US default 'extremely unlikely'

Before we go deep into the mess, it is important to highlight the difference between a shutdown and debt crisis. In simple terms, in a shutdown, the government lacks the legal authority to spend money on non-essential services. In a debt crisis, the government is mandated to spend money — but doesn't have the legal authority to borrow the money to spend it.

What happens if the debt crisis occur (post 17th October) ? - A Default!

U.S. will certainly default if it does not pay its bills on time or the debt ceiling is not raised. Ahan - then the debt ceiling should be our discussion as it is the only temporary, please note, -TEMPORARY life line. If the US does not raise its USD 16.7 trillion debt ceiling "temporarily" by October 17, the country will default on its debt.

What US could potentially do:

The most extraordinary measure the government could take and that is to exhaust its cash. It is expected that the U.S. will have about $30 billion in cash, which will be short of expenditures that can reach as high as $60 billion in subsequent days. This is dangerously low level of cash in the bag.

The US government could use all their tax revenues to meet their interest payments on debt and roll-over the existing debt. They will have to take extreme measures such as cuts in public spending (healthcare programs) and defense spending. This will attract a lot of repercussion from the public, but it has to happen one day, then why not today!

President Obama is left with no option but to kill the fly

Even if the Congress decides to raise the debt limit, the republicans will be looking  for some very critical areas, prior to the approval, such as cuts in government spending, reducing the impact of Obamacare and no new taxes. They will keep their focus limited to the spending. An ice-break could prevent:

- Sliding US Dollar

- China catching the cold; biggest buyer of US debt

- America gets downgraded again!

- Banking industry getting banged
- Army pull-out

You are broke because you have overspent, and a correction is required not delay. Again, in simple words - Open the government and pay your bills.

Forgive me for using the word "Temporary" temporarily and wish not to use this again in near future.

Once upon a time in Greece

Battered Greece witnessed  its budget deficit fall to 9.1% of GDP in 2011. When George Papandreou took charge of office in 2006, the budget deficit was around 13% of GDP, way higher than the falsified figure of 5% stated by Karamanlis's government. The country currently has a debt of around USD 485 bn. There is immense pressure on the government to raise finance to pay off the debt which seems never-lasting (looking at the figure! but hope lives).

To continue to remain a member of the Euro Zone, members are required to maintain a budget deficit of no more than 3% of GDP and the debt to GDP must not exceed 60%. The current budget deficit is more than 9% of GDP and the debt is more than 120% of GDP!!! Greece is an unusual member of the Euro Zone which in the past had a two digit budget deficit and continues to have a three digit debt to GDP%.

The new coalition government, under Lucas Papademos, like the previous government plans to cut deficits, but we need to analyze how realistic these plans are fiscally and politically. The government is bound to raise taxes and cut spending on pensions, healthcare and welfare of the public. This comes at the expense of the turmoils in the form of protests and strikes campaigned by the strong labor unions in Greece. Any government in Greece is closely linked to the trade unions for political reasons and hence these unions are in a strong position to force governments to satisfy their expectations and demands. Any changes in the austerity measures will have both economic and political repercussions.

So what is the way out ? What options do we have ? Will Greece be forced out of the Euro Zone or will Greece be bailed out by the fellow EU members (mainly Germany and France). Let's analyze both the scenarios.

In the first case, we need to understand that there was no exit clause at the time of setting/joining the Euro Zone. Greece might approach the IMF like Hungary, but additional austerity measures will be required. The costs involved in switching back to the drachma from the Euro will be excessively high. The drachma would depreciate and the debt would surge as it is denominated in Euros. Hence, this is not a feasible option. Now, we are left with the second option, i.e. Plan: Bailout Greece!. It can be depicted from the chart above that France and Germany (the two leading Euro Zone countries) are most exposed to the Greek debt, hence if Greece falls, it will definitely have a knock-on effect and these countries will use all their muscles to save it. We have observed the significance of the Greek debt issue in the politics of France and Germany. The French and German banks have held significant amounts of the Greek debt and hence are a big support to its survival. 

Conclusively, I believe that the Greeks will be bailed out by their fellow EU members. We have to wait for the elections to get over in France and see the approach of the newly elected government towards this highly critical issue.

Iceland: Fish and Investment Banking

In 2003, Iceland's three biggest banks had assets of only a few billion dollars, about 100% of the nation's GDP. By the mid of 2006, the banking assets grew over USD 140 billion and were so much greater than Iceland's GDP, that there was no purpose in calculating the percentage. Many bankers, economists and authors believe that this was a phase when the banking system achieved rapid expansion. The harsh truth is that Iceland was no more a country, but a hedge fund.
The three major banks were pumping money into the Icelandic economy, driving the value of stocks and real estate crazy. Students in universities were fleeing from the economics of fishing to the economics of money.

This materialistic ambition turned out to have a downside. The collapse of the three major banks resulted in banking losses of more than USD 100 billion. For a country with a population of 300,000 the losses per person works out to around USD 330,000. The losses do not end here. Moreover, there were personal losses incurred through foreign currency speculation and collapses in the stock market. In 2011, the public debt per person stood at USD 42,714 more than USA's USD 33,555.

Learning points:

- Too much banking not good for the economic health. Do not create fake capital by trading in assets at inflated values. For example, I own apples and you own oranges. We agree that each fruit is worth millions. You sell me oranges and I sell you apples for millions. Now, we are no more fruitsellers but banks with assets worth millions.

- Give fish a chance. It will work again!

- Do not buy a Range Rover or Bentley if you cannot afford it. In the end, you are left with two options, either you burn it to get insurance money or ship it to a customer to earn in foreign currency.

The Failed Corporations; A Lesson to Learn

1- South Sea Bubble (1711-1720)

Investors had no idea of how their investments were being utilized in the business by the directors. The troubles arose when Spain entered in war with Britain. Directors, knowing the situation, started selling off their investments secretly. This led to a depressing effect on the investors' confidence . As a result issuing shares in the UK was banned (until 1825) and investors started shifting their investments to the U.S. Some historians name this collapse as mother of all failures.




2 - Polly Peck International, PPI (1940-1990)

Asil Nadir, a Turkish Cypriot, took over a major share in PPI as a Chief Executive. The company was mainly in to the electronics trading, but later entered into the trading of foodstuff competing with giants like Chiquita and Dole. A millions of pounds of funds were transferred to subsidiaries in Northern Cyprus in form of payments. These companies were being run by Asil Nadir's son. The company started to default on its payments to creditors which alarmed the board and authorities.Ultimately, the company collapsed.




3 - Maxwell Foundation (1970-1992)

Robert Maxwell misappropriated the funds, including the Mirror Group pension fund, to finance his loss making ventures. Neither the auditors nor the board were able to prevent this misappropriation which led to miserable failures.




4- Barings Bank (1762 - 1995)

Nick Leeson headed the trading of derivatives' operations in Singapore. This business was being run/managed during a 'deregulation period'. There were no controls, segregation of duties and no division between front and back office. The traders were accounting for the transactions either incorrectly or fraudulently and reporting inflated profits to the head office. Nick Leeson was gambling the bank's money (or the public monies). The money kept arriving and Nick Leeson kept gambling. It was the Kobe earthquake which caused a stock market crash (which affected all the tiger economies) resulting in a loss of £800 million to Barings Bank. Ultimately, Barings bank was sold to ING for £1.




5- Enron (1985-2001)

An Energy company headed from Houston, Texas was run by Kenneth Lay, the chairman, who entered in to contracts to deal in energy derivatives. The company had set special purpose entities for off balance sheet financing, in order to channel funds into Enron without the need of reflecting the substance in the accounts, i.e. hide its debt. The company was downgraded by various credit rating agencies impacting the investors' confidence. The share prices were on a free fall and the company faced some serious issues with the cash flow. The results were the same: Wind it!