Turkish dismay

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0:42Today on the show, how do you say pump and dump in Turkish? This is Unhedged, the finance and markets podcast from the Financial Times. And I am Rob Armstrong, coming to you from the clammy FT studios in New York, New York. Joining me today is one of my favorite colleagues, J.P. Rathbone, who has either worked on or led, I think, every foreign desk the FT operates. Am I exaggerating, J.P.? Let's just leave that exaggeration and enjoy it. No, but really, you've run Africa, Latin America, now you're in Turkey. You're basically the British Empire. You have most of the surface of the planet covered, I would say.

1:29No, it was Latin America. That's where I cut my teeth. Not Africa. Oh, not Africa. Okay. Well, just walk me through this very colorful scandal in the Turkish stock market. Yes, of course. So the envelope to understand the stories is a classic pump and dump scheme run by Spivs. And you go back about two years and there are two. I have to stop you on behalf of our American listeners. Spiv. Give me a working definition of the word Spiv, JP. A guy who opens his coat and says, I've got a whole load of watches. Do you want one? OK, so we have a pump and dump run by Spivs. Go on. So go back about two years, and there are two main investment funds in this sorry tale.

2:20One is called Terra, and the other is called Pusala. And they establish closed-end funds with limited subscribers, and they start their magic, which basically involves buying each other's shares and coordinating to buy the shares of other small, illiquid companies. And we get concentrated buying. Share price zooms up. Their own net asset value increases. And what a wonderful performance that is. Retail investors jump on board thinking, woohoo, this is amazing. And we're talking like 43 ,000 % returns over three years. The bubble pops all of a sudden. And everyone is thinking, whoa, where did this come from?

3:02Why did it happen? Who is responsible? Who can we blame? and how can I get my money back? And that in a nutshell is what's happened. Yeah, it sounds very familiar. It's slight echoes of Bernie Madoff here in the United States, a fund product where the return seemed almost too good to be true and turned out to be too good to be true. But in this case, the performance numbers we're talking about really sound too good to be true. Hundreds of percent returns. Didn't this look too fantastical to be real from the outset? Yeah, absolutely, which is why everyone in the business knew it was too fantastical to be real.

3:44But if you're just a punter in an economy such as Turkey, and there's been very high inflation for the past three, four years, I mean, we're talking it's down to 30 % at the moment, and that's viewed as a triumph. So there's lots of instability. Plus, you've got macroeconomy in the dumps. your pay packet is being eroded by inflation and you're desperate to make ends meet if you're a small guy or small woman you get oh my god 600 return that'll solve my rental bill all my school fees or whatever it is so that's the kind of money that i understand has gone into this because what's noteworthy about this although it's all been all over the press last week the kind of detail that you'd expect to see in reporting in most countries is sort of absent here.

4:36I'm really struck by the open secret aspect of this, John Paul. I mean, just reading your reporting, back in June, we had a warning from MSCI talking about recurring instances of possible coordinated trading behavior, which turns out to be what happened. We had the Minister of Finance saying last November that the government knew manipulation was taking place and was talking about regulating things. And, you know, last week, the Justice Minister said criminal market manipulation should not go unanswered. So how can it be that officials and, you know, big names in markets are saying this stinks, but it just keeps happening.

5:26This is one of these cases where everyone in the know knew it was happening and everyone outside thought it was rubbish and rubbished those thoughts. So you've got certain members of the press here, which is largely state controlled, saying it's fantastic. You've got the head of one of these funds appearing on the cover of Gentleman magazine, looking very dapper in his suit and saying he's the new voice for capitalism in Turkey. So you've got all that kind of soft, soapy sell. Then last November, when the finance minister says, we know that there is manipulation taking place. And in June, when MSCI says, we think there is manipulation taking place.

6:07These are little snippets of news in a newscape which is dominated by Gaza, the war in Iran, the war against inflation. And it's just sort of specialist press. So that's how come it just kind of carries on only half watched. How did it unravel? So the trigger was in August after humming and whoring for several months. The regulators here tightened rules, which basically stuck a stick into the whole gyroscope of this Ponzi scheme. And it just fell over. and were allowed to call it a Ponzi scheme because the justice minister has now called it a Ponzi scheme. And I'm sure that they were aware of what they were doing and the consequences.

6:55And the timing was probably tied to NSCI, which was going to downgrade Turkey in November unless it acted. And investors suddenly got worried. And there was, I think it was, a request for$6 billion of redemption from one of these funds, the Pusilla funds, in one day. And it said, we can't meet this. And then as that generalized across the market, and we're talking Wednesday last week, then other funds started saying the same. And then there was a run on the funds and the regulators stepped in. And there's various schemes that we can talk about what happens next. Yeah, let's do talk about them.

7:34We have a lot of people, a lot of retail investors involved here. How can officials put this monster back in its box? So what really struck me is that the market shaker happens on Wednesday and Thursday and Friday. They've really done a pretty comprehensive package. The central bank has stepped in and it's loosened loan collateral stuff so there's less force selling by the banks. Various stop losses are introduced on the stock exchange. Two major banks are appointed to collate all the funds that are going to be liquidated to liquidate them. And the worst of the crisis seems to be storaged. That said, you've still got 131 funds with a notional value of$18 billion in them and a rough scheme that's still being worked out about how to pool and sell whatever assets are left in them and give the recovery value back to the small investors.

8:28And the number that's being floated around is 20 cents on the dollar. Who knows? But it won't be big. Why we know it won't be big, as a matter of fact, is because the Capital Markets Board said back in December that they thought some of these fund market prices are fictitious. But that was an internal memorandum. There's an extremely striking contrast here, John Paul, between the run-up to this scandal bursting to the surface in that something clearly was wrong. It had been flagged multiple times, yet nothing was done about it. That feels very kind of Wild West frontier market. And the response to the crisis you just described, which sounds very professional and practiced and orderly, much like something that would happen in the wake of a financial crisis in a country like the U.S.

9:33or in Europe. How can those two sit side by side, such a wild run-up followed by kind of this tidy clean-up? Well, my working hypothesis on this, and it's pure speculation, is that the authorities recognized there was a problem, figured out that something would have to be done about it at some point, figured out that these were the elements that were required, central bank, sovereign wealth fund, liquidation procedures. and then having ring-fenced the problem, then you get into the nitty-gritty of the organogram of Turkish politics and the lines and dotted lines of who knew what and who is covering for who and who is responsible or who should be held responsible.

10:17And that is the messy stuff that's going to be left for time to sort out. But if you're a regulator, that's the last thing you want to get involved in. I think that is the first time the word organogram has been used on this podcast, and I congratulate you for that, JP. So let's turn to the future. Turkey's an important country in an important region. Do you think this scandal leaves a mark in its aspirations or its path forward? And what is that mark going to look like, do you think? The way I sort of look at Turkey is there are two Turkeys if you're an outsider. There's the foreign policy, Turkey, NATO member, second biggest standing army in NATO after the United States, booming defense industry, and all these good things.

11:09And President Erdogan, who is now in his 25th year of power, is very good at doing that kind of foreign policy stuff. And then there's the other Turkey, which is inside the country. And here you're seeing extremely high inflation, dubious application of the rule of law, handicapping if not prosecution of opposition politicians, and a sense of institutions being co-opted by the state. They're fulfilling their function in the letter of the law but not in the spirit. I mean, I guess this gets at something that is important to me and to this show, which is the role that well-functioning capital markets kind of plays in a country that works.

12:03And it seems to me, if you have the perception that your markets are rigged, that's a pretty important pillar underneath kind of confidence in civil society broadly. Turkey does some things fantastically well. It's really dynamic entrepreneurs here, absolutely, without doubt. But talk to Turks, and there is a really distinct feeling across all people, all sectors, society, that everything is rigged and everything depends on who you know, rather than a blind application of the rule of law. And capital markets has got a Wild West feeling here. In the equity market, I would say. Debt markets and the foreign exchange market, everything is super smooth, very regulated.

12:58So in the sense that rigged capital markets is indicative of rigged markets elsewhere in a society, then that would be an accurate reflection of how many Turks perceive their situation. Paul, one important part of the Turkish financial landscape from the point of view of international investors is the carry trade because nominal returns in the country are so high. Does that remain a theme in the shadow of this scandal? Totally, totally. If the inflation, say, is 30 % and say you're on a lira deposit, say you're getting 42%, so that's a 12 % return, bingo. you know you can easily get 10 % or so from your just the most simple plain vanilla sticking your money in a Turkish liver account and there the figure that people are watching is not the stock market it's reserve levels and while reserve levels are high that trade will be safe Turkey doesn't want an uncontrolled devaluation because the exchange rate is a inflation anchor and you You can ply that trade pretty happily.

14:18By and large, financial stability is what this government and President Erdogan prizes most. So just to make sure I understand you correctly, you watch the reserve levels because how you get blown out of a carry trade like that, where you get some foreign money, put it into lira and park it in a high returning bank account in Turkey, the way you get blown out of that trade is because the currency is suddenly devalued. So you just want to make sure the country has enough foreign exchange reserves to defend its currency in the case of an emergency. Am I following you correctly? Absolutely. And on a Turkish TV screen watching the news, there's a little number in one of the bottom corners that is the exchange rate.

15:06And that Exchange rate is the most closely watched figure in all of Turkey. You mentioned President Erdogan, and I wonder what this means for his political fortunes, whether it affects his position in the country at all. I think he'll just float way, way, way above it. It's got nothing to do with me. Sorted out regulators. Everyone will be jailed. We're doing our best to reimburse depositors, and Turkey is embarking on the Turkish century and is a great country and will remain so. So I think he'll remain immune. That's why I think the ring fencing of the problem is so important. And then what happens inside that ring fence becomes its own mini-drama that no doubt will become so convoluted and difficult to understand.

16:00Listeners, please stay inside the unhedged ring fence while we take a break. And after that, we'll be back with Long and Short.

16:45Listeners, welcome back. This is Long and Short, which is the portion of the show where we go long things we like and short things we don't like. JP, do you have a long or a short for us today? I am long swimming, having swum the Bosphorus at the end of August, to which I invite young Turk Rob Armstrong to come and join me during this year. How long is that swim? Well, it depends on the current. If the current's really fast, it's two kilometers. If there is no current, then it's six. Six kilometers would be a struggle, but I can handle it. I can swim a mile with some confidence. I am going to go short the U.S.

17:2710-year Treasury. There is a general sense of relief out there in the world this week now that the yield on the 10 has fallen below 5 % again. And I will say here for the benefit of the listeners that yields and prices go opposite directions. I just feel like every fundamental indicator we have, from the rate of growth in the country being high, to the deficit being large, to the rate of inflation, right on down the line, everything tells me that six months from today, the 10-year bond will be at or above 5%. So I've made myself hostage to fortune. Mark it on your calendars, listeners. We'll be back in your ears on Thursday.

18:14Until then, stay sharp out there.