MFC Distressing Reality 20090316

MARKET FORCE
June 2007
A View Of Distressing Reality

Market Force
16 March 2009
Real Economy
The Real Economy is driven by consumers spending money on their basic and discretionary needs, and purchasing tangible and intangible assets that serve their current and future purposes Education Medical Retail Housing Assets Cars The goods and services that meet these needs are supplied by manufacturers and service suppliers, who also function as the employment providers for the household wageearners Manufacturing Small Companies Medium Companies
HOUSEHOLDS
Consumers Children Workers
SERVICES
Information Culture
FACTORIES
Construction Large Companies Utilities
Market Force Tourism

Copyright 2001-2009, Market Force Company, All Rights Reserved.
Real Economy
The interaction between these three dynamics is the primary source of value creation (GDP) in the economy, and must be the core focus of any economic progress This model has existed in one form or another throughout history
Market Force
Real Economy + Financial Sector

TRADITIONAL BANKING Assets
Cash Consumer Loans Mortgage Loans Corporate Loans
Liabilities
Customer Deposits
Risk Capital
Traditional banking is a relatively new phenomenon that has developed in a supporting role to serve valuable functions that support the Real Economy : ! Storage of money as a unit of exchange (Customer Deposits = Savings) ! Transaction services that simplify the payment for goods and services ! Providing of loans to finance the purchase of assets, goods and services These functions are provided almost entirely by using Other Peoples Money (OPM)
Market Force
Economic and Financial Interaction

Traditional Banking surrounds much of the real economy, which has come to depend vitally on its smooth functioning
TRADITIONAL BANKING
Market Force

One of the key functions of Traditional Banking is to recycle the funds generated by the Real Economy, providing liquidity and the opportunity for value creation (GDP)
TRADITIONAL BANKING
Market Force

However, it is important to remember that Finance is not the Real Economy It is a derivative of the real economy Without the real economy, Finance has no reason to exist
TRADITIONAL BANKING
Market Force

In principle, Private Equity can represent direct investment into companies and services, and in this model it therefore directly supports the growth of the real economy - but it is also a derivative function, and not a direct creator of GDP itself
PRIVATE EQUITY TRADITIONAL BANKING
Market Force

Listed Equity provides capital to the real economy when companies actually sell their shares to the market, but most of the time it only serves as a trading and valuing platform removed from and derived from the real economy, and is not in itself a primary source of GDP
LISTED EQUITY PRIVATE EQUITY TRADITIONAL BANKING
Market Force

Likewise, Investment Banking is a derivative function assisting the allocation of capital (OPM) to various financing or investing activities
INVESTMENT BANKING LISTED EQUITY PRIVATE EQUITY TRADITIONAL BANKING
Market Force

Most Trading is fundamentally removed from the real economy, and represents transactions with no direct effect on consumption
TRADING INVESTMENT BANKING LISTED EQUITY PRIVATE EQUITY TRADITIONAL BANKING
Market Force

DERIVATIVES
And Derivatives are actually . . . derivatives of derivatives . . . of derivatives . . . of derivatives
TRADING INVESTMENT BANKING LISTED EQUITY PRIVATE EQUITY TRADITIONAL BANKING
Market Force
. . . furthest removed from contributing to real economic activity

CORRUPTED BANKING Assets
Cash Bonds
Liabilities
Customer Deposits
Derivatives Consumer Loans Over the last several decades, as the financial sector has become more sophisticated, the Traditional Banking model has gradually become deeply corrupted : Borrowed Money (especially short-term wholesale financing) has increased bank liability risks Market instruments like Bonds and Derivatives have changed the nature of the bank balance sheet
Mortgage Loans Corporate Loans
Borrowed Money
Risk Capital
Market Force

These new embedded risks were not immediately obvious for the danger they created . . .
TRADITIONAL BANKING
Market Force

. . . until failures elsewhere in the financial system created destruction of derivatives . . .
TRADITIONAL BANKING
Market Force
. . . that in principle should not have spilled over into Traditional Banking

A major consequence has been that Traditional Banking has ceased to perform its vital function of recycling the funds generated by the Real Economy, providing liquidity and the opportunity for value creation (GDP) . . .
TRADITIONAL BANKING
. . . and in fact by causing a reversal of flows, has instead been removing liquidity from the market and destroying the activities of value creation (GDP) Market Force

INITIAL RESPONSES TO CORRUPTED BANKING Assets
Cash Bonds
Liabilities
Customer Deposits
Derivatives Consumer Loans Initial responses to the financial crisis were to try and protect the banks . . . not the real economy : Customer Deposits received government guarantees to try and keep cash in the banks Bank risk capital was refilled Mortgage Loans Corporate Loans Borrowed Money
Risk Capital
Market Force

SECOND-ROUND EFFECTS OF CORRUPTED BANKING Assets
Cash Bonds
Liabilities
Customer Deposits
Derivatives Consumer Loans But these actions did not address the real problems of banks : Borrowed Money was not guaranteed and wanted to flee Bonds and Derivatives continued to collapse in value Mortgage Loans Corporate Loans Borrowed Money
And little was done to maintain the primary Lending function
Risk Capital
Market Force

Liabilities
Customer Deposits
OBSERVATIONS :
1. It has become obvious that governments are effectively obliged to guarantee bank deposits 2. This obligation will not go away in the future
Risk Capital
Market Force

CORRUPTED BANKING Assets
Cash Bonds
Liabilities
Customer Deposits
Derivatives Consumer Loans
OBSERVATIONS (continued) :
3. Huge injections of liquidity into the financial sector have not translated into liquidity for the real economy 4. Banks are actively disintermediating themselves from the real economy in natural response to their balance sheet stress We need to "endure" a period of cyclical correction and capital consolidation
Mortgage Loans Corporate Loans
Borrowed Money
Risk Capital
before real investment and lending activity can begin anew Banker viewpoint, 15 December 2008 Market Force 5. Instead, they are focusing on absorbing the consequences of past errors

Liabilities
Customer Deposits
OBSERVATIONS (continued) :
Risk Capital
6. Contraction of real-economy lending has become the cause of the economic contraction, not the consequence 7. The distressing reality is that without direct intervention, the real economy will be obliged to continue contracting 8. Economic contraction will create business failures, unemployment, and individual bankruptcies 9. Continuation of this process is a Death Spiral, feeding on itself with no clear benefit
Market Force

INTERVENTION BANKING ? Assets
Liabilities
Customer Deposits
CONCLUSIONS :
Risk Reserves
1. The government already effectively owns the liability for Customer Deposits, which is the real money of the economy 2. With banks removing themselves from the market, it seems inevitable that the government must involve in real lending 3. This lending can be funded with the same Customer Deposits that the government has now taken responsibility for 4. And this lending should be structured with a suitable Risk Reserve that covers the practical default risks
Market Force

Liabilities
Customer Deposits
CONCLUSIONS (continued) :
Risk Reserves
5. This Back-To-Basics approach appears to have become inevitable regardless how you choose to dress it up 6. This is not a Korean problem it is a global and systemic problem manifesting in countries all over the world 7. Other countries are implicitly already starting to do this for example, U.S. and UK auto industry bailout attempts 8. The key issue is to ensure continued access to ordinary borrowing for consumers and small and medium businesses
Market Force UNAVOIDABLE SHIFT2001-2009, Market Force Company, All Rights Reserved. OLD TRUTHS Copyright TO A NEW PARADIGM BASED ON

Liabilities
Customer Deposits
IMMEDIATE OPPORTUNITIES FOR KOREA :

1. Silver Bullet Credit Cards 2. Time Bomb Mortgages 3. Too-Short Corporate Loans 4. Working Capital Credit Lines 5. Chaebol Squeeze Bill Payments " Convert immediately to 30-year monthly amortizing
Risk Reserves
" Convert immediately to revolving credits / 5% minimum monthly payment " Encourage conversion to 5~10-year monthly amortizing " Activate immediately for revolving financing of A/R at 80% advance rate " Activate Credit Central to buy chaebol notes and control issuance
Market Force " INCREASE EXISTING LIQUIDITY FOR REAL ECONOMY PARTICIPANTS
" REDUCE MATURITY RISKS (LIQUIDITY SHRINKAGE) FOR REAL ECONOMY PARTICIPANTS Copyright 2001-2009, Market Force Company, All Rights Reserved.
Key Issues - 1
How to get the liquidity recycling machine working again at levels that match recent economic activity, even while the financial sector is being restructured ? Will it become necessary for governments to effectively direct financial lending ? That is what is already happening in the U.S., UK, France, Germany ?, China, Korea, and elsewhere . . . Can Traditional Banking be expected to function effectively without the complete removal of the sources of corruption ? TRADITIONAL BANKING
The implications of this would clearly be to require deposit-taking financial institutions to be completely separated from market-participating institutions, and NOT the other way round as the U.S. Government has recently been encouraging with mergers of investment banks into bank holding companies Because deposit-taking financial institutions must effectively be guaranteed by governments, and perhaps directed by governments, what will be the relevance of their shareholders ? Market Force
Key Issues - 2
Is there a need for the creation of new financial intermediation models that will be more reliable providers of capital and liquidity to the Real Economy, and that can be less prone to amplifying cyclical downturns by withdrawing liquidity from the market when it is most needed ? What implications does all this have for the emergence or continued growth of newer intermediaries in the financial system, including the Islamic Finance model ?
TRADITIONAL BANKING
What implications does all this have for other layers of the financial system ? Is there a valuable role for private capital in Business Development Funds (10 - 20 years time horizon) as distinct from the current role of private equity in short-term leveraged buyout funds (3 - 5 years time horizon) ?
Market Force
June 2007
Market Force
1 August 2008

MFC Distressing Reality 20090316

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

MFC Distressing Reality 20090316

Uploaded by

Copyright:

Available Formats

MARKET FORCE

A View Of Distressing Reality

Market Force Tourism

Real Economy + Financial Sector

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

And Derivatives are actually . . . derivatives of derivatives . . . of derivatives . . . of derivatives

TRADING INVESTMENT BANKING LISTED EQUITY PRIVATE EQUITY TRADITIONAL BANKING

. . . furthest removed from contributing to real economic activity

Real Economy + Financial Sector

Mortgage Loans Corporate Loans

Economic and Financial Interaction

Economic and Financial Interaction

Economic and Financial Interaction

Real Economy + Financial Sector

Real Economy + Financial Sector

And little was done to maintain the primary Lending function

Copyright 2001-2009, Market Force Company, All Rights Reserved.

Real Economy + Financial Sector

Real Economy + Financial Sector

Derivatives Consumer Loans

Mortgage Loans Corporate Loans

Real Economy + Financial Sector

Real Economy + Financial Sector

Real Economy + Financial Sector

Real Economy + Financial Sector

IMMEDIATE OPPORTUNITIES FOR KOREA :

You might also like