The Economist provided a very nice chart last week (see Still in a Spin) breaking down the foreign bank exposure to Greek sovereign debt (as compiled and reported by the BIS).

From the table, it seems that French, German, and Swiss banks have the greatest overall exposure to Greek government debt. But there is much more to it than that…

The figures presumably capture the nominal amount that foreign banks hold in Greek government debt expressed as a percentage of Greece’s total outstanding debt. However, to the extent that foreign banks have hedged their exposure through insurance purchased in the CDS market, the table will not reflect the true exposure of those banks.

We can’t quite know the extent of the exposure to Greek sovereign debt without knowing the exposure of banks (and non-bank financial institutions) to CDS positions on Greek sovereign debt. Since the CDS market is opaque and unregulated, my fear is that, aside from the obvious threat of contagion to the other PIIGS economies, the lack of transparency regarding exposure to Greek CDS contracts might result in a “credit crunch” redux. Might there be a sovereign equivalent to AIG or AMBAC out there?

With the global economy in the midst of a still fragile recovery, I certainly hope not…

The most recent issue of The Economist ran a wonderful survey of innovation in emerging markets (see Special Report on Innovation in Emerging Markets). The collection of articles discusses how innovation is helping developing countries catch up with their developed country counterparts, and how emerging market multinationals, through internal innovation and acquisition, are becoming formidable global competitors.

Developing countries are becoming hotbeds of business innovation in much the same way as Japan did from the 1950s onwards. They are coming up with new products and services that are dramatically cheaper than their Western equivalents: $3,000 cars, $300 computers and $30 mobile phones that provide nationwide service for just 2 cents a minute. They are reinventing systems of production and distribution, and they are experimenting with entirely new business models.

Emerging-market champions have not only proved highly competitive in their own backyards, they are also going global themselves.

The United Nations World Investment Report calculates that there are now around 21,500 multinationals based in the emerging world. The best of these…are as good as anybody in the world. The number of companies from Brazil, India, China or Russia on the Financial Times 500 list more than quadrupled in 2006-08, from 15 to 62. Brazilian top 20 multinationals more than doubled their foreign assets in a single year, 2006.

At the same time Western multinationals are investing ever bigger hopes in emerging markets. They regard them as sources of economic growth and high-quality brainpower, both of which they desperately need. Multinationals expect about 70% of the world’s growth over the next few years to come from emerging markets, with 40% coming from just two countries, China and India. They have also noted that China and to a lesser extent India have been pouring resources into education over the past couple of decades. China produces 75,000 people with higher degrees in engineering or computer science and India 60,000 every year.

The world’s biggest multinationals are becoming increasingly happy to do their research and development in emerging markets. Companies in the Fortune 500 list have 98 R&D facilities in China and 63 in India.

I agree that there are some truly exciting opportunities in developing markets, especially China, India, and Brazil. The potential those markets hold certainly make me hopeful for the prospects of long-term economic development.

That said however, frequent readers of this blog know where I stand with respect to the prospects for developing countries (and their firms) to quickly close the capabilities gap with the developed world. Despite the incredible potential these markets hold, my position has been that we ought not get too giddy thinking that developing countries will be able to catch up anytime soon (see China Attracting High-Tech Research or Doing Business in a Developing Country). They face some serious headwinds.

First, the US alone accounts for one third of worldwide R&D expenditure. Developed countries as a group account for around three quarters of worldwide R&D expenditure. Second, much of the R&D that developed country multinationals conduct in developing countries is skewed toward low value-added activities. Third, much of the “innovative” activity engaged in by local firms in developing countries centers on the simplification of existing technologies from developed countries for less sophisticated local consumers. Fourth, developing countries are still relatively economically and politically unstable. They are fraught with structural problems that in no way guarantees that their economic growth will continue unimpeded, and their political and economic institutions remain underdeveloped. Finally, it is true that emerging market multinationals have grown significantly over the past several years with an impressive number of entries on the Financial Times 500 list. However, much of that growth has been achieved through acquisition of developed market firms at the peak of the equity bubble. It will be interesting to see how those acquisitions fare over the next decade.

I hope that doesn’t come across as curmudgeonly because I do absolutely believe that there will be nothing more exciting than witnessing the growth and development (both the good and the bad) of the BRIC markets over the next 50-100 years (if only I could live long enough). I just think that the unbridled optimism with which many mainstream media pundits describe emerging markets needs to be put into context, and tempered with a dose of reality.

Nevertheless, each and every article in The Economist survey is well worth the read. I strongly encourage you to take a look for yourself (see Special Report on Innovation in Emerging Markets).

It’s been a whirlwind few weeks of travel for me – beginning in Holland, then on to Paris, followed by a trip to DC. But I am now back in New York, looking forward to getting back to a more regular, regimented schedule.

In the meantime, I thought I’d share some articles that I’ve enjoyed reading over the past few weeks.

1. Canadian Pension Organization to Buy UK Lottery – Details how a Canadian Teacher’s Pension organization is trying to acquire a British lottery operator. Can someone please explain to me the logic of a pension fund running a lottery company, …in a foreign country no less? This defies just about all corporate strategy logic regarding M&A activity. What do pension funds know about running lottery companies?? And if they’re simply a financial buyer, what business discipline will they be able to impose, especially since the owners get only a small portion of the profit? Also, I can’t help but wonder how Canadian teachers will feel about owning a gambling operation.
2. The Celebrity Effect – Details research on the financial impact of appointing celebrities to a company’s Board of Directors (e.g., Evander Holyfield at Coca Cola; Michael Jordan at Oakley; Billie Jean King at Philip Morris; Gerald Ford at American Express). Although the research suggests that firms benefit from announcing celebrity directors, I remain skeptical. I have brought board members from various large public corporations to speak in my class, and they have expressed disappointment with the celebrity members of their boards, sharing stories about celebrities who typically do not pull their weight. I can understand if a celebrity has a particular expertise that lends itself to the business or if a former politician joins the board of a firm that operates in the government sector and/or for which political connections are especially important. However, by and large, I think that many of these appointments are ceremonial, and likely do not create value.
3. The Panda has Two Faces – A story from the Economist on the perils of doing business in China. They stress the political, economic, and cultural quandary facing foreign entrants (see also So You Want to Do Business in a Developing Country). A choice quote from the Economist article, “[China] regards foreign investment as a mechanism for acquiring foreign know-how rather than just jobs and capital; hence the insistence on joint ventures…political difficulties are piled on top of cultural difficulties. The Chinese emphasis on personal connections (guanxi) makes it hard to distinguish between business-as-usual and corruption. And the weakness of the legal system means that companies operate in a confusing half-light. Transparency International’s most recent Corruption Perceptions Index ranks China 79th out of 180 countries…”
4. Relax, We’re Fine – The future of the US economy according to David Brooks. Although the title of the article might be viewed as insensitive to the plight of the millions of Americans who are currently unemployed, I think that David is rightly optimistic about the long-term prospects of the US economy. And it’s nice to remind ourselves of that sometimes, …especially when things don’t feel so great at the moment. A choice quote, “…the U.S. remains a magnet for immigrants…the U.S. is among the best at assimilating them (while China is exceptionally poor). As a result, half the world’s skilled immigrants come to the U.S. As Kotkin notes, between 1990 and 2005, immigrants started a quarter of the new venture-backed public companies. The United States already measures at the top or close to the top of nearly every global measure of economic competitiveness. A comprehensive 2008 Rand Corporation study found that the U.S. leads the world in scientific and technological development. The U.S. now accounts for a third of the world’s research-and-development spending. Partly as a result, the average American worker is nearly 10 times more productive than the average Chinese worker, a gap that will close but not go away in our lifetimes.” This is exactly why I find it hard to believe some of the predictions that China will soon overtake the US as a technological super-power (see also China Attracting High-Tech Research).
5. The Return of History – A David Brooks two-fer. This Op-Ed is his critique of the field of economics. These are not necessarily new arguments (see Future of Financial Economics, Future of Financial Economics Part Deux, and Krugman on the Future of Economics). Moreover, I am not so sure I agree with David’s prediction with respect to Act V. Nevertheless, it was thought-provoking and provided an entertaining read.

Anyhow, I hope you find these articles well worth your time to read. Enjoy!

In January I predicted that “major” bankruptcies in 2010 would number around 300 (see Notable Bankruptcies of 2009). According to Bankruptcydata.com, there were 29 “major” filings in the first quarter of 2010. Assuming that bankruptcies are equally distributed throughout the year, this puts us on pace for around 120 bankruptcies. That would be well shy of my prediction.

What a difference a year makes!

As I mentioned in previous posts (see Notable Bankruptcies of 2009: Q3 and Notable Bankruptcies of 2009), the stylized fact that the pace of corporate bankruptcies diminished throughout 2009, and now into 2010, begs the question of whether the underlying cause was a structurally improved economy or the massive Fed/Treasury liquidity programs keeping weaker firms on artificial life support.

Although the economy certainly seems to be improving (the recent uptick in employment stands as evidence of such an improvement), I still believe that the drop in bankruptcies has a lot to do with the Fed/Treasury liquidity programs. We will find out shortly as the Fed/Treasury now begin to unwind such programs, and with peak stimulus now behind us. In this sense then, I believe that the true test for corporate balance sheets (and by extension, the economy) will come in the second half of the year.

It is therefore still my expectation that the pace of corporate bankruptcy filings will increase throughout 2010. If fundamentally weak companies are being propped up by the provision of credit/liquidity to an economy that cannot structurally support them, it is only a matter of time before bankruptcies begin to reflect the true underlying economic fundamentals.

Anyhow, below you can find an updated list of what I see as the “noteworthy” bankruptcies of 2010, as reported by Bankrupctydata.com (please note that this is not an exhaustive list):

• Affiliated Media, Inc. (Newspapers)
• Anthracite Capital, Inc. (Real Estate)
• Atrium Companies, Inc. (Windows and Doors)
• Black Gaming, LLC (Gambling)
• Electrical Components International, Inc. (Manufacturing)
• EnviroSolutions Holdings, Inc. (Waste Disposal)
• FirstFed Financial Corp. (Banking)
• Haights Cross Communications, Inc. (Publishing)
• International Aluminum Corporation (Real Estate)
• Mesa Air Group, Inc. (Airlines)
• Morris Publishing Group, LLC (Media)
• Movie Gallery, Inc. (Retail)
• Neenah Enterprises, Inc. (Manufacturing)
• Orleans Homebuilders, Inc. (Real Estate)
• Penton Business Media Holdings, Inc. (Media)
• Regent Communications, Inc. (Media)
• Spheris Inc. (IT Services)
• Uno Restaurant Holdings Corporation (Restaurants)
• Xerium Technologies, Inc. (Paper)

In addition to the “notable” bankruptcies (e.g., those firms with assets greater than $50M) tracked by Bankruptcydata, the U.S. government tracks all bankruptcy filings by type (e.g., Chapter 7, Chapter 11, Chapter 13). You can find detailed bankruptcy statistics at the U.S. Courts website or from ABI. Business bankruptcies for all of 2009 came in at 60,837 compared to 43,546 for 2008.

The chart above presents annual (calendar year) business bankruptcy filings from 1990-2009 (click on the picture for a larger image). The number of filings had been trending steadily downward from 1990 through 2006. In 2007 the numbers began to reverse course. My expectation for 2009 was for 55,000 total business bankruptcies (see Notable Bankruptcies of 2009: Q1).

Taking stock of my 2009 predictions: They were a bit on the high side in the “notable” bankruptcy category, but a bit on the low side for total business bankruptcies. So I underestimated the number of small-firm bankruptcies and over-estimated the number of large-firm bankruptcies.

What can we make about the difference in accuracy across my predictions given that they were estimated using the same predictive methodology?

I think it speaks to the nature of the Fed/Treasury liquidity provisions and its impact on the broader economy. That is, the reason we did not observe large-firm bankruptcies more in line with my prediction is probably because larger firms had greater access to liquidity and were beneficiaries of the stimulus program. By contrast, smaller businesses struggled to access capital markets thereby exacerbating their crisis. Putting numbers to it: There was an 8% increase in large-firm bankruptcies from 2008 to 2009, but a 40% increase in small-firm bankruptcies.

This is why I believe that the dip in the pace of large-firm bankruptcies throughout 2009 was more a function of liquidity provisions than a wildly improving economy. The difficulty small firms had obtaining capital was a recurring theme in 2009. And for good reason. Unfortunately, I don’t expect that to change anytime soon.