Understanding Emotional Capital

Posted on November 12, 2017. Filed under: Uncategorized | Tags: , , , , , , |

Most Humans are emotional animals, and not just humans, the statement is probably true for most living species on Earth. Unlike money, emotions are hard wired in the overall design of a human being, so separating emotions from a human being is, more or less equivalent to taking out the core of what is being a human.

The driving force behind a goal, ambition, or a dream of achieving something of significance, tends to be emotion. And emotions do play key role in how committed a human is. The idea of a human being, to be in relationship with another human being is also, mostly based on the underlying emotions that humans tend to have for each other. And once they have invested their emotions in a relationship, they tend to work extremely hard to make it work.

My own understanding of a human emotion or emotions in general is still evolving. I have always felt that, humans should not be emotionally attached to their business or profession, and my rational for holding that view has mostly been based on the assumption that, emotions will comprise the ability of a human being to make rational decisions. And the evidence tends to suggest that the view may have a strong merit. But over time, my own view on the subject matter has evolved, and in the process, it has changed somewhat.

And today, I am of the opinion that, emotions are natural enhancing tools, and maybe,I need to relearn the definition and the role that emotions can play in helping humans progress. A business or a profession, whatever it might be, may lose some of the essential intensity, if humans weren’t emotionally invested in it. And the loss of emotional attachment to a business, may not necessarily mean that, the decision making process will become more rationale based.

As humans grow, so does their emotional capital. And through a process of trial & error, also commonly known as living, most human beings tend to get a better handle of their own reservoir of emotional capital. It is by learning to better utilise and understand their emotional capital that, humans can define their own success, whatever that might be. Or in other words, learning to invest your emotional capital wisely by a way of trial & error, will define where you may end up in your human journey.

So therefore, building the right reservoir of emotional capital, by better understanding how emotions can help or enhance a human being positively, individuals as well as the society at large, can learn to make better decisions, whether business or otherwise. The idea that emotions show the weak side of a human being has no scientific merit. And emotional Capital is good for your overall well-being including the financial well-being.

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Infrastructure Financing: Tapping into a diversified Funding Pool

Posted on January 16, 2012. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

As a key asset infrastructure is one of the most important driving force of an economy and has a direct impact on the overall growth and development story of the country. Infrastructure assets support a wide range of systems in both public and private sectors without which the industrial society of today simply won’t function or be as efficient. Generally developed world tends to have better infrastructure than emerging economies but having said that the overall spending on infrastructure in GDP terms by developed economies have been declining recently whereas the emerging world has increased its overall spending on infrastructure. In a fast growing economy you would expect the demand for infrastructure assets to increase immensely year-on-year and the opposite is true for a slow growth economic environment.

 So the state of a country’s economy certainly plays an important role in infrastructural needs of that nation. Infrastructure assets should always be forwarding looking because the rapid growth in population and economy especially in emerging countries will put strain on the existing infrastructure creating bottlenecks relatively quickly but at the same time parts of the countries experiencing lower or minimal growth may create a situation of overcapacity.

 Conceiving a smart and forward looking infrastructure asset and supporting it with the right capital is always critical.In the past federal, state, local tax bases other funding sources have been used to pay for vital infrastructure projects across the world. We have seen the business model for developing and funding infrastructure assets evolve in the last decade where a number of high profile infrastructure assets were built and paid for through Public Private Partnership or Initiative ( PPP or PPI). Although a number of high profile PPP projects have failed this model of developing and financing infrastructure projects is still considered one of the best way to pay for it.

 While emerging economies have the need to keep building vital infrastructure to support their growth and improve the living standards of its citizens, the developed nations especially the US are sitting on an aging infrastructure that needs to be updated. All this requires capital and with the ongoing financial CRISIS it is getting harder to source funding for infrastructure assets as banks are still struggling to fix their balance sheet. Also the asset-liability (ALM) mismatch is one of the major defects in the traditional business model followed by banks today which makes it tougher for them to commit more resources towards financing infrastructure projects. Most infrastructure projects require long term capital commitments ranging from 7 to 20 or more whereas banks own source of capital ( i.e. deposits) tend to be of much shorter tenure ranging between 1 to 5 years or less. There are also regulatory issues including of the overall exposure to the sector and the credit risk rating of the asset which limits the ability of traditional banks to commit capital. Alternate source of capital providers including of hedge funds dedicated to investing in infrastructure sector as an asset class tend to prefer investing in liquid assets and in most cases their exposure to the sector is limited to owning stocks or debts of listed utilities, toll road operators, constructions companies, ports operators among others.

 There is a strong need to diversify the source of capital base by making infrastructure an appealing asset class to a wide range of investors especially when governments including of developed as well the developing world are targeting infrastructure spending. Recently the ministry of finance of India announced an initiative called Infrastructure debt fund as to way to attract capital into the sector. This is a step in the right direction but having said that the proposal doesn’t address the core issue facing prospective investors when looking at infrastructure financing opportunities. The government of India is targeting an investment of over US$ 1 trillion ( around 10% of GDP) on infrastructure in its 12th five year growth plan for the country and the expectation is that the private sector’s share will be 50%. It is no doubt a highly ambitious plan and through Infrastructure debt fund the government’s objective is to facilitate the flow of capital from public and private sectors as well as foreign investors into infrastructure projects in India. The government figures suggest that there is a funding gap of over US$ 135 billion and this is based on the assumptions that there will be as much as 50% budgetary support for the planned investment in its recently announced 12th five year plan and the policy & regulatory reforms will mobilize over US $174 billions. Looking at the state of infrastructure in India and the balance sheet strength of the local banks it is safe to say that in reality the funding gap may be much higher than government’s expectation.

 In the developed world, UK chancellor has earmarked over GBP 30 billion in infrastructure spending in his speech delivered to the British parliament in November of 2011. The UK treasury is hoping that two-thirds of its earmarked for infrastructure investments will come from the National Association of Pension Funds and the Pension Protection Fund. It is also seeking investments in infrastructure from insurance companies and from China. The United States will need to spend over $2.2 trillion on updating and developing infrastructure assets across the country over a period of five years to meet the current needs and around $1.1 trillion of the overall spending would be new. This is according to the American Society of Civil Engineers (ASCE), and while private sector is expected to make its contribution most of the heavy spending will have to come from the government as evident from the previous spending on infrastructure in the US. The Congressional Budget Office figures suggests that the federal government, state and local governments spent over US$ 312 billion in 2004 on just water and transport infrastructure in the United states with very little contribution from the private sector.

 The current state of the global economy makes it extremely difficult for infrastructure projects to get funded. In markets like China banks are over exposed to the sector by lending to local government financial vehicles (LGFV) and most local governments are sitting on bad projects that aren’t making money and have also created overcapacity. There is also a lack of an efficient and developed secondary market for infrastructure loans in emerging market economies especially in countries like India, making it difficult for both public and private sector banks to refinance their loan books and in most cases the banks are as the end users of credit by holding the asset on their balance sheet until maturity   therefore becoming super exposed to the sector and minimizing their ability to grant more loans. Also Indian banks have recently been running a daily deficit of over INR 1trillion per day for the past few months causing a systemic liquidity deficit in the banking system further limiting their ability to commit more capital to the sector.

 Considering the above, Infrastructure debt fund (IDF) initiative of the ministry of finance of India does sound like an idea whose time has time come as it proposes to offer banks a platform to help refinance their existing loan book and by means of credit enhancement also be able to tap into low cost long term funding sources including of Insurance and pension funds. Having said that Indian banks will be competing for capital with their peers and there are no guarantees that foreign pension and insurance funds will pick Indian infrastructure assets over others. Money has no nationality and most investors will need to understand the structure better before committing capital. According to the public information released by the ministry of finance of India, the proposed IDFs will either be formatted as a mutual fund or a non bank financial company under modus operandi set out by the regulatory agencies including of SEBI and RBI.

 Although the case for IDFs has merit going forward the structure will have to evolve incorporating the realities of the market. Besides IDFs other plausible long term, simpler and sustainable solution will be for banks to set up their own independent infrastructure investment companies or in a consortium with credit guarantee agencies, construction & development companies, Institutional investors, regional development banks, multilateral agencies, utilities among others. As the promoter of the “ Infra Investment Company(IIC)” banks will inject their existing infrastructure assets and loan books along with the cash flows ( from the projects) into the balance sheet of the company and other founding partners will provide seed capital (in cash equity) of around 10% to 15% of the assets held by the company in order to secure a strong rating and valuation. The Infra Investment company(IIC) will have fixed and guaranteed revenue stream coming from existing infrastructure assets it owns and it will be relatively easier for such a company to secure a credit loss insurance cover on its pool of revenues further protecting its cash flow.

To access a diversified pool of investor base the “IIC” could do dual listing in local and foreign markets, issue bonds in local as well as foreign currency supported by its balance sheet and the strength of its credit rating. It can also act as a platform to deliver infrastructure related credit and assets to end users including of pension and insurance funds. Also through the “IIC” institutional investors such as pension and insurance funds could commit new capital into the sector removing the need for them to hire a fund or portfolio manager to manage their investment in the infrastructure sector across various asset class.

 Infrastructure assets are a vital support pillar of any economy and though some investors may consider the sector boring, good Infrastructure investments does create a positive cycle of growth, providing essential networks and services, stimulating economic growth and improving the standard of living for current and future generations. Also the investment in the sector tends to be less volatile than any other publicly traded securities.

 Although the Infra structure Investment company may not address all the existing issues in the sector but by adopting a flexible strategy the “IIC” should be able to tap into a wide range of funding pool including of retail equity investors, institutional investors, sector focused investors among others. It provides an opportunity to Investors who in principle do like infrastructure but are reluctant to buy into it because of the lack of liquidity that comes with it.

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Oh, Recovery, What is thy shape?

Posted on May 16, 2009. Filed under: Uncategorized | Tags: , , , , , , |

Some of my friends and colleagues are busy trying to figure out what could be the shape of the most eagerly awaited recovery. The debate is whether we are going to see a V, W, and U or prolonged I__I shaped recovery. 

 There are some who are suggesting we are probably going to see a V shaped recovery then there are those who are predicting a U or prolonged U shaped recovery and yes there others who believe we might see a W shaped recovery. Boy! Go Figure. Someone has to be right but then I wonder isn’t this all a bit premature? Aren’t we getting ahead of ourselves on making such prognoses or am I simply being Silly?

Let’s find out, shall we?

The shape of the current economy could probably give us some clues as to what the shape of the recovery might be or at the least we could rule out some.  To get a good estimate of the health of the economy let us look at some of headline news during the week ending Friday, the 15th May 09.

We will start with the numbers out from the European Union. 

According to European Union’s statistic office the GDP in the 16 member Europe region fell by over 2.5% from the fourth quarter, the steepest decline in over 12 years. This was above the market expectation of 2%. German economy shrank by over 3.8% from the fourth quarter of 08; the Italian economy by close to 2.4%; the Spanish economy contracted by around 1.8% in the first quarter of 09; the French economy by around 1.2%. Some pretty grim numbers, no doubt. The Euro zone inflation is at record low of 0.6%. Going forward the rising unemployment will dampen the consumer confidence and there is a strong possibility of inflation remaining lower the ECB’s target of 2%.

 And how are things at the corporate front? 

ING announced higher then expected net loss of Euro 793 million in the first quarter of 09. Allianz reported a fall in profit by over 98%

So how is the UK doing?

According to the Council of Mortgage Lender’s, Home repossession surged by over 51% in the first quarter of 09.  Rents for commercial properties in London fell by over 25% over a period of 12 months. The prognosis is pretty grim especially if we take into account a 56% increase in the number of companies going out of business in England and Wales in the first quarter of 09. With unemployment expected to reach 3 million by 2010 one can safely conclude that we are looking at a slow paced recovery.

Let us look at the US and others.

US retail sales dropped more then expected by 0.4% in April after a 1.3% drop in March. The new mortgage applications dropped to the lowest level since March. Consumers are mostly cash -strapped and to hope that they going to keep spending lavishly is probably a wishful thinking. On the unemployment front the news isn’t good either. The recent announcement by GM to slash its dealership network by around 1,100 and Chrysler by around 789 paints a pretty grim picture.

What about others? 

According to FSS Russia GDP shrank by almost 23% on quarter – on – quarter terms.

China seems to be doing better then the rest. The domestic investment has increased significantly but it will be unwise to assume that China be able to recover in Isolation. The exports and import number out from China are not that encouraging. With the current momentum it is safe to assume that China could grow at 7% or there about in 09 but it won’t be a position to save the world. The data out from China on the 11tth of May suggests very strongly that China has slipped into a deeper disinflation. Consumer prices fell by over 1.5 percent, factory gate prices fell by over 6.5% so it’s highly unlikely that we are going to see a significant increase in demand for raw materials from China. 

There seems to be a slow paced growth momentum building in Asia but it will be unsafe to assume that the recovery will be rapid and the growth will be on a scale seen before.

Something to think about 

When talking about any recovery I think we should keep in mind that going forward the central banks of the world and the governments will have to raise rates and taxes to fix their balance sheet and to deal with hyper inflation. And on top of that we are going to be overloaded with Heavy Regulation. That’s the aftermath. And these are not the factors that will support speedy recovery on a big scale in fact just the opposite; it will choke off the recovery. It’s pretty much like throwing a spanner into a wheel. There is so much uncertainty ahead. I think we can safely rule out a V shaped recovery. We saw most markets get back in the Red again (at least for now) the week ending Friday, the 15th May 09 on growth and earning concerns probably the markets were pricing in a pretty rapid V Shaped recovery which they now believe is extremely unlikely hence the retreat. One can’t help but wonder as to whatever happened to all the talk about the negatives being priced-in? Probably the investors are beginning to realize that the prices rose too fast without any solid fundamental support or justification for it and the massive rallies were overdone. I’m not for a moment assuming or suggesting that we are not going to see speculation driven rallies. 

Going forward 

We are not done with volatility yet. We are going to see more mixed data come out in the next quarter which will probably swing the markets both ways. The hope is that the investors will not loose foresight and look at the story behind the numbers and not get carried away by sheer sentiments like seen in the past. 

All the talk about the shape of the recovery is probably premature and a clear sign of the market getting ahead of itself. We should be able to get a good estimate of the health of the economy after the H1 numbers for 2009 are out. It should serve as a good us a pointer for 2009. It should also tell us if the worst is over or there is more to come. Looking at the first quarter numbers we could safely assume with that recovery most likely months away. 

The bottom line is what the markets need is a sustainable recovery that won’t slip out of our hands. And a slow paced recovery will probably be a blessing in disguise for the global economy. It will take time to reconstruct the financial system which we all know now was pretty flawed to begin with and  prone to boom and bust type events.

The shape is secondary honestly speaking I’ll take it in whatever shape it comes.

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The route of recovery: Asia to Africa ( A to A )

Posted on May 12, 2009. Filed under: Uncategorized | Tags: , , , , |

The steep decline in capital flow including the private capital in addition to the falling commodities prices will severely undermine Africa’s growth going forward. We have to keep in mind that a major portion of Africa’s capital flow in the past came from Asian countries China being at the forefront of it. Asian’s FDI flow to Africa has been a major contributor to the rapid growth and economic expansion of African economies. In trade terms Africa’s exports to Asia which consists of commodities, including oil, non-oil minerals, metals, and agricultural raw materials, now accounts for 86% of its total exports to Asia. Besides China and India Africa’s export to five ASEAN countries (Indonesia, Malaysia, Singapore, Philippines and Thailand) have grown by over 70% and stood at around US$ 44 billion (approx ). Based on the recent data Asia is now Africa’s biggest trading partner.

Africa is now very interlinked with Asian economies so it’s safe to assume that without a recovery in Asia we won’t see a recovery in Africa. Also going forward the ability of African companies and the Governments to attract capital from international markets will be severely undermined for a simple reason that they are now having to compete for the same capital with European and US governments who are also in the market raising capital very aggressively. The expectation is that Asian economies (excluding Japan ) will probably recover faster then US or EU which will obviously benefit Africa.

The African business leaders and politicians should work closely with their Asian counterparts to make sure they are able to quickly tap into the recovery in Asia without any time lag. This is the time for Africa to work on setting a stage for a sustainable future growth.

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Something to think about…

Posted on May 7, 2009. Filed under: Uncategorized | Tags: , , , , , |

The hope is that the anxious investors looking out of their foxhole and roaring to go back on the hunt understand that it will take time to reconstruct the financial system because the one we had was pretty flawed and was always prone to boom and bust type events.

The other important thing that I think we should point out is that when you have too much regulation you don’t have rapid growth or economic expansion and there is no doubt that we are going to be overloaded with new regulations which might even choke the growth before its ready to rock and roll. So we might not get the economic bang we are all awaiting. For any economic expansion you need access to competitive (cheap) capital but the problem is, going forward the central banks will have to raise rates and the governments will have to raise taxes to fix their balance sheet which is pretty much like throwing a spanner into a wheel. Something to think about! 

And what about the financial services sector.  Could this be another options ?

The argument is that the US government will probably not to get into action with a “final” plan for the banking sector because it don’t have a good estimate as yet as to how bad things could get, and coming up with a “final” plan that has to be revised subsequently can’t be good for confidence. So, the idea could be to wait until it is fairly sure that the recession has bottomed out, with the attendant impact on the banks’ balance sheets, and then let the most problematic banks go bust. Jamie Dimon is suggesting that they might be asked to take over some banks. So who knows?   The leaked report is suggesting  that around 10 banks out of 19 might need to raise additional capital including of Citibank, Bank of America, Wells Fargo and Morgan Stanley among others but let’s see what the reality is going be. I suspect that the Govt. will probably strongly urge (meaning force but they won’t admit) the problematic banks to merge with or be acquired by stronger bank. I think this is what Jamie Dimon is suggesting (if one was to read between the lines). The criticism of stress testing is growing from all the corners especially from the ex regulators who were at the forefront during the S&L crisis. I think market has pretty much decided to go positive on bad or good data. It doesn’t matter that’s how it looks like. And the word for that is “everything is priced in” so no worries. A very interesting way of saying ” Guys we couldn’t careless, we just want to make quick money”. Which is ok I guess. Look at Bank of America and AIG stocks for example both these companies are beaten down with losses mounting but their stocks are up. That’s why I am convinced that market has abandon common sense or may be you don’t need common sense?

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Getting the Patient Out of Intensive Care – The Economy

Posted on March 14, 2009. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

To get the “Patient “ i.e. the economy out of intensive care the government in the US has now embarked upon addressing the three BIG issues which it believes are at the forefront of fixing the economy.

So what are these three BIG issues? The downturn in the economy, a very sick financial sector and a paralyzed housing market

Let’s see how the government officials are trying to address or shall I say tackle these issues.

FIXING THE FINANCIAL SECTOR

So what’s the proposal for fixing a very sick financial services sector i.e. the banks?

Under the proposed financial stability plan the first on the list of items deals with a compulsory “stress testing” for banks with over US 100 billion in assets. With this testing the treasury hopes to determine the exact exposure of individual banks to toxic assets. Through the capital assistance program the treasury will provide capital injections where needed with clear lending requirements and limits on dividends, stock repurchase, acquisition and compensation etc. These investments made by the treasury will be kept under a trust called “ Financial Stability Trust”  although the treasury has not shed more light on the  options available to severely undercapitalized financial institutions on prima-facie this is a step in the right direction.

The second on the list is what market is calling a Public-Private Investment Fund (PPIF).Well, we all know the price tag for a probable fix is going to be around US 2 trillion (for now at least). A big part of it is supposed to come from the government and the rest from private investors. The idea is to use this vehicle (whatever you want to call it) to absorb the toxic assets sitting in the balance sheets of the banks at a cost and hope to make some money when the valuation recovers. Under the draft proposed plan it is believed that the government through treasury will provide some sort of guarantee and loans from Federal Reserve will limit the downside risk to private sector investors.  These loans will be on top of the Fed’s existing commitment in the amount of over US 2.4 trillion to support a dysfunctional financial system.  It is assumed that the government will rely heavily on the skills of the private investors to correctly price these toxic assets (and in some cases DEAD assets). It is safe to say that some of these assets will recover from their current valuation over a period time but what we can’t safely say is how much. The fear is that a good chunk of these toxic assets are shall we say DEAD assets with no hope of recovery. So it’s unclear to see how the proposed partnership will make money from this exercise. Similar initiatives taken by the Japanese government over a decade ago (in the 90’s) didn’t deliver the desired result and eventually they had to make the tough call of nationalizing banks with insufficient capital. An average of all projections suggests that the total loss on U.S. securities and loans could reach over US3.3 trillion dollars of this over US 1.6 trillion will have to absorbed the by US based banks. The consensus view is that the banks will require additional capital to keep afloat as the losses mounts. We will have to wait and see. Surely, there is a need to learn the lessons from the past and if past is a guide to the future then it looks like we haven’t learnt MUCH!

The third on the list is a Fed’s initiative called Term Asset Backed Loan Facility a.k.a TALF which is aimed at auto, consumer and student loans. We will have to wait and see how these initiatives play out in the end.

PLAN FOR FIXING THE ECONOMY

The BIG question on everybody’s mind is will the mother of all stimulus packages deliver the BIG BANG the US economy desperately needs?

The recently approved US 787 billion fiscal stimulus package has had a mixed reaction from the market. The question is how will the stimulus package benefit the US economy and the tax payers are probably asking themselves WHAT WILL THIS STIMULUS PACKAGE GET US besides putting an enormous stress on the fiscal deficit of the country. These outflows along with other spending will drive the U.S. fiscal deficit over $ 1.7 trillion (based on estimates) and the government debt/GDP ratio over 85% in the financial year 09. Taking this entire spending spree into account one has to believe that the Government surely thinks that the stimulus package will deliver the goods.

So what’s the aim of the package?

At the forefront of it is creating or saving jobs. The hope is to arrest the mounting job losses by creating over 3 million jobs and get the consumers spending again by providing them with cash tax credit.

Huge chunk of the money will be spent on infrastructure (roads and bridges), school projects, energy efficient buildings, renewable energy and new power lines that would distribute energy from renewable sources, various other projects including of water and public transit and emergency aid to states.

ADDRESSING THE PARALYZED HOUSING MARKET

Some in the US (especially the democrats) have been calling for a housing stimulus bill that will help the struggling home owners stay in their homes and also stop the house prices from falling further. President Obama recently announced an expected plan to fight a deepening housing crisis by committing up to US 275 billion to stop the wave of foreclosures sweeping the US. The plan aims to help around 9 million American families. Under the proposed plan a US 75 billion fund will be formed to reduce the monthly payments for homeowners and provide them a buffer of up to $ 6,000 against any decline in the value of the houses. The treasury will also agree to double its financial aid to Fannie Mae and Freddie Mac enabling them to play a bigger role in supporting the housing sector. The aim is obviously to increase the confidence in Fannie and Freddie ensuring the strength and security of the mortgage market and to help maintain mortgage affordability.

Now the question is what’s the prognosis and will this work?

Well, the short answer will obviously be, it’s too early to tell. We will have to wait and see. Although the package might not be perfect and we could endlessly argue about the pros and cons of the plan, it is probably safe to conclude that these spending should at least arrest the current downward momentum of the economy eventually helping the US economy by putting it on the path to recovery.  Surely the focus should be on getting the SICK PATIENT i.e. the economy out of intensive care before making any prognosis of a full recovery, and recover it will.

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Investing in 2009 : Back to Basics

Posted on March 14, 2009. Filed under: Uncategorized | Tags: , , , , , , , , , |

All the talk about Recession and now DEPRESSION can make anyone nervous. Wall Street “ Pros “are making predictions, and in doing so, creating more chaos. Let’s look at the current rallies. One wonders, is this a sustainable rally or a one off, I want to feel good bear market rally. We are seeing markets rally despite of all the negative NEWS. One might argue that the Market is always FORWARD LOOKING. Which begs the question, is it forward looking or just SPECULATING? Let us just look at some of the headline stories of this week to get a perspective. GE downgraded; Germany’s growth collapsing by a record since world war II; UK and France Industrial output at lowest in over four decades; Jobless rate in the US reaching close to 10 %; U.S. household net worth plunging by a record $ 5.1 trillion; Japan’s GDP shrinking by over 12% annually; World Bank is now predicting a negative global growth in 2009. In spite of all these very negative news we saw the markets rallied. One would argue, what’s the basis of this rally? Well may be some “market pros” were expecting the worst and they believe these news are not that BAD after all? The reality is, we have a lot of UNCERTAINTY about the road ahead and it’s unsafe to give any estimate on the growth and earning prospect of a company against this backdrop of negative news. Surely, it will be unwise for someone to assume that the WORST is now behind us. And as to whether we have reached a BOTTOM, well we will have to wait and see.

What should we expect in 2009? How is it going to affect the average JOE on the MAIN STREET

Well, the short answer to that are things LOOK PRETTY BAD but this is not the end of the world as we know it. Yes, there will be changes for sure. Wall Street “Pros” don’t have the answers but best guesses and assumptions.
The turn-around will happen only when the average folks on the main street feel that things are going to get better for them. Unfortunately, the market has not reached the bottom yet, because the bad news keeps coming. So don’t be surprised by the volatility. We should have a good estimate of the health of the economy after the H1 numbers for 2009 are out. It should tell us how bad the economy is and should also give us a pointer for 2009. It should also tell us if the worst is over or there is more to come. We are expecting a pretty UGLY Q1 and Q2 of 2009. Navigating our way through this GLOBAL CRISIS is going to be very challenging to say the least. But rest assured that ” Pros “ will be tempted to make predictions which will probably create more volatility and make the main street more nervous about the future, but this should not worry the folks on the main street. Listen! Pros don’t have a crystal ball so their prediction is mostly a BEST GUESS. They have made wrong calls. We don’t need to be reminded of that. We have seen respected rating agencies fail and market Guru like Mr Buffet getting it WRONG.

So what should we do and who should we trust?

Well, to start with, always look at the bigger picture and the stories behind the numbers, because numbers do not paint the entire picture, so dig deep. We don’t know if the folks on the main street will keep away from Wall Street in 2009, especially after Bernie Madoff debacle. Wall Street of 2009 will definitely be different as the fear of God has been put in most heavy-weight players who once thought they were invincible. We have seen many hedge-funds and banks going BUST and there will be probably more.

What’s the message for an average “JOE”on the main street?

Well, first and foremost, investing should be based on KEEP IT SIMPLE AND BASIC approach. Invest in what you understand and what makes sense to you and not to an EXECUTIVE on Wall Street. Don’t join the rat-race. Ask yourself a simple question – “Can I live with the risk I am taking?” Think long term.

Complicated products are not the answer. In all honesty, no one understands them fully. This does not mean the death of INNOVATION. In fact innovation is good for the market and also for the folks on the Main Street, but innovation should bring simplicity by making things simple to understand, and it does not have to be complicated

Investors have lost faith in money managers. Going forward the money managers will have to be more accountable and disclose their investment strategy fully. Regulators will need to develop a better understanding of products they are regulating. We have witnessed a “ COLLECTIVE “ failure and there is a lot of blame to go around.

2009 will be the year when we will start going BACK TO BASICS. We will see BANKS go back to what they do best ” BANKING “. The markets will come back at some point and there will be parties again on the streets, but the question is, will this happen again? I am sure it will. After all, we are human beings!

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Finding a Fix : The Big Picture

Posted on March 14, 2009. Filed under: Uncategorized | Tags: , , , , , , |

The markets seem to be questioning the government’s ability to find a workable solution to this current turmoil in other words government’s ability to find a FIX. And this is becoming increasingly evident by the way markets have reacted in the past few weeks. Al though one might say that the market itself is INEFFICIENT by design and DYSFUNCTIONAL in the current environment. And there are also those who would say that the whole MESS was created by the same market participants themselves in the first place. People who thought the party would never end and carried on with their reckless business practice. So going by the norm that the market is always right is a probably flawed perception? Well, whatever one might say, it’s hard to entirely disagree especially when we have a market that is increasingly behaving like a yo-yo. It either gets too optimistic or finds itself in a fluke rally only to shed all its previous gains or it takes an extreme negative view on everything loosing foresight.

Some would disagree with the above observation and some might agree. Whatever side you are on, one can safely say that without government support the market may not have survived.

But even with government support the market is not working as it should.

Is the government missing something?

Well, the government has not able to address the CORE issue. LIQUIDITY is not the only dark cloud hanging over the market there is also a big question mark over the SUSTAINABILITY of the whole system. While all the actions on the part of the government has so far been on resolving the liquidity issue the government has failed to address the sustainability question. The market is extremely fearful of nasty surprises going forward.

Should we worry about the Sustainability of the system?

Besides bailing out the banks the governments of the developed world and some in the developing world are borrowing heavily to finance their stimulus packages which are aimed at fighting the deepening recession. Their fiscal position is under a lot of pressure. Some governments’ in the developed world are now running double digit budget deficits. And there are no reasons to suggest that these deficits won’t increase further especially when jobs losses are mounting and the recession is deepening shrinking the tax revenues.

How badly is the economy doing?

Let us look at the numbers to get some perspective. Based on the latest data, the business confidence is now at the lowest in 26-years in Germany, exports have plunged by over 7.3% in the fourth quarter causing the Europe’s largest economy to contract the most in over 20 years; the jobless rate in the 16-nations Euro region is now over 8.4%,the lowest growth seen in decades; the U.K. economy reporting the lowest growth since 1980, unemployment at the highest in 16 years, consumer confidence the lowest in over three decades in the UK; the U.S. economy shrinking by 6.2% in the fourth quarter the worst growth since 1982, unemployed reaching the highest since 1992 rising to 7.6%; Japan’s exports plunge by over 45% in Jan 09, GDP growth rate fell by over 12.7% annually the highest since 1974; we are seeing export oriented economies including of Singapore, Korea, Taiwan ,Nordic region along with others fall into deeper recession.

The economies like Brazil, China, India, Russia and others who were supposed to be resilient to the global economic downward are now under pressure too. The news from Brazil, India and Russia are not very encouraging. Brazil’s unemployment rate has now jumped to the highest in over 8 years; the growth rate is at lowest since 2003. India (Asia’s 3rd largest economy) grew at the slowest pace since 2003. Russian retail sales grew at the slowest pace in more then 10 years, the GDP may contract by over 2.2% in 09. Chinese government will also have to revisit its 8% growth target. Though there are some signs that the Chinese economy might be recovering after Beijing implemented the US $ 585 billion stimulus package however it is too early to tell whether the positive numbers are temporary or unclear seasonal numbers. There is a strong possibility of China not growing above 7% in FY 09.

The list of bad news is getting bigger. In short the recent numbers paint a pretty grim picture of the health of the economy and there are no reasons to assume that the worst is over. The global economy is still hurting. World economic growth outlook for 2009 is very gloomy indeed. It is difficult to envisage a global recovery without the US economy getting back on the growth trajectory. Although, we expect the US $ 787 billion stimulus package will help the US economy going forward there are no reasons to assume that the economic conditions will improve in H2 of 09.

Is the government taking too much risk?

Taking the above into account one can’t help but wonder is relying on future tax revenues to keep bailing out banks and financing stimulus packages a good idea? Especially when you consider that there is too much uncertainty about the growth prospect of the economy.

Is this sustainable?

It is safe to conclude that Governments balance sheet is under extreme pressure and probably close to CRITICAL LEVELS. Some governments in the CEE area might already be BROKE! There is no doubt that bigger nations in the EU will have to carry them.

The Governments’ are probably expecting the economy to turn around quickly and hoping that banks (especially in the developed world) won’t throw any nasty surprises going forward. Makes you wonder if they have concluded that the worst is over and the economy could be on the ascending course soon? Well, we hope not! In spite of the recently announced bank bailout packages by the governments in the UK, US and in the EU it will be ill-advised to assume that the CRISIS in the banking sector is now over. Some analysts would argue that by agreeing to insure the assets of RBS and possibly Lloyds banking group, the UK government has managed to draw a line in the sand. Well, we will have to wait and see. The exercise is risky to say the least. Any additional losses (which is expected) on the insured assets would take the government’s balance sheet further in the RED. There is a very strong possibility that banks will have to raise more money to keep afloat and might need additional government support. The recent announcement by HSBC to raise over US $ 17.7 billion to bolster its capital is a testament that banks would need more capital to keep afloat.

Will the government (especially the US and UK) be able to provide additional support to the banks?

To answer this question we need to get a good understanding of the financial strength of the governments. By looking at the numbers we should be able to get a good sense of the fiscal position of some of the major economies. Let’s just look at the U.S. and U.K. Shall we? According to the “U.S. treasury, Financial Report of the United States, 2002-2008, the total Federal Government deficit now stands at over US$ 65.5 trillion( under GAAP accounting). This US$ 65.5 trillion deficit exceeds the world’s total GDP. Shocking right! Well, that’s why US is considered too big to fail. Now let’s get a UK perspective too shall we? Looking at UK government’s getting out of CRISIS spending so far, the government has spent over two trillion in funding its stimulus program and various bank bailouts. This is on top of close to a trillion committed in form of loan guarantees. According to the Centre for Policy studies UK’s national debt could be over 103% of the GDP (based on last year numbers).

Numbers don’t look pretty, do they? The balance sheets are at CRITICAL levels.

There is a big question mark over the government’s ability to provide additional bailouts to the banks without seriously undermining their currencies and credit worthiness

To make things worse the latest numbers out from the U.S., UK, Europe, Asia or LATAM are not encouraging at all and there is nothing in them to suggest that we are close to the BOTTOM. Although, we expect the steps taken by various governments around the world (in form of stimulus packages and bailouts) would help arrest the downturn in the economy, however, it is unclear how long that might take. And any nasty surprises down the road could deepen the CRISIS.

The road ahead

There is still a big question mark over the SUSTAINABILITY of the banks and their business model. Further losses will put the banks and the governments guaranteeing their toxic assets over the CLIFF especially considering the fact that the assets of the some banks considered too big to fail dwarfs the total GDP of some European economies.

There is a very strong possibility of a crisis in CEE (Central and Eastern Europe) spilling over to Europe and to the rest of world. The worst hit would be the European banks. They hold between 55-95% of the market share (depending on the country) in the region through their subsidiaries. It is estimated that banks have lent over US $ 1.6 trillion in CEE (Central and Eastern Europe). Based on estimates, the combined exposure of Austrian banks in the CEE area could be over 73% of Austria’s GDP. Default on banks books could push Austria over the CLIFF. Besides Austria other European economies will be hit badly as well. The new program launched by the three developments EIB, EBRD and World Bank to lend up to Euro 25 billion to Easter European banks will not be enough to save them. It will only be a drop in the ocean.

The health of the world economy is deteriorating. And there is no doubt that we are in the midst of a major global crisis of historic proportion not seen in generations. Even though, we have all the major world economies are doing their very best to FIX the ailing economy it’s hard to tell if some would survive the crisis without an outside help. Failure of one country could spill over to others and seriously hamper the recovery process. We can never accurately predict the shortcomings so it makes sense to have a PLAN B (back up plan). It’s better to be safe then sorry. We should envisage that finding a sustainable FIX may require major economies of the world to come together and deploy their combined resources and skills to help us overcome this CRISIS.

The question is will the world come together?

The answer lies in history. There are precedents when the world has come together and combined its efforts and resources to solve major global crisis. Do we need to give examples? Nah I don’t think so!

The markets worldwide are getting hammered. The cost of two years contract to protect against any potential decline in the S&P’ s 500 index is now over US $ 15,160 on Chicago board of Options exchange compare with US$ 6,800 ( approx) in 2007, more then 220% increase in just two years. Since the beginning of the CRISIS, we have seen over US $ 10.5 trillion of equity value being wiped out. These numbers clearly indicate that we are in the middle of a SEVERE BEAR market.

Looking at the performance of the global market we can safely conclude (without a doubt) that none of the markets are immune to this turmoil. And the longer this CRISIS is allowed to continue the worst it’s going get for everyone.

The world leaders are now beginning to recognize that this is a global CRISIS of catastrophic proportion which could have lasting consequences if left to run its course. The so called decoupling of the emerging world from the U.S. has not materialized. It turned out to be a false impression after all.

There is a realization setting in among world leaders that they will have to work together. We are seeing unprecedented level of cooperation among central banks of the world and regional economic blocks i.e. ASEAN, EU and others. Asian and EU nations have already taken coordinated actions and are closely working with each other. Asian central banks have recently agreed to create a pool of US$ 120 billion to shield the local currency. The idea of an Asian version of IMF to shield the central banks is also gaining ground. Last month, Japanese government agreed to increase its bilateral facility to Indonesia. German government officials have recently said that they may have to consider bailing out the smaller in economies in the Euro zone.

We are seeing signs that the governments around the world are now beginning to realize that if their coordinated efforts don’t deliver results then may have to consider combining their resources and efforts to overcome this global economic CRISIS. Unfortunately, the measures taken by various governments so far on individual basis runs the risk of being quickly eroded if the markets continue to lack in confidence. It is perhaps time to look at THE BIG PICTURE and consider a large scale initiative carrying the support of the world.

What could be a possible solution?

It is probably the right time to consider an international entity created by G 20 to rescue the financial institutions from a meltdown under a global financial rescue initiative (GFRI). This entity could be structured along the framework of an aggregator Bank which will compliment the existing bailouts measures taken by various governments and allow them to use the additional resources available through the GFRI if and when needed to save their economies from getting buried in the burden of mounting debts that might create hyper inflation and another asset bubble going forward.

The strength of G 20

The combined GDP of G20 countries accounts for 90% of the world’s total and their trade volume is over 80% of the global trade.

How much could they commit?

Under the GFRI the G-20 countries could commit a small percentage of their GDP to this entity through their Central Banks or ministry of finance.

Based on a median of all projections we can estimate that the total loss on U.S. securities and loans alone could reach over US 3.3 trillion. For safety we could work with a higher number of let’s say US $ 4 trillion. Some of these assets will probably recover in value but some might not. A good chunk of these toxic assets would be absorbed by the existing bailouts in place to support the financial system. There is now a strong possibility of non U.S. assets turning sour. We are already seeing how various asset classes besides sub prime are now being affected. Well, if the patient is not treated the disease may well spread in other healthy parts of the body that could lead to fatality. The same applies for economy. Going forward, we will need to get a good assessment of the health of the economy. The additional commitment from G20 could act a cushion. It may be used if and when required

Can we get a good estimate of the real depth of the toxic assets clogging banks balance sheet?

We should be able to get very good estimates of the amount of toxic assets the banks are holding in their balance sheet. This is an auditing exercise. I must say, by auditing the banks, we do run the risk of discovering that there is a huge black hole and the system is probably INSOLVENT. Some banks might already have a good estimate of what their exact exposure could be but to avoid any surprises let the independent auditing be mandatory. Then put them through a series of stress test to get a good estimate of the amount of capital an individual bank/ financial institution will require to remain healthy. The stress test should be design to get a good estimation of what amount should be written off and what could still be recovered from the toxic assets held by the bank. Using a scale of 1 to 10 (10 being 100 percent) rank the recovery rate of the toxic asset assets. For example an asset with a 5 ranking will be marked at 50% of its value at maturity. And then put them under an eligible to apply candidate category.

What sort of the numbers are we talking about?

For safety and to keep a good buffer let us assume that the financial institutions may collectively have additional losses of over US $ 2 trillion on their assets going forward.

Taking the above into account the new entity created by G 20 under the GFRI could have commitments in the amount of US 2 trillion or upwards to avoid any surprises down the road. The life of this entity could be at least 25 years to give it a strong chance of success. The commitments or funding from G 20 countries could be in the form of government bonds issued directly to the entity created under the GFRI. The commitments will obviously vary from country to country (because of their GDP).

The newly created entity may carry the same ratings as World Bank.

What would be a possible working structure?

Financial institutions falling under the eligible to apply category could approach the entity created under the GFRI to replace its toxic assets with high quality assets under an asset swap agreement. These financial assets could be in the form of guarantees or bonds or CDs issued by the new entity directly to the bank. To determine a fair value when replacing the toxic assets the entity could take a median of the monthly rate of depreciation in the value of the recoverable toxic assets and it could agree to hold the toxic assets until maturity. The banks/ financial institution will pay an annual fee to the entity for holding the toxic assets. This exercise would restore the confidence in banks balance sheet by sanitizing it from the toxic assets.

It will probably be a good idea to allow the entity to hold equity positions in the financial institutions on a case by case basis to bolster their capital.

Will the GFRI created entity be the looser in all this?

The entity (aggregator bank) created under GFRI would have all the expertise and resources to manage, restructure distressed assets and find value. Banks/Financial institution using the GFRI could pay an annual fee. Also with the methodology used for estimating the fair value for the recoverable toxic assets, there is a strong possibility that the entity will make money.

So how does this all benefit the G20?

Most of the economies in G 20 are feeling the strain on their fiscal positions and it’s getting worst everyday. The budget deficits are getting bigger because of the stimulus packages along with other rescue packages (for banks, auto sectors etc) they are putting in place to fight the downturn in their respective economies. And in spite of the steps taken by various governments so far, the market has not reacted positively because it lacks confidence in the individual governments’ ability to FIX this GLOBAL CRISIS.

The GFRI will send a strong signal and instill a lasting confidence in the market without which the markets around the world won’t see sustainable rallies and economic growth. That’s the BIG PICTURE.

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