Financial Freedom SG

We often find insights when difficult topics are made funny. This skit by two British comedians makes the reasons for the fallout of the sub-prime financial crisis memorable.

It's hilarious, highly recommended!

I read an article in Conde' Nast Portfolio.com about the end of investment banking firms in 2008.

Written in a witty style, it shows the widespread greed, ignorance and total lack of conscience by the people working in the finance industry.

It introduces Meredith Whitney to people who have yet to know of her, basically the lady analyst who blew the whistle on Citibank (they should hire her) saying that they will have to cut their dividend or go bust. Within four days of her prediction, Citibank CEO resigned and its market value was down $369 billion. And the bank cut its dividend 3 months later.

Chronicling the rise of the derviatives and the CDOs and how one guy, Steve Eisman, (who happens to be Meredith Whitney's mentor) on the inside saw what was happening and who made quite a bit of money shorting the sub-prime mortgage bonds. He is also a sort of hero who tried to question the CEOs of rating agencies, sub-prime mortgage lenders, investment bankers etc and warning them of the dangers of what they were doing.

Suffice to say, it is a very entertaining and sobbering look at all the greedy cats who tried to make a ton of money but sold their souls to the devils.

Read the article here. It is long but it is worthwhile reading it.

We are living in dangerous times. The world is on the brink of another Great Depression. The excesses of the Bush administrations and the lack of discipline in spending more (going into a war started against Iraq) together with a populist approach to cutting taxes for the rich mirrors the same greed and short term thinking that is prevalent in a banking and investment system which went wild.

The lack of fiscal prudence and proper regulations, together with excessive greed in the highest echelon of the Wall Street community on top of the explosion of the financial WMD (weapons of mass destruction)- the derivatives market, means that we are now at the very brink.

The $700 billion bailout plan is barely enough to clear the mess of the Lehman Brothers collapse. It shows plainly that no country can afford another bank failure of the same scale or even a few smaller banks in succession. This is because the credit default swap, a form of derivative, will exacerbate and multiple the effect of the bank failure.

To just protect existing deposits is no longer enough. To encourage bank mergers is again no longer enough. To buy bank toxic sub prime mortgages is again, no longer enough. It is too late for all that, although it will help.

The governments of the world need to look closer at the derivative markets. To shut it down to ensure that no more new problems occur, while at the same time put a value at say 50% or lower from the time the whole mess started when the sub prime crisis occurred. The governments cannot afford to put its value at 0% for the ripple effects will kill the banks and shut off all forms of credit available to businesses for their normal cash flow operations. And this value has to be fixed for ALL derivatives and be guarantee by ALL nations, if not the group of seven countries have to start by doing the guarantee and get more nations on board. And all the holdings of the derivatives will be held by the governments with the IMF or the International Bank as the holder, while the banks or financial firms will be pledged the value of the derivatives by the central banks.

At one stroke, it will free up all the toxic debts hanging around the necks of firms and re-liquidate these banks and financial firms. Also, these money provided by the central banks will be on condition that the banks use it for lending and investments purposes and not for hoarding. This will restart investment and consumption so that the economy will not come to a standstill.

The banks can no longer do much to help themselves, although it could have been the case just three months earlier. Now it is the time of central banks and governments of the world to come together to unstuck the derivative markets and financial credit.

The time to buy has come. I've been buying stocks spread out over 3 weeks. Thinking of accumulating unit trusts (mutual funds) also especially in Greater China region where the general Chinese stock market price/earnings ratio has fallen below 10% from its heady heights of over 50%. Anyone who wants to participate in the twin economic rise of India and China can hedge and buy BRIC (Brazil, Russia, India and China) unit trusts too.

I'm fully invested into the market, over 80% of my liquid funds are in the market. Earlier ones are drowning in red and I've been buying some more. Where possible, my salary will be saved and put into investments in the next few months. Fear is at the apex now, but the measures that the Federal Reserve and Treasury Departments in US should ease the credit crunch and resolve the sub-prime mortgage crisis.

Of course the market may go down further, but I am no sage or predictor of what is to come. I just think that the market has cheap valuation of stocks so it is time to go in where others fear to tread. Buy quality, preferably those with high dividend payouts and put a bit into financial stocks and banks (just about 5-10% as no one knows if the crisis has a long way more to run or the new measures will nip it in the bud). Read this article at fool.com about why it is time to be greedy.

As the greatest living investor in our midst, Warren Buffett, is quoted as saying in the same article, "I will tell you how to be rich.... Be fearful when others are greedy. Be greedy when others are fearful". Buy. Now.

Read an interesting news article on yahoo about the almost 100% certainty that the Federal Reserve will cut interest rates again. Possibly by a full percentage point to make it 2%.

This means that the US$ will be under attack again, fueling inflation fears and making it more likely that stagflation will happen.

There are two things which needs to be done.

1. The world and USA needs a little of someone of the stature of the old John Pierpoint Morgan in the early 20th century. This is to bind all the financial firms operating in the USA and who holds sub-prime or any type of mortgages. So if there is a bank run or flight of capital from any institution, the rest will stand by these firms and provide the liquidity to make it solvent and viable. This prevents the domino effect where banks fall in turns until there is a systemic failure in the credit market and all credit dries up.

Some may argue that there are firms which are relatively unaffected by the sub-prime so why should they be involved? The counter is that all the financial firms lend to companies and each other in a global economy. Here in small Singapore, some of the local banks here had written down assets because of the sub-prime meltdown. And more to the point no one knows for sure which firms have yet to announce losses due to this. The key is that when it spread to firms which fail not because of sub-prime but because of the secondary effects of this contagion, then it may be too late.

2. The small home owners in US affected by the sub-prime or have yet to be but are servicing unbearable interests but cannot refinancing their mortgages because no banks or mortgage firm are willing to bear the risk needs to be taken care of. Or the contagion will be a full fledged housing loan crisis, not just the sub-prime.

Home owners at risk or are defaulting needs to be taken care of by immediately nationalising the housing debt to be service at near to the levels that the Federal Reserve is providing for the banks and at risk financial firms. It is no good just taking care of the banks while a disaster in the making looms in the background. The next wave of defaults could flood the whole financial edifice, even if they are united. So this is even more pressing than point 1.

When the crisis settles, a tax on the financial firms will be impose to recover any monies extended by the government to resolve the crisis, including the costs of nationalising the housing debt. These debts will be rated by independent rating agencies or auditors before being sold off to the banks and financial firms. Dangerous times calls for extreme action and government intervention.

The biggest news over the weekend was the rescue of Bear Stearns by the Federal Reserve and JP Morgan. Bear Stearns is the fifth largest Securities firm in the US and has a large mortgage securities business that became embroiled in the sub-prime mortgage contagion.

The rescue package involves JP Morgan guarantee the liquidity of Bear Stearns for another 4 weeks with the help of the Federal Reserve Bank. This was the Federal Reserve first rescue of a securities firm since the Great Depression. This action allows the liquidity hit firm to seek for a buyer or someone in the finance world to merge with it and provide it with the liquidity to continue operations.

This action by the Federal Reserve mirrors the action taken by the British Central Bank in bailing out and nationalising Northern Rock after a bank run there. The Northern Rock saga started because of fears over the sub-prime crisis also because the contagion has spread worldwide as banks and financial institutions all took a bite at the sub-prime loan. So a bank has fallen in UK in the first domino and a huge Securities firm in USA is the second.

When the Asian Currencies Crisis started, it spread through the whole of Asia and afflicted quite a few economies before the wave of speculators were stopped at Hong Kong where the bow tied Financial Secretary, Donald Tsang, utilised his country's reserves to stem the tide. Battling against the wave of currency speculators with Hong Kong reserves and probably help from China's Zhu Rongji.

Bailing out of financial institutions in USA could be seen by commentators in the country as something that a free economy will do, preferring to let the financial institution die a natural death. However, the whole financial edifice could come crashing down if the fingers of the Federal Reserve does not plug into the holes in the dike. Also the country and the world needs the likes of a John Pierpont Morgan who prevented a early panic in 1907 or a Donald Tsang to do what is necessary to calm the markets.

We are entering a dangerous period, the next few weeks could see the financial markets plummet as news of this sinks in and the analysts make their projections and forecast.

Banks should declare all their sub-prime exposure to clear uncertainty in the markets and prevent liquidity from drying up as they are fearing one another and do not dare to loan to another institution which could be deeply mired in this sub-prime crisis and become embroiled in it.

In an amazing move, the Federal Reserve cuts interest rates by 3 basis points which is the biggest cut since 1984 during an unscheduled meeting. This changes the interest rates to 3.5%.

This decision is obviously a panic move by the Fed in response to the falling stock market and could have been done to prevent a credit crunch. Imagine a stock market crash mirroring the 1929 crash on top of a housing crisis. It would certainly send the world into another Great Depression.

However, the cut in the rates does not solve the biggest problem facing the US economy now. It is a liquidity crunch from banks stuck with CDOs that no one in the right mind wants to buy. No matter the grades of these CDOs, these financial instruments are the equivalent of radioactive matter. This means that banks will be cutting down lending, becoming more conservative and wary of each other because some banks have more CDOs than others and some of their peers have not declared their holdings and exposure to this widening sub-prime crisis. It would not do to lend money to another bank only to discover that the other bank has huge CDOs exposure.

So banks will less willing to lend to each other and this crisis of confidence will spread to other companies. Could your company be extending credit to a company with investments in CDOs?

The invisible hand of a market economy has failed in this case, so there is an urgent need for the governments of the world and central banks to come together and buy over these CDOs. Open the books of all the major banks for a start and book the losses of the lower grade CDOs to the banks (all the ninja loans- no income, no job or assets), take over half or the whole CDO portfolio of the bank using the central bank of the domicile country. Move to the next tier of banks and repeat. If the losses being booked to the banks are big enough to impair the ability to lend, the sovereign countries' funds like those in Middle East (who are earning a pile from high oil prices) and in Asia can be sounded out for investments like what happened with UBS and Citicorp.

At a stroke, this removes the uncertainty of how much CDO exposure individual banks have and it frees up the banks to do the most essential task in the economy- providing credit to individuals and companies. These CDOs that central banks take over will not be bad loans and again because they are the central bank, the central bank or Federal Reserve can set a separate fixed interest rate on these housing loans in their CDOs so that these loans can be serviced without the households being unduely burdened. Ban further issuance and transfer of CDOs unless they are sufficiently tweaked so that there is oversight by the local regulatory authority.

I don't know whether this scheme will work, but it beats just cutting interest rates which doesn't solve the root problem of a looming liquidity and confidence crisis in banks and more defaults from CDOs.

For the ordinary investor like me in this period, there is only one word- diversify!

I was surfing online yesterday and I managed to stumble onto three sites which I think was good. The first is a site which has reasearch on materials done on finance matters. These research articles and commentaries are well written and interesting. So I forsee myself spending some time reading all the interesting articles that they have online. Some of the ones with interesting articles are the '7 Deadly Sins of Investors' , 'The Twenty Best Financial Blogs' and 'The Efficient Executioner of Excellence'.

The title of the site which links to all these articles and many more other interesting looking links is a rather long title, 'Using The Internet To Keep Up To Date With The Latest Journal Articles And Working Papers In Finance'. If you ignore the rather off putting name of the site, you will find a treasure trove of information and articles to improve your understanding of all things financial. I think I would spend some time to look through the sites so I can improve my own knowledge. If you are a finance student or an educator in the financial field it would be a must linked site. Similarly for the serious investor.

Another site that I found interesting and good to read is by a Singaporean who is very experienced in financial and insurance matters having being the head honcho of NTUC income for 30 years. The guy is Tan Kin Lian and this is his blog. There is a wide range of questions that interested people have asked him and his replies are succinct and to the point. So this is another site that people can gain a lot of financial knowledge and views from. Even if you are not from Singapore, some of the financial instruments mentioned in his blog are useful because it is available worldwide. I read his article reproduced by a local chinese daily that is issued free every morning and stumbled onto his blog this way.

The last site that I will mention in my post is the one by Wall Street Journal which is the subject of takeover talks. I was mildly interested by this takeover so I went to look for information about them and saw a great finance website that they have done up. It has many sections like for personal finance which will be good for investors trying to learn more and I read their report on one family's journey into the subprime trap. It provides a sobbering perspective into the subprime issue where even ordinary Americans earning a relatively good income are hit by this subprime issue. The nice thing about their article is that they also provide a link to blogs which talks about the article too so you can read what other bloggers think about the issue and the article. Something for our local Straits Times to learn? :)

The markets for today is down again, although the good thing is that it recovered from a steeper fall in the opening session. I guess that those who went in early shorted the market (selling a share without owning the share) in expectation of a big fall today and bought it back later in the day causing it to rise slightly as bargain hunters moved in too.

The news that is going around the world is suddenly all about this 'sub-prime' and what it means. Basically, what this is about is that there is this group of people with poor credit histories and cannot get a housing loan from financial institution. So some smart people in the financial industry invents a new product called the sub-prime loan where all these people are pooled together collectively in a big loan that other financial institution can get a chunk off. Since this people cannot get a loan otherwise as they are considered a risky prospect to lend money to, this product is basically their last chance. So as in all financial product, high risk equals high returns, so these borrowers pay a high interests for these sub-prime loans.

All else being equal, these collective loan offered to banks with all these risky borrowers will actually lower the risk to the bank than one risky borrower who goes to the bank to ask for a housing loan. The rationale for this is the same as collective investment when you invest in several risky investment product, your risk actually goes down. However, in investment, there are two types of risks. One is systematic risk and the other is unsystematic risk. Diversification only reduces unsystematic risk because proper diversification means that you are invested into different industries and different countries so something that says affect one bank in Singapore does not affect the banks in Hong Kong nor the manufacturing industry but it may affect the other banks in Singapore.

Systematic risk cannot be erased by diversification as it is inherent in the nature of investment. So this is the systematic risk of default that occured in the sub-prime market. Since the housing market is slumping with little demand, the prices are falling and if the borrowers are defaulting, those financial institutions that buys these sub-prime loans will have their money gone as the assets that they pick up will be less as prices are lower because of low demand for housing. Once those financial institutions who buy over these sub-prime loans goes or announces huge losses, the economy will go into a tailspin. So at the moment, the sub-prime market in United States is the focus of the financial industries world wide as it can bring the whole bull market worldwide into a permanent bear market.

The indicators are turning bearish.