My Overdrive column on the US subprime housing woes. 

Now we are witnessing the dark side of global finance. The crisis in the US subprime mortgage market is sending a rippling effect across the global financial markets, hitting stock markets badly and causing a credit squeeze.

The Thai stock market has not been spared the wrath as it has been facing selling pressure over the past week. Yesterday alone the SET index shed almost 4 per cent on selling pressure of the foreign institutional investors, who needed the cash to meet redemption or alleviate the tight credit situation at their homes.

How can the event in the US subprime mortgage market shock the world and result in a global credit squeeze?

It started off with easy credit and the low interest rate environment several years back. Financial institutions or mortgage companies went after homebuyers like crazy, giving them easy loans to purchase their homes. Buyers with obscure credit histories have also found the money being placed into their hands.

Never mind the payback time. If these homebuyers could not pay their instalments, the financial institutions or mortgage companies could foreclose the properties and sold them to other buyers. By the way, US home prices would continue to rise, so that at the end of the day nobody would get hurt.

Then there were a bunch of smart US investment bankers, who repackaged these risky subprime loans into mortgagebacked securities and resold them to not only US investors but also to investors around the world.

That was not the end of the story yet. The investment bankers also bundled the subprime mortagebacked securities, mixed them up with other financial instruments and called them as collateralised debt obligations (CDOs). The CDOs, bundled together with high and poor quality productions, were also sold worldwide, with European financial institutions and insurance companies having the largest exposure. The buyers grabbed the CDOs, which gave out yields of more than 10 per cent compared to more than 5 per cent for government treasuries.

The problems were accentuated several weeks ago when defaults among the subprime mortgage borrowers were becoming more apparent. As demand for the US securities or CDOs dried up, the banks and funds were unable to sell and had to mark down the value of their holdings.

This has resulted in a chain effect because banks are unwilling to lend money out because they are not certain with the credit worthiness of their institutional clients. This has in turn spooked the global investors and caused credit markets worldwide to tighten.

The US Federal Reserve, the European Central Bank, the Bank of Japan and other central banks have reacted to the credit squeeze by pumping cash by a combined of more than US$300 billion into money markets to smooth out trading, otherwise the global financial systems would collapse.

The European Central Bank has been in the biggest trouble because of the heavy exposure of the European financial institutions and funds to the CDOs. It is bloodsoaked, having to pour in the largest chunk of liquidity to save the European financial markets.

In the meantime, the European financial institutions and funds with exposure to the US mortgage securities and CDOs are losing money in a hurry. The dust has not settled yet. Once the turmoil subsides, we’ll see several institutions folding their business.

Is the US doing enough to calm the financial turmoil. The Fed has not been much in a hurry to come to the rescue. Some economists even argue that the Fed should not cut interest rate to help out the banks and the institutions facing the crunch because that would create a moral hazard like the time of the collapse of the hedge fund LTCM in 1998.

Instead, the Fed should continue to focus on inflation targeting, or managing its monetary policy to curb inflation at a time when the general economic situation remains intact.

By the way, the US investment bankers have flooded the world with the CDOs. The European and Asian institutions and funds now have learnt another hard lesson. They will never beat out the Americans when it comes to highrisk, highreturn financial derivatives.

When the dust settles, somebody might step in to buy these CDOs back at sharp discounts.

Thailand is facing the tailspin from this global financial turmoil. The foreign investors, who earlier held about Bt400Bt500 billion in Thai stocks, are retreating to bring the cash home to meet redemption.

Fortunately, the Thai banks have not yet become too sophisticated with their investment portfolio. They have very little exposure to the CDOs. However, the Thai authorities have to stay alert over any ramifications of the global credit squeeze by being prepared to pour in liquidity to keep the Thai financial system afloat and to prevent the Thai companies from facing the credit squeeze.

August 15, 2007

Currency Act stumbles at the doorstep of Parliament

6:30 PM:  Dr Chalongphob Susangkarn, the finance minister, was scheduled to introduce the draft amendment to the Currency Act to the National Legislative Assembly in the afternoon. But he abruptly decided to pull it out before members of the NLA had a chance to deliberate it.

Apparently, Chalongphob sensed that something fishy was going on.

He was afraid that if he did not move fast enough, he might suffer a similar fate like Krirk-krai Jiraphaet, the commerce minister. Krirk-krai lost the battle last week to push through draft amendment of the Foreign Business Act after fierce resistance from the hard core members of the NLA.

Chalongphob would like to delay the deliberation of the Currency Act until September 12, 2007. During this time, he would like the Bank of Thailand to educate or inform the public about the merit of this draft amendment.

Chalongphob said he was afraid that some media and some Thais did not understand the merit of the draft amendment good enough.

Those who oppose the draft amendment of the Currency Act belong to the same group, who spearheaded a drive to torpedo the draft amendment of the Foreign Business Act last week.

The Bank of Thailand, who will have oversight over this law, has become a fat target following its controversial management of the foreign exchange policy. The NLA would like to hold the BOT in check.

Chalongphob will need a lot of political lobbying to do if he would like to pass the Currency Act. He should not commit the same mistake as Krirk-krai, who was not prepared at all to deal with the rebels in the NLA. They succeeded in grilling and cornering him into withdrawing the draft amendment of the Foreign Business Act.

Personally, I think the financial laws -- from the Currency Act, the Financial Institutions Act, the Bank of Thailand Act to the Deposit Guarantee Institution Act -- need to be passed because they would strengthen our financial system.

But the hard core members of the NLA are relying on nationalistic tactics to kill these laws, although some would like to show off their muscle because they are aiming for further political career in the next government.

Offshore and onshore baht tried to bridge gap 

The gap between the offshore and onshore baht rates has narrowed further. In the morning session, the offshore spot rate stood at Bt33.10/US dollar, compared to Bt32.60/US dollar in the evening.

But the onshore spot rate was Bt34.15/US dollar, with one-year swap premium of Bt0.45.  

The BOT has indicated that they have not intervened in the foreign exchange market in the offshore to curb the baht rise. However, there were lots of rumours over the central bank's intervention, resulting in dollar buying.

However, Thai stock market has still continued to face sell-off from the global turmoil of the US subprime mortgage market. Yesterday the foreign net sell was Bt4 billion. Today, the net sell continued at around Bt2 billion.

August 14, 2007

Currency Act is up for amendment

5:00 PM: Tomorrow the National Legislative Assembly will deliberate an amendment to the Currency Act. It is one out of legal amendments that the Finance Ministry and the Bank of Thailand have proposed as part of a reform of the Thai financial system.

The Council of State, the country's top legal advisory body, has already completed its scrunity of the legal language and framework of the Deposit Guaranteee Corporation Act and the Financial Institutions Act. Both Acts have already been sent back to the Surayud government so that the government may propose them to the National Legislative Assembly for passage.

The Bank of Thailand Act is still under scrutiny of the Council of State. This Act has been delayed a bit because after the arrival of Dr Chalongphob Susangkarn as finance minister earlier this year, he would like to adjust some clauses in this law.

The old version, proposed by MR Pridiyathorn Devakula, required an independent body outside the realm of the Finance Ministry to appoint the governor of the Bank of Thailand. Chalongphob did not agree to this idea. He insisted that the status quo position that Finance Ministry must still hold the authority to appoint or dismiss the central bank's governor.

 The key issue of the amendment to the Currency Act today is how to make it more transparent and make the central bank more accountable to its foreign reserves management.

The Currency Act, once approved by parliament, will require the central bank to mark to market its foreign reserves position every month. This will help create transparency to the central bank's foreign exchange management.

At present, the central bank only marks to market its foreign reserves at the end of its financial year. If it concides with the central bank's massive revaluation of the losses or gains of the foreign exchange in a volatile market environment, it will then cause a big impact on the financial markets.

For instance, at the end of last year the central bank shocked the market when it reported a foreign exchange revaluation loss of Bt174 billion for the whole year operation. If the central bank, which intervened heavily last year by buying up the US dollar to stem the baht appreciation, was required to mark to market its foreign exchange reserves every month, it would have shown incremental losses that would allow the financial markets to absorb the knowledge. The central bank is losing money because it accumulate the dollar assets while the dollar value is falling.

Now the Bank of Thailand holds US$73.2 billion in gross international reserves, and also another US$12.5 billion in dollar forward contracts.

Citigroup Global Markets (August 13, 2007) reports that the proposed amendment to the Currency Act "can indirectly curb the BOT's excess direct market intervention to soothe market instability."

With the huge international reserves, "the BOT may be restrained from taking a strong position to defend US dollar when conversion of export and other offshroe flows favour the baht. A weak baht will always be in favour of the BOT's long dollar position," it said.

Citigrou Global Markets added: "Making these losses or gains transparent with regulator end-month marked to market adjustments, can lower the extent of BOT's involvement in exchange stability. While no limits on how much foreign exchange can be bought or sold will be enforced under the amendment, the regular monthly valuation adjustment of official reserves will enable the monetary authority to assess just how much more financial scope it has for further exchange market intervention that may risk financial losses."

Some people in the financial markets have told me that they suspect that the central bank introduced capital controls in December last year in order to protect itself or in other words prevent its foreign exchange losses from going out of control.

August 14, 2007

Baht onshore/offshore gap narrows

3:15 PM: I received a call from a foreign exchange dealer at a Thai commercial bank informing that the gap between the onshore and offshore baht rates has narrowed significantly. The gap, used to be as wide as Bt4 a month ago, is now less than Bt1.

The spot rate of the offshore baht is traded at Bt31.55/US dolar. The one-year swap rate (the interest rate differential between US and Thai) is Bt1.18.  The outright offshore rate is thus Bt32.73/US dollar.

The spot rate of the onshore baht is Bt34.10/US dollar, while the outright rate is Bt33.63/US dollar (the swap rate is minus due to the Thai interest rate is lower than the US rate).

Therefore, the difference between the onshore and offshore baht rate is now Bt0.90.

Why is the gap between the onshore and offshore baht rates narrowing?

The dealer told me that the international money managers have been selling Thai stocks and taking the money out of the country. This has resulted in a weakening of the baht.

She and her treasury colleagues also suspect that the Bank of Thailand might intervene in the offshore baht market in Singapore weaken the baht and to narrow the gap.

The wide gap has created nervousness among the exporters, who in the past have rushed to sell the dollar for the baht when the offshore baht rate appreciates.

But our Nation's reporter Anoma Srisukkasem believed that the narrower gap between the onshore and offshore baht rates might result from the central bank's July measures, which have allowed baht players in the offshore to access baht in the onshore market to unwind their positions established before the capital control announcement on December 18, 2006.

Some three to four big players stepped into the onshore market to get hold on the baht to unwind their positions. Altogether, the total amount so far has reached around Bt20 billion.

With this relaxation, the Bank of Thailand has demonstrated that it does not have an unkind heart. Probably, this has helped to ease the tight baht situation in Singapore.

The Bank of Thailand is now facing less pressure on how to manage its foreign exchange operations. The six measures that it has earlier announced to further increase foreign exchange liberalisation have helped ease the baht pressure.

"There has been some dollar parking in the offshore, which has also reduced pressure on the baht," one foreign exchange expert told me today.

In the third week of July, the central bank was net buyer of the dollar by around US$550 million. Last week, it was also likely to be a net buyer too. During this time, the central bank does not have to exert to much muscle to keep the baht in line with Thailand's fundamentals due to the events in the US subprime mortgage market and selling pressure of Thai equities.

We shall see whether the central bank will try to keep the baht at the exchange rate target zone of Bt34/US dollar between now and the end of the year now that the baht has broken back to Bt34.10/US dollar.

IN the meantime, the financial markets have stabilised after the intervention of between US$200-US$300 billion by the global central banks to inject liquidity into the financial systems. This has soothed the concern over the credit squeeze arising from the problems in the US subprime mortgage market.

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Local investors offered more alternatives for offshore investments 

The investing public in Thailand is getting more options for starting and expanding their offshore portfolios thanks to the relaxation of quota allocation rules, according to a news report prepared by the Securities and Exchange Commission. 

The meeting – represented by the SEC, the Bank of Thailand, the Fiscal Policy Office, the Stock Exchange of Thailand, the Association of Securities Companies and the Association of Asset Management Companies — agreed that the SEC should provide more flexibility of offshore investments for domestic investors as summarized below:

  
1. An institutional investor is allowed a quota of up to USD50 million only when offshore investments are made through authorized securities brokers or purchased from authorized securities dealers;

2. A general investor is allowed a quota of up to USD5 million only through authorized private fund operators, but investments in securities listed on regulated exchanges may be made through authorized securities brokers;

3. Authorized securities business operators shall report their clients’ offshore portfolios in compliance with the Bank of Thailand’s rules and procedures.

Foreign currency-based offshore securities shall be solicited exclusively to local institutional investors and private funds through securities business licensees in compliance with the SEC’s securities issuance regulations.

In addition, to increase product diversification on the Stock Exchange and business opportunities for local securities firms, the SEC will allow listing and trading of foreign securities in the following forms:

1. Transferable Custody Receipts of such products as leading foreign stocks and those of Exchange Traded Funds: and

2. Foreign companies’ stocks listed on the Stock Exchange, the rules and conditions for which are under the SEC’s consideration.  

Up until now, the Bank of Thailand has allowed only mutual funds, provident funds and proprietary portfolios of securities and asset management companies to undertake offshore investments. 

The SEC Secretary-General Thirachai Phuvanatnaranubala said: “These new criteria mean more alternatives for private funds as well as institutional and general investors to invest abroad with the benefit of professional services and advice. Likewise, asset management and securities companies will be able to make the most of diverse business opportunities.”

Maris Tarab, Chairman of the Association of Investment Management Companies, said: “Under the new rules, our estimate for eligible overseas investments of private funds is 120 billion baht or around 5 percent of the 2.3 trillion baht total of commercial bank deposits of at least 10 million baht per account of natural persons and private sector juristic persons as of the end of May 2007. This excludes the collective 700 billion baht deposit total of non-profit foundations, savings cooperatives, insurance and life insurance companies.” 
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August 12, 2007

Thai equity investors take note

10:10 AM: Thai equity investors should not take the ongoing turbulence of the financial markets and the growing loss of confidence in the global banking system for granted. Due to the credit squeeze, international money managers are likely to sell Thai and other Asian stocks to meet redemptions at home.

According to Nomura International (HK) Ltd (August 9, 2007), although the broad global money supply remains bouyant, there has been a reduction in the cash money markets as a result of tightening lending criteria, cutting off credit lines, and collateral revaluation. Rish aversion has become interestingly evident.

"We continue to warn Asian investors that they will face ongoing indiscriminate selling pressure as Asian financial assets are liquidated by banks in order to offset losses from illiquid assets such as the subprime debt," Nomura said.

"The extraordinary actions by the European Central Bank (which pumps in US$84 billion on Friday on top of US$130 billion on Thursday) and rise in LIBOR hint at a severe liquidity crunch."

Impact of subprime loan panic on Thai banks

9: 30 AM: The direct impact of the subprime loan panic on Thai banks so far is not significant, although we aren't sure yet about the impact on the overall global liquidity and financial system.

Thai banks have small exposure to foreign assets. Their investments total around US$29 billion or 15 per cent of their total assets. Of this amount, almost 90 per cent account for government and other domestic bonds. The remaining 9 per cent or US$2 billion represents foreign investments.

According to a report of CLSA Asia Pacific Markets report (august 8, 2007), Kasikornbank has the highest foreign bond investment portfolio of around 33 per cent of its investment portfolio. But it has no exposure to the CDOs. The majority of its investment is in government bonds and other top graded coroporate bonds.

CLSA estimates that Kasikornbank's foreign bond yield is around 5.3 per cent, which reflects its exposure to overseas bonds with high credit rating.

But on the other hand, BankThai records an implied yield of around 10.9 per cent from its overseas bond holdings. Not surprisingly, BankThai has admitted that it has around US$50 billion in US subprime exposure.

Bank of Ayudha has an exposure of US$85 million in A-rated CDOs, with no exposure to the subprime market.

CLSA's top picks are Kasikornbank, Bank of Ayudhya and Siam City Bank, although overall it rates the Thai banking system as neutral.

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BankThai has given its rationale for investing in foreign assets pr CDOs because of its excess liquidity. According to Bualuang Securities, BankThai's CDOs get 8-9 per cent yields. It is the only Thai bank to have acknowledged the possibility of losing money from its investment in the CDOs as a result of the downturn of the US subprime mortgage market.

That's why it has set aside Bt276.32 million as provisions in the first half of 2007 for this potential loss of investing US$50 million in the collateralised debt obligation backed by US resident mortage market.

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August 11, 2007

US housing bubbles going bust 

10: 30: PM: Alongkorn Polabutr, a deputy leader of the Democrat Party, has called for the government to be prepared for the adverse impact from the bubbles that are going bust in the US sub-prime housing market. The jitters have hit the global financial markets, including the Thai stock market index, which broke below the 800 level on Friday.

Alongkorn recommended that the Surayud government should hold an urgent Cabinet meeting to discuss the impact of the collapse of the US sub-prime housing market on Thailand and try to come up with measures to cushion the country from the potential global financial crisis.

On Friday, major central banks around the world pumped liquidity into the financial systems to prevent a credit squeeze after share prices plummeted sharply on panic selling. The US Federal Reserve injected US$38 billion in three rounds of intervention to save the financial system. 

The European Central Bank pumped in US$84 billion into the financial system on Friday after pitching in US$130 billion on Thursday. The central bank of Japan injected US$8.5 billion, compared with US$4.2 billion for the Reserve Bank of Australia to alleviate the credit squeeze.

What the heck is going on?

The global central banks are afraid of the prospects of an evaporation of liquidity from the financial system. In global finance, liquidity is everything.

In simple term, the problems started with the mortgage loans made to subprime borrowers in the US that went sour. The subprime borrowers have weak credit histories. But the lenders had been eager to push money into their hands so that they could buy new or second homes. Now they are having a difficult time paying off their instalments.

The problems do not end their. For the mortgage loans of the subprime borrowers had been repackaged as mortage-backed securities and sold to the investment banks and other investors globally. The worldwide markets of mortgage backed securities are huge and rather liquidity.

The matter does not end there. For the best and the brightest of the financiers have taken these mortgage-backed securities and repackaged them with other types of debt instruments before selling them as collateralised debt obligations (CDOs). The CDOs securities are designed with complex structures, so that some take the first loss when any of the underlying debt defaults while other securities suffer losses only after the poorer rated tranches lose money.

So when the widespread default in the subprime mortgage borrowers become apparent,  it hit the underlying value of the mortage-backed securities and CDOs. As investment banks, banks, funds and investors have exposure to these complex securities, they are going to lose money badly. This has created a tight credit system as banks do not have confidence to lend money for fears of the bad credit. Without the liquidity, it is difficult to value these complex securities.

To prevent the credit squeeze, the global central banks have to inject liquidity to keep the financial markets functioning. The US Federal Reserve has extended short term loans through the repurchase market. It even takes the mortgage backed securities as collaterals in exchange for the liquidity it injects. This is not its standard practice to accept mortage backed securities, with poor credit ratings, as collaterals.

The Fed's intervention was also aimed at stabilise the interest rates, otherwise the rates could have gone up skyhigh from the credit squeeze.

During the 1997 crisis in Thailand, the Financial Institution Development Fund was forced to provide blanket guarantee to bank and finance company deposits. Still, the depositors rushed to withdraw their money because they were not confidence with the financial status of the ailing finance companies and banks.

They withdrew so much money that the finance companies and banks did not have enough money on hand to hand back to them because the deposits had been extended to long-term investment. So the FIDF had to inject cash or liquidity into these ailing finance companies and banks. In return, the ailing finance companies and banks had to pledged their assets as collaterals, including in the end their office desks, pictures on the walls and computers.

My good guess is that the Fed will have several beautiful abstract pictures of high art to hang on its wall after this stormy episode.