No Sovereign Immunity

The term ‘Sovereign Lending’ implies the delightful possibility that we could lend out the
Windsors for weddings, bah mitzvahs and sundry supermarket openings, which to a great extent I suppose is what they actually do, except on a somewhat grander scale. However, back in the late 1970s and early 1980s this lending to states turned into a euphemism for trying to get ‘the stuff back’ from bust and over-borrowed nations. This national sovereign lending had become banking fashion fad with new departments being created and the concept of lending to nations was altogether seen to be far more appealing than just lending to the same old corporate again. So why was this suddenly so popular amongst international bankers? Because countries don’t go bankrupt do they! Or do they?

Then there came a realisation that countries can and in fact do go bust. In those days we had the caricature sharp suited American banker going south of the Rio Grande to lend out suitcases of greenbacks at cheap rates to virtually anyone who would take them - so long, that is, as they had some form of a letter of comfort from the local state or government. Thus Latin America was swept up in a frenzy of bank lending with cheap money for projects many of which were seen as being hair brained even in those days.

I recall a steel plant being funded and to be built from scratch in the middle of the Brazilian forests, which to this day I don’t think has produced an ounce of metal, and also the British financing of warships to be stationed in the strategically vital port of the city of Manaus which has to be at least several thousands of miles from the nearest international border. Also at that time we had the new BAe146 being sold as a great short take-off jet, which apparently would be perfect for third world dusty African air strips - except no-one on the continent had the facilities to service four high tech jet engines in the middle of nowhere. I think one was eventually sold to Mali for important national security reasons (presumably for the president to get out of the country quickly).

So money was shipped out and the risks were for someone else to manage. The lending was big, and the fees eye wateringly generous as reflected in the acrylic ‘tombstones’ that listed all the participating banks that joined in the syndication. Where you stood on the list was according to your seniority in the debt, your fee and your banking ego. And for those who said “no” - well, they just weren’t proper players. Big was butch and size was everything. The quality of lending seemed to be a wholly secondary issue.

Of course it all ended in tears, firstly with Mexico’s default but the contagion swiftly spread around the globe and especially throughout Latin America. The low cost rates had doubled and tripled and what was previously just affordable on a good day became totally uneconomic and destructive not only to those states but of course also to the banks in due course as well. Some may recall the failure of Crocker Bank in California which was brought down by its overseas adventures, and of course this in turn triggered the mortal injury for Midland Bank which was eventually to be rescued by HSBC.

Many countries with corrupt leaders and officials were blamed but certainly this was the first time I had come across such degenerate banking behaviour as debt was shovelled out in return for fat fees, and then, to rub salt into the wounds, after the default, usurious penalties were charged just to pile on the pain.

It was not of course just the bankers, certainly the lawyers who drafted the huge tomes of legal documentation had equally astonishing fees and in one case I can recall actually just duplicated documentation within the same tome - presumably to get extra fees for production and output. Nothing seems to change.

However, now we are dealing with a different sort of sovereign debt crisis. Dubai has been a bubble waiting to burst for some time, and has been covered in detail elsewhere, but countries such as Greece and Ireland are closer to home, albeit within the Eurozone. Here the pressures are marked by the widening in the debt spreads and the increasing aggravation of the Germans towards these junior Euro nations who lack the financial discipline to control their borrowing effectively.

This though is not just a financial problem but a political one. The issue will be which
governments will have the strength and courage to face their electorate with what must be penalising measures to try and restructure the country’s finances? Well to be fair Dublin has started to act and face up to their responsibilities, but I fear others will be less determined as their politicians waver and weaken. The reaction from those citizens will not be pleasant and I fear a whiff of tear gas will be in the air before twelve months is out.

Although not in the Euro, the one name that also stands out as being a case needing urgent attention is that of the UK. Morgan Stanley’s note last week highlighted some of the threats here if political uncertainty increased and especially if we ended up with an unclear election result. Their worry was that, in extremis, we could see a fiscal crisis with capital flight and Sterling suffering severe weakness along with a sell-off of gilts. The issue must be that whoever is in charge after the election must be able to lay out a credible plan for the nation’s debt management - if not then we will almost certainly lose our valuable AAA credit rate status.

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One of the immediate effects of investors trying to find anything better than ‘sod all’ on cash accounts has been the ‘dash for trash’ that I have mentioned before. One the consequences for that is the inevitable pulling forward of flotations and IPOs as corporate advisers take advantage of a window of opportunity to raise money for businesses and get their prospective new issues away. These may well include such names as New Look, Gartmore and Pets at Home.

These floats may well in fact have a very important structural effect on our economy as many of these companies will be coming from the private equity stables. Private Equity has suffered greatly for the past two years as they have been unable to move their portfolios of investments.

This will allow the freeing up of more capital to be deployed into the next generation of
ventures and aid the depleted banking system in the provision of support. After such a period of corporate constipation, some economic syrup of figs could provide some much needed relief. Eew, sorry.

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And finally... Wisconsin, USA. Planning and timing is everything in a good crime. Maybe the bank robber needed the money to buy a watch. It would seem he needed one after arriving six minutes after the Guardian Credit Union in Waukesha closed. Police said a man wearing a ski mask entered the first set of doors at 5:36 p.m. on Wednesday with a gun, apparently not realising the bank was closed.

Police Sgt. Jerry Habanek told the press that police are reviewing security tapes and
investigating. He said the robber could have planned poorly or possibly had another reason, like getting tied up in traffic.

The message is clear. If you want to really rob a bank - join one.

Have a good week.

Justin A Urquart Stewart
Director
Seven Investment Management Limited

For previous editions of our Weekly Update, please click here

This article represents a personal and light-hearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777. Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.