Understanding the global impact of the Subprime Crisis; implications of GIC and Temasek Holdings bailout

16 Feb

The Singapore’s Government Investment Corporation (GIC) and Temasek Holdings have recently made acquisitions and provided bailouts to European and American financial institutions.

The former has injected US$6.88 billion in Citigroup and 11 billion Swiss franc (equivalent to US$10 billion) in Swiss- based UBS. GIC’s stake in UBS makes it the largest single shareholder of the institution (about 9%). On the other hand, Temasek Holdings has acquired $4.4 billion worth of Merrill Lynch & Co.

To understand why the European and American financial institutions have sought overseas investors for bailouts, it is essential to clarify how they have found themselves in a mess in the first place.

Citi (which used to be called Citibank) posted its largest $18 billion loss of its 196 years of history recently. Similarly, Merill Lynch posted a whooping $9.8 billion fourth-quarter loss and $16.7 billion of write-downs on mortgage-related investments and leveraged loans. UBS also wrote down $14.7 billion last year due to its U.S. subprime mortgages. In a nutshell, the US subprime mortgage crisis. It has been explained by the mainstream media as a situation whereby banks offer ‘subprime loans’ to people with risky credit ratings. As these people began to default on their repayments, it led to a wave of repossessions and bank losses; and henceforth, the crisis.

However, the situation is more complex than what has been portrayed. In her series of articles on the recent crises, Pam Martens argued that it is the rot of the financial system that has caused the financial meltdown.

In her article, ‘The Toxic Giant and It’s Own Black Hole, Wall Street Metes Out Street Justice to Citigroup’, she accuses Citi of being non-accountable, belonging to the ilk of Enron when the former company repeatedly avoided public trials in the past, by paying millions to regulatory bodies and private plaintiffs when investor sued them for ‘creating off balance sheet structures to hide the debt of large U.S. firms such as Enron.’

These non-accountable off balance sheet structures are known as CDOs (collateralized debt obligations), ‘opaque and convoluted debt instruments managed by Citigroup,’ through its ‘Cayman Islands SIVs(Structured Investment Vehicles), transmuted into AAA-rated commercial paper, landed in the so-called safe money market funds in the U.S., including an astonishing amount at Citigroup’s competitor, Merrill Lynch.’

Citi currently manages 7 SIVs, according to her and ‘not consolidated on Citigroup’s balance sheet‘: Centauri Corp., Beta Finance Corp., Sedna Finance Corp., Five Finance Corp., and Dorada Corp. The group created two SIVs, Zela Finance Corp. and Vetra Finance Corp in November 2006. All these SIVs contain ‘approximately $80 Billion in what is increasingly being viewed as toxic debt.’

Her predictions in this November 2007 article hit close to home as we witness Citi posting its losses.

Not only is Citi in the red, other financial institutions which has bought out the group, such as Merrill Lynch, has suffered a similar fate. According to Pam, Merrill Lynch injected about $52.9 Million in Beta Finance, $53 Million in Five Finance, $10 Million in Sedna Finance, and $10.7 Million in Zela Finance (all Citi ‘s SIVs). In buying out Citi, Merrill Lynch ‘increases its exposure’ to the subprime mortage losses, hence suffering a loss as well.

For the uninitiated, SIVs are companies or vehicles which basically borrow ‘low-yielding currencies, lending high-yielding ones and profiting from the spread.’ By borrowing money in the short term in order to invest in higher-yielding or more risky assets longer term, through ‘offshore and often unregulated facilities’, they are then ‘sold to wealthy investors and hedge funds for their high yield.’

SIVs, are by their nature, not reflected on the balance sheets of their parent companies, and hence unaccountable. Through a ‘complex asset-backed securities’, and without ‘any reserves to back them up’, it will not be an exaggeration to claim that their effects can have a domino effect. Yet, how does SIVs tie in with the subprime mortgage crisis? The answer is simple. Many of the subprime loans (whether in terms of housing mortagages or credit cards) are made through SIVs.

In another article, ‘Wall Street’s Bad Boys and Their Washington Enablers; Banksters Gone Wild’, Pam criticised the Bush administration and Wall Street for being responsible in this whole debacle.

‘To state the truth would be admitting that the Bush administration and its crony capitalists failed to properly audit the largest banks in America; failed to pay attention as they stashed hundreds of billions of dollars off their balance sheets in a replay of Enronomics; failed to prosecute the banksters when they parked this toxic waste in Mom and Pop money market funds across the country; and failed to jail the banksters before they burned down the bank and became a global threat to financial stability.

And while the Securities and Exchange Commission (SEC), Federal Reserve Board (FRB), and Congress bear much blame for the financial crisis, the Office of the Controller of the Currency (OCC) stands out as the quintessential enabler of corruption on Wall Street.

Eric Toussain, president of the Committee for the Abolition of Third World Debt, opined that the problem is more widespread, structural and cannot be easily solved as it is a result of the abject failure of the neoliberal capitalist model.’ He blamed it on the ‘directors of the private financial institutions’, ‘the governments of the main industrialised countries, the directors of the main central banks, the directors of the BIS, of the IMF and the World Bank’ for an opaque financial system that has and is failing.

On SIVS, he said, the ‘complex debt and loan packages’ through SIVs from the sale of CDOs ‘do not create real wealth’ and are ‘largely speculative financial operations’.

As the crisis unfolds in August 2007, he related how the domino and multiplier effect, can have an impact on the financial system, ‘the investors who habitually bought commercial papers issued by the SIVs stopped buying them because they no longer had confidence in the health and credibility of the SIVs. Consequently the SIVs lacked liquidity for buying mortgage bonds and the crisis worsened. The big banks that had created these SIVs had to honour SIV commitments to avoid them going bankrupt.’

Thus, to summarize, the result of the housing and credit financial meltdown in the US and indirectly, Europe, would have a significant impact on other parts of the world. The deregulation of the financial market over the years, coupled with the lack of transparency and accountability in SIVs directly contributed to the current financial woes in the US.

As Singapore’s GIC and Temasek Holdings, which uses the Singapore reserves for investment, pumps money into Citi, Merill Lynch and UBS, all posting losses due to the US subprime housing crisis, the possibility of another Enron scandal, due to the understated opaqueness of the financial vehicles and system, is, if not, worrying.

On the other hand, some analysts have termed the buyout of the western financial giants as a form of ‘reverse neocolonialism’ since most of the buyers are sovereign wealth funds (SWFs) from developing countries such as China, Saudi Arabia and Russia. These wealth funds, like our GIC and Temasek, unlikely to publicly disclose their financial books, which will only add another layer of opaqueness to the current flurry of transactions.

In a latest statement by Finance Minister Tharman Shanmugaratnam in Parliament, the government reiterated that the decisions made by GIC and Temasek are driven by ‘thoroughly assessed risk, hard-headed commercial decisions after careful assessment of the risk and the prospect for returns over the long term’ and that the Singapore government has no role in influencing the decision.

Considering that GIC and Temasek Holdings made these investments with the national reserves, it does not inspire confidence that its previous acquisitions such as the Barclay Banks and Shincorp have seen losses instead of gains.

At the time of writing this report, Bank of China has been suspended from trading shares on the Shanghai Stock Exchange for the entire 22 January. As the bank is not required to fully disclose its financial results till April, analysts have predicted that the state-owned lender, are possibly looking at writing off a quarter of the nearly $US8 billion ($9.3 billion) it holds in securities backed by sub-prime mortgages. Other banks in China that are likely to be affected due to holding subprime investments include Industrial & Commercial Bank of China and China Construction Bank.

For the average Singaporean, the burning question is whether GICs and Temasek Holdings have made the right decision to bail out the financial institutions.

On another more pressing and global level, the crisis reveals the opaqueness of a financial system which poses disastrous threats which can spin out of hand. One could even second guess if Citi might even turn up to become another Enron. Hopefully, this will serve as a wake up call for banks, financial institutions, national and international financial regulators to further regulate and instill a more transparent and accountable system.

===

References:

1. The Toxic Giant and It’s Own Black Hole, Wall Street Metes Out Street Justice to Citigroup, Counterpunch, Pam Martens, 6 November 2007

2. What are SIVS and what are they doing to our financial markets?, DailybuySellAdviser.com, extracted on 21 January 2008

3. Wall Street’s Bad Boys and Their Washington Enablers; Banksters Gone Wild, Counterpunch, Pam Marten, 7 December 2007

4. An International Contamination, The US Subprime Crisis Goes Global, Counterpunch, Eric Toussain, 12/13 January 2008

5. Tharman says not govt’s role to comment on GIC, Temasek investments, Channel News Asia, 21 January 2008

6. Bank of China shares suspended, AL Jazeera, 22 January 2008

7. Sub-prime likely to hit Bank of China, The Australian, Jason Leo in Beijing and James T. Areddy in Shanghai, reprinted from The Wall Street Journal, 22 January 2008

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One Response to “Understanding the global impact of the Subprime Crisis; implications of GIC and Temasek Holdings bailout”

  1. Dodgypress February 4, 2008 at 9:11 pm #

    Just read came across you site, and read this interesting and yet frightening article.

    Really does make one wonder about the state of the global financial system.

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