Distressed debt in Germany: What's next? Possible innovative exit strategies

During the past two years, private equity funds have acquired substantial portfolios of nonperforming loans from banks in Germany. Typically a private equity investor does not commit funds unless exit strategies are clearly defined. The usual exit strategies for distressed debt investors are fix it (restructuring and turnaround), sell it (sale of debt or equity), or shut it down (liquidation). A new alternative exit strategy for NPL investors considered here is the transfer of credit recovery risk. --Focus,diversification,specialization,monitoring,bank returns,bank risk,Non Performing Loans,Distressed debt investing,Synthetic securitization,Collateralized debt obligations,Credit risk transfer,Credit derivatives,Credit default swaps,Credit recovery swaps,Credit portfolio management,Credit portfolio risk,Credit portfolio returns,Efficiency of credit risk portfolio allocations,Learning effects

The re-emergence of distressed exchanges in corporate restructurings

In 2008 and 2009, bondholders of ailing companies were affected by a reemergence of an important corporate restructuring strategy, known as a Distressed Exchange. Fourteen companies in 2008 completed this desperate attempt to avoid a formal bankruptcy filing – about twice as many as any single year in the last 25 years, involving twice as much in dollar amount than in the entire prior history (1984-2007). And, in just the first four months of 2009, nine firms have already completed distressed exchanges. The recovery rate to bondholders participating in distressed exchanges over the last 25 years is significantly higher than recoveries on other, more dramatic types of default – namely payment defaults and bankruptcies. But, there is no guarantee that a distressed exchange will permanently immunize the firm from further distress, with almost 50% of all companies completing distressed exchanges prior to 2008 ultimately filing for bankruptcy

The 2007 Meltdown in Structured Securitization: Searching for Lessons not Scapegoats

The intensity of recent turbulence in financial markets has surprised nearly everyone. This paper searches out the root causes of the crisis, distinguishing them from scapegoating explanations that have been used in policy circles to divert attention from the underlying breakdown of incentives. Incentive conflicts explain how securitization went wrong, why credit ratings proved so inaccurate, and why it is superficial to blame the crisis on mark-to-market accounting, an unexpected loss of liquidity or trends in globalization and deregulation in financial markets. Our analysis finds disturbing implications of the crisis for Basel II and its implementation. We argue that the principal source of financial instability lies in contradictory political and bureaucratic incentives that undermine the effectiveness of financial regulation and supervision in every country in the world. We conclude the paper by identifying reforms that would improve incentives by increasing transparency and accountability in government and industry alike.Financial crisis, Securitization, Regulation and Supervision, Safety Nets

The 2007 Meltdown in Structured Securitization: Searching for Lessons not Scapegoats

The intensity of recent turbulence in financial markets has surprised nearly everyone. This paper searches out the root causes of the crisis, distinguishing them from scapegoating explanations that have been used in policy circles to divert attention from the underlying breakdown of incentives. Incentive conflicts explain how securitization went wrong, why credit ratings proved so inaccurate, and why it is superficial to blame the crisis on mark-to-market accounting, an unexpected loss of liquidity or trends in globalization and deregulation in financial markets. Our analysis finds disturbing implications of the crisis for Basel II and its implementation. We argue that the principal source of financial instability lies in contradictory political and bureaucratic incentives that undermine the effectiveness of financial regulation and supervision in every country in the world. We conclude the paper by identifying reforms that would improve incentives by increasing transparency and accountability in government and industry alike.Financial crisis, Securitization, Regulation and Supervision, Safety Nets

Origins and Resolution of Financial Crises; Lessons from the Current and Northern European Crises

Since July 2007 the world economy has experienced a severe financial crisis originating in the U.S. housing market. The crisis has subsequently spread to the financial sectors in European and Asian economies and led to a severe worldwide recession. The existing literature on financial crises rarely distinguish between factors that create the original strain on the financial sector and factors that explain why these strains lead to system-wide contagion and a possible credit crunch. Most of the literature on financial crises refers to factors that cause an original disruption in the financial system. We argue that a financial crisis with its contagion within the system is caused by failures of legal, regulatory and political institutions. One policy implication of our view is that the need for various forms of rescues of financial firms in times of crises would be reduced if appropriate institutions could be put in place Lacking appropriate institutions to avoid contagion within the financial system and a potential credit crunch, ad hoc financial crisis management is required. We draw on experiences from the financial crises in the Nordic countries at the end of the 1980s and the beginning of the 1990s. In particular, the Swedish model for crisis resolution, which has received attention during the current crisis, is discussed in order to illustrate the problems policy makers face in a financial crisis without appropriate institutions. Current European Union approaches to the crisis are discussed before turning to policy implications from an emerging market perspective in the current crisis.Financial Crisis; Institutional Failure; Insolvency Procedures; Contagion; Systemic Effects; Macroeconomic Shock; Financial Crisis Management; Swedish Model

Credit derivatives, macro risks, and systemic risks

This paper explores some bigger-picture risks associated with credit derivatives. Drawing a distinction between the market's perception of credit and "real credit" as reflected in the formal definition of a credit event, the author examines the well-documented macro drivers of credit generally. ; The author next enumerates frequently cited concerns with credit derivatives: the exceedingly large notional trade in credit default swaps relative to outstanding debt, the increasing involvement of hedge funds in these products, and operational concerns that have surfaced in the past year or two. ; The paper then considers the possibilities of associated systemic risk, looking at the issues of modeling and proper hedging, risk management, and valuation of new and sometimes complex credit derivative instruments. ; Despite the inherent risks involved in credit derivatives, the market for these instruments continues to grow rapidly as people find them practical and beneficial for hedging risk, generating income, and distributing credit risk among a broader institutional base. Evolving market practices and safeguards should help establish a more efficient, transparent marketplace. Whether credit risk is best allocated outside of the traditional financial intermediaries remains an open question.Credit derivatives ; Risk

"The European Central Bank and Why Things Are the Way They Are: A Historic Monetary Policy Pivot Point and Moment of (Relative) Clarity"

Not since the Great Depression have monetary policy matters and institutions weighed so heavily in commercial, financial, and political arenas. Apart from the eurozone crisis and global monetary policy issues, for nearly two years all else has counted for little more than noise on a relative risk basis. In major developed economies, a hypermature secular decline in interest rates is pancaking against a hard, roughly zero lower-rate bound (i.e., barring imposition of rather extreme policies such as a tax on cash holdings, which could conceivably drive rates deeply negative). Relentlessly mounting aggregate debt loads are rendering monetary- and fiscal policy-impaired governments and segments of society insolvent and struggling to escape liquidity quicksands and stubbornly low or negative growth and employment trends. At the center of the current crisis is the European Monetary Union (EMU)-a monetary union lacking fiscal and political integration. Such partial integration limits policy alternatives relative to either full federal integration of member-states or no integration at all. As we have witnessed since spring 2008, this operationally constrained middle ground progressively magnifies economic divergence and political and social discord across member-states. Given the scale and scope of the eurozone crisis, policy and actions taken (or not taken) by the European Central Bank (ECB) meaningfully impact markets large and small, and ripple with force through every major monetary policy domain. History, for the moment, has rendered the ECB the world's most important monetary policy pivot point. Since November 2011, the ECB has taken on an arguably activist liquidity-provider role relative to private banks (and, in some important measure, indirectly to sovereigns) while maintaining its long-held post as rhetorical promoter of staunch fiscal discipline relative to sovereignty-encased "peripheral" states lacking full monetary and fiscal integration. In December 2011, the ECB made clear its intention to inject massive liquidity when faced with crises of scale in future. Already demonstratively disposed toward easing due to conditions on their respective domestic fronts, other major central banks have mobilized since the third quarter of 2011. The collective global central banking policy posture has thus become more homogenized, synchronized, and directionally clear than at any time since early 2009.Eurozone; Monetary Policy; Fiscal Policy; European Central Bank; European Monetary Union; Debt Monetization; Euro; Basel; Sovereign Debt; Credit Default Swaps; Liquidity; Solvency; Deleveraging; LTRO

A Primer on Private Equity at Work: Management, Employment, and Sustainability

[Excerpt] Private equity, hedge funds, sovereign wealth funds and other private pools of capital form part of the growing shadow banking system in the United States; these new financial intermediaries provide an alternative investment mechanism to the traditional banking system. Private equity and hedge funds have their origins in the U.S., while the first sovereign wealth fund was created by the Kuwaiti Government in 1953. While they have separate roots and distinct business models, these alternative investment vehicles increasingly have been merged into overarching asset management funds that encompass all three alternative investments. These funds have wielded increasing power in financial and non-financial sectors – not only via direct investments but also indirectly, as their strategies – such as high use of debt to fund investments – have been adopted by investment arms of banks and by publicly-traded corporations. This primer focuses on private equity (PE) because this is the new financial intermediary that most directly affects the management of, and employment relations in, operating companies that employ millions of U.S. workers. However, as the boundaries among alternative investment funds have begun to blur, we will touch on hedge funds and sovereign wealth funds as their activities relate to private equity. To address the question of why these new financial intermediaries have become prominent in the last three decades, we begin by outlining the changes in financial regulation in the U.S. and the characteristics of labor market institutions that have facilitated the emergence and rapid growth of private equity and other alternative investment funds. We outline the changes in size and scope of the private equity industry; describe the generic PE business model, using examples from the retail sector where it has been particularly active; and examine the sources of gains for PE investors. We then review the impact of private equity buyouts on the sustainability of the operating companies and on workers and employment relations in these companies. In the period since the collapse of the housing and real estate markets and the onset of recession and financial crisis, the risk of financial distress and even bankruptcies among the highly leveraged operating companies in PE portfolios has increased. We examine this increased risk to operating companies in this period. In addition, we discuss the experience of private equity firms in the post-crisis period, noting the signs of recovery in the sector as well as the continuing challenges facing private equity investors. We illustrate our points – both positive and negative – with brief case examples to help clarify the issues. We conclude with proposals for regulatory changes that are needed to curb the destructive outcomes associated with some types of private equity activity

A Primer on Private Equity at Work: Management, Employment, and Sustainability

Private equity, hedge funds, sovereign wealth funds and other private pools of capital form part of the growing shadow banking system in the United States; these new financial intermediaries provide an alternative investment mechanism to the traditional banking system.2 Private equity and hedge funds have their origins in the U.S., while the first sovereign wealth fund was created by the Kuwaiti Government in 1953. While they have separate roots and distinct business models, these alternative investment vehicles increasingly have been merged into overarching asset management funds that encompass all three alternative investments. These funds have wielded increasing power in financial and non-financial sectors -- not only via direct investments but also indirectly, as their strategies -- such as high use of debt to fund investments -- have been adopted by investment arms of banks and by publicly-traded corporations