World Economic News
Extreme Turmoil in Hedge Funds Revealed
The data on foreign capital flows into the U.S., provided by the Treasury Department earlier this week, point to some extraordinary developments. The supposedly "good news," emphasized by the financial media, was that total net inflows in June reached $71.2 billion, significantly more than in previous months. Allegedly, this proves strong foreign demand for U.S. assets. Actually, it shows something quite different. The monthly report by the Treasury Department, where total capital inflows are divided up into asset classes and countries, gives a first hint of what really was going on.
The first anomaly is the collapse in foreign net purchases of U.S. government bonds. After the "New Economy" crash, net purchases of Treasuries and agency bonds (that is, bonds issued by Fannie Mae and Freddie Mac) accounted for the largest portion of net capital flows into the U.S. But during June 2005, foreigners bought just $7.9 billion of U.S. government bonds, a decline by 74% compared to the average for the first five months of the year ($30.7 billion). The reason for this is not a sudden drop in Asian central bank purchases. Such purchases are no longer as strong as during the time of the huge Japanese currency interventions. But Asian countries still provided $34.1 billion in net inflows to the U.S. in that month.
More important is the role of a group of certain islands, the so-called "offshore centers." If only the Caribbean Islands, the Bahamas, Bermuda, the Cayman Islands, the Netherland Antilles, as well as the Channel Islands and the Isle of Man, are taken into account here, then these combined offshore centers sold off a total of $36.4 billion in U.S. government bonds and another $12.8 billion in U.S. agency bonds. While the same offshore centers had bought a net $132 billion of U.S. government bonds during the first quarter of 2005, they sold off a net $44 billion during the second quarter, with most of such net sales occurring in June. These are not any kind of cyclical changes, driven by some changes in "supply and demand." These documented sales of U.S. government and agency bonds by offshore centers are the tip of the iceberg of huge emergency liquidations by a large number of hedge funds, often registered in offshore centers.
But how could foreign capital inflows into the U.S. be strong in June, when hedge funds at the same time were selling off Treasuries and agency bonds? This leads to another anomaly in the June capital flow figures. Never before in history, not even during the days of the "New Economy" hype of the late 1990s, had foreigners such a huge net amount of U.S. corporate bonds. The figure for June, $52.2 billion, is the highest on record and exceeds the average for the first five months of 2005 ($22.3 billion) by 134%.
Who was buying these corporate bonds, just after GM and Ford had been downgraded and the entire corporate bond market was in complete disarray? According to the Treasury Department data, more than half of all these net purchases of U.S. corporate bonds came from Britain ($22.8 billion), the Channel Islands and Isle of Man ($3.2 billion), and Ireland ($2.5 billion). Another $13.3 billion had been provided by the other above-mentioned offshore centers.
There can be probably only one conclusion. These purchases are a reflection of a giant international bail-out operation, with huge amounts of money being channeled, in part via the City of London, into hedge funds directly and the corporate bonds held by those funds.
Ontario Defends Pensions in Bankruptcy Case
The Ontario provincial government has followed the Canadian government, in refusing to allow the large national steel producer Stelco to emerge from bankruptcy, without making major contributions to its underfunded pension plans. In doing so, the Liberal government is acting as though its legislation, proposed June 4, which giving pension contributions high priority in corporate bankruptcies (in contrast to the U.S. situation epitomized by United Airlines' massive pension default) were already in effect.
Ontario Finance Minister Gregory Sorbara on Aug. 16 ruled that the Stelco plan for emerging from bankruptcy is unacceptable, because of insufficient contribution to the steelworkers' pension plan. Stelco's first proposed plan had scheduled no contributions to the pension plans in the short term at all (they are underfunded, in total, by about $1.3 billion/Canadian, according to Canadian government pension rules); that plan was rejected. The plan rejected yesterday, proposed a $200 million/Canadian contribution (about $141 million/U.S.). The government is insisting Stelco pay $320 million/Canadian, about 25% of its pension underfunding deficit, as part of its reorganization.
Although the standard Wall Street argument against requiring pension payments of bankrupt companies, is that neither banks nor investor groups would lend money to a bankrupt which had to prioritize such payments, the Canadian case shows otherwise. Five steelworkers' locals have arranged a financing bid for Stelco by Tricap Management Ltd., which includes an immediate Canadian $500 million contribution to the pension plans. Stelco has rejected this financing bid so far, under pressure from other bondholders.
In a parallel court case over the reorganization plan, the steelworkers'/retirees' locals are claiming the status of unsecured creditors to the bankruptcy, in the amount of Stelco's $1.3 billion/Canadian underfunding of their plans. A court in Ottawa is about to rule on this.