Kuwait - Assignment #2 Kuwaitʹs al‐Manakh Stock Market...

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Unformatted text preview: Assignment #2 Kuwaitʹs al‐Manakh Stock Market Case . The Kuwait al‐Manakh Stock Market crash in 1982 resulted in outstanding debts of some $94 billion and left the country in a state of economic panic. The Kuwaiti judicial system faced the near impossible task of assigning criminal and financial liability among the 6,000 investors caught in a web of 29,000 ʺbouncedʺ postdated checks and IOUs associated with the bankruptcies and business failures. Postdated checks and IOUs, written on behalf of speculative Kuwaiti investors and traders, funded the marketʹs boom and led to its dramatic crash. Developing a method to disentangle the web of outstanding debt could save many years, and nearly $10 billion in court and attorney fees. In addition, the disentanglement would ʺnet outʺ offsetting debts and reduce the magnitude of the total outstanding debt resulting from the crash, thereby reducing the negative impact of the market crash on the economy. The government of Kuwait recognized that this complex web had to be disentangled quickly, fairly, and in a way most beneficial to the economy. His Excellency Shaikh Ali AI‐Khalifa AI‐Sabah, Minister of Finance and Oil of Kuwait, turned to the Kuwait Institute for Scientific Research for help. Events leading up to the creation of the al‐manakh stock exchange The al‐Manakh Stock Market was established in 1979 by Kuwaiti trading companies and speculative investors to take the place of the very tightly controlled official stock market of Kuwait (KSE). After the KSE had undergone a major crash in 1977, permanent government controls were put in place to control Kuwaitʹs highly speculative investors, who were motivated by high liquidity coupled with poor returns on Kuwaiti investments abroad as a result of volatile exchange rates. Oil‐rich Kuwaitis had few places to invest their money other than in the countryʹs stock market, but as the KSE began to boom, speculative traders entered the market, and the rapid speculative growth eventually caused the KSE to crash. Speculators writing postdated checks for investments that they could not afford meant that the marketʹs boom was supported by funds that did not exist. Once out of control, when one investor defaulted, a chain reaction of bankruptcies was inevitable since investors could not honor their checks and IOUs because their accounts receivable and expected market returns were needed to fund these debts. After the crash, the complicated puzzle of unpayable debts led to the bottom falling out of the KSE and produced a widespread panic in the Kuwaiti economy. As a result, the government bailed out creditors at a cost of$525 million. Tight government controls, including new laws severely restricting the use of postdated checks on the KSE, were established following this crash to curb further speculative trading. Events leading up to the al‐Manakh crash The Kuwaiti government owned nearly half of the countryʹs share‐holding companies, and with very few investment opportunities other than oil, wealthy Kuwaitis had few investment alternatives at home. After a third major oil hike in 1979, wealthy Kuwaitis enjoyed a time of prosperity. Public spending andthe demand for places to invest money rose. This increase in liquidity combined with few investment alternatives led to another speculative bubble. Since returns on foreign investments were poor, investors looked at the al‐ Manakh Stock Exchange as a place where they could carry out the speculative trading that had occurred on the KSE prior to the 1977 crash. The al‐Manakh exchange was unregulated, and in the absence of government regulation or supervision, the use of postdated checks soared along with stock prices. Traders created numerous Gulf companies in neighboring Arab states solely for speculative purposes to avoid domestic regulations governing new companies. Investors poured money anywhere they could. At the peak of the stock marketʹs explosion, 3.5 billion shares were traded, or more than four times the 837 million of the KSE. A 100 percent increase in stock value within a few weeks was not surprising to the 6,000 individuals and corporations feverishly trading in the al‐Manakh market. By 1982, the al‐Manakh exchange was out of control. Untrained and uncertified brokers were trading worthless securities at astronomical PIE ratios. With a complicated mesh of postdated checks being traded to fund the explosion, traders used crude and often illegal methods of settlement. The inevitable crash left traders in a complicated puzzle of postdated checks and IOUs, making it difficult to determine who was responsible for each trade. Traders faced the disastrous implications of having written postdated checks 1 against funds that they expected to receive in the future, from the sale of stocks at a profit before the postdated checks came due. The crash In August 1982, the bubble burst when one of the largest of the 18 major trading companies defaulted on its debts. During the month, traded shares fell from 602 to 72 million as securities traded in the market lost 60 to 98 percent of their value. The crash was a huge shock to the Kuwaiti economy. Initially, neither the central bank nor the government knew the magnitude of the crash and the resulting outstanding debt. Traders were left with worthless stocks in defunct Gulf companies as well as a web of two‐way IOU notes and postdated checks. First calculations of the resulting outstanding debt after the crash produced a figure of $94 billion, or 4.3 times the Kuwaiti gross domestic product. The majority of this figure was the sum of the face value of nearly 29,000 postdated checks. In addition, 95 percent of the total outstanding debt involved only 18 traders who were caught in a mesh of entangled debt responsibilities. Attempts to rectify the situation In late 1982, the government took some steps to attempt to contain the damage. It established a clearing house with the purpose of collecting, matching, verifying, and systematizing the financial accounts of individuals and brokers, and set aside a $1.7 billion trust fund to compensate small investors (losses less than $1.7 million). Finally, an arbitration panel was established to effect settlements, and to sanction and finalize settlements reached voluntarily between traders. Unfortunately, the governmentʹs initial strategy of forcing traders to pay their debts as part of the solution did not work. Many traders had become insolvent and few were willing to meet their accounts payable before collecting their receivables, especially when their accounts receivable were needed to pay off their debts. This problem, and the fact that a resolution did not seem to be arising in the near future, led the Kuwaiti government to form the Corporation for the Settlement of Company Forward Share Transactions. This company established a special task force made up of A. A. Eliman (San Francisco State University), M. Girgis (LTC Techno‐Economics Research Group, Inc.), and S. Kotob (Kuwait Institute for Scientific Research). Under the supervision of the Kuwaiti minister of oil and finance, the task force began the high priority task of untangling traders and settling debts. Appreciating the tradersʹ entanglement Table 1 illustrates the example of six entangled traders. Each trader had some assets, (potentially) an uncollected receivable from each other trader, and (potentially) an unpaid payable to each other trader. Table 1. An example of four entangled traders Payables (in $ mil) to Trader Payables Payables A B C D E F from trader 11 5 A 0 8 6 14 44 B C D E F Receivables 42 5 6 33 15 101 0 40 15 16 7 86 23 0 21 20 11 86 5 30 0 9 4 53 10 20 17 0 3 56 20 10 7 24 0 75 100 105 66 102 40 In this situation, a trader is said to be definitely solvent if he has more assets than payables even if he may not collect none of his receivables. Some traders, however, may not be able to determine how much of their debt they could pay before knowing what portion of their receivables they would collect from the other entangled traders. Therefore, one can appreciate how the situation could not be resolved without outside intervention to decide who could and should pay what and to whom. The task force first defined the debt settlement ratio (DSR): 2 DSR = Minimum { 1, (Assets + actually collected receivables)/ Payables} In order to determine the portion of debt that could be honored by each trader, the task force set out a series of equations to determine each traderʹs DSR that was dependent on collectible receivables: Computing each traderʹs DSR would essentially require first determining the payments that each trader would make. A further problem with this method was the necessity to restrict the payments from solvent traders to the amount they actually owed. The task force, however, was able to use DSRs as a method of trader classification without knowing what portion of receivables would be collected (Table 2). Table 2. An example of four entangled traders A B C D E F Assets DSR Solvent (DSR=1) 4 ? seemingly 7 ? definitely no 2 ? definitely no 3 ? definitely no 5 ? definitely no 1 ? seemingly A method for disentangling the traders After considering the dilemma faced in determining the tradersʹ DSRs, the task force realized that determining DSRs would actually disentangle the traders, since each intertrader payment would have to be calculated to determine tradersʹ collectible receivables. However, the rationale behind these payments needed to be decided. What should these payments accomplish? What possible settlement options were the fairest and/or the most beneficial to the economy? Possible payment disentanglement rationales considered included attempting to: i) Limit the number of bankruptcies ii) Pay off as many solvent creditors as possible iii) Achieve the largest possible total payments to all creditors iv) Maximize the sum of traders’ DSRs or equivalently insolventsʹ v) Minimize insolventsʹ deficits (assets + actual receivables ‐ actual payables) The task force also needed to consider the following factors: 1) A trader should not pay out more than the amount owed 2) All solvent traders should honor their payables in cash by liquidating assets if necessary 3) Traders who actually owed money should not make net gains. 4) By Kuwaiti law, debts to multiple creditors had to be paid in equal proportion of the amount owed to each creditor The task force had many decisions to make to arrive at an equitable solution that would disentangle the web of debts and ʺnet outʺ the actual loss to the economy. If a credible solution could not be found, each of the 29,000 postdated checks and IOUs would require three court cases to settle: a criminal case, a commercial case, and a bankruptcy case. The outcome of this legal process would send many Kuwaiti entrepreneurs to jail, including many with strong political and social ties; would cost the government some $380 million; and would require the judicial system to increase capacity 18‐fold for five years. Most importantly, the Kuwaiti economy’s state of panic and recession would not improve until the situation was resolved. Time was of the essence. a. How would you simplify the problem? By inspection, find a feasible resolution that satisfies the factors 1), 2), and 3) described above. b. Without canceling out bilateral and multilateral liabilities, use LP to find a resolution that maximizes the sum of definitely insolvent traders’ DSRs while satisfying the factors 1), 2), and 3). c. Without canceling out bilateral and multilateral liabilities, use LP to find a resolution that maximizes the sum of definitely insolvent traders’ payments to all creditors while satisfying the factors 1), 2), and 3). d. Without canceling out bilateral and multilateral liabilities, use LP to find a resolution that minimize sum of definitely insolvent tradersʹ deficits (assets + actual receivables ‐ actual payables). e. Without canceling out bilateral and multilateral liabilities, find a resolution that satisfies all the factors 1), 2), 3) and 4). (Prepared by Sam Ridesec under the supervision of Professor Peter Bell, Richard Ivey School of Business, the University of Western Ontario, Canada. Copyright 1998, by The Institute for Operations Research and the Management Sciences. Modified by S. Kim.) 3 ...
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This note was uploaded on 03/23/2010 for the course MANAGEMENT d2 taught by Professor Mr.mac during the Spring '10 term at American InterContinental University Los Angeles.

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