Tuesday, September 30, 2008


US bailout plan rejected; worldwide impact on stocks

Ever since the sub-prime crisis came to the fore November- December of 2008, there has been a lot of worries about where this will eventually take the US economy. And this looks like a slow-action horror movie whose climax is coming. So, there was the shock when Bear Stearns went down, and then for some time it looked like the worst was over; the worst that could happen was a recession, but the sub-prime was over. And then happened the next round of corporate disasters that decimated the investment banking community on Wall Street; Lehman Brothers was allowed to die a quick and painful death, Merrill Lynch was bought up whole by a bank, Morgan Stanley and Goldman Sachs turned into normal banks, AIG got a lifeline from the Government that decided it was too big to fail without much impact, and then the banks started toppling - Washington Mutual and Wachovia, both not so small banks were sold for a song.
Current situation in the street ? Panic since there is a lot of holding in these reduced value mortgages, and as a result, banks are not able to decide whether the money they lend to other banks will return since there is no guarantee about the finances of the other banks and other institutions. As a result, lending to other banks and companies, the life-blood of the finance system of the economy is down massively. Lending, and the ability to get money from banks through loans and working capital requirements are what lets an economy work. The solution ? Take on these tainted mortgages till the credit system starts reviving, and then sell these mortgages (they still have value) when the economy has recovered. This will give confidence to the economy and its institutions. However, this runs into multiple problems.

- Ordinary citizens worried about being able to payback the loans and repay the mortgage are outraged that no one cares about them, and everybody is instead worried about some Wall Street gents who already have too much money. How does a collapse affect the ordinary Joe on the street ?
1. Tainted assets means that banks are unsure about the value of assets they hold, and make it more difficult for them to estimate their losses; this in turn causes a loss in confidence about the financial status of the bank and prevents the bank from being able to get capital - this in turn will surely and steadily lead to the bank going down the disaster bank
2. It is not just Wall Street that is affected, mainline banks in which Americans hold their deposits, are getting affected
3. The finance sector is so closely integrated with the overall economy (and is in fact a major glue of the whole economy); a crash will bring the economy down to its knees
4. People do not realize, but they are heavily involved with the stock market. Pension funds and retirement plans are typically heavily invested into the market, and downturns in the market affect the overall value of these funds

- Republicans believe that the Government needs to be small,and the market should be free. Such a bailout plan is likely to reverse both of these concepts, and this is a matter of principle
However, right now the US economy is on a major precipice, and it badly needs sentiment to be reflected. The overall aim of any ruling structure is to take measures such that it improves the life and condition of citizens, and the current situation is that a recession needs to be avoided and the economy is brought back from the brink (as stated by any number of economists and finance experts).

However, in a major setback to the President, and to the leadership of both parties, a majority of Congressmen rejected the bill. It is the treasury secretary who is responsible for ensuring that the economy remains purring, and he (and a number of experts) believe that such a plan is necessary to prevent the economy from going into a severe crisis; unfortunately a majority of the elected representatives don't agree.

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Saturday, September 27, 2008


Banks in US in serious problem

Things have been happening in the US finance sector that have not happened before for a long time. The US Federal Government is proposing that it is the essential guarantor of most mega-finance companies; only allowing some of them such as Lehman Brothers to fail. The US Government has so far saved or intervened in the affairs of Bear Stearns, AIG, Fannie and Freddie, Merrill Lynch (no direct financial involvement), and the latest domino, Washington Mutual. It is the case of Washington Mutual that is different from the others since the others are involved either directly in investment banking or exposed to the mortgage industry; WaMu was a clear Main Street bank, and yet it collapsed like a house of cards, following the same script as the others (exposure to mortgage industry, liquidity problems, and then a sudden downgrade to 'junk' status by credit rating agencies that decimated its ability to raise more funds). It is also the way of takeover of WaMu that is seemingly setting a precedent. Given its precarious existence and risk of failure, Federal regulators seized the bank without even consulting with the board, and sold it off to JLMorgan Chase & Co for a much lower price than they would have to pay just a few months back. The Federal Deposit Insurance Corp. (FDIC) benefited from this transaction since JPMorgan is now responsible for the bank liabilities, and not the FDIC. However, given the method employed in this case, banks looking to get hold of another ailing bank, Wachovia, may be looking for a similar process (it proves much cheaper to buy through this method rather than an open purchase):

Wachovia Corp.'s suitors may use a template honed by JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon last week: Wait to see whether regulators will seize the bank, then buy the best assets and let the government sort out the rest, according to analysts. The bidders may try that tactic again at Charlotte, North Carolina-based Wachovia following its 27 percent plunge in New York trading yesterday, according to analysts at Goldman Sachs Group Inc. and Egan-Jones Ratings Co. They may get help from regulators, who said the U.S. benefited from seizing and selling WaMu because the Federal Deposit Insurance Corp. didn't have to tap its $45 billion insurance fund.
Wachovia dropped $3.70 to $10 in New York Stock Exchange composite trading yesterday and lost $1.50 more in extended hours. Yields on Wachovia's bonds soared to 24 percent, from 7.5 percent on Sept. 5, an indication that investors are concerned about default. Analysts questioned Wachovia's ability to stay independent after seeing loan losses tied to WaMu. JPMorgan is taking on $176 billion in mortgage-related assets and taking writedowns of about $31 billion, the New York bank said. Some of those were option ARM loans, which are prone to default because they let borrowers defer some interest and add it to the principal.

Given that Wachovia also has huge exposures to mortgage loans, other banks are licking their chops at the sidelines, waiting for the Bank to run into more problems, and begin the downward spiral of liquidity problems -> credit problems -> credit rating downgrades -> unable to raise funds. And given the financial deal to take on the massive bad mortgage assets of depressed companies is under active discussion among the politicians, but no immediate solution yet seems to be coming out, sentiment will only go worse.
What does this mean for Indian markets ? As liquidity problems arise among top US companies, they will try and get funds from wherever they can, including liquidating their stock holdings in the Indian market, causing more downturns.

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Monday, September 22, 2008


End of the road for investment banking ?

It has been decades now that Wall Street has been run by big investment banks. The exact names may keep changing as some of the smaller firms became bigger, and some of the bigger firms fall (and of course, names keep on changing with mergers and acquisitions), but the basic structure of large investment firms that handled investments for individual depositors as well as large institutions (as distinct from banks who depend on deposits for their cheap source of capital) has more or remained constant for so long that most people do not know of any other mechanism on Wall Street. And then suddenly, in the space of an year, Poof!, it all disappears. It started late last year when reports started coming in of problems in the category of non-collateral high-risk loans known as sub-prime. And these loans were in turn converted by financial magic into a range of investment instruments (explaining at more this level of detail will make this a highly technical discussion !) that were traded by a variety of financial institutions including banks and investment firms. When these sub-prime loans started collapsing, the sheer extent of these loans the subsequent losses caused huge losses for those holding these instruments.
Once people sensed that these investment firms were in danger, further credit to them was slow in coming, people started withdrawing their investments, and then the credit rating agencies started declaring them as various shades of high-risk, junk status. Once this happened, for all practical purposes, these institutions were finished, with the actual spiral of destruction collapsing very fast. And, now with the Administration and Federal Bank of the USA very worried, they have taken steps to prevent some of the more huge ones:

Federal regulators converted Wall Street's remaining stand-alone investment banks - Goldman Sachs and Morgan Stanley - into bank holding companies Sunday night. The move allows Goldman and Morgan to scoop up retail banks and to streamline their borrowing from the Federal Reserve. But it also puts Goldman and Morgan under the Fed's supervision, increasing the agency's regulatory oversight and possibly forcing them to raise additional capital. As banks, Morgan and Goldman will be forced to take less risk, which will mean fewer profits.
And it brings to a close the era of the Wall Street investment bank, a storied institution that traded stocks and bonds, advised mergers and showered lavish bonuses on its executives. In the past eight days, the federal government announced a $700 billion plan to rescue the financial sector by buying up troubled mortgage assets and an $85 billion emergency loan to insurance titan American International Group. Also, Lehman filed for bankruptcy and Bank of America took over Merrill Lynch.

So, even though both these huge huge firms were not in immediate financial danger, they were sensing that they were in grave danger of running afoul of sentiment. In a scenario where investment banks were automatically assumed to be in danger, neither of these firms would have wanted to be the next company picked up for speculation; once in the target of negative public sentiment, even a profitable investment bank could quickly reach the edge of collapse.
This action goes against the normal distance that the US Government would like to maintain from the private market, but politicians of all shades have realized the extreme danger to the economy, and are willing to run with this. Making these investment firms as companies that will act like normal banks will give far more stability.

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Friday, September 19, 2008


India stock market update as of 19 September 2008

Topsy-turvy is the sign these days, and the market is doing its best to make sure that the market remains topsy-turvy (climbing up or down very rapidly and suddenly); analysing the market remain a difficult job. What irritates me about some analysts is the absolute certainty with which they make their predictions. Right now, for anybody investing in the market over the previous many years, the market just proves that nobody can predict what can happen.
I was just reading an article in the New York Times web page about how the US Congress was informed about the sudden fall of the financial titans, and how the US Government will have to pump in huge amounts of money; the credit environment is so bad, and the sentiment is so low, that this needs to be done else the financial economy will fall, and that too very suddenly.
All this affects the Indian stock market immensely as well. Many of these institutions own chunks of the Indian market, and in a crisis they start liquidating everything they own. At the same time, sentiment overall should not fall so badly since it is clear that central banks the world over will intervene to keep the economy from falling drastically.

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Tuesday, September 16, 2008


India stock market update as of 16 September 2008

The Indian stock market is getting very badly caught up in the global problems. If you look at the overall trends that affect the market, rising inflation and increasing commodity prices (especially foodstuffs and crude oil) were the critical factors that were affecting the economy. Those seem to be slowly on the way down now, with crude temporarily falling below the $100 mark, and the rise in the commodity market slowly coming to an end. These are all good signs for the economy.
However, when the US economy sustains problems, these cause problems for everybody. The rapid decline of some of the largest financial corporations such as Lehman Brothers, Merrill Lynch and AIG have both a direct and indirect effect. They have cross investments in many Indian companies, and can be trusted to sell these as soon as they can. In addition, they are a harbringer of a long term problem in the economy, and leave people with a bad feeling, something that translates into a bad sentiment.
Overall, I know people who are slowly gaining small shares in the market, but at the same time, they are also worried, since even investments bought a few weeks back have fallen. The textbook approach is to keep on making small investments into fundamentally sound companies such as Airtel, Reliance, Tata, and for a risky touch, into some companies that have fallen very badly; they are the ones who are expected to rise within a few months of a recovery and can promise high returns (but I repeat again, this is risky).

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