Swiss Franc going bonkers

Disclaimers:

1. I am employed by one of financial institutions involved in mortgage lending denominated in CHF, my financial well-being might be negatively affected by aftermaths of sudden appreciation of CHF.

2. I do not possess any substantial (in equivalent of more than 1,000 PLN) liabilities nor assets in or denominated to any foreign currency.

With hindsight it sinks in to me the decision of Swiss monetary authorities from 15 January 2015 deserve some more attention. The Swiss National Bank, apart from discontinuing its policy of warding off appreciation of the country’s currency, decided also to slash interest rates by 50 basis points, pushing policy rate further down into negative territory…

This move calls into questions one of economic paradigms I would take for granted during five years of studies and four years of banking career. Until recently in the economic theory the “floor” for interest rates was zero. Whenever the range of a central bank’s instruments in monetary loosening was described, one mentioned decreasing interest rates to zero and if this turned out to be insufficient, enlarging monetary base. Whenever I asked chaps from market risk department to estimate maximum negative valuation of an interest rate swap, it went without saying the scenario to analyse was an overnight drop in interest rate in a given currency to zero. Time and central bankers proved us wrong…

Interest rate is cost of money. Because as a matter of principle money cannot be bought or sold, the price is paid for temporary transfer of money, i.e. for borrowing or lending it. Theoretically, the cost of money can be negative, but in practice it seemed irrational. Recent goings-on have disproved economic theory. Thus we witness theory of economics is still in the making.

Negative interest rates have serious implications for stability of financial system. We already see the first apparently eerie effects of SNB’s move. Yields of Swiss governments bonds have entered negative territory, not only on secondary market, but also on debt auctions. In practice if yield on a10-year bond is –0.09%, you pay now 100.91 units of a currency to be paid back 100.00 units in ten years. At first glance it such investment makes little sense and the negative yield can be interpreted as safekeeping fee. Nonetheless, investors snap up on such bonds. Why? “The Economist” has beaten it to me in providing a comprehensive answer.

Government bond market naturally crops up as the first illustration of how central bank’s policy impinges on financial system. Let’s examine the outcomes for other economic actors.

Interest rates at which commercial banks lend or borrow money are strongly tied to rates set by a central bank shaping monetary policy of a currency in which those banks lend and borrow. On the lending side the situation is at first sight straight-forward. Components of cost of credit are a variable rate taken from inter-bank market (LIBOR) which is the cost of funding for a bank and the bank’s margin over LIBOR, standing for reward for credit risk borne by the bank. Whenever positive margin is higher than negative LIBOR, the cost of credit remains positive. If the margin, however, was low enough not to fully cover negative LIBOR, we would be faced with a situation when a borrower would have to repay less than they had borrowed. Consider a 1Y 10,000,000 CHF overdraft with cost of 1M LIBOR + 100 bps a Swiss company takes out. The principal is to be repaid at maturity, interest to be paid monthly. But if 1M LIBOR is –1.12%, then what? My first answer would be that no interest payments would occur, but how to handle loan principal? Should the net cost of –0.12% per annum be amortised over time and decrease outstanding loan by 1,000 CHF? If so, what if within a year 1M LIBOR rises above –1.00%? Loan administration staff and finance staff at some banks should begin to scratch their heads now!

From the borrowers’ (no matter if talk of individuals or enterprises) perspective the loan with negative cost is a veritable bargain. Probably the SNB intended to spur borrowing, thus increase monetary base and trigger inflation that would result in currency depreciation. The side effect of this action is that the break-even point for borrowers has been set too low, i.e. some entities that would not be eligible for a loan if LIBOR ran at 1% are now creditworthy. This pool of borrowers will likely default on their debts when interest rates increase, threatening economic growth in the future.

From the depositors’ perspective negative interest rates make horrible news. If commercial banks are to get funding on market conditions, they should pay depositors LIBOR. Businesses have no choice and will need to accept the negative rate. No one would imagine companies switching from bank transfer to handling payments in cash. Individuals, however, might choose to withdraw money from banks and decide to keep their savings in cash in a piggy bank / in a drawer / under the carpet. Of course if you keep cash at home, you are exposed to risk of physical damage or theft, but I presume some depositors would be willing to take those risks. A sudden outflow of cash from the banking system could pose a threat to banks’ liquidity. The effects could be comparable to a regular bank run.

In Poland, the Banks’ association and the Ministry of finance have worked out and agreed on measures to ease the pain of over half a million CHF mortgage borrowers. The proposals are modest and require banks to make some concessions that will somewhat decrease their profits, but in return should fend off provisions for past due debts. The measures will include:

1. lower or no FX spread on instalments – directly hits banks’ earnings, however gives a relief of up to 4% to borrowers,

2. using negative LIBOR as a base rate, however the total sum of base rate and margin might not fall below zero – at best a borrower would not pay any interest on the loan,

3. banks will refrain from calling for additional collateral – it has to be underlined in extreme cases LTV ratio, measure relation of outstanding debt to property market value, might be reaching even 200% (e.g. a borrower owns a flat which could be sold for 500,000 PLN but their debt in PLN is 1,000,000 PLN), the concession is a violation of one of Financial Supervision’s recommendations on mortgage lending, but given the current market situation, it is the best possible solution,

4. extension of lending periods, which would result in lower monthly instalments – given record-low credit cost in CHF and prospects of CHF/PLN returning to levels seen before 15 January 2015, it is a reasonable to wait out the period of ultra-strong CHF.

The compromise is very wise, since both banks and borrowers will share responsibility for the event which has taken both sides aback. That being said, one must not forget during the lending spree which reached in climax between 2006 and 2008 banks aggressively foisted upon their customers loans denominated in foreign currencies, particularly to those mortgage applicants who could not afford to service mortgage loans in PLN, but in CHF, in which interest rates were lower, were creditworthy.

For those with shorter memory, a short reminder, how in July 2006 the same politicians who today bleat how evil CHF lending was, expressed their disapproval of Financial Watchdog’s efforts to curb mortgage lending in foreign currencies.

The Polish Financial Supervision has also come out with another proposal that seems to hold water. The distressed borrowers could be given the option to convert their loans into PLN at the CHF/PLN rate from the day the loan was taken out, however they would need to return to banks difference between lower interest paid in CHF and PLN. The CHF appreciated rapidly in late 2008 and despite staying around or above 3.00 since then, a monthly instalment of a rate in CHF was lower than a monthly instalment in PLN until the first quarter of 2013. This was due to interest rate differential between CHF and PLN that offset CHF appreciation. This proposal should remind CHF borrowers for many years they benefited from their decision, however the reward was accompanied by FX risk… Impact for banks is very hard to estimate, in depends on so many technical assumption of the operation that any attempts to give a ballpark figure are doomed to fail.

The proposal, apart from questions of legal nature, gives rise to several technical / mathematical questions, e.g.:

1. how the current outstanding debt in PLN would be determined (not only FX rate but also loan amortisation needs to be taken into account),

2. how the difference is interest base and effects of loan amortization and changing time value of money would be accounted for,

3. would the borrowers have to return the difference in interest paid in cash, or would banks be willing to add it to the outstanding debt, if yes, would breach of currently binding Recommendation S in terms of max. LTV ratio be allowed,

and many other, proving this idea makes sense, but is on account a quick fix.

Many accuse banks of reaping profits from CHF appreciation. Had it worked like this, we would see enormous profits of institutions involved in CHF-denominated lending in their 1Q2015 financial reports. But we will not. CHF-denominated loans are banks’ assets, but they are effectively funded by liabilities. Because Polish banks do not take deposits in CHF, rarely issue bonds in CHF and generally do not take out loans in CHF (there are exceptions when funding is secured by parent companies), they have to replace funding in PLN by funding in CHF. This is done with use of FX swaps, derivatives which compose of FX spot and FX forward. For example, in order to replace a 3M deposit in PLN with a 3M deposit in CHF, a Polish bank sells PLN and buys CHF at a current date at spot CHF/PLN rate and agrees to conclude a reserve transaction in 3 months, at pre-agreed CHF/PLN rate which reflects interest rate differential between PLN and CHF. Thus effective cost of funding is LIBOR rather than WIBOR. Such operations are risky, because long-term assets are matched by short-term liabilities which needs to rolled over frequently. The roll-over risk materialised in late 2008 when access to FX swap virtually dried out and intermediation of Polish and Swiss central banks was requisite to match positions on Polish banks’ balance sheets.

Banks’ earnings on loans denominated in foreign currencies are made up of spreads. When such loan was disbursed, a bank earned profit on a spread between market FX rate and bid rate (i.e. if NBP CHF/PLN rate was 2.30 PLN, a bank would convert CHF into PLN at 2.20). Then banks earned on spread between market FX rate and ask rate each time an instalment was repaid. This practice was curbed in 2011 thanks to anti-spread law. I dare to claim as of today portfolios of FX-denominated loans, after costs of hedging and provisions for bad debts, generate negative income for the banks.

My own guess is that the period of negative interest rates and ultra-high CHF will not last long. Negative cost of money will lead to distortions in financial system, while strong CHF will send the Swiss economy into deep recession. Bright future is not ahead though. Just three days ago ECB announced it would launch out into quantitative easing. If without near-zero interest rate and expanding money supply economies of the Euro zone are unable to grow, it means they are still on their knees, almost seven years since the outbreak of full-blown crisis in early autumn of 2008. This time there will be more than seven lean years…

Worries - shelved

It's been a sort of a hectic weekend, hence a very short note. My dear few avid readers - accept my apologies.

The political event of the week in Poland was a debacle of referendum in Warsaw. The turnout of 25.66%, vs. roughly 29% required to deem the voting valid, was too low to oust Mrs Gronkiewicz Waltz from her stool in the town hall. A month before the referendum at least 40% of Warsaw's inhabitants would avow to take part in a vote (and depose the mayor). In my opinion all the efforts of the civic movement aimed at removing the haughty mayor were thwarted, when the referendum campaign was dominated by politicians trying to capitalise on Warsaw's inhabitants disgruntlement. Warsaw remains a stronghold of PO, but those people would easily give up on supporting the party, if only they were faced with a decent alternative. When Mr Kaczynski stepped in, the lesser of two evils was chosen. PiS officially treats the referendum as its success, however I dare to argue had it been engaging so actively in the anti-mayoral campaign, the turnout would have been higher. Lots of people must have got angry seeing the civic initiative turning into political squabble. The proper course of action would have been for the politicians to launch a campaign after the new election were called, or to run a campaign in more constructive way - all what the critics of the mayor would say was "Mrs Gronkiewicz Waltz is a bad mayor, let's oust her", no proposal beyond the moment she loses her position, no counter-proposals on how to sort out what has been done wrong by her. To recap - pure flavour of Polish politics with little policies.

The global political event of the week was the debt ceiling in the United States. As illustrated to the right, the easier option has been chosen - now there is more room to pump in the shit. Currently creditworthiness of the United States cannot be evaluated in terms of its capacity to repay its debt, this may only be considered as ability to roll it over. Yet, this cannot be done until the end of the world. The only way the US government can get rid of its huge debt is... inflation, which would reduce the real value of liabilities, thus through inflation tax the US government would dupe its creditors and its own citizens - the middle class, except for those heavily indebted, who usually benefit from high inflation. The new Fed governor, extremely dovish, would most probably see to it.

Lean times...

How come during the first wave of the crisis (I still assume economic misery lasting since 2008 would only ease, not cease) Poland was a “green island” on the map of Europe, while these days, although Polish economy does not, and predictably will not, contract, there are several CEE countries that outpace Poland in terms of GDP growth. How come? In my view there are two factors that contribute to relative frailty of the Polish economy. First is the strength of the Polish currency, the other is dwindling consumer confidence.

The former can be easily quantified and its impact on growth can be explicated with referring to currency regimes. Currencies of countries severely hit by the economic woes in late 2008 and 2009 were pegged to EUR (Baltic States), or these countries had just adopted the single currency (Slovakia). Polish zloty was then allowed to float and speculators betting against our currency sold it off  to levels which considerably boosted competitiveness of Polish exports and decreased demand on foreign products. Today PLN is fairly valued against other currencies and so Poland cannot fully benefit from advantages of cheap domestic currency.

The latter is less measurable (although you can always work out several indices or ratios to quantify optimism among consumers or entrepreneurs), it is more about collective state of mind and expectations. In 2009 Poles would rush to the shops as if economic slowdown was just a newspaper headline. Retail sales were rising, not soaring, but most Poles stayed optimistic about the future.

These days confidence is shrinking. Consumer feel much more insecure about the future and their salaries in real terms have dropped, while basic costs of living keep going up. Whenever we spend more to meet our basic needs (dwelling maintenance, food) and our income does not rise, we are forced to save on something else. And so we cut back expenses on culture, entertainment, going out, holidays, cars, etc. Plus when we feel insecure about the future, especially about the terms of our employment, we tend to put aside money for a rainy day. This is all visible around…

Just over the recent week Gazeta Wyborcza published two pieces on this trend. The first says fear of being fired is worse than joblessness. From the economic point of view it is better to have the job, than to be out on the limb, but from psychological point of view, the former state, combined with insecurity about tomorrow appears more crippling. Once you are jobless, your situation seems controllable. When, just like me, you have a job, but at the back of your head you have the thought that each day you go to work might be your last day there (I’m still better off because I have a generous severance pay guaranteed!), it is much more crippling emotionally. How can you plan anything? How can you decide to take out a loan if your repayment capacity might be jeopardised? How can you spend more, if a natural reaction in such situation is building a cash buffer? A human needs some stability, while today’s economy cannot offer it.

The second article dwells on general trend on the labour market – employment is falling, salary hikes are frozen, employees hold down the job, and, fearing of losing the job, expend less. This has severe implications for the total economy and becomes a self-fulfilling prophecy: consumers spend less, aggregate demand falls, producers put out less, needs fewer staff, lay off, those laid-off buy less and so the vicious circle keeps turning. Private consumption is the propeller of GDP and drop in it, compounded by limitations in offsetting it by other components of GDP (private investment, government spending, net exports), is quickly reflected in economic growth statistics. Also the current disinflation, despite its unsustainable character (1.7% y/y inflation in January was caused by temporarily cheaper fuels and drop in natural gas rates for households – do not cut interest rates so rashly!), is also the aftermath of lower consumer spending.

Skimping on every step is not just a figment of panicking journalists’ imagination. I can see it around, but not everyone is cutting down on splurging money. Fewer people buy coffee in the morning in our canteen (5 PLN per mug each day, giving it up leaves 100 PLN in your pocket each month), more prepare instant coffee, paid by the employer. I find it harder to find company for a lunch, as more people bring food from home. If they decide to eat out, they prefer our subsidised canteen to more expensive eateries in the vicinity of our office. Prices above 15 PLN for main course (without a soup) are prohibitive for Poles all ranking among 5% best-earning ones. Many decide to eat only a soup… They see merits of shoes bought in Deichmann or CCC, when choosing their holiday destinations, they seek cheaper places. Polish countryside is again an option, with agro-tourism being far less costly than mountain or seaside posh resorts. If abroad, Bulgaria, Hungary and Albania are all the rage, offering much cheaper accommodation that Mediterranean countries. Colleagues who have returned from winter holidays say lodgings and borrowing skis are much cheaper and despite this there are fewer tourists. Zakopane was all desolated as prices of rooms and in restaurants were far too steep (50 PLN for a lunch for one person is a daylight robbery indeed!). Going to a cinema – not more often than once a month, to a theatre – once in a quarter – restraints on spending on culture are quite typical. Car or public transport – the latter quite often wins. Traffic density and number of cars covered by snow for an extended period are respectively: lower and higher this winter. Traffic jams are not as bad as they use to be... No wonder if many people have given up on their cars.

Maybe what are just observing is just the farewell to credit-fuelled growth and onset of era of frugality. Number of new mortgages granted by banks in 2013 might be record-low, this will surely have implications for the property market, i.e. accelerate process of adjusting prices to purchasing power of buyers. There is one more time bomb ticking and I have not heard anyone’s concern about it in Poland – there is a property bubble swelling in Switzerland and the country’s central bank might be likely to raise interest rates. This might in turn hit mortgage debtors in Poland with their liabilities denominated in CHF, as amount of monthly instalment is much more sensitive to interest rate than to exchange rate. I am not envisaging spectacular bankruptcies of distressed borrowers, bad debts will not soar. Instead “home-owners” will be bending over backwards to make ends meet and avoid foreclosures even harder and this will also decrease private consumption.

The upbeat part of the post is, again, that property prices should be heading down…

Affordability

I can't afford to... - so what the hell does it mean? As an economist I should understand and clearly define the meaning of such predication, yet I could struggle and all attempts to do it could go in vain. Affordability is probably one of the most ambiguous concepts in economics, containing enough imprecision to leave its users much room for (mis)interpretations.

Personally, I would distniguish three main concepts of it. If you can afford to buy something, you:
1) have enough money not only to purchase the item you want to have but also don't need to cut back on other expenditures - a very conservative approach, I'm kind of attracted by,
2) have enough money to spend it on a specific item - conservative approach, the one I'm guided by while managing my personal finances,
3) expect to have enough money to service the debt you run up to buy what you want and in the meantime don't have to tighten the belt while repaying the loan - a contemporary approach, not really what I embrace, yet not what I reject,
4) expect to have money to pay back the loan you take out to finance you dreams, but struggle to make ends meet - a subprime approach, what I consider a regular folly and signifcant threat to financial stability on micro- and macroeconomic levels.

While approaches no. 2 and 3 prevail, the difference between the two can be illustrated by the language of accounting. If you have cash at hand to buy something, I would call it a balance-sheet approach, whereas calculating what share of your monthly income can be spent on debt service can be called a cash-flow approach. Banks, when they analyse their customers' creditworthiness, check, whether the current cash flows are high enough to cover the debt service expenses. This method is a huge simplification, as it assumes that:
1) a borrower doesn't lose their source of income (downcase scenario) or
2) a borrower doesn't receive an additional income (upcase scenario).

Most people around lean towards the cash-flow approach. It's not uncommon that a human being is impatient and would like to have its needs met immediately*, without waiting and putting money aside and often without initial sacrifices. Such approach squares also with life-time income theory, yet as every model is based on several assumptions, including no misfortune is going to crop up. The model works properly as long as your career develops in a natural course (i.e. at startpoint you earn little and then your earnings rise until you retire), no illness, accident or death hits you. Well, there is no perfect model in economics, each model has its limitations, and inputs will always determine outputs.

My personal preference of the balance-sheet approach stems from the insecurity. I hope what future holds for me is only bright and do my best to ensure it, but since I've seen fellow good workers laid off out of the blue in an inhuman way, I don't want to take a risk of having a debt burden and being jobless at the same time.

* Example I heard at work in April 2011, one of my colleagues saying about her friends: They have a flat, but would like to swap it for a bigger one, but unfortunately their outstanding mortgage debt in CHF is higher than the market value of their current flat - my jaw dropped open, how about yours???

Another example - recently I changed my commuting routes and leave the car at a P&R car park closer to home, this lets me save some 3 PLN each day. But I did it not because I can't afford to buy petrol - I could even easily drive directly to the office every day and spend on it some 200 PLN more a month. I clamped down on driving because I consider it a waste of money which could be put it aside and utilised in a better way in the future.

Next week: The Iron Lady - film review (watched it, but had too little time to put all my thought into the correct order)

Orbanomics

Liberal media in Poland and across Europe have joyfully relished on the economic decline of Hungary under Victor Orban’s rule. The fellow CEE country does not fare well, despite Mr Obran’s peculiar efforts to tackle the crisis and may face insolvency even sooner than far more stricken Greece.

When examining economic situation of Hungary, biased media often leave out how Hungarian economy was wrecked by eight years of leftist rule, marked by soaring corruption, concealing ever-deteriorating state of public finances and unfettered living beyond means, both on public and private level. In September 2006, confessions of Hungary’s former prime minister leaked to the media and triggered widespread outrage. Things came to a head. While neighbouring economies were booming, Hungary had to implement first austerity programme, aimed at turning public finances around. Retrenchments slowed the economy down, yet the country kept moving ahead. The veritable turmoil sparked off in autumn 2008, when CEE currencies were sold off in the wake of Lehman bankruptcy. The sell-off of Hungarian forint was much more justified than in the case of Polish zloty, as Hungarian economy has already suffered from structural problems. Hungarian central bank immediately jacked up interest rates, hoping that the higher price of money would attract speculative capital. It did not, but as each interest hike, the move stifled the already ailing economy.

The Hungarian economy was particularly severely hit by depreciating HUF, mainly owing to unconstrained mortgage lending in foreign currencies. Millions of Hungarians have found it increasingly difficult to service their mortgage debts. Many borrowers defaulted on their obligations, so banks had to make massive write-offs on bad loans, households had to tighten the belt, cut down on various expenses and keep servicing their debts. As a result, consumption and investments fell, government spending was also curbed. Hungary was the first country that applied for a bail-out from the IMF and EU to bring back financial stability in the country.

Such pitiable was the shape of Hungarian economy taken over by Mr Orban’s party in mid- 2010, after it had won over two-third seats in the parliament, majority allowing to pass almost any law they wanted, including entitlement to change constitution. Mr Orban, in over year and a half managed to make extensive use of power he had been entrusted. He has had many successful attempts to tweak with scope of civic liberties, including free speech, economic order has also been revamped. The most controversial economic changes were:

1) Nationalisation of assets held by pension funds and using it to reduce public debt. As an unfaltering critic of obligatory participation to private-run pension funds, I could agree this was a good move. But look at the way it has been done. Citizens were given the choice – either to transfer “their” savings into the state-run system, or to pay pension contributions to both the state and to private-run funds and retain “their” savings in the private-run system, but being deprived of the right to pension benefit paid by the state. Fair deal? Plus note pension funds were scrapped not because they had been a scam, but only to inject cash the state budget had been running out of.

2) Freezing CHF/HUF rate at which distressed debtors repaid their CHF-denominated mortgages. In the first variant the rate was to be fixed for a few years, the government would pay the difference between the fixed rate and market rate, and debtors would repay the difference after a few years. In the second variant, losses were covered by banks which had granted loans. This reminds of the option quarrel, when some politicians also tried to nullify legally binding contracts.

3) Taxation reform, consisting in replacing two PIT rates of 17% and 32% by a flat tax of 16% - the measure did not revive the economy, but, predictably, brought down budget revenues. Guess who benefited the most… From 1 January 2012 key VAT rate was raised from 25% to 27%. Guess who lost the most…

4) Tampering with central bank’s independence, allowing political influence on the decisions taken by hitherto independent body and making it possible for the government to tap its monetary reserves to pay government debt in foreign currencies.

Well, until now the uncanny experiments have not dragged the Hungarian economy out of the recession. Over the last month three main rating agencies have downgraded Hungary’s sovereign rating to junk status, this should not be put down only to high debt-toGDP ratio of approximately 80%. The main reason for the downgrade was the unpredictability of Hungarian decision-makers. As the ex-member of Polish monetary policy council said yesterday, these are not only several ratios, determining a country’s capacity to service debt, that set debt service costs, the key driver of financing costs is credibility and Hungarian government completely lacks it. No wonder it has to pay over 10% for its 10Y bonds, yet it puts a bold face and declares readiness to turn down potential financial aid from the IMF and the EU, condition on pulling back from curbing central bank’s independence.

No one should draw pleasure from watching our ill-run neighbour going under (unless you are a currency speculator). But Hungarian troubles should teach us a lesson. Remember the evening of 9 October 2011 when Jarosław Kaczyński expressed his hopes that one day there would be Budapest in Warsaw? Not letting it happen does not simply mean preventing Mr Kaczyński from winning majority in the parliament. If we do not want Poland to follow the path of Hungary we have to prevent it from plunging into such economic and political downfall. To some extent, it is rather improbable that things in Poland might with take a dire shape. Political class is not as corrupt as it was in Hungary, we have never lived beyond our means to the extent Hungarians did, burden of mortgage debts is not too heavy to carry for Poles, public finances are in a better shape, but... Do we know if the ruling politicians tell us the truth about public finances? I think Mr Rostowski runs our finances quite prudently, but when I listen to him, I am not convinced he tells the whole truth. It is not inconceivable that, when in distress, Polish central bank might buy up Polish government bonds, which would be a violation of constitution and would be actual act of printing money – if this happens, expect a condemnation on PES.

Whatever future holds for Hungary and for Poland, I hope Hungarians and other nations draw conclusions from the current economic ailments of the former country. Whenever we assess Mr Orban, we must not forget about the context in which he gained power. At least we cannot accuse him of inactivity. He does try to overcome the crisis. A drowning man will catch a straw, so maybe this might be excuse for moves which in my opinion are inexcusable and detrimental for the economy. Time and financial markets will soon prove somebody right.

Financial markets, I say. Very few countries can afford to mess with financial markets. And you can do it only if you do not have to rely on them, i.e. when you do not have to finance your debt by issuing bonds. Mr Orban unfortunately forgot that public debt of his country accounts for 80% of GDP, so he might be fighting a losing battle…

It won’t cease soon

Some people say if you don’t have a profile on facebook or another social networking website, you simply don’t exist. I’m not in favour of this theory, but there is a grain of truth in it. Over the week when I was offline, my high-school classmates organised a Christmas meet-up and notified me via facebook. I learnt about the gathering the day after it was held. I wouldn’t have turned up anyway, as it was held at the same time as Christmas party of my company, but no one considered any other way of getting in touch with me…

The other thing I spotted on facebook last Saturday after logging in was a message from my middle-school classmate. Let’s name him Marek (name deliberately changed, again, I’m sure he at least once visited my blog and is aware of its existence). He asked me to give him my phone number and tell when he could call me, implying the sooner the better. I’m generally sensitised to all requests when I feel I can lend somebody a helping hand and felt a bit guilty, as his message was dated 14 December and I read it three days later. I went for a walk, grabbed my mobile and dialled his number (how come I had his number, he didn’t have mine?).

Marek was more than happy to hear my voice in the receiver. Without even exchanging pleasantries, he cut to the chase and asked if I had lent any money to our classmate, Karol. He left me a bit speechless for a moment, but instead of telling him I had done this mistake, my reply was: “has your money also gone down the drain?” (też utopiłeś pieniądze?).

Marek and I have known each other since we were six. He lived with his mother and sister in a neighbouring block of flats in Piaseczno, we went to the same group in the nursery school and then attended the same class and primary and middle school. We even chose the same high school, I surmise his choice was a bit influenced by mine. Marek’s life has always been uphill. He grew up without father and most of time without any financial aid from him. He has never been really talented (truth be told, even if it’s bitter), but as long as he could, he has made up for his by hard work and consistency. He has always aimed high and never liked to give up on his plans.

Despite financial hardship, Marek managed to put aside some money. In August 2010 he lent a large chunk of it, i.e. 8,000 PLN to our ex-friend, Karol. Unlike me, he secured his interests by signing a loan agreement with the hapless debtor. Until now Karol and his mother have paid him back 5,000 PLN, while 3,000 PLN remains outstanding and odds of getting it back are dwindling. As it turns out, precedence of creditors depends on their capacity to claim their money back. My loan to Karol was backed by gentleman’s agreement; Karol’s mother claims she respects it, yet when others threaten to take steps to recover their money, it’s not hard to guess who’ll be paid off first. Marek is not even better-off, just because his recovery ratio is 62.5%, while mine is 0%. For me 1,000 PLN is not a big sum, compared to my savings and earnings, for Marek 3,000 is much, much more and currently he desperately needs that money.

[insertion: it just occurred to me I could help Marek out and lend him 3,000 PLN, but I won’t…]

With the legally binding obligation to return the money, Marek is going to take the case to the court. Some law students who provide other students with legal advice free of charge have helped him write a claim and in the new year he intends to file a lawsuit against Karol. The case was if I would testify. Without much hesitation I agreed to appear before court. After all I’ll be telling the truth, but maybe I’ll help the guy who’s had it uphill all his life and doesn’t deserve to lose much of his savings. Testifying will not fray my nerves, as I’ve got over the lost money long ago and I won’t forget the story of a guy who used to my good friend, who was an up-and-coming talent and who squandered all opportunities life had offered to him, anyway.

On 9 December I sent to Karol’s family a Christmas card. I packed in an envelope and didn’t sign sender’s name at the back of it, just to give it a chance of not landing in a rubbish bin before being opened.

Just after finished the call with Marek I rang Karol’s mother, immensely curious to find out how the family are doing. What I heard from her has not impressed nor touched me, actually nothing I would hear about Karol would surprise me. Apart from what I listened about misery of Karol’s father who had undergone a surgery and Karol’s senile grandparents (all their ailments are somehow related to Karol having fallen into troubles), I have been informed that Karol is doing a sentence for unpaid debts and since his mother and I last talked, he tried to take away his life three times and is determined to try it again.

The shock came after hanging up. It sank in to me that this woman was at the end of her tether. She’s so tired of what she’s gone through that she doesn’t even appear to be moved by the fact his son wanted to commit suicide it even seems she has already come to terms with the inexorable eventuality of Karol’s suicidal departure.

Maybe the story is not apposite for the Christmas tide, but this the time, when apart from rejoicing, we should think about fellow people’s misery. Remember Band Aid’s “Do they know it’s Christmas”, peaked with Bono’s verse “Well tonight thank God it’s them, instead of you”? Cherish what you have, if you can read this post, I bet most people have it worse than you and your problems are laughably small, compared to theirs.

Shame on you if you fool me once...

…but shame on me if you fool me twice. Sometimes sayings that refer to ordinary life apply to politics and economy as well.

Have you ever wondered how many times have Greeks double-crossed their breadwinners from the EU? Greece joined the European Economic Community in 1981. I have to plead I know little about the backstage of entrance to European Communities at that time, but from what I remember at that time a country which applied for a membership did not have to meet any quantitative criteria. From that point being a member of EEC has helped Greece make a big stride, yet not in terms of development, but in terms of standard of living.

Things have changed after the Maastricht Treaty was signed and took effect. It laid foundation for single currency area and set requirements a country which wanted to join it had to meet. Two of them referred to soundness of public finances – each applicant had to keep general government deficit below 3% of GDP and the whole public debt could not account for more than 60% of GDP. These are figures, and whenever statistics are in use, room for tampering can be found. Here’s the rub – when calculating the public debt a country was allowed to legally subtract some of its liabilities. The main method of concealing some of debts was using complex financial instruments, mainly cross-currency swaps that allowed the Greek government to issue bonds in other currencies at “arranged rates” and with deferred maturity. The operation that helped Greeks dupe the EU was brought off in liaison with Goldman Sachs (the bank that rules the world, there is more than just a grain of truth in this assertion). Thus in official statistics the debt was curbed, in fact it morphed into time bomb that would blow up Greece’s public finances in a few years.

For many years Greek sovereign bonds were treated as safe investment. When banking crisis in 2008 reached its zenith, many banks in Europe, including Dexia lost millions on toxic US mortgage-market-related assets, but then received capital injections. This money was parked in safe havens. One of them were Greek bonds. Collapse of Greece’s public finances came to the light in September 2009. From then on, Greece has faced insolvency many times. For the first time it received a bailout package in May 2010. Over 100 billion Euros let the country avoid bankruptcy then, but this was just the first injection of never-ending drip of money. To borrow money on preferential terms from the EU and the IMF, Greece had to implement painful austerity measures. Greeks, pampered by overgrown welfare system, went to the streets to protest against dreadful retrenchment programme. The country repeatedly came to a standstill, strikes exacerbated economic contraction and debt-to-GDP ratio soared.

In most European countries the crisis was sparked by excessive expansion of deregulated banking industry, mainly consisting in reckless mortgage lending. In Greece banking sector stayed relatively healthy. The overgrown welfare state and lack of competitiveness of Greek economy were the nails used to close the coffin of Greece. Many privileges, despite social unrest, can be scrapped, but structural changes are will not be easily brought in, given the mentality of Greek society. Big grey economy and widespread claimant stance (postawa roszczeniowa) will be a stumble block. Greece must not only cut ridiculous expenses, but also take steps to boost its tax revenue base. Tax evasion must finally be severely punished, wages must finally be linked to efficiency. It sounds simply, but Greece has to get to grips with bigger challenges. In needs to carry out structural reforms to make its products and services sellable on global markets. It would be easier if they could be sold at lower prices, but as long as Greece is a member of the Eurozone, devaluation of currency does not come into play.

Solidarity is a glue that stick together the European Union. Poland is also a big beneficiary of this. As a poorer country we receive lots of money to modernise the country. A big leap being made in infrastructure development can be put down the inflow of EU funds, but life is not only about taking, but also about giving. One country should not sponge on other, as Greece has done. And if other countries bail one country out, it should not come up with ideas such as the one to call a referendum whether to accept another tranche of bailout package, subject to another dose of painful reforms.

Someone finally should bite the bullet and pull the plug on Greece. I would simply let it go bust, let banks write down or write off value of Greek bonds (most creditors of Greece are capable to absorb such losses, although it would be a blow to their shareholders). I would even let it start from scratch. But even in such scenario, I seriously doubt if Greeks would learn from their mistakes. They would rather be taught that if creditors let them get away with not meeting their obligations, that they can carry on living off other countries’ backs.

The Euro, as a currency, as well as the Eurozone, are political, not economic undertakings and for that reason no one will have the courage to kick out Greece from the eurozone. Admitting one’s defeat is a bitter pill to swallow, but in my view, this painful solution would in long-term turn out to be best, and less costly than pumping next billions into a bankrupt country.

The Inside Job - film review

It starts with shots of intact Icelandic landscapes. In early 2000s the country finalised reform of its financial sector, which consisted mainly in deregulation. Until mid-2008 Iceland received glowing praises for the reform, which, as said by economists, strengthened the country’s financial stability and accelerated its economic growth. In fact deregulation of financial institution in Iceland gave rise above all to excessive credit expansion and, eventually, to an ultimate collapse of the country’s banking system.

This is just the prelude to another story told about the recent economic crisis. Clever, bright, yet not leftist and not politically involved. Some claim it does espouse leftists views on economy, but I did not discern it. If the film calls for something, it is surely not a revolution that would overturn the current unbridled capitalism, but for reverting to traditional capitalism, based on freedom, responsibility, playing by the rules and straightforward decency.

The main thesis the film sets out is that the financial industry in most developed countries has been allowed, by politicians and economists, to spiral out of control, then, by means of privatising gains and socialising losses, led to the recent crisis and went unpunished. The work, divided into five parts, explicates mechanics of events and decisions in the run-up to the crisis. I do not know if the way facts are presented is clear enough for a layman, but for me it seems the job has been done well.

Part 1: How we got there.

Filmmakers have come up with a theory that since the end of the Great Depression, until early 1980s when Ronald Reagan was sworn in as US president, the United States did not see any major economic crisis. This success, in fact untrue, since early 1970s saw oil crises, bringing about periods of stagflation, that put the era of Keynesianism to the end, is put down to the strict regulation of banking industry that prevented financial institutions from growing big. It was after Ronald Reagan took over and pressed ahead with his doctrine of Reaganomics when deregulated financial industry began to distend.

Two last decades of the 20^th century saw two financial crises triggered by deregulation – S&L crisis and the dot-com bubble. The former is thought to have been caused by excessive law liberalisation, the latter by simple lack of integrity. The film brings back commonly known, exposed by the press, examples of stock market analysts saying privately the dot-com stocks they had valuated at sky-high prices were just junk.

The end of the previous century brought also much more tie-ups between business and politics. Transfers from positions of CEOs of big investment banks to positions in state administration and the other way round became the order of the day. Number of lobbyists hired by financial industry to protect its interests soared. Belief in self-regulation of the financial industry became an officially recognised doctrine.

Part 2: The Bubble

Around 2000, deregulation was full-blown and any attempts to bring some markets under supervision met stiff resistance from financial industry, backed by officials from FED, at that time chaired by Alan Greenspan, an remorseless advocate of deregulation. One of the proposals eventually rejected around 10 years ago was the one to oversee derivatives market. Personally I’m in two minds about this. Derivatives are like axe, itself good, good when you use to it to chop wood, but evil when you use it to kill your mother-in-law. Derivatives can be used for transfer of risk, hedging and speculation. Two first purposes seem safe, but usually derivatives were used for speculation and this sparked the whole turmoil in the recent crisis.

Those who have never dwelled on the mechanism of mortgage lending in the US in early 2000s are recommended to see the part clarifying how this all happened. The same part brings up the ever-lasting issue of risk vs. return trade-off. So either you grant loans to creditworthy borrower and make safely small profits, or give risky loans and cash in more, as long as they perform. You just cannot circumvent this!

The film reminds that one of the causes of the crisis were flawed remuneration schemes that put emphasis only on performance, regardless of risks taken. Risk-adjusted salaries and loss-sharing together with profit-sharing before the crisis could have mitigated the aftermaths of the financial meltdown.

Very remarkable is the last episode of this part in which a psychologist tries to examine the specific features of a typical banker’s personality. As you would have thought this an alpha male, compulsive risk-taker, inconsiderate, acting on the spur of the moment. Such types were much desired by banks and still are, since only thanks to their bravado profits of banks in good times could be that high and banks did not spare money to finance entertainment for them…

Part 3: The Crisis

Begins with the face of Ben Bernanke and his utterance from mid-2005 in which, when interviewed by a journalist of one of US TV stations, he claimed there was very tiny risk that there was a tremendous housing bubble and found it improbable that bursting of it would plunge the whole country into a recession. Several economist claim to have warned Bernanke of the impending disaster but he would always shrug off those warnings. Deliberately?

His pronouncement coincided with the peak of the housing bubble. The film indicates a direct cause why it burst and it is strikingly simple – the housing market run out of suckers who wanted to buy houses at exorbitant prices and financial markets run out of suckers who wanted to buy securities backed by lousy mortgages.

Then comes another commendably clear explanation of how financial crisis spilled over into real economy. Finally, the makers conclude that, as always, those who suffer the most are not those guilty, but the poorest. The bailout programmes rescued big financial institutions (as an economist I realise it was cheaper to help them out than to let them go bust and the whole plan was purely pragmatic) and left millions of ordinary people unaided. This is again symbolised by empty houses, may this bleak sight serve as a symbol of human folly and may it caution others not to repeat the same mistakes.

Part 4: Accountability

What accountability? Current “crony capitalism” is based on lack of responsibility. Either I win or you lose. What a game! Fortunes of banks CEOs who brought institutions the had run on a brink of collapse are intact. Bankers got away with punishment. If someone went to jail, it was only for fraudulent activities. In 2008 and 2009 correlation between remunerations and performance and financial standing of managed institution was totally disrupted.

The film also lays bare the hypocritical take of financial industry on deregulation. Prior to the crisis they were against, in autumn of 2008 when financial tsunami was about to wipe out the whole industry they called for tighter regulation, and when in 2009 the worst was over again they returned to their previous stances.

The crisis has changed nothing. Financial institutions are bigger and more powerful than ever before.

At the end, the film outlines several tie-ups between renowned academics from best business schools in the US and the financial industry. The study of economics, as carried out by people financed by the industry and who get well-paid jobs there, is described as “corrupt” and indeed conflicts of interests are visible… Should we believe scholars then?

Part 5: Where we are now

I am thankful, again, I do not live in the United States. Level of inequality in the US society is continually increasing, while social mobility is decreasing. In Poland, by sheer hard work, it is still possible to rise from rags to riches. Many poor people in Poland still can afford to get in to university and break away from poverty. In the US it is out of reach. The US economy has made a huge shift towards innovativeness and high-tech. Jobs in new industries require good education which, due to its costs, is out of reach for more and more Americans. In Poland financial institutions are not powerful, their power is as big as it should be, maybe except for Pension Fund Managing Companies, which showed how to defend their interests during the debate on pension system earlier this year.

Filmmakers also blame the “culture of going into debts” for the crisis. Media and financial institutions, as they claim, have incited people on consumption spree, brought them into troubles and profited from their misery. Also limited access to higher education is said to be one of the reasons why people run up huge debts.

Barack Obama’s presidency turned out to be a big letdown for all those who had hoped for the CHANGE. He went back on the promises to curb excesses of the financial industry. European government somehow managed to tackle the issue, Mr Obama failed.

The film ends with a lovely conclusion: Real engineers build bridges, financial engineers build dreams. Many people dreamt of their own houses. Their dreams have turned into nightmares.

Personally I have two main reflections after watching the film.

Firstly, if so many people “declined to be interviewed for this film”, are their consciences not clear?

Secondly, I could not resist the impression that many people who agreed to be interviewed mastered lying through their teeth to perfection. This is an immensely useful ability in the contemporary world. Sadly…

No mercy for risk-takers

Sometimes you can hear a widespread opinion that financial markets resemble a casino, sometimes you are told prices of financial instruments do not reflect their fundamental values, but follow a random walk. Even if these assertions are half-truths, they must not be disregarded by anyone who wishes to be a market participant. If you enter a financial market, no matter if you buy, sell, borrow or lend, you take risks. Come to terms with it, put up, or ship out!

Over two years ago Poland witnessed sad stories of companies which speculated on currency options. In 2008 zloty strengthened, its appreciation was potentially detrimental to exporters, for who export sales would no longer be cost-effective. Banks found a solution to their problems – stricken exporters were offered an opportunity to buy currency options on sale of EUR at fixed rate, usually higher than market one. Unfortunately, such a hedge had to cost, so banks came up with a strategy called risk reversal. The rest was once described, there’s no need to repeat it.

Broadly at the same time, in 2008, Polish zloty (hereinafter PLN) hit its high against Swiss Franc (hereinafter CHF). Mortgage loans denominated in CHF were extremely popular in that time, as the housing boom was at its climax, and CHF gave the opportunity to have lower debt service costs, thanks to gradual decline of CHF/PLN exchange rate and lower interest rates in CHF. Then came the turmoil on financial markets and PLN plummeted against currencies of highly-developed countries, deemed to be safe havens. In early 2009 the trend again turned back and zloty’s value in other currencies was back increasing. 2011 saw Greek crisis and printing money in the United States, so EUR and USD began to be regarded as riskier assets, while CHF still enjoyed the status of safe haven and kept strengthening against other, also major, currencies. In July 2008 CHF/PLN rate was at its ever-time lows at around 2.00, in June 2011 it climbed near 3.40. This translates into financial standing of homeowners who have taken out loans in CHF in 2007 or first eight months of 2008 when CHF/PLN rate ranging from 2.00 to 2.50, and who now are facing a problem of mounting debts. Currently many of them have so-called negative equity (what’s the Polish for negative equity?), what means their outstanding debt is higher than the market value of their property, but this is not yet the biggest problem, since as long as they settle their monthly payments in time, banks do not raise any alerts. The bigger problem is posed by rising debt service costs. Monthly instalments, as loans, are also denominated in CHF and then converted into PLN. If a debtor’s rate is 500 CHF, holding everything else unchanged, when CHF/PLN exchange rate was 2.20, a monthly payment was 1,100 PLN. When the rate soared to 3.40, the instalment soared to 1,700 PLN. Makes a difference, doesn’t it. When loan repayments make up a small portion of a borrower’s income, a borrower stays afloat, but if a borrower could only make ends meet when CHF/PLN stood below 2.50 PLN, a borrower is distressed.

The parliamentary election is coming and politicians search for various ways of “buying” votes. Election year is usually a period when politicians from ruling parties are more eager to give away gifts and those staying as opposition have inclinations to come up with promises of gifts they will give away if they win. Some of the Polish politicians have taken a leaf out of Hungarian book and put forward to freeze the CHF/PLN rate at 2.75 for the borrowers who have taken out mortgage loans in CHF at rates lower than 2.75. The difference between the market rate and 2.75 would be paid by the state. But who is “the state”??? Yes, my reader, it’s you, it’s me, it’s every person and every company that pays taxes in Poland. And this ridiculous idea is just another bail-out. Someone has taken a loan in a foreign currency and exposed themselves to a currency risk – cool, now they have to face the music. The scenario in which CHF/PLN goes up by at least 50% should have been taken into account when the decision to take the loan was made! And banks should have prepared sensitivity analyses, but as far as I know the recommendation of Polish Financial Supervision Authority that curbed lending in foreign currencies came into force some two years too late…

This is actually not the first time, in 2009 deputy prime minister Pawlak proposed to cancel legally valid option contracts between stricken companies and banks. The idea to freeze the CHF/PLN rate is not as shockingly silly as the Pawlak’s attempt to turn back time, but will not meet my approval.

On this blog there will never, ever be any consent for bailing out risk-takers. Either you take a risk and accept the rules of the game – you win or lose, or you just don’t engage in risky transactions. If there is to be a relief for troubled borrowers, why doesn’t somebody return me let’s say 200 PLN out of almost 900 PLN I lost recently on the stock market? I knew how aggressive speculation could end up and this time the worst scenario materialised. I made a mistake and covered the loss-making position far too late, thus incurring a bigger loss, but I’m the only one to blame, and I have no right to moan, just as some people with “encumberance in Swiss currency” do. I’m sick of listening to them griping and tell them politely that if they made their bed, they have to sleep in it. And they politely shut up… Maybe I’m ruthless, but those people really have to suffer consequences of their decisions.

Keep your fingers crossed on Thursday, between 10:30 and 11:00 a.m.

Are we in 2008?

The title sounds at least weird, but this is exactly what occured to me quite recently. A few days ago I waited for my friend outside her office and I remembered the time when we met, during our internship at M********* Bank, it was in summer 2008. We looked back on those times and I put our memories into a broader, economic perspective. Then I discussed it with my colleagues at the office and they shared my observations. Three years have passed and economic situation is disturbingly similar to that in 2008. Just come to think of it...

There is a rally on commodities market, just like in 2008.
Rising prices of commodities have sent the inflation rising, just like in 2008.
Stock market has been underperforming for while, although scale of the correction is not as huge as in summer 2008 when the correction turned into a full-blown bear market.
Pace of GDP growth in developed economies is slowing down just like in 2008, there is a serious threat of double-dip recession in Japan and United States.

In 2008 world saw a spectacular turmoil on financial markets following the bankruptcy of Lehman Brothers bank. In 2011 we might witness a similar disaster. This time the biggest sore points are Greece and USA.

Problems of the former have kept us company from May 2010, when it transpired the country would be soon unable to roll over its debts. The default was somehow staved off with a huge bail-out package, but the issue remains unresolved and pain in the necks of European politicians and bankers is getting more and more severe. For the last 13 months Greece has been effectively a corpse, artificially kept alive by a drip of money flowing from the IMF and EU. If it hadn't been for those loans, the stricken country would have gone insolvent on 19 May 2010. This was fended off by the EU mostly because bondholders of the Greek government are mainly French and German banks, which had bought Greek gilts after collapse on sub-prime securities market, as government bonds were at that time deemed to be a risk-free investment. Those banks, if Greece defaulted on its debts would have to write off large sums of money, losses would deplete their equity, or even gobbled them up at all. To prevent a knock-on effect, governments would have to shore up capitals of those banks, but in 2011 it wouldn't be as easy as three years earlier. Then government bonds were treated as safe haven and so called "investors" were eager to help the governments meet their borrowing needs. Today, as government bonds are more or less risky assets, it would be impossible to finance another bank bail-out programme, or at least it would be hard, as potential debt buyers would require a generous rate of return. EU countries are bending over backwards to stave off the Greek disaster, but this looks unfeasible. If the next tranche of the EU / IMF funded rescue package is to be disbursed in July, Greece has to pass an austerity programme that would involve tax hikes and painful cuts in expenditures. Greeks, accustomed to welfare and bunking off, don't give a green light to the programme and the odds it will be carried out are getting lower. If Greece fails to meet requirements set by its lenders and the lenders don't give in and turn a blind eye on Greek governments fecklessness, the real bankruptcy is in the offing. And even if the next tranche is disbursed, problems of the country and its creditors won't be solved, but only postponed. Best case scenario for bondholders is soft restructuring, meaning write-downs on Greek government securities will bemade over time. And Greece itself is poised for a downfall, well-earned downfall... Grrece has long been effectively bankrupt. Everyone realises it, and everyone is afraid to speak it out.

USA are in a slightly better situation. For no apparent reason their debt is rated AAA, despite the fact the country is on its way towards a technical default. If the congress, where republicans have the majority, doesn't raise the debt ceiling by 2 August, the US government will have no money to buy back its treasury bills (by rolling over the debt), what means effective insolvency. Funnily enough, rating agency can downgrade US rating only if the debt ceiling is not increased. So if they keep on running up debts, triple-A rating would be reaffirmed. A farce? No, this is real, so the rating agencies grading US debt as prime investment are in for a disredit comparable to the one with sub-prime securities and Lehman rating. But United States have a way with its creditors that Greece doesn't have. USA can print as much money as they want and monetise their debt - this is the only way it will can be paid off, with the detriment to those hapless guys who hold US treasury bonds. I hope Barack Obama's face will adorn $10,000,000 banknotes and Ben Bernanke will deserve to look at Americans from a $100,000,000 note.

I'm looking forward to both imminent defaults. Both wretched Greece and wretched United States have worked hard to go default and there's no point in averting it. Of course many economists and probably all politicians would disagree with me and do their best to ward off the bankruptcies, as these bankruptcies would give rise to a turmoil on financial markets much bigger than the one following Lehman's collapse. Indeed, they would, but we need to suffer this stress to clean the air and finally learn the lesson from the crisis. Price for living beyond our means should finally be paid, conclusions should be drawn, bail-outs should become thing of the past, moral hazard should recede to the realm of academic discussions on economics.

But they won't...

And please don't ask me what the safe haven for money now is.
Government bonds - no longer
Stocks - will plummet
Commodities - will plummet
Bank deposits - why not, but given the current inflation profits in real terms are negative.
Gold - seems overvalued
Properties - somethign tangible, but don't expect the market value to increase in the coming years...

Was it really about trust?

A follow-up to the story from late August. Not a breakthrough hitherto, although things have moved on a bit. I still haven’t got back a single zloty out of one thousand I had lent my ex-classmate over six months ago.

I tried to get in touch with Karol a few times, he wrote back to some text messages, but never picked up a phone. Once, in mid-October he claimed he had made a transfer to me a month earlier. When I told him I hadn’t received any money he couldn’t believe it, but also couldn’t submit any receipt of bank transfer executed. Funnily enough, not only didn’t he have any confirmation slip, but also he didn’t know to which bank account he had transferred the money. The next day he dropped me another text in which he asserted he had just transferred money and asked for a reply when I got the money. Needless to say I once again I didn’t see a single zloty.

On 19 November Karol’s mother called me. To my surprise it turned out he had told his family about much more transfers sent to me. She also added he wouldn’t return any money to me because he was “undergoing a therapy” and pledged to take over his debts. We also arranged a meeting next day, in the evening. I met up with her in her house in Piaseczno. Once well-furnished and well-maintained flat has lost its finery. Karol’s mother was quite jittery (they still have some other problems in the family) and explained she was desperately trying to borrow some money to straighten things out. I think I managed to talk her out of turning to a loan shark (who the f*ck invented the name of the company which surely doesn’t cater for provident people?) and suggested she should apply for a regular cash loan in a bank. She also asked me not to call Adam (Karol’s brother) because his nerves were frayed after months of sorting out his brother’s problems and having two full-time jobs for a few months to earn more money.

The sentence about the therapy was the most puzzling. The first supposition that occurred to me was that he had got addicted to gambling and lost all his money as a compulsive casino-visitor. Then I began putting the pieces of jigsaw puzzle together, all goings-on from the day I had lent him the money and the possible sequence of events began to unfold it was even more frightful than gambling.

Schizophrenia is a quite possible explanation. Did he lie he was a chairman of a student organisation or did he think he was? Did he have a job or did he think he had a job? Did he think he had had ordered those transfers and was he really baffled because he couldn’t find any documents to prove it? Was his strange behaviour at home, before he moved out, about which his brother told me, a sign of developing mental illness? Probably I’ll never find out the truth about what has happened, but if it’s really schizophrenia, it’s a tragic story. Karol and his family might have met a tragic fate. He was an up-and-coming lawyer, now, regardless of what he’s being cured from, he’s not going to finish his studies. His family, once well-off are now almost destitute. Will they manage to give him a helping hand after they lost all their ample savings getting him out of troubles? A fellow blogger’s wife, who is a psychiatrist, told me care from family and friends is essential to return to a rather normal life after symptoms of schizophrenia recede. Or will he be left to his own devices on account of his misdeeds?

For two weeks they Karol’s mother didn’t call me. If she fails to do it for a while, I’ll get in touch with her in January. Her assurances to pay me off sounded credible, so I’ll give them at least a bit more peaceful period before Christmas. I told her the repayment wasn’t urgent for me and I could wait for some time, but in the long run I wished to get the money back. I hope we’ll agree on a repayment schedule and I mull over what then. Given their situation and mine, I think it would be wise to write down a part of the debt, but only when they repay more than a half of it in time.

Another question is if I’ll every lend any money (except small change everyone can afford to lose) to anyone. I think lending some money (no more than a few hundred PLN) to friends I keep in with regularly doesn’t have to be ruled out. The other thing is securing the loan by signing a loan agreement, which enables me to claim my money in a court. But if I had signed a valid loan agreement with Karol on that hapless day, would I be better off now? I could sue him, I would have to lose time for wrangling with Polish judiciary system and quite probably the court would hand down a ruling favourable for me, but what would the ruling mean in a situation when my debtor is out of cash and, moreover, insane? Maybe his family would go to a great extent to repay the debt? Who would cover the litigation costs? Finally, I’d have to listen the whole sanctimony…

Hmm… I know by dint of age I’m wet behind ears and maybe I don’t handle the matter properly… So what do you make of it?

Who couldn’t care less...

Apologies for not posting last weekend. The profound reason for that negligence was coming down with some undiagnosed illness. It came to me as a surprise. The last time I had been ill in March 2001 and from then on I managed to forget how to feels to have fever or sore throat. Luckily, I’ve almost recuperated (still suffering from some irksome irritation in the throat), so it’s time to catch up…

Prior to coming down with no one knows what, I finally saw the (in)famous public debt meter installed in the very hub of Warsaw. I took the photo to the right on 13 October, so the outstanding debt of the Polish state has risen within ten days by probably some few hundred million PLN. “It’s not the matter how much you owe, the point is how much you earn”, some economist argue. Indeed if you earn one million PLN a year and have to repay a loan of 100,000 PLN you are better off than an unemployed couple with five children who can’t make ends meet and have 1,000 PLN to repay. When it comes to a state an indicator of relative indebtness is debt-to-GDP ratio. In Poland it runs at around 54%. Is it a lot? Japan’s debt has almost reached 200% of its GDP, the country’s economy is stagnating, but nothing heralds an imminent collapse of Japanese public finances. Greek debt-to-GDP ration exceeds 110% and in May 2010 Greece faced serious problems rolling over it. At the same time the same ratio in Italy was five percentage points higher, but financial markets perceived default of Greece as much more probable than Italy’s. In United States public debt accounts for around 80% of its gross domestic product and US bonds are still rated AAA. German public debt has reached record-high levels, but yields on German bonds are the lowest in the history (what makes borrowing very cheap for German taxpayers). Is there any logic in it?

So is 54% a lot? Much depends not only on how much revenues the state collects, but also on how much it spends structure the spending. In Poland rigid government expenses determine the growth of public debt.

Is 54% a reason to worry? Thousands of people pass the display with the meter by every day and they don’t care. Who’s going to pay it off? They? Their children? The state? If the state then who? Who is the state? The prime minister Tusk? The finance minister Rostowski? Do they realise majority of them are Polish state’s creditors? Most of them obligatorily put aside money in pension funds, which are obliged to hold at least 60% of their portfolio in Polish gilts. Some of them put their savings into bond funds (which hold mostly government bonds), some buy government bonds directly. Have they ever thought Polish state could one day go default? Do they realise interest they earn is nothing else but taxes paid by their relatives, friends, neighbours and by… themselves?

Does the government care about the meter? They say in comparison to other, wealthier states, our relative indebtness is negligible and there is no reason to worry. If the European Commission gives consent for not counting government bonds bought by pension funds into public debt, our debt-to-GDP ratio will plunge by around ten percentage points. I dread to see the complacency of minister Rostowski’s face when this creative-accounting decision is passed.

Does the opposition care about the meter? No, they have other stuff to gripe about. Besides, the thoughtless economic policy PiS-led government pursued when they were in power only exacerbated out debt problem. When the economy was thriving, instead of amassing a budget surplus, not only did they fail to reduce the public debt, but they cut revenues and raised spending. Thanks to that pro-cyclical move we are where we are and we wasted the chance to carry through some unpopular reforms when their negative effects could have been mitigated. Minister Rostowski was right to say someone from PiS should apologise to Poles for what their misconduct.

And ordinary people don’t care even if they see the “debt per capita”. Every Pole, including infants, disabled, pupils, senile old men owes 19,267 PLN. Whom do they owe? Partly themselves (individual bondholders), partly banks and investment funds from Poland and abroad. What if there was an initiative to crack down on the problem, chip in and pay it all off? I would join it. I would fork out 19,267 PLN of my savings if it could only help solve the problem. But let’s face it, the idea is completely unfeasible. Many Poles don’t even have so much money put aside, the stats include millions of people who don’t earn any money because they can’t. Most people wouldn’t agree to chip in and pay off our debts. Debts can’t be paid right away because bond holders wouldn’t agree to be paid off before bonds mature. Money would have to be collected and invested somehow, the whole process of paying off would last decades. And finally this one-off move wouldn’t solve structural problems, the debt spiral would just start over, after a few years with no incentives to cut spending the problem would relapse.

I wonder how financial markets would react to the decision of Polish government not to refinance its debt. In practice it wouldn’t be a decision not to issue new bonds, but the bonds would be issued on terms set by the government. It would be them who would beg us for issuing bonds, not us begging them to finance our debt. Interesting!

This burning issue could be addressed by some academics from my school, but I don’t believe it will ever happen. Students are believed to be have in innate tendency to bunk off, but from what I’ve noticed that affliction is rubbing off on lecturers. The fact that students are lazy is commonly known, but the fact scholars are lazy and don’t even bother to pretend they aren’t becomes embarrassing. I observe how laziness and ignorance are becoming a virtue. This is how the Polish higher education system is going downhill. Students want to put as little effort as possible and lecturers simply play along with them, because they find it convenient. Soon no classes will be held, students won’t have to attend them, lecturers will be paid anyway, in the exam period easy exams on which everyone cheats will be held. Happy students will get their diplomas, a bunch of wankers will get paid and thus will also be happy, nobody will get tired and that’s the point!

Within last two weeks I found out that:
1. If a lecture starts ten minutes later, it is a sufficient reason to finish it ten minutes earlier and have a fifteen minutes long break. Ninety minutes shrink to sixty five. And everyone is happy.
2. The blue chip index of Paris Stock Exchange is CACK 40. And Mr Lecturer thought it very clever of him to hit students with such an English-language joke.
3. And last but not least during the workshop I found out I even can’t lie so I don’t deserve to be called a student. („pan oszukiwać nie umie, co z pana za student?”)

I’ve felt like a sucker many times in life, given that I’m generally straightforward this feeling will be haunting me, but this time it wasn’t just an insult to me (I couldn’t be even assertive enough to respond to it without striking back), but it bore testimony to what set of values is instilled in students. Appalling. And, to make it worse, no one will stand up to it!

Alright, the school is bringing me down, but I’ve got just three months left there. And what after I graduate? I should look out for a job…

It’s not an easy task, some people have more luck than others. For instance, this year’s graduate, daughter of current finance minister, aged 23, was fixed up with a cushy job in Polish Foreign Ministry. According to the Ministry’s spokesman, previous translators did their job poorly and minister Sikorski was dissatisfied with them (here I do believe it, after seeing korpus dyplomatyczny translated as “diplomatic corpse” and dziękujemy za gościnność as “we thank for your hostility” I know anything’s possible) and decided to fire them and take on his fellow minister’s daughter. Since then, all minister’s speeches and official writings have been edited by Ms Rostowska who ensures they are all written in impeccable English.

Ms Rostowska is not well-known public figure, so journalist paid by hostile media had to go an extra mile to find any photo of her. The only one they procured was her profile picture from facebook (right) which proves her impeccable credentials, high qualifications and fondness for modern art. This photo disappeared from all main news sites after Ms Rostowska filed several request to remove it and now it can be found on some niche sites only. For no apparent reason the news item also has been removed from most main sites, but what has once been put into Internet will remain there forever and info about Ms Rostowska career circulates around the Net.

I screwed it all up and can’t boast about no prior experience as Mr Rostowska (if she hadn’t worked during her studies, what they hell do they do in England?), but if it happens that I have to look for a job next year, I’ll have to set a new photo as a profile picture on facebook. In the foreground: me, wielding a bottle of plonk, in the background, a board saying “I feel like shagging a young piece of arse” (mam ochotę przelecieć jakąś młodą dupę). Will it boost my chances on labour market? If a recruiter from the company I worked for this summer had found my blog (I try to keep it rather anonymous, but I didn’t do so at the beginning), would it make a problem to find my profile on facebook?

Yes, I admit, I am nasty and malicious, but that’s the way of coping with absurdities.

Next week I’ll post a book review – will be nicer!

A short story about the price of trust

Till some time ago I thought the price of mistrust was much higher, but the moment I had to pay the price of trust I changed my mind.

Karol (name deliberately changed) joined my class almost exactly ten years ago, when we were beginning our first year at middle school (gimnazjum). I don’t even remember if he sat behind the same desk I sat, or was it me who joined him in. As a rather sociable person he quite easily found his way around us (we’d been together as a class for six years on then), though I can’t say he would get along with everyone for the next three years of middle school. Soon by dint of sitting next to each other we became good mates, though I could never say we had ever been friends. We were just good classmates, spent some time after school together, but surely weren’t friends for good and bad times.

Karol soon became the best student in our class and later even in the whole school. Teachers deemed him to be impeccably well-mannered and he soon also became an exemplary pupil. In fact as we all knew he was not just extraordinarily clever. He was a typical “smarty pants” – no one else would get away with getting a bad grade when being unprepared for a lesson, no one else would wriggle out of being punished for cheating during a class test. For some reason he had a charm which worked on all teachers, but my classmates and I weren’t impressed with his continuous wheeling and dealing.

Karol somehow also had an inclination for trying to outfox everyone around, but not everyone could discern it. Many people, including my parents warned me against him, I treated those advice seriously, but they didn’t dissuade me from helping him putting into practice some of his stillborn ideas. Fortunately, it never ended up badly for me, so actually I could have gone unharmed out of this friendship… Within those three years there were many conflicts within our class, but even despite falling in love with the same girl (who eventually chose him) somehow we didn’t fall out, all tribulations didn’t tear us apart.

As I dropped in on his house quite often, I met his parents and older brother, Adam (name also changed), who incidentally attended the same high school as I did, so we had an opportunity to get to know each other better. Although born to the same parents they were totally different – Adam was a paragon of virtues, Karol kept trying to outwit the whole world around.

With time we my friends from middle school fell in with new companies from high schools, old friendships began to break off. Karol and I met usually met in a bus, since we both commuted to high schools to Warsaw. From time to time we called each other, sent text messages, wished happy birthday or merry Christmas. We hadn’t been keeping in with each other since the beginning of our studies in 2006. Occasionally I met his brother in a bus and when I asked him about Karol, I’d usually hear his inclination for wheeling and dealing had only intensified (to Adam’s discontent).

Karol turned to me a few times in 2008 and 2009. Every time he had a great deal to strike but he was hard up for cash and asked me to lend him some few hundred and later even few thousand zlotys. Every time he claimed he had an opportunity to earn thirty to fifty per cent or so and promised to share profits with me, but never revealed what the gooses that laid golden eggs were. As an economist I know such opportunities generally don’t happen in the real world and each time his loan requests were rejected by me.

On 31 May 2010 a text message from him hit me out of the blue. That time he didn’t write about any profitable (read: shady) business to be done, he said we was in an urgent need of money (2,500 PLN) because he had to pay a bill (lie( of a student organisation he was in charge of (lie). The organisation was about to have its expenses reimbursed within a week plus he was about to get his salary within a few days as well. What he described were just some liquidity problems he temporarily had. He managed to earn my trust by offering to meet quickly and sign a loan agreement that would secure the repayment. On that day I was in the middle of exam period and didn’t wish to bother to meet him to sign a stupid piece of paper.

At the beginning I lied to him I had all my money in stocks and investment funds and it would take me three days to turn the assets to cash, but later on I gave in. I transferred to him 1,000 PLN since I realised this was a quite risky move and of course we didn’t meet up to put any signatures. I know very well why I did it, actually despite myself. Just before it all happened I had painfully experienced a blatant example of mistrust and I told myself the relationships between people could not be founded on mistrust, hence my half-baked decision.

Karol offered to return all money four days later in cash. He offered to come to my house, but as it was the day after Corpus Christi downpour I was busy tidying up my garden I asked him to transfer the money to me next Monday. The other reason was that my parents still don’t know about the sunk money – I somehow don’t fancy hearing the “Haven’t I told you” phrase…

On Sunday he asked me to lend him another 500 PLN, I refused. The money I had lent him didn’t appear next Monday, moreover, Karol stopped answering his phone and writing back to my text messages. Soon his voice mailbox got jammed and I realised things must have gone pretty nasty. I got in touch with his brother who promised to tell him to call me, his mother couldn’t tell me where I could find him. Karol’s behaviour became more and more mysterious.

I had a few phone calls with Adam in June, which consisted in reading between the lines. In early July we finally talked openly. Adam politely asked if I had given his brother any money and if Karol hadn’t given it back to me, I politely confirmed to find out I was a bit out of luck. Karol would behave strangely for the last four years, he moved out from home in 2009. For the last two years his family had been paying his debts until they ran out of cash. They decided not to run up their own debts to repay Karol’s obligations, so all debtors who turned to them were simply rebuffed. Karol managed to ruin financially his quite well-off family. From what I could infer from what Adam had told me, I estimate his all debts could total to around 100,000 PLN. Staggering? During the open conversation in early July Adam told me Karol had assured them he had found a job and promised to give his family a half of his salary. Till now (I called Adam yesterday) they haven’t received a single zloty from Karol. He tritely explained it away by telling his employer hadn’t paid him yet. Adam and his parents still remember about my ten stoovers and still openly declare they will transfer it back to me as soon as Karol gives them the money. I don’t hold out much hopes for getting the money back, but given the very good stance of Karol’s family, there’s still a glimmer of hope. I’ll treat this thousand as a windfall if it ever comes back to me.

Never mind the money now. One thousand more won’t make me much happier, one thousand less won’t make me much sadder (but wiser?).

How come? He used to be the best student in the whole school, everyone spoke highly about him, he was held in high esteem by everyone. Everyone said he would be really successful in the future. My teachers from middle school would never believe in the story above.

And the roles reversed. Seven years ago his family was much better-off than mine. Karol had brand-name clothes and footwear, would go on holiday abroad two years in a year, had all electronic gadgets. At the same time I had clothes from normal shops or from a supermarket, I within those three years I was abroad once for a week and spent two third of my holidays at home and didn’t have all newest consumer electronics devices – my parents were scrimping and saving to buy their dreamt-up house. Today my family’s and mine financial standing is satisfying, his family is flat broke and he ended up as a downright cheater.

I wonder what Karol feels now. I’d be surely conscience-stricken having done something so awful. I wonder how it feels to borrow money with an intention not to give it back. When I talked about it with Scatts two months ago he said in the UK he would never make a down payment for a house without securing it properly, which is normal in Poland. In the UK, in turn, he would lend someone a few hundred pound right away, in Poland he wouldn’t hope to get the money back. Cross-cultural differences?

And how did Karol manage to get into such debts? Stock market? Not that easy. Gambling? Possible. Leveraged risky deals is for me the most probable explanation. If you borrow a lot to increase your profits and it doesn’t work out you’re left with huge debts. That probably dragged Karol (and his family I feel sorry for) down.