Thursday, June 4, 2009

Increased demand for non-FDIC backed debt offering

Banks have offered billions of $ of debt that is not guaranteed by FDIC. Yet, there is high demand for the debt. That is a good indication that the investors are believing in the capital markets; especially, the banks. Return of confidence is good for capitalism.

Rising commodities - true demand vs. speculative trading

Rising price of commodities bode well for economic growth. At the same time, it brings inflation alive. Regulators must be vigilant to ensure the rising price is due to demand instead of speculative trading.

Taming 2 Trillion Dollar Budget Deficit

Stimulus spending was required to jump-start the economy. GDP has fallen. so has export. Tax base can not be raised to cover for the whopping budget short-fall. Now, the government must look into ways to reduce budget so that money printing press does not overwork.

Wednesday, June 3, 2009

Housing sector - pending home sales vs. housing start

Pending home sales data indicates that the tax incentive issued by the administration is aiding home sales. However, the housing start is falling which is indicating the reverse trend. But, in the days of uncertainly like this, putting deposit down for a new house is risky while good value is found in existing houses.

Chrysler and GM Chapter 11 - important to economic recovery

Fairness of the treatment of secured bond holders in case of Chrysler and unsecured bond holders in case of GM is questionable. However, the threat of bankruptcy has enabled these companies to close competitive gap in labor contract. The speed at which Chrysler is emerging from bankruptcy is remarkable. I hope GM speeds through Chapter 11 the same way.

Banks repaying TARP money - boost of investor confidence while diluting shares

JP Morgan was a reluctant borrower of TARP money, while others borrowed out of necessity. Now, JP Morgan, Goldman and Morgan Stanley as well as few others are lining up to repay TARP money. Government has announced rules on repayment - that the bank must be able to raise capital without Fed Guarantee.

1. Issuing of common stock
2. Converting preferred to common stock
3. Issuing non-FDIC guaranteed debt

All these have helped banks to raise capital, but have significantly diluted bank shares. However, it reinforces investor confidence.

Banks need to operate without the strings attached to hire and retain employees. This is certainly key to capitalism to return to normalcy.

Banks Raising Capital identified in Stress Test - Investor confidence regained

Many of the banks have raised money through selling common shares, converting preferred to common and selling debt to raise capital cushion identified by stress test. The speed at which the banks were able to raise capital is remarkable. Although that is not particularly helpful to the stock price due to dilution, it demonstrates the fact that the investors are confident in the capital markets. It is the most important part of the recovery.

Wednesday, April 8, 2009

Fed Bank Stress Test

Bank stress test has been completed. The results are withheld until earning season is over. The aggregated result may be released. This indicates that at an aggregate level, the stress test results reveal weakness vs. strength.

What if weakness is revealed?

It could force capital infusion. Where will the capital infusion come from? It could come through Public-Private-Investment-Program (PPIP) since the others have been exhausted.

What if strength is revealed?

Then, the banks can focus on serving customers instead of worrying about raising capital.

Tuesday, April 7, 2009

Liquidity vs, Credit Crisis

Liquidity - ability to turn an asset to cash.
Credit - Ability to borrow.

Liquidity Crisis - Inability to sell assets; such as, loan portfolio, asset backed security and CDO.

Credit Crisis - Consumer and business unable to borrow.

Thursday, March 26, 2009

Impact of Market Downturn on Hedgefund and Mutual Fund Industry

Both the industries have witnessed massive redemption. Their portfolios have shrunk due to the sudden fall in equities. Due to these, the overall portfolio sizes have shrunk. The industry will endure the following 5 changes.

1. Increase Fee Structure - Fees will rise to spread the cost to fewer investors.
2. Increased Consolidation - Industry will consolidate. Weak players will disappear. Weak Funds will disappear. strong funds and companies will strengthen.
3. Increase capital outflow and retail investment in stocks and bonds - With equities at decades low, retail investors are venturing into the stock and bond market in greater number.
4. Increased Regulation - Hedge fund industry has enjoyed relaxed regulation. That will be a luxury going forward. They will need to maintain higher capital to absorb risk. They will have to be more transparent with their methods. They will also be subject to more regulatory oversight.
5. Increased flight to ETF - ETFs are more tax efficient and regulated. Investors will fly to ETF to avoid the cost structure of mutual fund and hedge fund.

Fed Bond Buyback

Last week when Fed Chairman announced US treasury buyback, bond yield fell and soon after mortgage rates fell as well. Then, market digested the news. The next day the market sold off. When Secretary Geither announced the details of public-private approach to purchasing toxic assets, market reacted positively. Then, Treasury tried to buy bonds. It received lukewarm response. Then, it received massive response.

Overall, the investors are expressing confidence. Market seem to reinforce that. A week is too early to declare victory. But, given the rout in the stock market and the recent improvement, FED effects seem to be working in the right direction.

Tuesday, March 24, 2009

Call for new global reserve currency is premature

US Dollar is the currency in which many countries hold their foreign reserves. Due to the FED decision to purchase treasury bonds and due to recent the fiscal deficit, trading partners; especially, China is wary of US Treasury Bonds (also of US $).

Oil trades in US $. Exports trade in US $. US $ is free float. Ruble is volatile. Chinese Yuan is float within a narrow band. Many countries have tied their currencies to US $ due to its history and stability.

Current US fiscal deficit and rise/fall of US $ is a short-term phenomenon. US is blessed with the bounty of nature, innovation, free market and entrepreneurship to overcome the deficit and balance budget.

Let's analyze Euro. Euro has gained in strength since its inception (was equivalent to $0.84 and ended above $1.50 last year), has lost strength after the global economic crisis. UK has thus far remained outside of Euro. Euro is a global currency in a limited scale (within the Euro zone). Has this alleviated the problems of the member countries? No.

A new global currency is not something the world needs. World needs to rid itself of the toxic assets and get back to the path of growth. That is what is truly needed.

Removal of toxic assets from bank balance sheets

Treasury's model is public private model. This will help to establish a realistic market price for the illiquid assets. Fed is on the hook for 85% of investment while the private investor is on the hook for 15%. It is better than FED being on the hook for 100% of investment as in the case of the insurance giant.

Market has reacted to this positively. Several institutions have expressed interest in this.

By removing troubled assets from banks balance sheets, banks will start lending more freely.

This approach is promising. Off course, time will tell the outcome.

US purchasing Treasury bond

Purchasing treasury means FED is injecting money into the market. Here is the effect of FED decision:

1. More money in the market raises inflation.
2. More money flow into the market makes more US dollar available. The more US $ available, the less desirable dollar becomes. Hence, US $ weakens.
3. Since FED is buying, yield has fallen
4. Since bond yield has fallen, mortgage rates have fallen.

Net impact - Overall, the currency has weakened. Mortgage rates have fallen. Gold price has risen.

Benefits -

1. This is good for housing sector.
2. This is also good for global domestic comanies - this will thelp their earning.
3. But, will raise inflation. To contain inflation, FED would raise interest rate.

Wednesday, March 11, 2009

Redefining Mark-to-market

FASB 157 defined fair value and provides a framework for measuring fair value of assets. This was issued recently. Fair value is based on the market exchange. Under market failure, fair value is difficult to obtain and ascertain. Market failure has occurred for the mortgage based securitized toxic assets. Fair value does not apply to these toxic assets. Market has not experienced the 60%+ correction as it has over the past 18 months. Therefore, mark-to-market needs to be assessed and redefined. The redefinition will stop the demise of healthy banks and diversified financial.

Case for re-instatement of up-tick rule

Should up-tick rule get re-instated or should it not?

Dow has lost more than 60% from October 2007. Negative news keeps pouring day after day. This has given rise to irrational trading. Short sellers are feasting on long term investors. Big name stocks have turned to penny stocks.

Market needs to stabilize for consumers to regain confidence in the markets. For that to occur, up-tick rule is essential. To make matters worse, the ponzi schemes have eroded savings and confidence from investors. Up-tick rule was in place since great depression and was suspended at the peak of the last bull market. Confidence in market is critical for economy to recover.

Re-reinstatement of up-tick rule will be a great way to boost confidence.

Tuesday, March 3, 2009

Re-instate up-tick rule to instill confidence in capital markets

Derivatives play an important role in the capital markets. Selling securities short (sell what one does not posses) and cover when price drop to profit from a sell without pre arranged means to cover the shorts is naked shorting. During a time of heightened concern of the recession, maybe the impending depression, public sentiment is high to exit the capital market to save whatever of their investment is left. That negative sentiment is feeding on the naked short sellers. That activity is bringing equity prices well below the book value for reputed companies.

Naked shorting is illegal. To prevent speculative short selling, up-tick rule is designed. Under the up-tick rule, short selling can be done provided the security is sold above the current market price of the security. However, this rule has been suspended. This rule needs to be re-instated to instill confidence of public in the capital markets.

Monday, March 2, 2009

Where will the economy recover first?

Where did the down fall begin? Well, it started in the housing sector. Then, it spread to banking sector. Then, it spread to insurance sector. The order in which the downturn unraveled is as follows:

1. Housing
2. Banking
3. Insurance
4. Manufacturing
5. oil & Natural Gas
6. Retail
7. Tech

How will it recover?

The economy would recover as follows.

1. Banking - Unless banks are healthy, banks can not lend. Treasury is using all the tools available to strengthen the banking sector.

2. Housing - Once money starts flowing freely, mortgages will flow freely. This will aid housing sector.

3. Manufacturing - Manufacturing sector will benefit from the stimulus package.

4. Insurance - Stable banking, housing and manufacturing will bolster insurance sector.

5. Tech - Once businesses and individuals start spending, tech sector will tech off.

6. Retail - Once public has more money, it would spend. Retail will benefit from consumer spending.

7. Oil & Natural Gas - Once manufacturing sector improves, oil & natural gas sector should improve due to demand.


There are four proven methods of valuing companies: Discounted Cash Flow (DCF), Transaction Comparable, Trading Comparable and Leverage Buy-out (LBO).

Many raise the question whether these valuation methods hold true during recession.

The answer is still "yes". But, these are affected due to the market conditions in the following 3 ways.

1. Discounting rate for DCF is reduced due to risk free rate. Simultaneously, the Free Cash Flow (FCF) is reduced due to abysmal sales. The overall valuation is less than what it used to be in pre-recession days.

2. In case of Transaction and Trading comparable, the multiple has been lowered.

3. In case of LBO, high yield bond sell is difficult in this market. LBO deals have rarely taken place since last Fall. Essentially, LBO deals are out of favor now.

Strategic buyers are still making purchases at a time of low valuation to fill a gap in their product, service or geography. Financial buyers are waiting in the sidelines for the market to improve.

Friday, February 27, 2009

Tangible Common Equity

Why is tangible common equity important for banks?

Common Equity is the riskiest of all the sources of funding a company receives from the investors point of view. Investors tend to lose most when a company defaults.

In the case of a bank, tangible common equity serves as a shock absorber. The more tangible common equity a bank has, the greater is the banks ability to withstand from losses.

While Tier 1 Capital ratio is important, Tangible Common Equity constitutes a large part of the Tier 1 Capital. Therefore, Tangible Common Equity is important indicator of the health of a bank.

Tuesday, February 24, 2009

Converting preferred shares received in return of TARP money to common shares

Conversion of preferred to common seems to be on the table for some banks. The argument for this proposition is that Tangible Common Equity will be boosted by doing so. There are merits and risk for doing so.


1. Increase Investor Confidence - If government owns common stock in a company, it would welcome the private investors to invest as well.
2. Decrease Interest Payment - When a company converts preferred to common, company does not have to pay the preferred dividend.


1. Diluted shareholder value - This will dilute share holder value.
2. Tax payer stake will be risky as common equity will head to 0 on the event of a bankruptcy
2. Public influence of private business - Private business will be meddled by government.

Monday, February 16, 2009

Lowering principal on mortgage payments

Will lowering principal on mortgage payments alleviate the housing market and economic crisis?

If principal on some mortgages are lowered, market will move towards a home price equilibrium that is lower than the current home prices. The houses for which mortgage principal is not reduced will lose value as an unintended consequence.

Lowering principal impacts households and corporations in the following ways:

1.For many households, home is the only nest egg. Bu reducing principal, their home nest egg will lose value.
2. For corporations holding mortgage backed securities will have to write down the security values due to reduced principal and interest payments.

Therefore, lowering mortgage principal on some houses or all houses is not a solution to current crisis.

Thursday, February 12, 2009

Gold and US $ moving in tandem - is this an anomaly?

Gold and US Dollar move in opposite directions. So, why are they gaining in strength in tandem?

US $ is gaining strength against the world currencies. Currencies in the other nations are becoming weaker due to reduced exports and due to less foreign currency remittance. Than is pushing US $ higher relatively while US $ should be falling due to deficit caused and will be caused by stimulus package.

Developing and few developed countries currencies are falling. Investors are flocking to gold as a safe heaven investment. Due to this the demand; hence, the price of gold is rising.

Developing countries currencies will lose strength

Developing countries are exporting less due to demand overseas. Developing countries are receiving less remittances from foreign workers due to retrenchments in the developed nations. These two factors will cause the currencies in the developing countries to fall further. US Dollar and Japanese Yen will gain in strength.

Friday, February 6, 2009


The issues facing countries during this financial crisis is enormous. The steady stream of job losses are weighing on the political strength whether to hold on to the tenants of WTO. Due to the pressure from the population, free trade is in serious question. Is the protectionism the answer to job recovery?

The world has become intertwined. Firms have become global. It would be difficult for companies to operate and generate jobs to alleviate the local job loss if the companies face trade barriers around the world.

Governments should intervene as they have rightly to provide economic package to stimulate the economy. Stimulus interlaced with protectionism will not only hurt the global recovery, but also it would affect the local economy in the long run.

Countries must focus on stimulus sans protectionism.

Wednesday, February 4, 2009

Spending vs. Savings

Consumer spending is critical for economic recovery.

There are conflicting views as to consumer spending. In Finland, the advertisements are stressing consumers to spend while in United States, bank advertisements stress savings with attractive CD rates. Why such a dichotomy in the world views of consumer spending vs. savings?

Case for savings:

1. Banks need to raise deposit levels
2. Banks can receive cheap funding with attractive CD rates
3. Banks can use the savings to lend money at higher rate
4. Savings is good for the over-leveraged consumer which has been living on borrowed money. So did the companies; banks included.
5. When money is saved in banks, money is not spent in the economy.

1. Case for spending
2. Money spent aids growth
3. Money spent supports employment
4. Money spent replenishes the coffers of state and local governments in terms of sales tax
5. Sales tax in turn helps governments to support government programs

While spending will do good for economy, savings will do good for consumers over leveraged personal balance sheet.

Tuesday, February 3, 2009

Tax-cut as a means to jump-start economy

When governments reduce tax - both personal and business tax, families and businesses have more money to spend. If they spend money, economic grows. But two important issues arise:

(1) What if the families and businesses do not spend, but rather hoard or pay off debt:

Then, the money not collected in taxes would not circulate to the market to spur growth. This is exactly what happened during 2008 tax rebate program in United Sates.

(2) What do the governments do that rely on tax revenue as source of income?
It does place burden on governments. But, governments happen to gain from sales tax and other fees instead from payroll tax.

If government encounter budget deficit, it can borrow. Deficit will have impact on currency, inflation and interest rate in the long run.

Tuesday, January 27, 2009

Bad Bank as a solution to banking crisis

Debt and equity securities held as "available for trading" are valued on a mark-to-market basis on a quarterly basis. Gain or loss in the securities is reported in the Mark-to-market accounting needs to be reflected in the income statement. When value of the securities fall, firm holding the securities reports a loss. When the value of the securities rise, firm holding the securities reports a gain.

With the value of the securities falling drastically over the past year, banks are writing down the securities on their balance sheet. They are reporting losses. Their balance sheet is shrinking. Shrinking balance sheet is changing their debt/equity ratio.

If the securities which are related to mortgage backed security (MBS) or Asset Backed Securities (ABS - credit card receivable, restaurant receivable), etc are removed from the banks balance sheets, the banks will not have to write down the assets quater over quarter as they have. Government can hold these securities in a "bad bank" structure. Government can hold the securities long-term and off load them when asset prices are reasonable. Due to the ability and intent of government to hold on to the securities till maturity, the accounting will be "at cost" accounting. Banks will benefit. Government will benefit. Citizens will benefit in a long run.

Bailout and curency strength

Bailout should weaken currency. Let's see how it has unfolded since September 2008. Some currencies have fallen significantly against others. Due to this US $ and Japanese Yen have gained their strengths. Yen still remains stronger against US $.

Since September 2008, governments around the globe have bailed out many industries. Where do governments receive the money to bail out. Well, they borrow. They borrow from one another and public. This borrowing takes places against IOU or bond issued by government. By doing so governments increase national debt. When supply of bonds increase suddenly, yield should have been higher to attract buyers. But, due to the plunging equity and corporate debt markets, investors are purchasing government bonds as a safe heaven investment (US Treasury bonds are free from default risk, but still exposed to market risk). This has driven the yield close to 0%. Once national debt increases, currency would lose strength.

Investments move from low interest rate to high interest rate countries for higher returns provided the exchange rate risk is within the investors tolerance. Exchange rate has anything but normal. Many European, South American and Asian currencies have been in a roller coaster ride for over the past 6 months.

US $ has gained strength against GBP, Euro, Ruble, Indian Rupee and all the commodity currencies (Canadian $, Australian $).

Yen has gained strength against almost all the major currencies. Why is the anomaly? Well, this because of national savings.

Thursday, January 22, 2009

Is Bank Nationalization a solution to reviving banks from the current crisis?

Nationalization of banks equates to government running banks. The fundamental question is a solution to the current banking crisis? The answer is "no" and "yes".

Should the government be in the business to run the business? No. Not in a capitalist system. But, the if banks keep falling at the rate they have in 2008 and in January 2009, then it should the last resort. Even if Government can nationalize banks, it is complex to nationalize all the banks. It is only practical to nationalize handful of big banks. Then, if the banks were nationalized, branches will be closed, competition will diminish and service will suffer.

Government has other means to revive banking systems before a drastic step like nationalization take place.

The fundamental problem gripping banks is the falling value of assets; especially, the structure securities. If the first tranche of TARP were used to purchase such assets and the assets were removed from the banks' balance sheets, the problem could have been ameliorated. The new administration has requested for the second half of TARP. It is floating the idea of accountability and transparency as well as requiring banks to lend. Hopefully, the new administration will be able to implement such measures.

Tuesday, January 20, 2009

New Currency World Order

A year ago US Dollar was weak against Euro, Great Britain Pound and even the Canadian Dollar. It was string against Japanese Yen. With the recession commodity prices plummeted. High rising Euro and ever strong GBP started to weaken against US Dollar. Yen on the other hand started gaining against US Dollar. A strong US Dollar is good for inflation, but bad for earnings of multinationals. Americans can take a trip to Europe and Australia without having to spend an arm and a leg. Is this new currency world order good? What will happen if the proposed $850 billion second stimulus package is enacted?

Monday, January 19, 2009

When will the economy recover?

Pundits say that the recession started in December 2007. By December 2008, world economy has been in recession for 12 months. A typical US recession lasted for about 12 months and a typical worldwide recession lasted for 12-18 months. Now, we are into the 13th month of recession. Should the US economy recover in 2nd half of 2009 or it would recover in first half of 2010? When would the worldwide economy recover?