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The toxic derivatives in Poland or “the polish subprime crisis”

2008 was a year of financial wonders – Lehman Brothers’ sudden collapse and Volkswagen/Porsche case, just to name a few. Poland had its own local story which burst in the autumn of 2008 and evoked a huge turmoil in the equity market. I am pretty sure that this case will turn up sooner or later in some other market and its remembrance will flash a red light. This is about how the most rational investment decision may turn out to be the worst one. Main characters: the good – entrepreneurs, the bad – banks and complex financial instruments. Sounds familiar?

The origin of the story was the constant appreciation of polish Zloty (PLN) which started when Poland entered the EU in 2004 and lasted for 5 consecutive years. Exporters complained about falling profitability of their businesses and in the face of Poland’s expected access to the eurozone nothing foreshadowed a change in the PLN appreciating trend.

Chart 1. EUR againts Polish Zloty currency (PLN), 2000-feb-2010.

Yet the contrarians won again. In the middle of 2008 we faced a strong reversal in the trend, as bad news started to flow in from all over the world, with Lehman Brothers bankruptcy reinforcing investor flight from emerging markets. During the next 3 months EURPLN went up by 20% and it was then when a middle-sized construction company listed on the Warsaw Stock Exchange (Erbud) announced a large downward revision of its net income forecast due to financial cost increase. A glance at the statement was enough to see that the rise in financial costs erased the company’s entire operating income for the FY 2008. Price fell 37% in one day.

What happened?

It turned out that the company, intending to protect revenues in EUR from appreciating PLN, used an FX option strategy called collar: long EURPLN, long EURPLN put, short EURPLN call. Assuming hedging 10 million EUR revenues, call strike at EURPLN = 3,0, put strike at EURPLN = 3,5, call premium = 1 million PLN, put premium = 2 million PLN, this is the payoff chart of such a strategy – looks fine, as the company’s revenues are hedged between 29 and 34 million PLN.

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Chart 2. EUR/PLN collar payoff

The problem was, this was NOT the strategy that Erbud employed. Since a put option was more expensive than a call, the company wrote twice more calls than bought puts (to make the structure free of charge). By altering only this assumption, the payoff diagram changes substantially:

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 Chart 3. EUR Zloty polish currency (PLN) asymmetrical collar payoff 

Erbud did not use hedging accounting so, when PLN crashed, loss from the strategy had to be booked immediately in the income statement as an unrealized loss. Erbud closed the transaction and realized the loss at EURPLN = 3,9 before settlement by going long a forward contract on EURPLN, which turned out to be a good decision, considering EURPLN peaking soon at 4,9. The company management board warned that it was not the only one to employ such an asymmetrical strategy.

So who’s next?

After this event, investors and financial press rushed to search for other companies hiding the poison pill in the form of written FX calls. Nobody until that moment would ever think that depreciation is negative for exporters! Interrogating management boards, banks, scrutinizing footnotes to financial statements – that was what everybody was doing in the market. ‘Puls Biznesu’ (Polish financial newspaper) published entire pages of CEOs’ declarations that they ‘did not enter any speculative option transactions’. I remember myself examining a CFO of a company who didn’t want to disclose terms of hedging strategies mentioned in a financial statement.

Scale of the problem

Erbud proved to be just the tip of the iceberg. As PLN depreciated further (EURPLN rose by 50%!), banks started calling companies for payment resulting from option settlements. And companies were simply unable to pay – losses from written calls exceeded cash reserves, in some cases even total assets. The foolishness of the firms was as amazing as the cunning of the banks. Transactions of triple and more call-to-put exposition took place. Sometimes the position taken in put options seriously exceeded contractual or expected revenues which in the same time were subject to decrease due to developing crisis. Banks, on the other hand, secured their side of the risk by including in the agreements a EURPLN threshold level at which terms were to be negotiated (in case put was in the money – this, of course, never occurred). It appeared that management boards hardly realized the construction of the transactions they entered into.

In total 100 firms listed on the Warsaw Stock Exchange (out of 350 listed) were engaged in so called ‘toxic options’, as revealed an investigation led by the KNF (Polish financial supervision authorities). Several companies went bankrupt, financial situation of plenty deteriorated (cash drain, increase in liabilities, creating provisions, financial losses). Exporters’ financial results for the 4th quarter of 2008 were simply DISASTROUS. Ironically, the ones that should perform relatively the best in times of currency depreciation, were hit the most and proved to be the worst investment at that time. Banks became victims of their own business, too – they were unable to execute all the receivables from the firms so they were forced to accept partial payments, create provisions for bad loans and write off losses. That was, again, visible in income statements and made option selling banks underperform the market. This was also the reason why the whole story was proclaimed to be ‘Polish subprime crisis’.

Side effects

It’s easy to imagine that the whole affair did not add to sympathy for banks; in fact they were hammered by the press, public opinion and the government. As entrepreneurs felt cheated, they brought actions against banks. Legal advisory for injured companies flourished. The KNF tightened disclosure requirements regarding hedging transactions. Financial institutions holding shares of unfortunate companies decided not to grant discharge to CEOs/CFOs.

The ‘toxic option’ case faded in the middle of 2009 when most of the calls expired. Yet takeovers of the firms which employed the cursed strategies still take place.


The instruments were advertised by banks as “cost-free option strategies“. 

Autor of this post: Aleksandra Tomala

These chinese are crazy

In China military discipline also applies in finance.

In China, the country where more copies are made, also seems to want to copy the western policy of strong growth in bank lending policy. What they should know is that this policy over many years has led us to the extremely serious present situation. Of course, when in early 2009 economic crisis create social tensions in China and the closure of factories, perhaps at that time, the chines autorities took this decision to increase lending. Do not forget that China has more than 1500 million people.

In March and April 2009 the Chinese government ordered Chinese banks to lend large sums of credits that should reach the market.

Lending in China (2005-june-2009, source: The People’s Bank Of China).

Chinese banks made new loans in 2009 for and amount of 9.6 trillion yuan, a 95.3% increase compared to 2008. Incredible it’s over 60% of gross national product until june 2009¡¡¡¡¡¡.

This credit growth is more than 3 times the increase in recent years for the chinese economy.

Mr. LIU Mingkang Chairman of the China Banking Regulatory Commission (CBRC) since march 2003, and member of the Monetary Policy Committee of the People’s Bank of China, and a member of the 17th Central Committee of the Communist Party of China, make an speech in Hong Kong, in january 2010, about this excesive loan growth. This was his speech:

“Among the packages, credit played the primary role in supporting massive infrastructure investment, as evidenced by the new enormous credit supply of RMB 9.5 trillion for the whole year, a dramatic rebound from the tightening of credit in 2008. That said, we actually controlled the credit growth the whole year around. If we take a look at the breakdown by quarters, we would find that the most rapid monthly credit expansion was in the first quarter, which was highly necessary. Every month in that quarter we disbursed RMB 1.52 trillion.  But quickly with our prudential management, it was followed by a gradual slowdown to normal levels the next three quarters, which was RMB 920 billion, 430 billion and 310 billion respectively. On average, the credit supply in 2009 grew by 31.7% y-o-y. Such rapid credit buildup stabilized market confidence, eased liquidity stress and picked up the economy. This year, we will continue to control the pace and amount of the credit, i.e., credit supply will go down to roughly RMB7.5 trillion and grow by 18% y-o-y.”

Acording to Blomberg and

Chinese banks extended 379.8 billion yuan ($55.6 billion) of loans in December, bringing total loan growth for the year to 9.6 trillion yuan. That’s a rise of 95.3% from the year earlier, according to the People’s Bank of China.  

And jump they have. In Shanghai, prices for high-end real estate were up 54 percent through September, to $500 per square foot. In November alone, housing prices in 70 major cities rose 5.7 percent, while housing starts nationwide rose a staggering 194 percent. The real estate rush is fueling fears of a bubble that could burst later in 2010, devastating homeowners, banks, developers, stock markets, and local governments.

Other PBoC data released Friday showed China’s foreign-exchange stockpile climbed to $2.4 trillion at the end of December, up $126.4 billion from the end of the third quarter.  

China foreign exchange reserves chart, and world countries ranking, (source: scmp).



¿Why twitter new users are descending?

Total Twitter users, and newly registered users (jan to nov 2009), (source: WebProNews via businessinsider)

Total Twitter users are increasing each month in 2009 at an excepcional rate, but alter july, new users has only declined in the next tour month. 9.4 million are new users in july, but 7.1 milion in november 2009

 Twitter is just closing a new venture round at $1 billion  valuation, read this techrunch post:

“Fast growing startup Twitter will soon be joining a select group of startups with private venture round valuations of $1 billion, we’ve heard from multiple sources. CEO Evan Williams disclosed the round to employees at a recent all hands meeting.”

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Czar Vladimir Putin and Russian business

Vladimir Putin and Oleg Deripaska video humiliation (1 minute), (source:

Watch this video, things are different in Russia. This is a meeting where President Vladimir Putin ordered billionaire Oleg Deripaska, to sign inmediatly a document.

The silence in the meeting is of enormous strain. This video can explain as how business is done in Russia and also who’s the boss. I think this is the document for reopen his Rusal factory, as I see in this second video.

Here you can see an interview with Oleg Deripaska, who is who signed the document in the previous video.

Deripaska became in 2008 the 9th richest man in the world according to Forbes with a fortune estimated at $28,000 million, but the enormous global crisis has reduced his wealth to “only” $ 3.500 million. I also found another video were Deripaska and another businessman, are trying to convince Putin.

List of russian tycoon Oleg Deripaska assets after creditors negotiation in 2009 (source: WSJ).

After 2008 crisis, Deripaska, has lost some big assets like 20% Magna stake, or german Hochtief 10% stake. He still maintain a p 53% stake in Rusal, the russian aluminum company.

Business in Russia are different. According Deal Book BlogRussia’s Interior Ministry announced, how a russian lawyer for an international investment fund, Hermitage Capital Management, died in a pretrial detention center on Monday, nearly a year after he was arrested in an escalating feud between the Russian authorities and the company, on Tuesday. 


Top 25 better paid hedge fund managers in 2008

Top 25 list of hedge fund managers by revenues in 2008 ( and alpha magazine). 

The mathematician James Simons was the first with $ 2,500 billion. George Soros, although it has earned a third of the 2007 revenues (see the list in 2007, and the 4 highest paid in the 2006), it has received $1.100 billion.

John Horseman, one of the top 20 Hedge Fund managers best payed in 2008, said he will step down from the Horseman Global Fund Ltd. after its value fell more than 20% this year. After more than 30 years in the Hedge Fund industry, as a fund manager in Gam Intl. Management, John started his firm in july 2000.

His flagship Horseman Global fund has made a compounded 16 percent return since inception (febreury 2001), according to the letter sended to investors. Also, John Horseman explained his disappointment with the outlook in financial markets. He is bearish but stock indexs are in positive territory this year:  but exactly wrote: “for personal reasons and also because of how I perceive the investment environment.”

Other veteran hedge fund managers have quit this year including Raptor Global’s James Pallotta, Cantillon Capital Management LLC’s founder William von Mueffling and Atticus Capital LP’s Timothy Barakett.

2009 performance for James Simons (Renaissance Tech. hedge fund), John Horseman (Horseman Capital) and Pether Thiel (Clarium Capital) until june-09.  

Moderating recovery in US housing market

Home prices in Las Vegas and Phoenix, year-over-year change until august 2009, S&P/Case-Shiller index (source: NYT).

Las Vegas and Phoenix are experiencing prices declines of more than 30% trought august 2009, according to S&P/Case-Shiller database published this week. Look at this excepcional interactive chart from New York Times.

Case-Shiller report showed a continued, yet notably weaker, bounce in prices with the Composite-10 index increasing 1.28% on a month-to-month basis.

Composite 10 and 20 city index, 1992-aug-09, (source: Bespokeinvestments).

Read in New York Times:

Even as new figures show house prices have risen for three consecutive months, concerns are growing that the real estate market will be severely tested this winter.

Read in Bespokeinvestments:

Only Las Vegas and Seattle traded at their multi-year lows in August, while the rest of the cities analyzed have bounced.  The composite 10- and 20-city indices have now bounced 5% off of their lows, while three cities (Cleveland, San Francisco, and Minneapolis) are now up more than 10%.  Prices in New York and Miami are only up 3%, while Boston, Chicago, and Washington DC are up about 7%-8%.

On a year-over-year basis, Dallas, Denver, Cleveland, and Boston are the closest to showing year-over-year gains, while Las Vegas is down the most YoY at -30%. The composite indices are still down 11% versus August 2008 prices.

In my point of view, the problem is, acording to Fitch, nearly 90% of option ARM mortgage have yet to reset. So, foreclosures will continue to rise untill 2011, so real estate market isn’t ready to bounce. 

Year over year % change in S&P/Case-Shiller home prices, august 2009 (source: Bespokeinvestments).


New York, Las Vegas, Cleveland, portland, Minneapolis and Charlotte real estate index charts, august-09 (source: Bespokeinvestments).


Phoenix, Los Angeles, San Francisco, San Diego, Denver and Washington DC real estate index prices, august-09 (source: Bespokeinvestments).


Miami, Tampa, Atlanta, Chicago, Boston and Detroit real estate index prices, august-09 (source: Bespokeinvestments).

A new king of the jungle in Wall Street, JP Morgan.

JP Morgan building in front of Wall Street stock exchange in 1914.

Esential interactive graphic courtesy The New York Times, which shows the change in size of American banks by market capitalisation betwen october 2007, just before this current crisis, and october 2009.

October 2007 US banks market cap (source:

1. Look at overall Picture, how is becoming minuscule until March 2009 and as subsequently recovered by stock prices apreciation and also capital increases.

2. In relacion to Citigroup, which was the largest bank in the world in 2007, and which was reduced to near 0 in March 2009. Only the recovery in stock but especially the capital increases have led to its current size, but far from number 1. In fact, present market cap is about $23 billion U.S.

3. The number 2 in 2007, Bank Of America, is now worth $141 billion, mainly due to its huge capital increases.

4. AIG in fact, no longer exists.

5. And after all this storm, who is the new king of the jungle … … ……….., JP Morgan. And the number 2 is Goldman Sachs.

6. Banks disappeared:  Two investment banks competitors, Lehman Brothers and Bear Stearns. And also large commercial banks have disappeared, Wachovia, or Washington Mutual.

2009 october US banks market cap (source:

As you will see the interactive chart, the total capitalization of U.S. banks in September 2009 is $947 billion, the October 2007 was $ 1.87 trillion, so more of $923 billion destruction, because there have been many capital increases. See the post, “the banks and the kiss of death“.

As I wrote some time ago, ( “JP Morgan did the same in the banking panic of 1907“) John Pierpont Morgan, in another similar banking crisis in 1907. In this period, some competitors was devoured by JP Morgan.

Dubai bubble. It’s the mother of all the crashes?

BBC video about Dubai real state crash (september 2009).


“The skyline of Dubai, including the Burj Dubai, the tallest building on earth, photographed from the World Islands. Construction of the much-hyped project, an archipelago of 300 man-made islands designed to resemble a world map, helped extend Dubai’s 45 miles of natural coastline to 467 miles, enough for everyone to have waterfront property — or so the brochures promised. The site used more than 34 million tons of rock and 320 million cubic meters of sand (making Dubai, oddly, a sand importer). State-owned megadeveloper Nakheel promotes the islands as “a blank canvas for orchestrating your own version of paradise, and where you’ll discover that the World really can revolve around you.” To some, however, the project represents Dubai’s fundamental flaws: overbuilding and poor planning. Despite prices ranging from $20 million to $50 million, the islands are without power or sewer systems. And while 70% of them have already been sold, development has begun on only one.”


Real State prices falls nearly 40% in 2009 ¡¡¡¡¡¡¡¡¡ (source: FT).

In the famous Palm Jumeirah, “Villa price tags have fallen to $2 million from $5 million, and many sit vacant. Real estate agent James Fox explains that in the overheated market, investors looking to flip properties often purchased houses before they were built; when the unregulated real estate market crashed, some were left with nothing but plots of sand. As anger grew, rumors spread that the island was sinking under the stress of traffic and overbuilding. Fox sees the real estate collapse as “a necessary correction of the market.”

The government will not release numbers, but it’s estimated that more than 3,000 abandoned cars have been found in 2009, many with keys in the ignition”.

Video advertising on Dubai 300 artificial islands resort.

Tour of Crown prince od Dubai’s garage.

Interview with 3 Dubai economy experts.

Finally, Dubai madness in 11 photos.

Is the Dollar ready to rally?

US Dollar chart and sentiment extremes bullish and bearish, (source:

10 October 2009, everyone thinks the US Dollar will continu to fall in nexts weeks or months. It’s a global perception. Even some of the world’s most renowned economists, including Nobel economist like Joe Stiglitz or Paul Krugman, just predict the end of the reign of the dollar. Is the World lossing faith in the Us Dollar?

The Nobel Prize in economics, Joe Stiglitz recommended not to keep savings in dollars.

“The United States must brace itself for the dollar to be usurped as the world’s reserve currency as American dominance wanes in the wake of the financial crisis”, the World Bank president, Robert Zoellick, warned yesterday.

Such is the global negative sentiment about the weakness of the dollar as the advisor polls of MBH Commodities, 96% of investors now think the Dollar will continue falling or rather plunging. Also the feeling of currencies investors (DSI source) is that only 5% think the dollar will rise.

Although I also think that in the medium to long term the dollar is likely to continue experiencing a structural weakness, I think we might be a few days or weeks to see a very strong dollar rally, be careful.

This situation reminds me the first week of March 2009, near the lows in stock markets. It was just the beginning of one of the biggest bull market in decades. I think that the dollar is just prepared for a big rally.

And remember: “One man can make mistakes, but the crowd is always wrong.”

PD: Read this funny and interesting post in, about present US Dollar bearish sentiment extreme.

One country is even more indebted than the United States ¡¡¡¡¡

Total US and UK debt as % of GDP (1870-2008).

One economic indicator has surprised me. In 2008, english currency, the Sterling began to depreciated againts dollar and Euro. One possible explanation was the enormous private and public english debt, bigger than american ones ¡¡¡¡¡¡¡.

US total debt (private and public) is 350% of their Gross Domestic Product (GDP) in 2008. Of course, this ratio will increase in the next 24 months.

For United Kingdom, it accounts for 450% of their Gross Domestic Product (GDP) and growing.

Spain is also in this “exclusive club” of countries with more than 300% of total debt relative to GDP.


World credit crunch ……. except for China

Global banks lending growth (2003-2008, source: FT).

Bank lending evolution is key in recent world economies. From 2003 to 2007 internal loans made in their countries by global banks grew at rates of between 5% in 2003 and 2004, 10% in 2006 and 2007. In contrast, loans to other countries and areas grew at rates of 20% annually. For example credits to Eastern Europe countries result in real state investments now completely unrecoverables. 

2009 lending to another countries has negative growth, and domestic lending growth has lowered.

US bank lending and M2 growth (2005-2009).

In United States, between 2005 to 2008, credit grew at higher rates as bank loans internally grew near 15% annually. It was in 2009 when credit crunch began with credit decreases at rates of -15% ¡¡¡¡¡¡¡¡¡¡¡¡¡¡¡¡¡. is very optimistic to think in economic recovery with this credit destruction.

Only in China, things are different, the Chinese government has led its banks to lend even more than in previous years. Credit growth in 2009 is reaching 35% ¡¡¡¡¡¡¡¡, 3 times more than in previous years, a genuine madness, which is leading many economists to publicly express the risk of creating new bubbles. Now the Chinese throw more gasoline on the fire.

Lending and M2 money supply growth in China (right chart, source: FT).

World current world economic recession map

World economic map, summer 2009 (source:

I found several interesting economic charts, thanks to Prieur Du Plessis site.

In this interactive map, you will see the current economic situation of each country and continent all over the world. You know that I usually talk about the bright economic future of the Asian continent and, the serious and huge imbalances in the U.S. and Europe.

In the color map you Hill see where is the countries in red, with severe recessions and which are orange and green. Only some American and African countries in addition to the Asian continent, escaping from the strong Western crisis. Surely, Africa and Latin America because their financial and credit system was not yet sufficiently developed to give loans for families and businesses everywhere. Thanks to its financial lag, its debt to GDP is low, so it’s crisis is much softer.

World exports by countries (jul-09).