Global banking's trim and brush up

My monthly trip to the barber's shop is something I usually look forward to. While I come home much lighter on the top, that fact is compensated for by the heavyweight, intellectual repartee I may also receive, on subjects ranging from culture, politics, economics, religion and metaphysics.

Although I have never acknowledged my admiration for my barber's world view, my occasional nods have been enough encouragement.

Last week, however, when I walked into his cramped salon he looked pretty downcast and began to go about his job without a word.

When the monotony of the electric trimmer became too much to bear, I quietly enquired how his business had been in the intervening weeks. With a long sigh he replied that, while it was good, he was seriously worried about the future.

I was puzzled, since as long as hair grows, what did he have to worry about? His response was unexpected, to say the least.

It was that there seemed to be some sort of international conspiracy against haircuts. That related to the fact that some were saying that in the long run they could damage the global financial system.

I had to put two and two together, which in my relative slumber was a momentary challenge. I realised that the haircuts he was referring to has nothing to do with his trade.

In the context of the recent media attention to debt restructuring, and a global situation of accumulating debt which is still overhanging economic and financial systems, his usage of the terminology was not so strange. There has indeed been talk of discounts on debt repayments, widely referred to in banking jargon as ‘haircuts'.

In the last week of January, US Treasury Secretary Timothy Geithner and his predecessor, Henry Paulson, spent long hours before the House Oversight and Government Reform Committee hearing on federal assistance to AIG to explain why haircuts were not a viable option in the bailout of the insurance behemoth.

Instead of making the counterparties accept a payment reduction, the New York Fed ended up unwinding AIG's collateralised debt obligations by paying 100 cents on the dollar while it's estimated market value was just 50.

The credit rating agencies had warned those dealing with the AIG counterparty problem that any haircut, or "selective default", could have caused domino-style rating downgrades for AIG and all counterparties, resulting in a massive increase in their cost of capital. In AIG's case all the counterparties were big US banks.

Worries have been growing in Europe too, of potential downgrades of the sovereign-debt ratings of countries such as Portugal, Italy, Ireland, Greece and Spain. They would translate into rating cuts for banks and bigger haircuts where these debts have been used as collateral.

Last week in Dubai, stocks recoiled in a sharp reaction to a media report saying that as part of its proposed restructuring Dubai World would offer creditors either a 60 per cent repayment over seven years with a sovereign guarantee, or full repayment with a debt-for-equity swap for property assets of Nakheel and no guarantee. Dubai World immediately denied the report.

In the globalised economy, bankers everywhere are tuning in to haircuts. So too my barber, it seems. And yet it is he whose craft has a natural hedge against turmoil in the financial world.