I have been more than a tad concerned about near-paralysis in the money markets and imploding equity prices. But this e-mail, from a well connected international investor not prone to alarm or (normally) the use of capital letters says that the banking crisis is staring to bring international shipping to a halt.
By way of background, letters of credit of various sorts are essential for trade. For instance, imagine the difficulty if you are, say, a Chinese manufacturer who wants to sell his wares to buyers overseas. How can he be sure the goods he ships will ever be paid for? Imagine the considerable difficulty and cost of chasing a deadbeat in a foreign country. Letters of credit. issued by banks, assure payment. They can also serve to finance the shipment (ie, fund the inventory while it is in transit).
Not only are banks now leery of lending to each other for much longer than overnight, they are also starting to refuse to honor letters of credit from other banks. From the above-mentioned reader:
At the end of the day, if every counterparty is bad then you don’t have a market and you don’t have an economy. I spoke to another friend of mine this afternoon, whose father has been in the shipping business forever. Pristine credit rating, rock solid balance sheet. He says if he takes his BNP Paribas letter of credit to Citi today for short term funding for his vessels, they won’t give it to him. That means he can’t ship goods, which means that within the next 2 weeks, physical shortages of commodities begins to show up. THE CENTRAL BANKS CAN’T LET THAT HAPPEN OR WE HAVE NO ECONOMY, LET ALONE A CREDIT SYSTEM.
We spoke later in the evening and said he had heard of another instance of a trade transaction failing, different parties entirely, this a shipment of coal, again due to the unwillingness of the seller’s bank to accept an LC from the buyer.
Update 12:10 AM: Confirmation comes from the Financial Post, “Grain piles up in ports” (hat tip reader Vox Sanus):
The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.
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.
“There’s all kinds of stuff stacked up on docks right now that can’t be shipped because people can’t get letters of credit,” said Bill Gary, president of Commodity Information Systems in Oklahoma City. “The problem is not demand, and it’s not supply because we have plenty of supply. It’s finding anyone who can come up with the credit to buy.”
So far the problem is mostly being felt in U. S. and South American ports, but observers say it is only a matter of time before it hits Canada.
“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….
Access to credit is key to the survival of maritime trade and insiders now say the supply is being severely restricted. More than 90% of the world’s trade by volume goes by ship…
“The credit crisis has made banks nervous and the last thing on their minds is making fresh loans,” Omar Nokta, an analyst at investment bank Dahlman Rose, said in an interview with Reuters.
While shipping has always been a cyclical industry whose fortunes rise and fall with the global economy, analysts said the current crisis over the drying up of credit is something they have never seen before.
Jason Myers, head of the Canadian Manufacturers and Exporters, said exporters across Canada are getting caught up in the turmoil as customers delay payments, forcing them to shoulder the cost.
“What some companies are saying is we can’t pay you until our customer pays us, so it becomes a question of who bears the financial risk and the cost,” Mr. Myers said. “We’re hearing about it more and more.”
What that means is that manufacturers are getting hit as revenue slows and longtime customers disappear from the order book altogether. As profits decline, investment in product development starts to fall, too, he said.
The Canadian Wheat Board, one of the world’s biggest grain marketers, has yet to refuse a customer because of poor credit, according to a spokeswoman. “As of this moment we haven’t run into that problem,” said Maureen Fitzhenry,
Why can’t the US goverment’s Overseas Private Investment Corporation handle this? OPIC provides loans, loan guarantees, and insurance to US business for cross-border investments. This sounds right up their alley.
Assuming this is an eligible trade LOC and not some kind of stand-by…why is the Fed not purchasing eligible bankers acceptances these days? Nobody left at the NYFRB who knows what they are?
Maybe the Export-Import Bank is even better placed.
Hope somebody gets on it —easily the scariest thing so far, ow.
I did an international trade finance project an eternity ago, but I can’t imagine much has changed. This is a low margin, document intensive backwater at most banks. This is probably nowhere on the list of things that the higher ups are worrying about right now because the impact on the customers and the wider world is way out of proportion to its importance to the banks. Thus this is very likely NOT to be on the agenda of the powers that be.
I really long for the days when the “credit crunch” was out of most people’s consciousness and those following it daily were a bunch of nerdy wonks, or very astute, concerned citizens.
It’s really frightening how quickly the whole house of cards is coming down on us. The panic has just begun. If international trade seizes up–even partially–we’re in for a long, dark, hungry winter. This is beyond terrifying.
Yves- reading your comment to readers makes me realize you possibly are not thanked enough by the ‘silent majority’ who check your site frequently (in my case multiple times a day for nearly a year). You do nothing less than a BANG UP JOB. You have been synthesizing the most coherent big picture story available anywhere in the blogosphere or even in mainstream press about what is really going on in financial markets.
Yves for Treasury Secretary! (And while that would be a horrible curse to you it would be a blessing for the rest of us!)
Truly fine work.
pd130: “easily the scariest thing so far.”
Yeah…definitely scariest post of the week.
BDI tanked another 10%…at 2500. Probably more room to go down as it was as low as 1800 in may 2005.
I also just saw via reuters: “Mt Gibson Iron asked to delay China deliveries.” They chalked it up to slowing demand in China and “tightening credit conditions” so i’m not sure if that is related to LOC problems like Yves mentioned above.
Yves– the Financial Post of Canada has an article on this:
I've been out of the shipping biz a couple years and have to concede this could be a very catastrophic problem in the making. However shipping is a very cyclical business and freight rates for both dry & wet cargoes have been at historic highs.
Shipbroker's daily & weekly recap's provide far better information. hellenicshippingnews.com is a free resource provides daily ship fixtures from some well known shipbrokers.
A bank refusing letters of credit is A Very Bad Thing. This is why we needed, and need, nationalization of the banks. Keeping the basic funding of the real economy going is beyond essential. Think about LA and NYC with two weeks of food on the shelves and no transport moving. You can’t mobilize the military fast enough to _get_ it moved, even if they weren’t overseas. That is doubleplus ungood.
So Hankie Paul, use some of those emergency powers to call up Citi and the rest and tell them that they will NOT, goddamit, refuse letters of credit. Get back hems ‘n’ haws” “As of this minute, _I_ own your shop. You are fired. I’m directing your assistant to direct your desks not to refuse letters of credit. Vacate the premisis immediately and leave the leys with Homeland Security. Got a problem? Call they FBI; they’re waiting to depose you anyway.”
My frustration at this point is that there is a market need here that someone should be able to meet. Someone who isn’t currently underwater in the finance mess.
Alex Tabarrok at MR talks about banks as bridges. Why can’t some new company (or main street bank with good balance sheet) step in here and serve just the shipping industry? If they made a big enough entry splash, I suspect they could convince buyers quickly that they were a reliable counterparty on the LC’s.
It’s an honest question – what are the barriers to entry here?
I hate to say it, the barriers to entry are large. One set of LCs are called documentary LCs, in which the payment is conditioned on the shipper having satisfied certain requirements and supplying documents along with the cargo to demonstrate that he has performed his side of the deal. For instance, for oil cargos, you’d need to verify that the tanks were full, that you’d satisfied all relevant duties and taxes an the port of embarkation and disembarkation, that the goods had been delivered to whatever acceptance point.
The requirement vary tremendously depending on the countries involved and the nature of the cargo.
It requires a great deal of very nitty gritty knowledge. And the paperwork is a huge mess. If a shipper does not satisfy the documentation requirements, even if the cargo really is in good order and was delivered on time to the right place, a documentary LC will be rejected.
Here are a few notes
Trading is always tough, you are essentially doing arbitrage, trying to find disparity in prices to make money.
I am from the bulk shipping industry and I can say that traders are often very respected because they have to handle
1) Knowledgeable about commodity they are trading
2) Worry about Shipper
3) Worry about Buyer
4) Worry about Quality
5) Be good at Finances, Bank Documents, contracts, L/C
6) Knowledgeable about Shipping be it Wet or Dry.
In a sense, having a successful trade take place is not that simple.
There are always cases of L/Cs being rejected due to disparity, late delivery, quality differences, etc etc etc
In summary I do not think the main part of the problem is sellers rejecting buyers due to their ability of not obtaining credit.
Not saying it doesn’t affect but i doubt the extent of it
However it must be said, there is a lot less cargo out in the market and it is still more a matter of supply and demand.
You can find the daily fixture and summary of dry cargo at http://shipchartering.blogspot.com
Everyone knows that the result of cutting international deliveries of food and/or fuel will be food riots and mass starvation within weeks.
There will be intense pressure on the IMF and WB to come up with a bailout now that the stakes have been raised to the continuation of civilization as we know it.
Is BNP Paribas specifically known to be at high risk of failure?
If you get my drift….
I’d much rather see Yves in Washington DC than Buffett in a Treasury role! Trust will be everything going forward and Buffett’s reputation is in the toilet, where it will be flushed into the sewer.
hmmmm…. think i might do an extra run to the supermarket this weekend.
There is an article in The Guardian today about the role that tax havens play in the current mess. http://www.guardian.co.uk/commentisfree/2008/oct/10/tax-banking
I generally have great respect for your analysis, although it concerns me – in respect of this particular Guardian story – that the first advertisement that greets me on naked capitalism is often one advertising offshore products in the British Virgin Islands. I hope you can pay more attention to the offshore phenomenon in future, and think about the relationship between tax havens, tax (and regulatory) competition, and the deregulatory mess (compounded by offshore complexity and secrecy) that is now unfolding.
I am absolutely amazed at the poor quality of the systems engineering here. All along we were told about the Masters of Risk these financial people are supposed to be, and here we have a simple, predictable, cascading failure.
Yves, you’re famous!
When I go to the supermarket I have to pay first and the get my cornflakes, so where is the problem?
I want to see Yves as Treasury Secretary and Michael Shedlock in charge of the Fed. (I know Michael wants the fed paradigm gone – but it has to be done in a controlled fashion over serval years).
This sounds like confirmation of Nouriel Roubini’s assertion that “the wheels are coming off.” It also very well could push us into the abyss….hope you have your seat belts on.
Actually as I understand,
a lot of banks are truly reluctant now to issue letters of credit.
In short, try not to visit third world country where there is little in place of “emergency supplies” of say grain, wheat, etc etc hint hint
I agree with posters who want to thank Yves for her wonderful, wonderful blog. I think at this point we ought to bombard our congresspeople with links to Naked Capitalism and tell them to read it. Maybe a few will. The one note of cheer in all this is that the Internet offers a powerful community of minds who can brainstorm at great speed–something not available in the 1930’s. This intellectual resource is something to be encouraged by. Don’t despair, folks; focus, think, and email!
Some fool above stated the solution to letter of credit fears is to nationalize the banks. Brilliant. And what if the issuing bank is the Bank of Zimbabwe. You want that letter of credit? Another brilliant financier states well if buyers and sellers use the same bank such as Citibank or HSBC problem solved.Not so. Citibank NA is not the same Citibank as the one in Argentina. Separate banks legally. That is why you cannot deposit funds in Argentina with immediate credit to your account in New York. A holding company is not the same thing as the bank company.
If you don’t have a clue about what your talking about shut up and learn before mouthing off and in the meantime for God’s sake don’t vote as well.
Here is a simple clue:when banks do not trust other banks we are in a world wide disaster. It means not only is your credit worthless but so is your money that is worthless, since there is no mechanism for transferring funds because no bank will trust another bank to cover the float time. They won’t take the risk. They can’t, they have a fiduciary duty to their depositors. It is bizarre that I can borrow money from my own bank at a lower rate than my bank can borrow at LIBOR. And that bank is a major player. They would actually be losing money by lending me money. If this goes on much longer a recession will be the least of our problems. See you on the bread line.
Time for a super credit insurance fund ?
Now, what we need is a Global Credit re-Insurance fund backed by government, but with its initial capital raised from various mega insurers around the world. The fund would be staffed by legendary insurer such as Warren Buffet who know the odds. This is to put to rest the counter party risk and so that corporation and banks that are not a credit risk can start borrowing again. This will also eliminate the uncertainty in the CDS market once and for all (rather than moving it to an exchange – we can do that later) as now all credit insurance contract are now centrally reinsured/cleared. Those that are no longer credit worthy would not be sold an insurance at a acceptable price and would need to be allowed to go down.
I am trying to fathom the CDS (and other larger derivatives) issue. As I understand , it is somewhat of an insurance product against some type of default/credit event.
Now, if there are multiple layers of circular bets ( lot of them leveraged ones ), a default is going to be like a hot potato being bounced around in circles, but that is not going to change the original default event, just the transfer of this loss from one party to another ( in case defaults continue in cascades ) or stop with a solvent party who will eat up the loss. So, if I am very solvent and strong today and the other parties in the game start defaulting, the loss stops with me or with my default. It seems that these government interventions are aimed at helping some of these institutions weather these CDS obligations thru tax-payer money and hopefully stop these cascading transfer of defaults thu CDS arrangements. This would work , if the number and amounts of defaults are within the system's capacity to handle these. It seems that even if they mostly offset each other, their extent is huge. And the juggernaut of more and more defaults has been set in motion by the recession that has started.
So, this seems to be a downward spiral.
It is quite obvious as to why these institutions do not trust each other–> each has its own CDS bets to cover, they have no clear idea as to other ones' bets, no prediction as to whose bets will come calling first, and when these bets will end up with them? They probably do not have enough money to pay most of the bets they have placed, if they go against them, they all are hoarding money and not lending money to each other, since they can not predict when next round of which CDS bets will be called to pay up. So they are not honoring each other's letters of credit.
It is not likely that governments can buy up all these defalts/credit events, other than creating more money from thin air and they should do it fast and then declare war on these circular bets called CDS and get rid of them. It may be too late to stave off a recession, but may be able to prevent deep depression.
Lawyers will make it certain that the painful process is prolonged and likely sabotaged. We have not even heard from lawyers regarding their interpretations of these CDS contracts.
OK. I agree with the careful argument put forward. What we all need to do however as business leaders is to not respond with fear and negativity as last time I checked, WE are responsible for doing our bit for sentiment.
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