An Anniversary with Moral Lesson

11^th September 2009

The Malta Independent - Friday Wisdom

This weekend will be the first anniversary of the collapse of Lehman Brothers who filed for bankruptcy late on Sunday, 12 September 2008. This sent global financial markets into a practical freeze changing the illiquidity problems faced by large international banks into a much more serious insolvency problem.

In biblical terms we speak of the divide between before and after Christ. In financial market terms this divide will probably be before and after Lehman.

Lehman’s collapse created a systemic dysfunction of the financial markets and when the problem of a single institution migrated to the whole system. When this happens it is likely that the main originator of the problem is the regulator rather than the institution. It is the regulators who have responsibility for the whole system and it is their responsibility to set the rules and to monitor and enforce their execution to ensure that no single institution becomes a risk to the whole system.

So the Lehman’s collapse, whilst obviously remaining the primary and direct responsibility of their management who drove the iconic investment bank to the wall, is also a certified failure to the inadequacy of the regulatory regime in the US. Having had a good warning signal six months earlier when the same fate was served on Bear Stearns, who had to be rescued in a panic engineered and state sponsored takeover by JP Morgan Chase, the regulators did not show sufficient enthusiasm and urgency in getting a detailed account of the interconnections and risks involved if the problem of Bear Stearns had to move to the next weakest link leading to a grave systemic risk.

With hindsight it looks almost unbelievable that this time last year, as the US Treasury Secretary was taking the decision that a Bear Stearn’s type of state sponsored takeover deal for Lehman Brothers, as requested by potential suitors Barclays and Nomura, was not on the cards as this would create moral hazard and as he had no real approval to risk taxpayers money on such arrangements ( no such compunction was shown in engineering the Bear Stearns deal) he had no proper knowledge of the consequences of such a decision.

These consequences did not take long to emerge. And the critical nexus was the world’s largest insurance company AIG who as an insurance company, irrespective of the fact that it had a strong and critically important financial products divisions, was not regulated by any of the Federal Regulators but by a small state insurance regulator who had no resources to control the entire world-wide ramification of AIG.

Whilst AIG plea for rescue loans was rejected outright in the crucial week leading to the Lehman collapse on the basis that it was not a financial institution and was not under the responsibly of any Federal Regulator, the tune quickly changed the day after Lehman filed for bankruptcy. The regulators were ‘surprised’ ( proving that they were sleeping at the wheel in the pre -Lehman years) to find that AIG had insured billions upon billions of bank bonds and toxic mortgage bonds through what is technically known as Credit Default Swaps (CDS). If AIG were to default on such CDS’s many of the critically important banks that had exposure to such bonds and toxic assets but were not reserving capital against them on the basis of the hitherto AAA guarantee of AIG, will instantly fall into the soup leading to world-wide financial system collapse.

With or without Congress authority, the Federal Reserve had to operate at the limit of its own role and rules to give emergency loans to AIG so that it can continue to honour its CDS obligations and avoid a wholesale systemic financial collapse. Eventually the US government had to use specially voted emergency funds to recapitalise AIG and bring it practically under State ownership and control.

The Lehman debacle has brought the reality of an untenable situation where profits are privatised and losses get socialised.

There is a moral lesson in all this for us in Malta. Thankfully our banking system was liquid and solvent enough to absorb the crisis effects with relatively little damage. However, over the last year we have seen an untypical interest by Maltese corporates to raise long term funding on the bond capital markets. Lower interest rates engineered by the ECB to cushion the crisis and the general liquid state of our economy gave bond issuers an incentive to switch from fluctuating interest rate bank borrowing to fixed interest long term borrowing on the capital markets.

Currently we are seeing three separate bond issues almost simultaneously floated on the market one of them coupled with an equity IPO. This is all well and good as it adds volume, depth and breadth to local capital markets.

My worry is that the local market is not sophisticated enough to take informed decisions on the suitability of such bonds for retail investors’ particular requirements and many investors are guided solely by the coupon on offer without seeking professional advice to place such coupon in the context of the risk involved.

There is no financial investment without risk. The impression many investors have that bonds are a perfect substitute to bank deposits irrespective of the quality of the issuer is wrong and regrettably our regulators are not doing enough to ensure that the retail market is well informed of this fact, and that in the absence of local bond rating mechanism investors should at least seek professional advice prior to parting with their money.

In this context, our political leaders would do well to exercise a measure of restraint not to substitute themselves for a rating mechanism by giving overt or tacit endorsement to corporate bond issues by untimely visits to the issuer organisation. President Abela’s visit to Palm City project co-owned by Corinthia during his recent visit to Libya was criticised in the local press as an inappropriate endorsement for Corinthia bond issue currently on the market. This was a bit of an unfair criticism as it is normal for the Head of State to visit local investments when visiting a foreign country and the Bond issue has nothing to do with the Palm City project per se, which has been funded by a bond issue under a different corporate name in the past.

Not the same defence can however be made to Prime Minister Gonzi’s visit to Melita Cable this week when he visited their Malta HQ and gave them a solid positive endorsement. At a time when Melita are launching their first corporate bond on the local market it is easy for the unsophisticated retail investor to interpret the prime minister’s endorsement as equivalent to a rating agency investment grade certificate.

Considering the untold damage that would befall the local capital markets if, God forbids, there is ever a default on any corporate bond in public subscription, politicians should be more ethical in allowing their personality to be used for marketing purposes during the launch of such bond issues. There is nothing wrong in a prime minister visiting and encouraging local private corporates undertaking investments for the benefit of the local economy, but the timing must be judiciously chosen not to send unintended messages to local investors.
   

Dreaming About Maximising our Tourism Potential

6^th September 2009

The Malta Independent on Sunday

To continue with my views on tourism following my column last Friday in the daily version of this paper, I find it almost offensive that a mediocre breakfast in a dull hotel in London, Paris or Berlin costs more than a half board package price in a superior Maltese hotel.

Those who have the slightest knowledge of how tourism works are probably protesting that London, Paris and Berlin are not our competitors, and as far as we are concerned their pricing is irrelevant.

True, our competitors are the Mediterranean resorts and our pricing has to be competitive with such resorts not with prices prevailing in the main European cities. But this is true if one accepts the status quo as an eternal permanent state of affairs.

It need not be totally true for innovators or dreamers who believe they can change the world.

With determination to improve, enhance and build an aura around our tourist product (especially those elements of it which give us a natural advantage if not unique attractions), with learning how to treat the tourist as a valued guest not as an exploitable number, and with massive investment in building a Malta brand to match the up market image we need to create, we can change what now seems immutable.

And change we must if we are to move from being price takers to price setters.

So why have we done nothing about it yet, one could reasonably ask? Do we not believe in our own potential? And if we don’t, how can we persuade others to believe in us?

This lack of self-esteem is indeed the biggest obstacle to set us on a long-term process to maximise our potential.

Let me give a small example of this lack of self-esteem. Take the karozzin service. Properly packaged this should be a premium service. Yet how do we package it?

Spend some time on City Gate bridge where many cruise passengers entering Valletta are a captive market for this service. Instead of a uniformed cab driver ready to deliver service against a well-exposed price list, tourists just a few metres away from the City Gate tourist office are subjected to poorly-dressed drivers rudely touting for business, price haggling typical of a Turkish bazaar and total obscurity as to what exactly is being promised. How long will the tour take? What route will be followed? Will the cab driver act as guide or just drive the cab?

I have no doubt that many potential clients for such service are put off not so much by the price but more by the perception that the process is loaded against the tourist who needs substantial negotiating skills to avoid being had. I would probably gladly pay a higher authorised and advertised price rather than a lower negotiated price, which leaves me with an aftertaste of having been fleeced.

Does it take too much to put an official tariff on cabs, to have drivers wearing an appropriate uniform, to ensure that cab drivers can give a well pronounced guide commentary via a loud speaker or to equip cabs with multi lingual pre-recorded audio service?

Absolutely not, but we take no pride in our product so where it matters, things keep to Third World standards.

It would be disastrous if we try to brand our product before we bring it up to the level that makes it saleable at a premium. Good advertising kills a bad product faster than bad advertising.

But even if and when we find the courage and determination to expose our tourist product to its full potential branding, it is a process that will take years of effort and many millions of investment.

And here we hit cultural barriers. We are impatient. We lack staying power. Our investors, especially the government that invests many millions annually in the industry, want immediate results. Problem is that investments in product improvement and branding are expensive and can only deliver results over the medium to long term if well executed.

Governments argue that in the long term we are all dead. They want results here and now. But here and now results are fickle, subsidy dependent and unsustainable.

To maximise our potential we need to overcome our lack of self-esteem and our short-termism. You could say that we need to be reborn. 

Facing Winter without Food

4^th September 2009

The Malta Independent - Friday Wisdom

Hoteliers are like ants facing winter without food.

At this time of the year, with August behind us and the tourism season past its peak, hoteliers would normally be counting their treasure and wondering how much of it can stay preserved as true profit when the lean winter months turn cash flow negative. Like ants they work hard in summer, when most of us are holidaying, and store resources to get them over the lean winter months, hoping that at the end of the financial year there will be enough left to justify their efforts and their return on capital. They hope there will be enough resources left to finance further investments to remain fresh and competitive.

This year rather than counting their treasure most hoteliers are scratching their heads and wondering if they have enough oxygen left to get through winter.

Considering how important tourism is for the general economy and for wide distribution of the wealth it creates, the problem is not just owned by hoteliers; it belongs to us all.

This year most hoteliers have probably not been far out in the number of guests staying at their hotel. But they are far out in their profitability. To get close to the numbers in volume terms they have had to discount extensively and all these discounts represent a straight one for one wipe off their bottom line as costs cannot respond in similar matter. The bulk of their costs are payroll, energy and maintenance/supplies. Payroll is a sticky expense with little space for economies except through redundancies or short work-weeks, which cannot be implemented while chasing volumes. Energy costs have gone up and maintenance costs tend to increase during lean periods, as hotels undergo extraordinary jobs during low occupancy periods.

The only solace comes from savings on financing costs as low interest rates make a positive contribution to the bottom line through savings in non-operating expenditure. The low interest rates most depositors are getting on their bank deposits indirectly subsidise the finance costs of business borrowers, not least hoteliers who borrow to finance their asset rich businesses.

The question hoteliers are asking themselves and everybody around them, is whether this is a one-off bad year or the start of a series. Given that tourism is very much dependent on the macro-economic performance of the main EU countries, our hoteliers have to make guesstimates in order to drive their business forward about whether 2010 will see a V shaped recovery from the recession or whether economic performance will be L, W or U shaped meaning that recovery will be slow, and that one should not expect the 2010 financial year to be much better than 2009.

This is a question that is vibrantly debated between economists and investment managers. Hoteliers cannot just debate such semantics. They have to base their business decisions on their view of the world one way or the other. They have to soon decide their rate strategy for 2010. They have to decide what investments are absolutely necessary and most of all they have to know if they have the financial resources, not only to get through next winter, but also through another poor summer after that, if the recovery proves anaemic.

Should government intervene with direct assistance to hotels beyond its contribution to the marketing efforts of the Tourism Authority? Can the government afford it, seeing that its own finances have suffered as well and will be way, way out of the planned deficit for 2009? Even if it can afford it, how can such assistance remain within the limits set by the EU single market, no subsidies, obligation?

These are not easy questions to answer but doing nothing is no solution either. Simply hoping that hoteliers can somehow get through the winter and that next summer everything will be business as usual is management by hope to the point of irresponsibility. We should hope for the best but we have to make back-up plans in case the best proves elusive.

There is no silver bullet. The true solution is resorting to strong international economic growth. But this is beyond our ability to influence. We can only react to, not influence, international economic realities.

Solutions cannot come from a single source. It would be wrong for hoteliers to expect government to come to their rescue. Banks cannot be expected to increase their risk unduly to keep hoteliers afloat during this difficult period. On the other hand leaving hoteliers to their own destiny could involve the death of set-ups that deserve to be assisted and saved.

Those hotels that have not made sufficient profits in the good years and are facing an existential threat from one bad year probably don’t deserve to be rescued. But those that have proven their ability to generate profits during the good times should be assisted if the current bad scenario prolongs.

It is time for the Tourism Authority to start serious consultations with the MHRA to see what sort of rescue packages would be needed if the crisis prolongs beyond next winter. If we let the deserving ones fail who is going to be there to take advantage of the rebound, when finally it comes? The theory that it is the second mouse that eats the cheese could have some short-term appeal but for the long term it does not promote investors’ confidence in the industry.