This article published exclusively on www.districonsult.com is based on news items regularly published and available on the Districonsult web site. It is voluntarily witty to allow us remembering that keeping a sense of humor is the best way to fight the consequences of the recession.
The year 2008 and particularly its last quarter will leave a profound imprint on all the Icelanders who were made to believe that the good times will last for ever. There were some minor financial alerts during the summer of 2007, like the subprime crisis and the beginning of the credit crunch but these were minor regional issues affecting only the real estate sector in a foreign country across the ocean. The Icelanders were not fully aware that their booming economy was built on three interrelated columns: globalization, leverage and debt creation.
Nevetheless, it was a real success story and as the Iceland information office emphatically describes it. “ The Icelandic economy is unique in size, its framework is outstanding, its fiscal position is pretty strong and its financial system is unique”. In other words, Iceland is an advanced country with excellent institutions. Its GDP per capita, ranks fifth highest in the world. Other figures speak for themselves: longevity is highest for males and the third highest for females. Unemployment is virtually unknown and criminality is nil. To sum it up, a paradise island surrounded by cold waters and covered with geysers.
The Banking sector was flourishing: Iceland’s big banks – Glitnir, Kaupthing and Landsbanki – expanded rapdily and accumulated assets of almost €100 billions which were about ten times the size of the Icelandic economy. In 2006, an analyst at Merrill Lynch warned the Icelanders “We are seeing the classic signs of an overleveraged banking system and this has flashed a red alarm signal. The banks are extremely vulnerable. Iceland’s biggest banks have grown so fast in the past three years that the loans they have made are now three times as great as their deposits, which is far above the European average”.
The Icelanders decided to ignore foreign advices and thought that their local recipes for enrichment or value creation were unique. They enjoyed very much making money with foreigners’ funds attracted by attractive interest rates, not available in other islands’ banks. The Icelandic ideal was to create mountains of debts which they would not be able to pay back or which could be included into an international rescue package. The party went on briskly until the main country banks were declared bankrupt on October 3rd 2008.
This wonderful saga describes well the past years until October 2008, as we all experienced them. These tales based on globalization, leverage and debt creation continued unabated until they got disbanded in the October global storms.
In spite of cool economic winds blowing since the summer of 2007, the Dow Industrial Index was still above 10000 at the beginning of the year and the FTSE above 7000. They are now respectively slightly above 5200 and 4000. Oil was at 90 dollars a barrel, went up to 147 in July and is around 60 dollars now. Gold was at 800$, went up to 1000$ in March and now is around 700$ a troy.
It took us a while to grasp the incomprehensible ups and downs of oil, metals and equities. Now it seems important to read carefully what follows quoted from RGE Monitor on 23.10 and reported on this web site: “Hedge fund indices agree that hedge funds started to lose money in July – and lost it in a big way last month. Why? This must be guesswork, but a popular hedge fund strategy involved selling “short” the stocks of banks while betting on energy prices to increase”. The argument was that lower rates to combat the credit crisis would feed through into inflation and cause funds to flow into oil. In the year to mid-July, this trade netted 345%. But then, the oil bubble burst. Since then, the “long oil, short banks” trade has lost 57%. Interesting, isn’t it?
Countries which form the BRIC group thought they were “decoupled” from the rest of the world as their banking systems were thought to be strong as they did not play on the subprime market or did not invest in “toxic assets” like the proud UBS and many others did it. It was mostly ignored that higher interest rates in the BRIC countries allowed them to borrow cheaply in Switzerland or in Japan and invest Yens or Swiss Francs into their performing stock markets which subsequently boomed and burst. We came only lately to realize, like all Icelanders, that no economy is decoupled and when the USA has pneunomia like they have to day, the rest of the world sneezes.
In 2006, New York University Professor Nouriel Roubini told large audiences at the IMF and World Bank that the financial crisis was gathering strength. On August 17th 2008, the New York Times revealed his name and prophecies in an article called “the seer that saw the storm coming”. Roubini’s predictions were based upon the analysis of the recurrent crisis which affected in the nineties several emerging countries like Brazil, Russia, Thailand, Indonesia and Argentina.
He observed that all these countries, before the crisis occurred, had common features: huge current account deficits financed with foreign borrowings, unregulated banking systems plagued with excessive borrowing and reckless lending. Corporate governance was often weak, with cronyism in abundance. Nouriel Roubini made extensive use of international comparisons and historical analogies employing a non technical framework to support his analysis and predictions.
He added pointedly: “This is not a subprime crisis but we also have problems with credit-card debts, student loans debts, home equity loans, auto loans, corporate debts and loans that financed leveraged buy outs. “All these forms of debt suffer from some or all of same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of credit rating agencies and lax government oversight. In conclusion, Professor Nouriel Roubini said: “The US financial system does not have only a subprime mortgage problem, but an overall subprime financial system crisis".
In November 2007, in a well researched presentation, Marc Fermont told an unaware industry audience in Puerto Rico that the main issue affecting chemical distribution globally was the rising debt levels of Private Equity owned chemical distributors. He added "to understand the performance and strategy of private equity owned companies, you need to analyze their debt levels and relevant debt costs" and concluded that “there is confusion between value creation and debt expansion, as the reported growing values shown for some recent transactions match up with mounting debt levels”.
Some members of the audience were surprised as they believed that chemical distribution was not affected by the subprime crisis and the impact of growing global regulations. They underestimated the toxic effects of high indebtedness and increasing interest rates. They were convinced that the private equity financial model was strong and recession proof. An upset participant commented contemptuously that such affirmations were “out of place and out of time”, naively ignoring that globalization, leverage and debt creation were the lifeblood which irrigated Icelandic and other countries’ economies at the time and until the final October 2008 crash.
Finally as published on October 22nd 2008, in front of the US House Committee, Alan Greenspan recognized that his ideology was flawed. Henry Waxman, the Committee Chairman, asked Greenspan: "You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crises. You were advised to do so by many others and now the whole economy pay the price” "Do you feel that your ideology pushed you to make decisions that you wish you had not made?" Greenspan replied: "Yes I found a flaw. I don't know how significant or permanent it is, but I've been very distressed by that fact." The problem is that this “flaw “ based on erroneous credit practices, leverage, debt creation and sometimes frauds has brought the world into its worst recession since forty years with rising youth unemployment, declining output, lower demand, cheated shareholders and poorer pensioners.
What will happen next to the Icelanders?
Few of us really care as we only know Bjork there: most Icelanders will go back fishing and bath in hot springs and their restructured Banks will parsimoniously manage, lend and borrow money to their local customers. Their foreign clients will go back to their local banks to pay their rent and will not seek anymore higher interest rates from overseas banking accounts.
What will happen next to Chemical Distributors?
I really care as I have many friends in the industry and I see the great professionalism and passion to succeed which exist in this important sector of the chemical industry. Most distributors will continue to successfully buy and sell chemicals and get good margins for it. They will face real challenges due to the global recession, lower chemical demand and prices and in some instances declining margins. Those companies with low debts and good operations will be able to cope with all these challenges and the high REACH registration costs. Some other distributors whose reputable owners are domiciled off-shore will additionally make huge efforts to pay back debts and higher interest costs. This might be more challenging to do in the future when and if margins decline.
Finally, all distributors will remember that ultimately customers and suppliers decide on the fate of their enterprise. Distributors will soon disregard impractical financially driven concepts conceived in Reykjavik and move back to long-established customer driven concepts based on giving customers good products and a superior service at a reasonable price, while managing effectively supplier partnerships.
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