Hans Christian Anderson and Vladimir Putin

Author: David Kotok, Post Date: August 19, 2008
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Tivoli Gardens’ pleasantries are brightened by the warming sunshine in this western Baltic nation.  It finally stopped raining.  Three flavors of herring and a cold beer will mask geo-political and financial concerns if you allow it to happen. 

Five and a half million Danish citizens live on their four hundred island nation, enjoy the fruits of the European Union (EU), accept their social welfare state and demonstrate their tolerance of people and events.  One wonders if they should think about Hans Christian Andersen’s fairy tales as the parents for whom the poet wrote metaphorically and not just as they were read to children.

I recalled Andersen’s “The Red Shoes” which teaches children the solace and joy one can find in heaven.  The adult version and adaptation ends much differently and in tragedy.  Was Georgia’s leader, Saakashvili, wearing red shoes when he engaged Russia and provided Putin with the pretext for the Russian army to invade Georgia? 

Clearly, there were American advisors present in Georgia.  Did they counsel Saakashvili to act militarily?  If they did, the White House has opened another Pandora’s box.  If Saakashvili acted unilaterally and without the counsel and advice of his American supporters, one must question his motivation.  Concomitantly, one must ponder possible American ineptitude.  Neither option gives comfort.  Unlike some folks here in Denmark at the western end of the Baltic Sea, we believe Putin and company have prepared and staged a division size, armored military incursion which was preceded by a multi-week intensive cyber warfare attack.  We wrote about this several days ago and also commented on CNBC yesterday morning from Copenhagen.  The responses range from full agreement and compliments on a candid assessment to being called names and being threatened. 

I thank readers who emailed constructive criticism and commentary.  To those who reduced their messages to name calling in disagreement with our views, I would call their attention to another Danish personality. 

Kierkegaard’s existentialism would argue that each person has the capacity to create the essential meaning of his or her life and that this is beyond the power of the civil authorities or religious doctrine.  In response one has to ask how existentialist the villager in Georgia feels today when his house has been destroyed by a tank. 

Let’s move to finance.  The CNBC interview (www.CNBC.com) and, subsequent, Yahoo story created a second flurry of email.  Here are some embellishing bullets:

  1. Firms like Merrill or UBS or Wachovia who are taking back as much as $100 billion of illiquid auction rate securities (ARS) do not require $100 billion of new capital to do so.  They acquire these securities as earning assets just as they would acquire any other earning asset.  If they already have adequate capital, they could substitute these ARS for other assets by selling the other assets.  They may fund the ARS acquisition by using various alternatives.  Wachovia, for example, could borrow money through its holding company or issue preferred stock or use insured bank deposits or borrow from the Federal Reserve or some combination of these and other possibilities. 

  2. The ARS being acquired have very low yields which means the firm that uses a higher cost of funding will experience a carry loss during the period they hold the ARS.  The buy-back of the ARS and the way it is funded is an income statement item. 

  3. The capital requirement arises out of the overall position of each firm.  It requires a certain ratio of capital to assets.  The ratios are different depending on which “tier” governs the asset type.  ARS will be viewed as illiquid and low earning assets.  They will be either held for a long time or sold at losses.  Either way they will operate to detract either directly or indirectly from the firm’s capital ratio. 

  4. If all other things were neutral and equal, the buy-back of ARS would be manageable by most of these firms.  But the ARS buy-back is another item on top of an already very serious list which includes financial turmoil, growing loan loss reserves, persistent and continuing mortgage related asset deterioration, growing consumer debt and home equity loan defaults, questionable commercial real estate asset values and ongoing housing price decline.

We reiterate the message in our CNBC interview.  We think the housing finance related crisis is about half over.  The end point is not in view.  The economic slow down in the United States is likely to worsen and the slow down in Europe is very real.  Many financial firms will need to raise more capital before this is over.  The list of total global financial losses which currently approximate a half trillion dollars.  In our view, hundreds of billions more are still to be revealed. 

Large looming governmental deficits are restricting the ability of the U.S. and Europeans to expand fiscal policy.  That means traditional fiscal stimulus is missing at the very time the economic cycle needs it the most.  Think about it:  the new American president will inherit a $500 billion deficit in the fiscal year of his inauguration.  That also impairs the NATO/EU/US response to Russia. 

By tomorrow night we will be in Estonia and encounter the eastern Baltic view.  Unlike Denmark, those countries are much closer in proximity and experience to the Russian bear.  We doubt if there will be any fairy tales at our meetings in Tallinn

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