and use them as collateral for their derivatives trades. The clearing houses are happy because they have the good securities as collateral and meet the new regulations. The banks are happy as they charge the derivatives trader for doing the swap and charge interest for the loans of the securities.

And the derivatives traders are happy as they have completed the derivatives trades, and to pay for them the traders have effectively “laundered” their sub-par securities.

Who is not going to be happy is the government and, by extension, all of us. If the derivatives trader’s bet fails, the clearing house will liquidate the collateral to cover some percentage of the default and go after the bank for the rest (the trader’s sub-par securities are with the bank). The bank will have to try to liquidate the sub-par securities and to maintain the bank’s reserve ratio at the same time, but they don’t have their nice, secure, high-quality bonds anymore.

Does this scenario sound familiar? It should. The only aspect missing is some smart insurance company offering insurance for the bank collateral-transformation desk and we can have a default swap AIG-type debacle all over again.

It is a blatant attempt to get around the regulations, and I am sure the bankers (in the back of their minds) are thinking that if it all goes wrong, the government will bail them out again.

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 Marine Parts Express is a division of Water Resources, Inc., a privately held Maine Corporation

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ChinaTrade: Myths vs. Reality

By Walter E. Williams

Townhall.com

Republicans and Democrats, liberals as well as conservatives, have bought into anti-Chinese trade demagoguery. Former House Speaker Nancy Pelosi suggested that tariffs against China are a “key part of our ‘Make It in America’ agenda.” During his 2010 campaign, Senate Majority Leader Harry Reid, D-Nev., called his tea party-backed Republican challenger, Sharron Angle, “a foreign worker’s best friend.” In a recent news conference, President Barack Obama gave his support to the anti-China campaign, declaring that China “has been very aggressive in gaming the trading system to its advantage,” adding that “we can and should take action against countries that are keeping their currencies undervalued … (and) that, above all, means China.”

Republican 2012 presidential candidates have jumped on the anti-China bandwagon. Mitt Romney wrote: “If I am fortunate enough to be elected president, I will work to fundamentally alter our economic relationship with China. … I will begin on Day One by designating China as the currency manipulator it is.” Former Sen. Rick Santorum, R-Pa., was even more challenging, saying, “I want to go to war with China.”

Let’s look at the magnitude of our trade with China. An excellent place to start is a recent publication (8/8/2011) by Galina Hale and Bart Hobijn, two economists at the Federal Reserve Bank of San Francisco, titled “The U.S. Content of ‘Made in China.’” One of the several questions they ask is: What is the fraction of U.S. consumer spending for goods made in China? Their data sources are the U.S. Census Bureau, the Bureau of Labor Statistics and the Commerce Department’s Bureau of Economic Analysis.

Hale and Hobijn find that the vast majority of goods and services sold in the United States are produced here. In 2010, total imports were about 16 percent of U.S. gross domestic product, and of that, 2.5 percent came from China. A total of 88.5 percent of U.S. consumer spending is on items made in the United States, the bulk of which are domestically produced services—such as medical care, housing, transportation, etc.—which make up about two-thirds of spending. Chinese goods account for 2.7 percent of U.S. personal consumption expenditures, about one-quarter of the 11.5 percent foreign share. Chinese imported goods consist mainly of furniture and household equipment; other durables; and clothing and shoes. In the clothing and shoes category, 35.6 percent of U.S.consumer purchases in 2010 were items with the “Made in China” label.

Much of what China sells us has considerable “local content.” Hale and Hobijn give the example of sneakers that might sell for $70. They point out that most of that price goes for transportation in the U.S., rent for the store where they are sold, profits for shareholders of the U.S. retailer, and marketing costs, which include the salaries, wages and benefits paid to the U.S. workers and managers responsible for getting sneakers to consumers. On average, 55 cents of every dollar spent on goods made in China goes for marketing services produced in the U.S.

Going hand in hand with today’s trade demagoguery is talk about decline in U.S. manufacturing. For the year 2008, the Federal Reserve estimated that the value of U.S. manufacturing output was about $3.7 trillion. If the U.S. manufacturing sector were a separate economy—with its own GDP—it would be tied with Germany as the world’s fourth-richest economy. Today’s manufacturing worker is so productive that the value of his average output is $234,220, three times higher than it was in 1980 and twice as high as it was in 1990. That means more can be produced with fewer workers, resulting in a precipitous fall in manufacturing jobs, from 19.5 million jobs in 1979 to a little more than 10 million today.

The bottom line is that we Americans are allowing ourselves to be suckered into believing that China is the source of our unemployment problems when the true culprit is Congress and the White House.

Reprinted with permission.

Dr. Williams, who very kindly and generously gave us permission to reprint this article on our blog, serves on the faculty of George Mason University as John M. Olin Distinguished Professor of Economics and is the author of “Race and Economics: How Much Can Be Blamed on Discrimination?” and “Up from the Projects: An Autobiography.”

Williams, Walter E. (2011, December 21). China trade: myths vs. reality. Townhall.com. Retrieved December 21, 2011, from http://townhall.com/columnists/walterewilliams/2011/12/21/china_trade_myths_vs_reality.

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Comments? Questions? Suggestions for topics for our blog or newsletter? Send them to info@marinepartsexpress.com.

Marine Parts Express is a division of Water Resources, Inc., a privately held Maine Corporation

Country Debt

By J.D. Neeson, President, Marine Parts Express

It struck me the other day that everyone talks about government debt and how much personal debt people have, but I had never seen what the total debt is. So here is a nifty table showing some of these. All the numbers are a percentage of a country’s GDP and are estimates.

Country	% GDP	% Government Debt	% Business/Bank Debt	% Household Debt
UK	497	77	340	80
Japan	492	213	226	53
Spain	366	66	210	90
France	341	88	223	30
Italy	313	110	165	38
South Korea	306	30	186	90
US	289	80	124	85
Germany	284	86	149	49
Canada	274	68	118	88

So, in the United States, the total debt is 289% of GDP and out of this number 80% of GDP is Government Debt, 124% of GDP is Business/Bank Debt and 85% of GDP is Household Debt. Or, to phrase it another way, as a percentage of total debt, which is a bit more revealing of the government and societal pressures that countries have to deal with and the decisions that are made either consciously or unconsciously.

Country	% Government Debt	% Business/Bank Debt	% Household Debt
UK	15	68	16
Japan	43	46	11
Spain	18	57	25
France	26	65	9
Italy	35	53	12
South Korea	10	61	29
US	28	43	29
Germany	30	52	17
Canada	25	43	32
Average Rate	26	54	20
Median Rate	26	53	17

There are all sorts of observations and deductions that can be made from these numbers. For example, I think what it shows is that while Japan and France have relatively low Household Debt they have higher than average Government and Business/Bank Debt. But the reasons for this are different. Japan has a history of high personal savings, but the country has been forced to keep society afloat through government support of its industries.

The French, on the other hand, have forced their industries to keep artificially high wages and benefits by government edict. That has kept Government Debt down, but has forced businesses to take up the slack. Much of the needs of the French people are supplied by either the government or by their employers, so personal debt is lower.

Another example is South Korea and the United Kingdom, both of which have relatively low Government Debt. Again, it is for different reasons. The Koreans are much more hands off when it comes to economic issues type forcing industry or households to take on the debt risk, while the U.K. form of socialism controls the economy more closely and forces industry to take on the debt.

You notice none of these broad generalizations include efficiency or value considerations and there are all sorts of other factors that create the choices that countries make. The only aspect that seems clear is that less debt is better than more debt and more capitalistic economies seem to spread debt risk over the entire economy more than the socialistic countries that either dictates the entity that will be the debtor or take the debt onto themselves.

I have no idea which is better, but this decision may affect which class of borrower has the most say in the governing of the country. In all cases, the beliefs and societal mores can tie the hands of decision makers more effectively than laws passed.

I would love to find the same sort of numbers for China, Dubai, or some other very strictly controlled economy more totalitarian form of government and compare it with the numbers for Sweden or Denmark. And wouldn’t poor Greece’s or Portugal’s numbers be fun to look at?

~J.D. Neeson

For all your marine engine parts needs, call us toll free at 877.621.2628, or outside theU.S., 207.882.6165.

Comments? Questions? Suggestions for topics for our blog or newsletter? Send them to info@marinepartsexpress.com.

Marine Parts Express is a division of Water Resources, Inc., a privately held Maine Corporation