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from Global Investing:

A scar on Bahrain’s financial marketplace

Bahrain's civil unrest -- which had a one-year anniversary this week -- has taken a toll on the local economy and left a deep scar on the Gulf state's aspiration to become an international financial hub.

A new paper from the Sovereign Wealth Fund Initiative, a research programme at Center for Emerging Market Enterprises (CEME) at the Fletcher School at Tufts University, examines how the political instability of 2011 is threatening Bahrain's efforts in the past 30 years to diversify its economy and develop the financial centre.

Asim Ali from University of Western Ontario and Shatha Al-Aswad, assistant vice president at State Street, argue in the paper that even before the revolt, Bahrain lagged in building the foundations of a truly international hub in the face of competition from Dubai and Qatar.

Unlike DIFC (Dubai International Financial  Centre) and QFC (Qatar Financial Centre), Bahrain insists upon local labor; currently 70% of employees in its banking and financial services industry are Bahrainis.  Bahrain’s reluctance to hire non-resident  talent  has made  Dubai...an alternative for those investors looking for a centre with more flexible labor practices such as DIFC provide...  The constraints  – a lack of formalized institutional and regulatory structure, along with an ad hoc business environment, underdeveloped infrastructure, and under-supplied skilled workforce – have negatively affected its growth and  potential to become the financial gateway in the Middle East.

Then came the crackdown of protesters.

Its ruling Al-Khalifa family unleashed  a ferocious extra-judicial crackdown against the opposition. It appeared the standard axiom of Gulf ruling families – securing legitimacy and counter-acting political opposition through redistribution of oil wealth – was sorely insufficient to address  citizens’ grievances.  These led not only to international opprobrium of  the  Bahrain government but also made foreign businesses reconsider Bahrain as a financial center – with many foreign business shifting  workers and operations to Dubai... Indeed, confidence in Bahrain as a financial hub took a major blow along with its image as a stable, tolerant and liberal state.

It remains to be seen what impact last year’s pro-democracy uprising will have on the state of Bahrain and its  ambition as a regional financial gateway– especially at a time when Dubai (DIFC) and Qatar (QFC) remain serious contenders to become dominant financial centers in the Middle East.

Bahrain had shown perseverance and strength in building its financial center, but democracy efforts and human right violations were able to  threaten the hard work of more than 30 years.

Bahrain's sovereign wealth fund Mumtalakat, which is leading the country's efforts to diversify its economy away from the hydrocarbon sector, suffered a series of ratings downgrades last year as a result of sovereign downgrades. Mumtalakat is rated triple-B.

from Breakingviews:

A Van Winkle return to Davos and to real problems

By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own.It was well past midnight in late January 2000 when an investment banking contact called my Davos hotel room to share the latest details on Vodafone’s hostile bid for Mannesmann. That was news, but the huge hostile takeover was no longer the largest deal in history. It had been displaced a few weeks earlier by the agreed merger of AOL and Time Warner. Such was the talk of the World Economic Forum. The great and the powerful had gathered together to celebrate the success of business and, especially, of finance.

Exuberance over technology and venture capital was almost limitless back in 2000, thanks to the seemingly limitless rise of the tech stocks. Dotcom startups were all the rage. When Japanese Internet mogul Masayoshi Son finished one panel, he was assailed by a gaggle of entrepreneurs waving business plans for him to peruse. In full disclosure, this columnist two weeks later signed up to establish the online financial commentary business that eventually became Reuters Breakingviews.

Coming back to this gathering 12 years later is a Rip Van Winklerian experience. The old world and its little worries look positively quaint. Back then, at what in retrospect proved to be the height of the Great Moderation, business was booming, the Nasdaq still had another 20 percent or so to climb, companies were merging like mad; everything looked rosy. President Bill Clinton parachuted in to give a victory lap. Even the demonstrations that took place against neoliberalism and world trade now look quaint. Defacing a McDonald’s is a far cry from overthrowing governments.

The economic moderation turned out to be built on financial excess. That AOL deal – hailed as visionary by all the delegates of 2000 – has become the poster child for foolish corporate finance. The Nasdaq is a third lower than 12 years ago (before adjusting for inflation). And the banks – what can I say? From triumph to tribulation.

The political world also looks much more treacherous. Geopolitics has not yielded to the irresistible forward march of free market capitalism, and peace no longer looks like something to be taken for granted. The 9/11 attacks spawned wars in Afghanistan and Iraq – the kinds of conflicts that in 2000 were supposed to be a thing of the past.

The World Economic Forum has changed with the times. The rise of the BRICs has brought greater diversity to the audience, which is a good thing. It has also brought many more people – so many, in fact, the organizers have expanded their caste system. There is now a dizzying number of different badges, each offering differing levels of access and status. It’s much easier to be here and still be excluded from the elite – much like the feeling of many of the world’s dispossessed.

The most striking difference, though, is in the increased complexity and severity of the questions confronting the collection of top business people, politicians, investors and academics. Europe’s sovereign debt crisis keeps trundling forward, bringing to the fore thorny challenges to sovereignty, the role of central banks and the solvency of nations. Instead of Clinton smiling from the podium, this year’s keynote address came from the troubled German Chancellor Angela Merkel, the leader with the most cards at the debt crisis table.

from Breakingviews:

De-globalisation of finance looks here to stay

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The global financial system is becoming more national. Three years after Western taxpayers were forced into a mass bailout of banks, Western lenders are in full retreat, encouraged by regulators and governments.

In the two decades leading up to the financial crisis, national borders became steadily less important in finance. The crisis made it clear that nationality does matter, because domestic taxpayers ended up supporting banks, including their far-flung operations. The crisis also showed that banks had too much leverage.

European banks are now leading a backwards charge. According to Barclays Capital, euro zone lenders had $1.2 trillion of assets in emerging markets in mid-2011 – double the amount just seven years earlier. A significant chunk of those assets are supported by the parent bank’s capital and funding. With capital scarce and funding costs high, retreat is the only option.

Europe’s banks are also pulling back on the business of lending in dollars, which were often borrowed from U.S. money market funds. After U.S. investors fled from Europe last year, that business looks too risky. Though the funds may be returning to the euro zone, banks are likely to remain wary.

Post-crisis regulation is contributing to de-globalisation. Capital-short banks in Europe and elsewhere have sold foreign businesses. And the UK government has accepted the recommendation of its Independent Commission on Banking to ringfence domestic retail banking operations, making foreign and investment banking units less appealing. The U.S. Federal Reserve’s latest stress tests effectively punished big U.S. lenders with extensive European operations by requiring them to be able to withstand a euro zone meltdown. And Canada and Japan fear the U.S. Volcker rule, which bans proprietary trading, will force lenders out of foreign sovereign debt markets.

from MacroScope:

European rescue: Who benefits?

The words "European bailout" normally conjure up images of inefficient public sectors, bloated pensions, corrupt governments. But market analyst John Hussman, in a recent research note cited here by Barry Ritholtz, says the reality is a bit more complicated:

The attempt to rescue distressed European debt by imposing heavy austerity on European people is largely driven by the desire to rescue bank bondholders from losses. Had banks not taken on spectacular amounts of leverage (encouraged by a misguided regulatory environment that required zero capital to be held against sovereign debt), European budget imbalances would have bit far sooner, and would have provoked corrective action years ago.

In other words, even if state actors mishandled government finances, Wall Street was, at the very least, an all-too-willing enabler.

from MacroScope:

Two cheers for financial innovation

Protests against Wall Street and the U.S. financial system are hanging over an annual gathering of economists and social scientists in Chicago. Yale economist Robert Shiller offered two cheers for capitalist finance, saying that while the U.S. free market system has contributed to higher living standards, the vehemence of the recent public outcry points to a need for greater democratization. This is how he put it in a speech:

Occupy Wall Street … was something that in some sense you could see coming. I think we have increasing concerns about inequality, which is getting worse, about the distribution of power.

But rather than throw the financial system out, Shiller called for tinkering. Financial institutions and structures such as insurance or mortgage securitization have a role in improving social and human welfare, Shiller argued. U.S. economic success is due to a financial system that has evolved over centuries and helped improve the quality of life, he added.  A shortcoming of the Occupy Wall Street movement is that it doesn’t accept those contributions, he said.

Changes in financial structures could make the financial system more responsive to people’s needs, said Shiller. For example, a new type of corporate entity that is allowed in six U.S. states – the “benefit corporation” -- could provide incentives for firms to link success more closely to improvements in social welfare. This charter allows the for-profit companies to explicitly pursue a social purpose as well as its business goal. By law, regular corporations have a fiduciary responsibility to their shareholders to be profitable, while a benefit corporation also has some accountability, overseen by a third party, to perform a public good.

Shiller also wonders why there can’t be a mortgage that has automatic work-out provisions built in. Such a mortgage could require changes to terms and conditions if the borrower experienced job loss or other financial strains. The lender would price in the possibility of such losses at the beginning and cautious borrowers might be willing to pay a higher price for the insurance, Shiller said. In effect, a 30-year fixed rate mortgage is a similar instrument, since it allows lenders to pay a higher interest rate for a long-term loan that that they can refinance.

To contain income disparity, there could be a tax indexed to inequality, the Yale professor suggested. When the income of the top 1 percent of U.S. wage earners exceeds a certain multiple of the nation's median income, the tax would kick in. In 2006, that multiple was 36, up from 12.5 in 1980, he said.

Shiller was not subject to the “mic check” interruption that the Occupy movement uses to disrupt some public officials’ speeches. But some thought he was taking too rosy a view of the benefits of the financial system and the public’s willingness to view financial executives sympathetically. Reynold Nesiba, an economics professor at Augustana College in Sioux Falls, South Dakota, said:

from Breakingviews:

Sky’s the limit on euro zone disaster scenarios

By Edward Hadas The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The modern industrial economy rests on three pillars: finance, government and industry. A sudden break-up of the euro zone would damage all three.

The 2008 failure of Lehman Brothers sets a stupidly grim precedent. Fear spread like wildfire across the previously pampered financial sector, producers panicked and the fiscal and monetary authorities dawdled. But the lessons should have been learned. In theory, there is time to prepare for an uneventful return to the pre-euro order of one country-one currency.

In practice, though, no one is close to ready. On the contrary, the financial pillar is already tottering. Depositors and institutional investors are undermining its foundations by running to ever shrinking islands of safety. If the euro fell, the financial equivalent of a multi-car pile-up would be likely: banks deprived of liquidity pull loans, induce recession, run up losses and go out of business. Asset markets become dysfunctional and central banks cannot keep up.

The government has a potent weapon to counter financial shortages: the electronic equivalent of the printing press. An empowered Greek central bank could do it just as well as the European Central Bank. But too much of such monetary creation out of nothing debases currencies and destroys trust. Fiscal deficits and monetary support are already high, so another significant increase in official activism would test the limits of the monetary imperium. The second economic pillar looks brittle.

If any significant governments lose their credibility – France, Italy, the United States and UK are all candidates - global financial disarray is all but certain. The result would be a hit to the third pillar, industry. World trade fell 11 percent in 2009 and global GDP declined by 0.7 percent. With governments weaker now than then, those declines could be doubled or tripled this time around. The chaos might tempt some government to use one of their non-economic powers: to engage in war.

from Unstructured Finance:

At the intersection of Wall and Main

By Jennifer Ablan and Matthew Goldstein

Whether you agree with it or not, the Occupy Wall Street protests that began two months ago in New York have ignited a debate over income inequality and the political clout of the nation’s banks.

Before the protesters began camping out in Zuccotti Park in lower Manhattan, much of the conversation had  focused on the federal government’s debt and not the equally big debt run-up by U.S. consumers in the years before the financial crisis. Now it seems you can’t go a day without reading a story about the vast gulf between rich and poor and the shrinking middle class, or how the housing crisis won’t get fixed until something is done to alleviate the burden for millions of homeowners who are underwater on their mortgages.

Last month a group of graduate journalism students from Columbia University spent some time at the Occupy Wall Street encampment in Zuccotti where they did in-depth interviews with over 200 protesters. (This was before New York City moved to forbid people from sleeping out in the concrete plaza). And the students findings were surprising in that the OWS protesters weren’t just a bunch of unemployed hippies, who all vote Democratic. Rather, they found that the majority of protesters didn’t identify with either political party, 56 percent didn’t have private health insurance and just under 40 percent gave President Obame a grade of C for managing the economy.

We talked to two of the students, Lili Holzer-Glier and Mollie Bloudoff-Indelicato, and this video discusses some of their research.

The findings of the Columbia students are something that many who work on Wall Street might want to pay more attention to. In our story “The Wall Street Disconnect,” we found that many of the 1 percent of the finance world just don’t get why so many people in the U.S. and around the world are upset with their profession.

The disconnect between Wall Street and Main Street is a bit startling, given that three years after the worst of the financial crisis unemployment remains at 9 percent, 15 percent of the country is on food stamps and at least 20 million people live in extreme poverty in this country. And in many states, entire neighborhoods are ravaged by foreclosures.

from MacroScope:

MF Global knows its former clients’ pain

Futures customers who smartly pulled their money out of failed MF Global Holdings Inc. in the weeks or months before the broker’s Oct. 31 collapse may not have escaped calamity after all.

As Reuters’ Jeanine Prezioso reports, some are worried the bankruptcy trustee could come after those funds to force them to share in any losses.

MF Global knows the feeling. It's been there, and done that.

After futures broker Sentinel Management Group Inc failed in 2007, the trustee in that case, Frederick Grede, sued 50 of its former customers to recoup $600 million in funds withdrawn prior to the bankruptcy.

Among them was MF Global, which had withdrawn $50 million from Sentinel shortly before Sentinel froze all accounts in a desperate effort to avert catastrophe.

MF Global, like Sentinel’s other customers, had deposited its own customers’ funds with Sentinel, which promised to deliver higher returns on those funds than MF Global could have generated on its own.

Instead, the broker collapsed, and four years later Sentinel’s trustee is still trying to get former customers, including MF Global, to share in Sentinel’s massive losses –nearly all of which, Grede says, stemmed from the broker’s failure to keep customer funds separate from its own.

from MacroScope:

MF Global: back to the futures

The implosion of MF Global Holdings Ltd, the largest independent U.S. futures broker until it filed for bankruptcy protection on Monday, calls to mind the collapse of Refco – which in its time was the largest independent U.S. futures broker – after revelations that Refco’s CEO had defrauded his investors. (London hedge fund company Man Group Plc bought Refco’s futures brokerage just about six years ago, and later spun off its brokerage and renamed it MF Global.)

But now that questions are arising on the whereabouts of assets that clients entrusted to Jon Corzine’s firm to back their futures trades,  it may also be worthwhile to bear in mind the bankruptcy of another futures brokerage – that of Sentinel Management, in 2007.

Sentinel was a different kind of futures brokerage than MF Global. The company largely managed money for other futures brokers, delivering outsized returns that, Sentinel's bankruptcy trustee says, were juiced up by improperly using customer money to secure bank loans that went to fund risky trades.  When the credit crisis hit in the summer of 2007, the scheme unraveled, and Sentinel quickly plunged into bankruptcy. Sentinel managed about $2 billion in customer assets; about $600 million of it was never recovered, and clients are still wrangling over how to divvy up what remains.

Futures brokers are required to keep their customers’ funds in dedicated accounts to protect them from being used for anything other than client business. At Sentinel, customer funds were allegedly moved from those protected accounts to other accounts so they could be used as collateral for loans to Sentinel’s  own trading operations. What happened at Sentinel “is one of the biggest regulatory violations you can commit,” explains Sentinel’s bankruptcy trustee Frederick Grede, because keeping customer accounts separate is a bedrock of the futures industry.  “It is so rare that when you first look at it, you can’t believe that it happened.” (Update: Sentinel's former owner and head trader both deny they mixed client accounts with the house account.)

Still, it does happen. In fact, Refco was slapped with a $1.25 million fine in 1994 and another $925,000 fine in 1996 for failing to segregate customer funds. But no customers lost money because of it. At Sentinel, it appears they did.

MF Global has not been accused of any wrongdoing, but on Tuesday its exchange regulator, CME Group Inc, said it was “not in compliance” with requirements to keep customer money separate from the firm’s other money, and the Federal Bureau of Investigation was showing preliminary interest. UBS analyst Alex Kramm says:

Money is supposed to be segregated at all times. If it’s not, clearly something was not right.

from The Great Debate:

Three principles for a new Wall Street

By Don Tapscott The view expressed here are his own.

Protesters set up the “Occupy Wall Street” base camp in New York a month ago because the location epitomizes the economic forces that control the U.S. and global economies. As one sign read: “This is not a recession. It’s a robbery.” To many it feels like just that. The financial services industry is in desperate need of reform. Many bankers have behaved as secretive corporate titans serving only their own interests, and insist the devastating consequences are not their fault. They are failing to fulfill their obligations to society—in some cases, even to shareholders--and a growing number of critics view the day-to-day behavior of the financial services industry as unacceptable. If the industry doesn’t initiate reform from within then it will eventually have more extreme reform imposed from outside.

In 2008, the routine gambles of Wall Street almost brought down global capitalism and yet, so far, nothing fundamentally has changed. Restoring long-term confidence in the financial services industry requires more than individual banks changing their behavior or even governments intervening with new rules. The industry needs a new modus operandi, where all of the key players (banks, insurers, investment brokers, rating agencies and regulators) adopt the three facets of collaboration: integrity, transparency, and embracing the commons.

Integrity. Trust is the expectation that the other party will act with integrity – be honest, considerate, and abide by its commitments. To re-establish trust, the financial services industry needs to have integrity as part of its DNA. But the cavalier manner in which many banking executives violated integrity was stunning. For example they sold sub-prime mortgages to people who could never make the payments; bundled them into securities and convinced rating agencies to classify them as AAA, and insurance companies to insure them.  They then sold these to unsuspecting investors. They violated all the values of Integrity. Everyone in the process suffered and the global economy was sent into a tailspin.

The 2008 meltdown and the Euro crises we face today illustrate how interconnected our world has become. Organizations must be much more aware of what is going on around them. It’s important to know the behavior of others and the potential impacts of the actions of distant third parties. If there is anything Wall Street should have learned from the mess they created it was that business cannot succeed in a world that is failing.

In everything from motivating employees, negotiating with partners, disclosing financial information, or explaining the environmental impacts of a new factory, companies and other organizations must tell the truth, be considerate of the interests of others, and be willing to be held accountable for delivering against their commitments.

Companies need to act with integrity – not just to secure a healthy business environment, but for their own sustainability and competitive advantage.  Increasingly, firms that exhibit ethical values and candor have discovered that they can build trust with customers, employees, shareholders and business partners. This makes them more competitive and profitable.