I practically have to start this post where I ended last night. I said more brokers would be shut down and three were intervened today, but more importantly the Comision Nacional de Valores (CNV) decided to eliminate a popular instrument used by brokers to leverage their balance sheets by accepting deposits from the public. At the same time, the regulator gave brokers six months to lower their leverage (debt) to twice their equity. Both these measures will have an important impact on brokers and could possibly bring down some more. Let me explain.
What the Comision Nacional de Valores (Venezuela’s SEC) did was to ban the use of a financial instrument called the “mutuo”. This instrument has been around for about eight years (i.e. it did not exist before Chavez). In it, a broker sells a client bond and signs a contract the client lends the broker back the bond with some interest. In the end, what the broker is doing is accepting a deposit under the promise of some interest rate for the period agreed on. The broker can then turn around, use the client’s money and even resell the bond to another client. In contrast with a bank, there are fewer regulations, no reserves and little supervision.Thus, brokers could pay more interest than banks and leverage their balance sheet, i.e. borrow money from their clients to do other things.
The problem is that if there is no supervision, depositors don’t have their funds guaranteed by Fogade like at a bank and brokers can borrow more than they should. While many brokers used “mutuos” adequately, others, such as U21, Banco Canaria’s brokerage unit, built up mutuos to absurd levels, such that it went broke.
In recent weeks, as U21 went under and the banking crisis developed, the CNV starting looking into other brokers who had “mutuos” with U21 and found a lot of them that when U21 went under, lost all their capital. So, they kept digging and as they did, they had to intervene more and more brokers. There were rumors that the CNV would impose a limit of two times your equity for all brokers as a way of limiting the mutuos (some brokers had as high as a factor of thirty). But instead, the CNV decided:
1) To give 90 days to all brokers to eliminate all their “mutuos”
2) To give them six months to bring the leverage (debt) they may to twice their equity. They will have to do it such that in two months the leverage is down to a factor of six, in four months a factor of four and then a factor of two after the six months.
I think this decision by the Government is unfair, because due to its inability to supervise the brokers that abused the system, it is penalizing all of them.A more correct decision would have been to limit leverage to twce equity, but allow mutuos to continue, and supervise!
Minister of Planning and Finance Giordani said yesterday there was a de-institutionalization of the regulating entities, but did not explain that it was the Chavez administration that caused it. For example, the Chavez administration named two Heads of the CNV who were former military with no experience in capital markets, both of whom are currently either indicted or have an order to be captured for corruption, one when he was Head of the CNV, the other after wards when he was named President of one of the failed banks. Quite a record, no? They learned fast, but apparently not about “mutuos”.
Giordani, like Chavez, seems to talk like this was all about an out of body experience he had, the lack of supervision, the “financial avalanche”, the external treasuries of the banks at their brokers, and the lack of articulation of the institutions, were all in the end by-products of decisions made by Chavez and his Government or the lack thereof. And Giordani has been Minister of Planning and a member of the Board of the Central Bank for nine of the eleven years of the Chavez administration, so he can’t skirt responsibility. As I said earlier, the “mutuo” did not even exist when Chavez got to power and its abuse took place in the last four years. The website Venepiramides, now well known, wrote one of its first posts under the Title “The parallel financial system of mutuos” in which the author warned that the authorities did not understand the dangers. This was over a year ago, others such as Veneconomia wrote about it in their monthly (by subscription), apparently only the Government was surprised by this.
As of October 31st. of last year, there were “mutuos” to the tune of some Bs. 15 billion, or US$ 2.5 billion at the swap rate. This includes U21 which was intervened in November and is now broke (and depositors lost all their money). With the decision to eliminate mutuos, basically brokers will have to return their money to their investors, all of it, within 90 days. This could be cumbersome for some, it is not easy to deleverage just like that, some assets may be illiquid or just the act of selling them may bring the price down.
Of course, this assumes that all brokers that used mutuos, large and small, did them by the book, which may be too much to hope given what the CNV has found so far. If not, we may see more brokers going under and this post ends like last night’s.
Expect this story to continue…