The World Bank’s latest restructure – what it means

The facts:

  • Over 10,000 people in around 100 locations around the world work for the World Bank;
  • The current president is Jim Yong Kim;
  • The Bank lends US$30 billion a year to support a wide range of activities from infrastructure loans, poverty alleviation, health grants, capacity building and ensuring inclusive growth;
  • It is financed by 188 members countries. 

What’s happening:

  • A reorganisation is planned and approved  – the 5th in 16 years. (Others were in 1997, 2001, 2007, 2010);
  • Latest restructuring approved by the governors of the World Bank and the IMF – in the annual meeting of the two bodies that arose from the Bretton Woods Conference. Kim also obtained the mandate when the World Bank / IMF meetings concluded on the 13th of October (where the Bank’s interim poverty target was set at bringing the number of people in ‘absolute poverty’ down to 9% by 2020;  
  • The current restructure will undo the earlier reorganisation undertaken in 1997;
  • Along with the restructure – there has also been a US$400 million budget cut. (to be phased over 3 years – and marks an 8% cut from the current $5 billion annual expenses); 
  • Full proposal for restructure found on this link (Click here)

What the new restructure means:

  • There will be 14 Global Practices – across the bank’s different projects and funds:
  • The 14 Global Practices include:
    1. Agriculture
    2. Education
    3. Energy and Extractive Industries
    4. Finance and Markets
    5. Health, Nutrition and Population
    6. Macroeconomics and Fiscal Management
    7. Poverty
    8. Social Protection and Labour
    9. Trade and Competitiveness
    10. Transport and Infrastructure
    11. Urban Rural and Social Development
    12. Environment and Natural Resources
    13. Water
    14. Governance
  • There will also be thematic areas such as gender, climate change, global employment, conflict and violence, public private partnerships (PPPs) which will be considered;
  • There will be greater centralisation (leading to less power to current country/regional based centres of influences);
  • A reshuffling of senior officers has begun – Sri Mulyani (previously Finance Minister of Indonesia) is now the bank’s COO;
  • Sanjay Pradhan (anti-graft expert) is now the VP for “change, knowledge and learning”;
  • Layoffs should be expected.  For example, each Global Practice will have one global director who will replace four regional heads and the vice president in a speciality area, which will potentially eliminate four senior jobs per expertise;
  • Reorganised bank would focus on working in partnership with the private sector;
  • The culture to shift towards greater tolerance towards a higher-risk / higher reward partnership (which potentially may include more controversial projects and possible moral hazards.)  
  • “If you have a spectacular failure, the only thing that I would be disappointed about is if we didn’t ensure we learned from that failure.” – Kim

The impacts:

  • In 1997, J. Wolfensohn (then President of the Bank) convinced Bank shareholders that a massive decentralisation, which would get development specialists out of Washington into the field, was the way forward. It was felt that being close to the markets would mean that the markets will benefit from the expertise of specialists who will be based in-market.
  • However, Kim wants a contrary approach. He wishes to close a large number of World Bank Group field offices and bring markets based staff of its four arms (International Bank for Reconstruction and Development, International Finance Corporate (IFC), International Development Agency, and Multilateral Investment Guarantee Agency (MIGA)) centrally;
  • Kim feels that the World Bank will become more efficient and effective through consolidating control of its far-flung operations back in Washington and also improve synergy between its four arms (listed above);
  • Kim feels that the World Bank (due to its current structure and bureaucracy) will become a series of regional banks rather than a world bank and fears that the World Bank could “become less than the sum of our parts,” and this in part was a driver for the process of re-centralisation;
  • Kim also wants the WB to coordinate the activities of other regional development institutions – though there are doubts where another layer of coordination going to help improve efficiency;
  • Kim wants the WB to be a “solutions bank” whereas previously J Wolfensohn wanted the WB to be a “knowledge bank” – the difference is not necessarily understood by many.

The questions that remain:

  • Should the World Bank restructure or downsize and let regional developmental agencies such as the ADB (both Asian Development Bank and the African Development Bank), the European Bank for Reconstruction take over some of its roles? The BRICS also recently set up the BRICS Development Bank – for financing infrastructure required for development. The BRICS DB will also be closer to the market and may be more responsive, reactive and attuned to the needs of developing nations. How will the Bank match this level of immediacy?
  • Furthermore, the Bank also feels it can help coordinate across the different regional development agencies (such as the ADB, etc) – but how receptive will they be to the Bank’s interference?
  • Furthermore, there are still hugely capital intensive projects that still need large tranches of low-cost funding and it may be likely that developing nations will turn to regional development agencies and bodies for funding rather than the World Bank where there remains a perception that the terms and policies of funding are dictated by developed/larger nations. How will the World Bank overcome this challenge?
  • Advocates for downsizing argue that since the incidence of global poverty has reduced in the last few decades (particularly India and China) and eligibility of these countries to get low cost financing from the WB has decreased significantly as a result.
  • Will the bank be focussed too much internally during the transition and not enough on developmental and capacity building programmes?
  • Should the bank also focus more on other development needs such as Anti Money Laundering and the Combating the Finance of Terrorism (AML/CFT), human trafficking, narcotics, climate change , and other issues that occur outside a single country context?

An idea: The Greek financial tragedy – a suggestion for resolution

An overview

Greece is battling to save itself from bankruptcy. It is estimated that Greece owes up to €350 billion (approximately US$465 billion). Greece’s biggest creditors are France, Germany, UK and US. Widespread tax evasion by the wealthy and elite coupled with unsustainably high public sector debt and wages have led to this current situation. A sharp downturn for the European economy has also meant that the Greek economy’s output also was not enough to service the excessive debt. As a result, there have been painful public sector cuts and tax rises – both which have not helped the ordinary man in the street.

In recent months, the IMF, the European Central Bank (ECB) and the European Commission (EC) have all been trying to get Greece to accept a package of austerity measures that have been set as preconditions for any further help/bailout support.

The Greek picture

Essentially, all of the powers that be want Greece to undertake a series of reforms that will increase taxation, reduce benefits, reduce public sector spending as part of an international rescue package that will prevent Greece from sliding into bankruptcy. Whilst this prevents default to major creditors, this will not necessarily help the Greek people. Cuts in government expenditure are the last thing a government should do in a recession – it sucks the country into a vicious spiral which will possibly not only bankrupt a country economically, but socially and spiritually as well.

So what can the Greeks do?

A possible solution

Now, we know the Greeks have a debt of about US$465 billion. That’s a lot of money to be paid back. Greece’s GDP per annum is only about US$300 billion! With a downward spiraling economy, how is Greece going to make enough to just pay back the interest on the loan, let alone pay off the entire loan quantum itself?!

Now, one thing to note is, despite the huge debt, the Greeks have the 30th largest holding of gold in reserves in the world. Greece currently holds up to 112 metric tons (MT) of gold. At the current gold price of about US$54m per MT, Greece has a total holding of about US$6 billion worth of gold.

What does this mean? Am I suggesting that the Greeks sell off all their gold and try to lower the debt? Nope. US$6 billion is a small drop in a huge well of US$465 billion debt!

My suggestion is that perhaps the Greeks should utilise this gold in a more creative manner.

But before going any further – a primer on financial derivations (‘put options’ in particular)

A stock option (which is a financial derivative which big banks use so artistically to lose not their wealth but the wealth of nations) is basically a contract between two parties in which the option buyer buys a right (but not obligation) to buy or sell 100 shares of an underlying stock at a predetermined price from/to seller at a determined date.

Options are one of the most risky investment products available (which explains why banks love them so much) with the potential to lose all your money – but there is also the opportunity of making heck of alot of money too. (With great risk comes great reward – if you’re lucky).

An option to buy a stock at a given price is known as a ‘call option’ while an option to sell a stock at a given price is known as a ‘put option’. The predetermined price agreed between both parties is known as a strike price.

So to surmise, a ‘put option’ gives the buyer the right (but not the obligation) to sell a stock at a specified price (‘strike price’) within a period of time.

Let’s assume you are a tad bearish (and you expect the stock price of a company or an index – such as the DJIA/FTSE/etc to fall) – you can take a position of ‘going long’ on the puts – which is basically another way of saying you will BUY the ‘put option’.

What does this mean in practical terms?

Let’s say Goreng plc (GOR) is currently trading at $50. You think that GOR is going to drop to about $30 in a month’s time. Since you have a bearish view of GOR, you decide to ‘go long’ on GOR ‘put options’. You go to your friendly brokerage agency and they sell you the ‘put option’ for $5 for 100 stocks of GOR (which means it costs you a total of $500) with a ‘strike price’ of $45 (which means you have the right to sell GOR for $45) in a month’s time.

In one month, let’s say, your oracular sense of pricing was right, and GOR does fall to $30. Although you don’t own any share of GOR at this time, you can still invoke your right to sell your 100 stocks of GOR for $45 even though the market price is only still $30. You can then go to the open market and buy 100 shares of GOR at $30 a pop and sell them immediately for $45. This will make you an immediate profit of $15 per stock – or $1500 for 100 stocks.

Your total profit therefore will be $1500 (profit on the sale of GOR) – $500 (price of options you paid) = $1,000.

Which means, you’ve just made $1,000 on an investment of $500. Small outlay – big return.

If on the other hand, your prediction on GOR’s price movement was as good as the Australian cricket team (i.e. rubbish), and GOR’s price did not go down, then the only thing you would have lost would be your purchase of put options for $500.

How are options priced? Options are priced in a number of ways, but one of the more common ways is a model known as the Black Scholes model – which I will not be going through in a great level of detail – particularly since I have forgotten the derivation of it since 2001 when I did my last Corporate Finance exams! But a simple Google search should come up with various calculators, etc.

Anyway this is how some of corporate history’s greatest insider traders made a lot of money illegally. They know of a piece of news that will dramatically affect the stock price negatively. But since they are in a privileged position (ie perhaps they are part of the management team), and the market does not know of the news yet, they decide to go long on put options in the hope that the downward spiraling of the stock price helps them make money – which hopefully they don’t have too much time to spend as they should be locked up way before they are escape with their ill-gotten gains.

Hope you’re with me so far…and so moving on…

A possible solution (continued)

And so, I thought of the Greek problem from a purely academic point of view and considered the following course of action (mind you I am not advocating that Greece should do this – but will be interesting to note what the reactions will be if it does)

  1. So Greece decides that it will liquidate its current gold reserves – and does so in a systematic but careful manner – so as not to arouse too much suspicion – and sells all of its gold for US$6 billion and holds it in US$.
  2. They then go to their nearest friendly (and extremely discreet brokerage firm) and decide to go long (or buy) put options on index options of some of the largest indices in the world (including Dow Jones Industrial Average – DJIA of the USA, CAC of France, DAX of Germany, FTSE of UK, SGX of Singapore, Hang Seng of Hong Kong) on very short expiry terms (of perhaps a month at most).
  3. The Greek Parliament (who will all have to be part of this enterprise) should then reconvene and make a statement to the world (and all their major creditors) that they will default on all of their loans.
  4. This will create extreme volatility in the major stock indices of the world, causing index prices and general share prices to fall precipitously. It will also lead to international outrage and condemnation of Greece.
  5. The Greek government – after a delay of about two weeks – should then quietly dispose of their put options which will be ‘in the black’ or be profitable.
  6. So how much will they make??
  7. Let’s say that Greece decides to go only with the DJIA Index Options. The Dow Jones Industrial Average index option contract has an underlying value that is equal to 1/100th of the level of the DJIA index. The Dow Jones Industrial Average index option trades under the symbol of DJX and has a contract multiplier of $100. Currently the DJIA Index stands at 11,231 which means it trades at $112.31 (11,231/100). Let’s say that the Greeks decide on 30 days (expiration) and a strike price of $111.00 (which means they have a right to sell the DJX at $111 in 30 days).
  8. This will mean that each put option will cost the Greeks approximately US$1.33 per option. Let’s assume that the Greeks invest ALL of their US$6 billion and purchase 48 million contracts (each contract is worth 100 put options). After the announcement of the news, let’s say that the DJIA matches its worst ever fall in 1987 of 20% drop. This will mean that the DJIA will fall to about 9,000 points and the DJX will therefore trade for $90. If at this point, the Greeks decide to exercise their rights and sell all of their put options or basically buy DJX for $90 and sell them on at $111 (as per their strike price), they should make about close to $100 billion. Other indices may fall even more – and the Greeks can make more money off it.
  9. Greece then says no to bailout – try and pay off the loans and move on with life.

What will happen – and can it work?

As I stated earlier, this is a purely academic exercise. I am not sure how practicable this would be in the real world.

However, if this were to happen, then it would be the first instance of the history of the world for an entire Parliament to have committed insider trading. And what is anyone going to do about it? It will shock the global financial system – but it will not necessarily cause a meltdown. It will also result in Greece being international pariahs (at least for a while), but come on, we cannot stay mad at the guys who gave us the likes of Socrates, Plato and Aristotle for too long?

It may also force the world to reconsider this bullshit notion that we can magically make money out of nothing – and force us to re-examine the way international finance is being conducted – just by machines and making money off ‘flash trading’ or basically super-fast trading done by computers with no real understanding of context.

We need a sustainable world – and this may be the trigger that forces us to rethink and retool ourselves.

And if the Greeks do pull it off – I can see them all dancing to Bob Marley/Inner Circle’s “Bad Boys”

Bad boys, bad boys whatcha gonna do whatcha gonna do?

When they come for you?Bad boys bad boys whatcha gonna do?

Whatcha gonna do whatcha gonna do when they come for you?