2econdsight

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What does US Banks credit downgrade say about Temasek?

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 If there’s one thing about Temasek Holdings that I learn and that bothers me most the last 3 years reading alternative reports and perspectives that I have missed just relying mostly on The Straits Times, this is it;

It’s my (citizen) money that Temasek managers are playing around with and that they get to pay themselves unknown sums that I (and all my fellow citizens) are told we have no right know or be informed about.

Now, with Chris’ help, I am reminded again that, not only have the PAP government set up a system whereby they take a chunk of our hard-earned money by fiat to give to their retired ex-ministers to oversee (for ? S$mil/yr salary) and their own to manage, pay them who-knows-how-much without telling us (shareholders) their remuneration package, the PAP government also implicitly guarantees that taxpayers’ (mostly citizens’) hard-earned money will backstop any losses or failures of investments by the same Temasek managers.

Thanks a lot, my fellow 69.9% voters who think that is a good way to continue with how their own money is used to invest, pay and guarantee the possible failures of Temasek Holdings!

Is this the kind of PAP-system of transparency and accountability that voters want to bequeath to their next generation? Or should we be demanding what Norwegian get from their Sovereign Fund operations?

Read on and be enlightened….

 

….

In an article earlier this year “Temasek is high risk according to S&P”, the writer points to a significant difference of opinion between Temasek and the credit rating agency S&P when the latter deemed Temasek in the risk category of the likes of Greece when it is graded on a standalone basis. That is to say, Temasek is, in S&P’s language “moderately high risk” and that its AAA-rating rested entirely on “the extreme likelihood of extraordinary support from the government”.

In this, the issue surrounding Temasek’s risk is rather familiar with those surrounding the big global banks in that the “the likelihood of extraordinary support from the government” has consequences.

Consequences of “extraordinary support”

Failures of large banks have severe economic consequences because of the crucial role of banks in capital formation and financial intermediation which drive the modern economy. The bankers therefore rightly assume that in a crisis the respective government will lend them “extraordinary support” because not doing so would invite wholesale economic catastrophe.

This happened in the crisis of 2007 to 2009 and the aftermath as banks received “extraordinary support” from the various governments in the form of special funding facilities, recapitalization or full/partial nationalization; all of which require tax-payers’ money (although the actual loss to taxpayers is a fraction of the amounts provided).

As such, the big banks operated with an “implicit guarantee” from the government. That is to say they are “safe” because ultimately they are backed by taxpayers even if the government makes no such explicit guarantee. This became the source of all sorts of misdeeds, not just the bankers. First the bankers took the necessary business of risk taking to excessive levels in order to generate high profits on ever thinner slice of capital to satisfy shareholders and to reward themselves. Second, bond holders do not monitor their investments in banks closely and accept lower yields than they should because they rightly assume that, at worse, they get repaid by taxpayer’s money. As such cost of financing for the banks are low, providing yet more ammunition for excessive risk taking.

Et tu, Temasek?

If all the above looks vaguely familiar, they do. That is because Temasek operated with the same sort of “implicit” guarantee based on “the extreme likelihood of extraordinary support from the government”. Like the banks, it did not earn its AAA rating itself and need not manage itself to the high standards of that rating because the rating is inferred by the strong credit of the Republic of Singapore.

The reason S&P graded Temasek poorly was not just the issue of the implicit guarantee but also that of Asset Liquidity. Temasek holds large controlling blocks of shares, mainly in markets with questionable depth such as China and Singapore itself (only 24% of its assets are invested in the deep markets of Europe and North America). This level of concentration mean disposal of large shareholdings entailed significant elevation of risk. Although, not an exact like for like comparison, no banks, not even in the cavalier pre 2007 days, have anywhere near the risk concentration of Temasek.

US Bank Downgrades

Last week, S&P downgraded the credit rating of the eight largest US Banks. The banks are also among what are now termed as Globally Systematically Important Banks or G-SIBs which means regulators regarded them as critically important to the functioning of the economy.

“We now consider the likelihood that the US government would provide extraordinary support to its banking system to be ‘uncertain’ and are removing the uplift based on government support from our ratings,” said S&P last week.

Safer and yet downgraded

The downgrade is not an indication of another financial crisis but is due to global financial reforms which makes banks safer and eliminate the implicit guarantee. Much of the safety now entails “bailing in” creditors by requiring banks to maintain high levels TLAC (Total Loss Absorbing Capacity) – holding sufficiently large amount of equity and long term unsecured debt of certain qualification (subordinated, Basel 3 compliant bonds). This provides the banks with the means to resolve their losses without resorting to government bailouts. It also make investors monitor their exposures to banks and accept a price consistent with the risk.

That S&P nevertheless feel necessary to downgrade the banks despite the reforms making banks safer simply points the power of that “extraordinary support” which is now uncertain. That power derives from taxpayers.

Singapore Taxpayers Guarantees Temasek

Now imagine Temasek without the “extraordinary support” which is ultimately provided by Singaporean taxpayers. Its credit rating will not be AAA and most unlikely the AA of Warren Buffet’s investment holding company, Berkshire Hathaway, given Temasek’s risk concentration.

Temasek can only accept the sort of risk concentration prevalent in its entire existence because of its implicit guarantee from the Republic of Singapore. That same implicit guarantee also provided low rate of financing to leverage its risk. Just like the banks. Probably worse because Temasek is also almost guaranteed with long term inflow of funds from the government; that is to say, unlike 99.9% of asset managers it faces no market pressure on its performance.

 

Chris Kuan

 

 

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4 thoughts on “What does US Banks credit downgrade say about Temasek?

  1. We can clearly see the effect of guarantee on the sovereign-debt of PIGS (PIIGS) countries – Portugal, Ireland, (Italy), Greece and Spain – during the debt crisis. These countries were clearly unable to refinance their government debt until the ECB stepped in to guarantee their debt. Now their borrowing costs are LOWER than that of the US Treasury!

    Yes, PIGS (Temasek) can fly as long as the governments want them to.

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    • No, the ECB did not guarantee their debts. Like most central banks, it is legally forbidden to do so (because when a central bank does that, it open a whole of worms in a sense of an easy way out for indebted government through debt monetization which then leads to currency debasement). What the ECB does is that it continues to accept the government bonds of these countries as eligible collateral in its normal open market operations and in this case emergency lending. This is completely different from saying the ECB guarantee their debt.

      Certainly the question is then why should the ECB continue to accept the bonds as eligible collateral. That is because of guarantees provided by the rescue package provided by the EU and the EZ surplus nations (e.g. Germany). To be fair, Ireland and Spain had a short term funding problem that needs bridge financing using guarantees from the EU and EZ surplus nations. The cause of their problem was not excessive govt debt but bank bailouts. Both are out of the woods pretty quickly. Italy had not needed any rescue at all and is actually quite strong because its debt are nearly all held by Italians (due to high savings rate). The real basket cases are Greece and Portugal – both of them were really unfit to have committed themselves to the Euro in the first place.

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      • Yes, technically speaking you are correct. However, the practical effect is that peripheral countries have been bailed out by the ECB. The current round of QE includes over a trillion euros of asset buying, including government bonds. New issues of government debt in some countries (e.g. Germany) have been essentially funded by the program. This has reduced the yields on all EU government bonds to below that of US treasuries, and some sovereign yields have gone negative. Draghi’s ‘Whatever It Takes’ is an implicit ECB guarantee. With his pledge, the euro has depreciated significantly against the USD. Should we call it currency debasement?

        Similarly, the Singapore government technically does not guarantee Temasek. But everyone understands the implicit guarantee of Temasek’s debt.

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  2. In fairness, the ECB is addressing one of many Achilles Heel of the Euro – the legal framework setting up the Euro prevents the central bank from acting as a lender of last resort, Because of this, the Euro is like a foreign currency to each EZ nation. That is to say no country can effectively take charge of its own the monetary regime unlike sovereign central banks like the Fed.

    The question as why European govt bond yields fell below US yields has less to do with the quantitative easing of the ECB but more to do with higher rates of GDP growth and inflation in the US. It should be noted that the US QE which ended 2 years ago was both bigger and longer than what the ECB is now doing; however US yields never approached zero let alone negative. The EZ is flirting with deflation, hence yields for the top notch EZ nations are close to zero or at times negative. The other reason is that the difference in inflation and GDP growth of the German-led bloc and the southern peripheral normally would have shown up in sharply appreciating currencies of the core or conversely sharply depreciating currencies of the southern peripheral. However since currency values are fixed by the adoption of the Euro, these differences show up in much higher bond yields of the peripheral over the core.

    I would not equate the guarantees provided by the EU and the EZ surplus nations to the indebted ones as similar to the implicit guarantee Temasek is operating under. Do note those guarantees came with punitive conditions. Then ask yourself, who has been “punished” for the Temasek and GIC debacle in 2009?

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