I just saw this in The Economist after writing to you and it corroborates your post on BDI.

Oct 18 issue pg. 71. Industry and the financial crisis. You can find a web link.

“There is even talk of grain cargoes piling up in ports in the Americas. [No doubt the same Financial Post report that we’ve seen.] Their buyers’ letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron-ore shipments.”

The article then goes on to describe the fall in BDI and discusses falling demand for commodities. Though that specific mention does corroborate your point, the writer drops the ball if L/C problems were to be a significant factor in the level of ocean traffic. It’s the only place that it’s mentioned. And the consequences of it being a serious problem are not mentioned at all. Given that the fall in BDI and commodities prices are already well known to anybody paying attention, if it were important it is somewhat a surprise that the writer neglected to dig deeper into the L/C question.

I still contend that isolated incidents (and so far they appear to be isolated) of L/C difficulties represent buyers’ desire to renegotiate contracts or their own inability to comply with previous commitments.

Thanks for the link to Clusterstock.

I apologize for not having been clear. Actually, I don’t think I did misconstrue your point and I saw the earlier post too as well as the Financial Post article.

“If banks are not honoring other banks’ letters of credit, international trade will break down.” GIVEN.

“And trade breaking down IS Smoot-Hawley on steroids.” GIVEN ALSO.

“Banks appear not to be honoring L/Cs as part of general aversion to taking bank credit risk.” NOT SO FAST. I WANT TO QUIBBLE.

As I tried to explain earlier, a L/C is a bank guarantee. No bank will make that guarantee without having a guarantee of its own. And an iron-clad one at that. Unlike the derivatives business, there is lots of history here in what you call this banking backwater. This is not something that hasn’t been thought through. There really isn’t any credit risk in an L/C. There is only “counterparty” risk. That’s why you can buy a L/C for a $50 fee. If it is in fact true that shippers are having difficulty obtaining L/C’s it’s because of the “counterparty risk”. And in today’s environment that risk may not be well known. Which is to me even more disturbing than if it were credit risk. Credit risk being the easier to price. If counterparty risk is such that shippers cannot get L/C’s – no deals. No exceptions. All stop. Mothball ships. You say Smoot-Hawley. You would be right to be alarmed.

I only meant to suggest that problems with L/C’s are not a driving factor in the drop of BDI. I myself suspect that BDI would be more heavily influenced by the fall in commodities prices than problems in obtaining L/C’s. Difficulties in obtaining L/C’s would also be seen in places other than BDI such as container rates. Container rates themselves are heavily influenced by general levels of business activity, which is sure to slow, and also foreign exchange rates. Bottom line is that it would be very hard to separate out the effect of L/C problems in these published numbers. I’m guessing it’s a minimal problem at the moment in spite of the story of the grain at the Vancouver docks. I bet it has to do with price and that some weasel wants out of his contract. Or that he made his contract and now can’t make his own guarantee with his bank. In the absence of his guarantee his banks L/C (guarantee) will not be forthcoming. I suspect that there are lots of goods on order that can no longer be paid for.

Love your work.

beginning to think that there may be a silver lining in this tsunami.

Every industry has lobbyists in DC, including the arrowhead industry.

I have been told by someone I know personally of two separate cases (as in different sets of players in each incident) of shippers with LONG established histories, sound balance sheets, of having their banks’ L/C refused by the shippers’ bank. Banks in question were both large international banks.

I would not cast aspersions on journalists if you have not read the stories in question.

Thisarticle from the Financial Post has specific quotes that point to L/Cs being an issue. For instance:

Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don’t trust the financial institution named in the buyer’s letter of credit, analysts said.

“We’ve got a nightmare in front of us and a lot of people are concerned it’s going to get a lot worse,” said Anthony Temple, a grain marketing expert based in Vancouver.

Note that the Canada article describes it as a PROSPECTIVE problem there, not one that is happening now. If it was the deal-breaking as you suggest, it would be reported as a current issue.

The article also suggests that there is a separate issue with buyers being slow to pay.

People do not decide to become involved in international trade overnight, particularly in this sort of environment, so I find it hard to believe that the issue is that of new buyers.

And intuitively, this makes sense. If banks will not lend to each other (much) in the interbank market, the L/C market often has longer exposures (some L/Cs are financial L/Cs, the others are documentary, which require that the shipper satisfy certain paperwork requirements to establish that his goods are what he says they are, that he has paid applicable duties and taxes, etc.), I would imagine that the length of these commitments is somewhat uncertain (that unlike interbank lending, which has a date certain for payment, which would also make them less attractive in an environment of extreme risk aversion.

I find it quite plausible that this issue is not on the radar screen. Does the shipping industry have any lobbyists in DC?

The L/C business is a complete backwater in banks. Low margin, operationally intensive. It is not a career path into senior management. It is very plausible to me, based on my experience consulting to banks, that a seize up here would go unnoticed given all the other pressing problems. This is just not a priority area for them from a business standpoint. Similarly, regulators pay it no mind, so again, Treasury, the Fed, the ECB would not even think about this until the pain became acute.

I have been thinking that if L/C is the block, it should be the first thing for the government to do the plumbing as as EvilHenryPaulson say it is vital and yet low cost for them.

So I think current situation is something like 90% fundamental driven and speculation unwinding and 10% L/C problem. Meaning bounce back of BDI index is unlikely until we see commodity prices picking up again. And given the pouring supply of new vessels, maybe BDI recovery will be slower even then…

I have not seen the multiple independently-sourced reports re: L/C that could confirm it. What I have seen is the crafty re-reporting of about 2 original stories. The rest confuse companies coming to a bank for the first time to seek a L/C or insurance, and not being able to get one because banks are cautious about their other lines of credit being drawn on. It is not about one bank refusing the next’s L/C. I think if you look at the articles now, you will not see any sourced report of banks refusing L/Cs — barring the aforementioned one that turned out to be about commodity pricing.

It’s more of a pandemic of lazy journalists as they seek to find a 2 line explanation of why shipping and the BDI is down dramatically.

Logically both the importing and exporting governments would have stepped in to ensure continued trade flow if the L/C was widespread. One of the lowest risk, most valuable products of credit to a country.

What I want to communicate is that while speculative trading may be halted due to the 2 factors of increased speculative grade credit rates, and depreciating goods, that there are no trade financing difficulties for traditional importers/exporters and thus trading continues.

Container traffic is down because demand is down, and dry shipping is down because demand is temporarily down due to commodity paper trades and China’s negotiating tactics. Trade financing has an impact that is invisible compared to these factors.

As for liquids, the market remains soft but there have been 5 VLCCs decommissioned this year so it’s better than what it otherwise would have. The important thing to BDI and shipping’s near future is how many of the previously contracted ship builders actually complete. If most of them complete on schedule then I think we will see the decommissioning of all but the newest ships as I expect a global recession with less trade volume and adding to a record number of ships does not make economic sense as a business.

L/C are definitely something _to monitor_, but nothing has happened yet

For some perspective of how far the credit crisis has or has not reached, see this minnesota fed working paper that highlights some of the recent credit data

Volumes falling to an unwinding of the China/commodities boom is one thing. But trade finance seizing up is an entirely different matter.