Option Valuation

Overheard between two MBA students [A and B] as they discuss another MBA student [C].

A: We had basically been discussing the new year eve parties
and i was telling C he should value it like an option
B: You said youu wanted help with option valuation!
A: The potential for an encounter is subject to much volatility
B: Okay, I can understand the analogy.
A: We wanted your expertise in option valuation to value the price of the party
A: Obviously the strike price is the ticket
B: Okay
A: The time frame is known. The woman's response is the volatility factor which we are having difficulty assigning value to. Bernanke has also helped by lowering interest rates to zero.
B:: Women are empirically known to be more volitile than the market. You have to take the volatility to be atleat 50%. If C can choose between the party and the chick, it has to be valued as a chooser! The best of both outcomes. Else if is buying the ticket, and can seek a refund then it is a put option.
A: One will lead to the other. Where is the chooser in it? If he doesn't got to the party, where will he meet the woman
B: I thought that he can go to a party with us or take a chick for a date
A: No, he is talking about going to a party and finding a girl there.
B: Then, it has to be valued as a compound call option. Event 2 is dependent on event 1. If he comes to the party, then there is a probability that he finds a chick. The key is in choosing the right party.
A: I guess that for him time also will be inversely proportional if he finds the girl at 6 AM, she may decide to go to breakfast rather than for some other 'activity'.
B: Yes, it seems to be a very complex option depending on whom he finds there. You can raise this question to (Aswath) Damodaran for real options. Anyway, from what i can see, we are busy valuing the option and C is busy with the chicks.
A: Yes, that is true. He seems to have disappeared.
B: I will catch up with you later.
A: Cool. Later.

Bismarck Bailout

Picture Source: Bloomberg.com
The US Government has finally saved the Bismarck from sinking by stepping in to secure a huge load of its troubled assets.
Bailout Plan
- $306 billion of troubled mortgages and toxic assets guaranteed by the U.S. government under a federal plan.
- $20 billion cash infusion from the Treasury, adding to $25 billion it received last month under the TARP.
- Citi to swallow first $29 billion of losses on the $306 billion pool
- After that, government covers 90% of losses, Citigroup covers other 10%
- CEO Vikram Pandit keeps his job

Price for Citi
- Government to get $27 billion of preferred shares with an 8% dividend
- Warrants to buy 254 million Citigroup shares @ $10.61 each

“The Achilles heel with Citi is their exposure to emerging markets and what’s going to happen when emerging markets turn down, as they’re doing now.”

Here is the entire article on Bloomberg.

PS: Seems like the government does work the weekends and late into the night.

Insurance Indeed

Picture Source: Bloomberg.com archives
Here is an interesting email that I received over the weekend that gives you an idea of the run-on-the-bank that Citibank is currently facing. While there are few rumors as to whether Citi will survive to see Monday morning, it is now almost certain that there is no news that will emerge before the start of markets. If there was any news, it would have emerged [or leaked] by this evening which would have given us a good sense of where Citi is currently headed. That has not happened and hence, I believe that we will see Citi opening to a low this coming week when markets do open on Monday.

Here is the email that I [and other Citibank customers received]

---

Dear Max,

Good news! Citibank is participating in the FDIC's Temporary Liquidity Guarantee Program. Through December 31, 2009, all of your non-interest and interest bearing checking deposit account balances are fully guaranteed by the FDIC for the entire amount in your account. *

And as a reminder, in October the FDIC increased the amount of insurance on eligible savings accounts -- such as savings, market rate, money market accounts, club and holiday accounts, and certificates of deposits -- from $100,000 to $250,000 through December 31, 2009.**
...

---

I have no doubts that my money is safe, given its meagre amounts. Nevertheless, I have withdrawn substantial amounts considering the fact that I may not be able to withdraw money immediately in case the bank does go under. Better to be safe than sorry they say.

While I do believe that Citigroup cannot be let to go down, purely because of the effect that it would have on the already bleeding financial markets, I am waiting to see what sort of a plan will be cooked up by the government and its emissaries.

Global Banking & Capital Markets

One of the most interesting classes that I take this semester is the Global Banking and Capital Markets class with Roy C Smith, an ex-chairperson of Goldman Sachs and someone who has seen a financial crisis too many [and for no fault of his own] in his long and illustrous career.

In this class, we have talked about the various crises that have been seen in the current times. We discussed a wide variety of current issues in the financial markets, while discussing the fundamentals of capital markets and financial systems
- the downward spiralling mortgage markets
- the bailout of Fannie Mae and Freddic Mac
- the unfortunate demise of Lehman Brothers
- the capital infusion in AIG
- the acquisition of Lehman Brothers' assets by Barclays PLC & Nomura
- the sale of Merrill Lynch to Bank of America
- capital raising by Morgan Stanley and Goldman Sachs
- the sale of WaMu to JPMorganChase
- the sale of Wachovia to Citi
- the subsequent renege and sale of Wachovia to Wells Fargo
- the downward spiral of Citi
- the fate of General Motors
- Troubled Asset Relief Program
- Federal Reserve and Ben Bernanke
- Treasury Secretary Hank Paulson and his efforts
- Banking Failures in the UK
- Banking Failures in the rest of Europe
- Banking in China
- the benefits of Obama vs. McCain
- What it means to have Obama

This was one of the most informative and illustrative class that I have taken at Stern. It touched upon various developments in the current financial turmoil [or what Prof. Smith refers to as the financial tsunami]. A great course. Most definitely recommended.

Here is an article that Prof. Smith wrote in Forbes where he talks about the questions that he, as a professor, and his students [that is us] would have for the new treasury of the Federal Reserve, Mr. Geithner.

I hope that Mr. Geithner reads this article and implements some of the suggestions and answers the questions that the professor and his class have for him and the new administration.

Citigroup, the Bismarck?

Roy Smith, my professor and ex-chairperson and partner of Goldman Sachs talks about the run down in the share price of Citigroup.
"We used to say that Citigroup was like the Bismarck. It could take bullets forever without sinking. But ultimately, the Bismarck sank."

At $26-billion, it is now worth about the same as Toronto-Dominion Bank and $11-billion less than Royal Bank of Canada.

One thing is for sure, Citigroup CANNOT fail. I just shudder to even think of the thought of where the markets are headed if it thinks that Citi could potentially fail.

Read an interesting article here which quotes the above italicized information. Could the markets go more downward? I shake my head in disbelief.

An Orderly Chapter

Taking my point [well, based on what I have learnt from professors, the press and my research] further on how I believe GM should handle its bankruptcy, this new article by Andrew Ross Sorkin of the DealBook column in the NYTimes online website talks about why he believes General Motors needs an orderly Chapter 11 bankruptcy.

Picture Source: Consumerist.com

Published in verbatim below from the article in DealBook in the NY Times.

---

Taxpayers shouldn’t fork over a cent to General Motors, Andrew Ross Sorkin argues is his latest DealBook column, noting that G.M is using money so quickly that a $10 billion infusion made today would disappear by February.

Instead of giving the ailing automaker a loan to get them over this “rough patch,” Mr. Sorkin says, the government should shepherd G.M. into an orderly bankruptcy, so that the company can begin a much-needed reorganization.

The goal — one aided by government involvement in a debtor-in-possession loan and a warranty guarantee fund — is to guide the carmaker into a Chapter 11 restructuring, not a Chapter 7 liquidation.

A Bridge Loan? U.S. Should Guide a Helpful Chapter 11
By ANDREW ROSS SORKIN

Tony Cervone, a spokesman for General Motors, has a warm and friendly way to summarize his ailing company’s ongoing dance with disaster.

“The fact is we’re looking at a short-term liquidity crisis that needs a bridge loan,” Mr. Cervone said this weekend to The Detroit Free Press.

To him, G.M. is merely in a temporary bind. If the government — that is, taxpayers — were just willing to spot G.M. some cash to get it over this little rough patch, everything would be just fine.

Mr. Cervone’s comment reflects what’s wrong with the mind-set in Detroit.

G.M is using money so quickly that a $10 billion infusion made today would disappear by February. That is why taxpayers shouldn’t fork over a cent, at least until shareholders are wiped out, management is tossed out and the industry is completely reorganized.

But there is a fix. Call it a government-sponsored bankruptcy, a G.S.B., if you will. It might sound a bit like an oxymoron, but it is an idea that has been quietly making the rounds in Washington. It makes a lot of sense.

Here’s how it could work:

First, let’s recognize that G.M. doesn’t need life support. What it needs is Chapter 11. The bankruptcy process is not a bad thing — indeed, it should be embraced. Bankruptcy allows companies to do tough things they could never do in the normal course of business. It has helped many companies turn themselves around and come out even stronger.

Bankruptcy would give G.M. enormous leverage with its debt holders — and, perhaps more important, with the U.A.W., whose gold-plated benefits are one reason G.M. is no longer competitive. A bankruptcy filing would also give G.M. the cover to close plants, rid itself of unprofitable brands and shed dealerships. In fact, unless G.M. files for bankruptcy, state laws would make it prohibitively expensive to shut dealerships.

So, first, the government would force G.M into a prepackaged bankruptcy now — even before policy makers may think it needs to be. As an inducement, the government would allow the merger with Chrysler to go forward. (There’s a lot of resistance to saving Chrysler too, but we need to look at the industry as a whole. And don’t worry: Cerberus, the private equity firm that owns Chrysler, would have its equity wiped out too.)

The merger should reduce costs by as much as $7 billion. But that’s not the tough stuff. The harder decisions are these: Both companies would have to jettison brands — lots of them. In the case of G.M., frankly, the only ones worth saving are Cadillac, Chevy and Buick. (Buick? Yes. Despite its lackluster sales and fuddy-duddy image in the United States, it’s a huge seller in China.)

That means Saturn, Pontiac, GMC and Saab would all disappear. Deutsche Bank estimates that reducing G.M.’s brands from eight to three would bring down the company’s cost base by $5 billion annually. If you’re able to shut the dealerships too, lop off another $4 billion. Chrysler is an even sadder situation: the only brand with any value is Jeep. Its Dodge Ram truck lineup could be merged with Chevy, which would also pick up pieces of the GMC business. And Chrysler’s minivan business could be combined into the Chevy brand as well.

In all, the 35 plants of G.M. and Chrysler would probably be cut by half.

Then the auto workers, whose benefits are off the charts.

G.M. currently employs about 8,000 people who actually don’t come to work. Those who do go to work are paid about $10 to $20 an hour more than people who do the same job building cars in the United States for foreign makers like Toyota. At G.M., as of 2007, the average worker was paid about $70 an hour, including health care and pension costs.

Those costs are already coming down slightly because of a renegotiated deal with U.A.W. last year, but not nearly enough.

Part of the problem is summed up by comments like this one in The Detroit Free Press, made by Kandy O’Neill, 39, an assembler at G.M.’s plant in Lake Orion, Mich., where she builds the Chevy Malibu and Pontiac G6. “I think we’ve given enough,” she said about the cuts to her salary and pension plan.

“Everybody wants to come down hard on the workers,” she said. “Nobody knows what we do inside there but the people who work there. It’s hard. It is not an easy job.”

When you read a line like that you might sympathize with her, but then you realize that nothing can be accomplished without bankruptcy. Ms. O’Neill: your company is asking the taxpayers — many of whom don’t have health care coverage — to pay your salary and health insurance.

And then we need these companies to agree to serious, strict enforcement of gas mileage standards. They should be producing the cleanest cars on the street. We may lose hundreds of thousands of jobs in this industry in the near term, but with the right kind of innovation, we should have millions of new jobs in the next 10 years.

Finally, we need to kick out management. That Rick Wagoner, chief executive of G.M., can say with a straight face that he still deserves to run this company is laughable. It would be impossible for him to put in place the serious changes that need to be made because he carries too much baggage. He’d have to undo years of his own neglect.

After all that is agreed, and only then, the government should come in with what’s known as debtor-in-possession financing to help the company through the bankruptcy process. Ideally, the government would be a “seed investor” and others would join it.

The goal should not be to keep these companies from filing Chapter 11, but from filing for Chapter 7 — which would mean liquidation.

With the debt market virtually closed, this is the time the government can come in and try to help. But to jump in front of the train now, without the requisite changes made to the industry first — which we all know can’t be done without Chapter 11 — would be foolish.

The automobile industry has argued that bankruptcy will be a disaster for the industry; that people won’t buy vehicles while they’re in bankruptcy for fear that the warranty won’t mean anything. There’s a fix for that too. The government should establish a warranty insurance fund that would insure the warranties of all G.M. and Chrysler vehicles bought while the combined company is still operating under bankruptcy protection. The cost to taxpayers should be next to nothing, assuming the company survives and can takeover the warranty obligations.

The government also should consider using some of the money for the financial industry rescue not to save the companies, but to retrain employees in the Detroit area and help promote development of new industry. A lot of people complain about the role of government in business and free markets. But it is hard to complain about efforts to make the nation’s workforce more employable.

Barack Obama, on “60 Minutes” Sunday night, said that government assistance must be “conditioned on labor, management, suppliers, lenders, all the stakeholders coming together with a plan.” He said, “So that we are creating a bridge loan to somewhere as opposed to a bridge loan to nowhere.”

Take note, Mr. Cervone: that bridge is called Chapter 11.

Hedge Funds fears

An article on how the fears of a Hedge Funds bust prediction may come true.

Produced in verbatim from CNN Money below

Hedge Funds May Sell At Year End As Banks Skimp On Lending
Dow Jones
November 19, 2008: 12:36 PM EST

NEW YORK -(Dow Jones)- For equity markets, 2008 will long be remembered as a year of massive selling, and it's likely to end the same way.

Hedge funds will find it increasingly difficult to obtain lending at the end of the year, a time when banks typically tighten their lending anyway as part of the "window dressing" process. This year, two key securities firms that supplied loans to hedge funds, Bear Stearns and Lehman Brothers, have disappeared, and the remaining firms that lend to hedge funds are hanging on to cash in an effort to deleverage themselves.

"These tight financing positions over year-end are likely to result in the forced sales of securities prior to year-end," said an Alliance Bernstein research report put out Wednesday.

The prospect of tight lending and higher rates for hedge fund borrowers suggest that the markets across asset classes still face further selling by hedge funds, a process that has contributed to market selloffs this fall. Already, hedge funds have to sweat out more investor redemption deadlines - some funds force investors to give either 35 or 30 days notice if they want to withdraw money by Dec. 31 - which could lead to selling as well.

As Dec. 31 approaches, banks, in a bid to prepare their balance sheets for year-end reporting and raise Tier 1 capital, will reduce their discretionary lending. "As this large funding source disappears, the cost of funding over that short period near Dec. 31 rises rapidly," wrote Brad Hintz, analyst and author of the report.

Major lenders face pressure and sources of lending are dwindling. Commercial banks experienced huge losses in 2008, and continue to face challenges regarding capital positions.

Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), which are in the middle of complying with their new bank holding company status, are under pressure to deleverage their balance sheet. Lehman Brothers and Bear Stearns were major sources of funding, and in 2007 provided $385 billion in funding, or about 40%, during the year-end turn, Bernstein says.

Bernstein notes that the "the year end turn is simply a seasonal spike in funding costs and liquidity pressure that occurs every December and ends Jan. 1. Though we believe this year will be worse than normal, conditions will quickly recover in the New Year."

Jobs in Asia

And the bad news seems to continue.

An article on hiring reductions in Asia.

Posted in verbatim from an article on Bloomberg.

Standard Chartered Postpones Hiring in Hong Kong

By Chia-Peck Wong

Nov. 19 (Bloomberg) -- Standard Chartered Plc, the third- biggest U.K. bank, pushed back its hiring plans in Hong Kong after the city slipped into an economic recession.

``We constantly review our hiring needs, but the market's momentum has changed so we have postponed hiring in some cases,'' Gabriel Kwan, a Hong Kong-based spokeswoman, said by phone today.

Banks and brokerages worldwide have announced more than 166,000 job cuts since the subprime-mortgage market's collapse last year. Citigroup Inc., the biggest U.S. bank by assets, said earlier this week that it will trim 52,000 jobs, while HSBC Holdings Plc said it eliminated 500 jobs in Asia, 90 percent of them in Hong Kong.

Hong Kong, the biggest contributor to Standard Chartered's pretax income in the first half with a 25 percent share, has entered its first recession since the SARS epidemic in 2003. Gross domestic product shrank a seasonally adjusted 0.5 percent in the third quarter from the previous three months, the government said last week.

Standard Chartered employs 5,500 in Hong Kong. The London- based bank has been reviewing its business and ``will try to redeploy staff to minimize the impact,'' Kwan said.

The HSBC cuts amount to about 2 percent of its total workforce in the city.

Other Banks

Hang Seng Bank Ltd., Hong Kong's second-biggest by assets, has no plans to trim its workforce of 8,210 in the city, spokeswoman Irene Chua said. The bank, a unit of HSBC, hasn't imposed a hiring freeze, redeployed workers or reduced business travel, she said, declining to elaborate further.

Bank of East Asia Ltd., the city's third-biggest by assets, said it has no plans to reduce headcount. The bank, which last cut workers in 2003, today said it will continue to monitor the situation.

The lender employs more than 4,200 workers in Hong Kong. Its shares have risen 7.3 percent since Oct. 27, when it said it would book an impairment loss of HK$3.5 billion ($452 million) this year after selling its entire portfolio of collateralized debt obligations.

BOC Hong Kong (Holdings) Ltd. is offering voluntary retirement to employees aged 50 or who have worked for 30 years to cut costs, the Standard reported today, without saying where it got the information.

``We are constantly reviewing and adjusting our human resources policy in a prudent manner according to the changes in market environment and business operation,'' BOC Hong Kong spokeswoman Angel Yip said by phone today. She declined to elaborate on specific measures or comment on the Standard report.

Cutting the LEH pie

He cuts the LEH pie. Well, he is doing his job and is getting paid for it. We are talking about Bryan Marsal, Lehman Brothers' Restructuring Officer. Nevertheless, his demands are not exactly reasonable. This sounds like a classic case of make hay while the sun shines.

An article on how the Lehman Restructuring Officer wants very high incentive fees. This is what I call highway robbery. Creditors and management should not allow it. I guess the verdict for this question really lies in the hands of the honorable bankruptcy judge in the court of South District of New York.

Produced in verbatim from Bloomberg.com below

Lehman Restructuring Officer Marsal Wants 25% Incentive Fees
By Linda Sandler and Christopher Scinta

Nov. 18 (Bloomberg) -- Lehman Brothers Holdings Inc.'s restructuring officer, Bryan Marsal, asked a court to pay his firm incentive fees as high as 25 percent on top of the hourly rates he's charging to liquidate the bank.

Marsal's company, Alvarez & Marsal, has 125 employees helping Lehman sell assets and unwind trades. Marsal previously asked for $2.5 million upfront and hourly fees of as high as $850 for himself and other top executives. Under a proposal filed yesterday, A&M would start earning its bonus after recovering $15 billion for unsecured creditors of Lehman, which listed $613 billion in debt.

"Especially in a case like this, where the firm is also getting hourly rates, you would not want to have triggers for the incentive payments that are too easy to meet," said Stephen Lubben, who teaches at Seton Hall University School of Law in Newark, New Jersey. "The triggers do seem to be low, and at the very least A&M should offer some explanation for why this should be so."

The restructuring firm's request is part of an estimated $1.4 billion in fees for lawyers, accountants and other professionals that will make Lehman's bankruptcy the most expensive ever, surpassing the record set by Enron Corp. in 2004 according to calculations by Lynn LoPucki, who teaches bankruptcy law at Harvard University and the University of California at Los Angeles.

Fee Enhancements
Restructuring experts often demand bonus payments. Perella Weinberg Partners LP in 2007 had to forgo a success fee it wanted for advising shareholders in the bankruptcy of energy company Calpine Corp., which objected to paying the bonus. A judge ruled the same year that law firm Cadwalader Wickersham & Taft, which represented Northwest Airlines Corp., wasn't entitled to $3.5 million in ``fee enhancements'' on top of its $502 average hourly rate.

Also in 2007, Alix Partners gave up a $5 million success fee it had sought on top of $25.6 million in professional charges while winding down futures-trader Refco Inc.

"Bonuses are normally only granted after the fact to crisis managers who produce exceptional, outstanding, and unexpected results," said Martin Bienenstock, a Dewey & LeBoeuf lawyer who represents Lehman creditors including Walt Disney Co.

"Crisis manager employees do not need to be guaranteed bonuses in advance because they expect short-term work and have no reason to threaten to leave (just the opposite, in fact)," Bienenstock said in an e-mail.

Lehman's lead law firm, Weil Gotshal & Manges, may earn $209 million in fees from the Lehman case, LoPucki estimated. Lehman would pay Weil, led by bankruptcy partner Harvey Miller, $650 to $950 an hour for partners and counsel, and $155 to $295 for paraprofessionals.

A&M Rates
A&M has said it will charge from $175 to $300 an hour for analysts or administrators and $550 to $850 for managing directors. It will bill Lehman for fees and expenses every month or more often if A&M prefers, according to court documents.

Lehman, once the fourth-largest investment bank, has said it foundered because of deteriorating subprime and structured investments. It filed the biggest U.S. bankruptcy Sept. 15 with mostly unsecured debts.

Rebecca Baker, a spokeswoman for A&M, didn't immediately return phone calls seeking comment today.

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Bitter pill for GM

Article after article, class after class and discussion after discussion seems to lead to one topic these days: General Motors.
Be it Roy Smith, David Yermack, Nouriel Roubini, Ed Altman or any other finance professor in school, discussions invariably funnel down to GM and on what they believe is the right approach to solve the problem. Give or take a few, the unilateral resolution is for GM to file for Chapter 11 bankruptcy.

Let us take a look at the CDS spreads that I noticed on the Bloomberg terminal this past week for General Motors.
Source: Bloomberg terminal in school
Based on industry perception, currently, there is a 60% probability that GM will default on it 5 year and 10 year debt. That is a very high probability given that most firms have a sub 10% probability of default.

Max Holmes very interestingly taught us last week the basics of Bankruptcy law in the US of A. He talked about how it is a hotch-potch between the Queen's [British] Bankruptcy Law and the law devised in the US by the founding fathers [maybe not the founding fathers of the nation, but rather the founding fathers of the corporate and bankruptcy law]. Chapter 7 of the Bankruptcy law is straight from the Victorian era [for the uninitiated, that is the British part] which talks about liquidation and is fairly severe. Chapter 11 of the Bankruptcy law on the other hand talks about restructuring and reorganization rather than pure liquidation. It is far more accomodating and forgiving, though not always for the management.

The unilateral [footnote: the ones I have heard] opinion in the NYU Stern academic fraternity is that General Motors should file for a Chapter 11 bankruptcy. In order to facilitate in its transition and reorganization out of bankruptcy, the firm should raise DIP [Debtor-In-Possession] financing. This will most definitely wipe out the Equity holders under the new capital structure [not that they have much left on the table anyway]. It is likely to impair the various existing tranches of its debt as well [including senior secured debt] as the DIP creditors will hold the highest priority [after the lawyer and administrative costs of course].

While the credit markets have frozen, it is likely that DIP financing should be available for the firm as it will be on very favorable terms [for the creditor] and will hold the highest seniority. There will be a lot of monitoring mechanism in place as well. The biggest factor is the possibility that the government will either provide the DIP financing itself [less likely] or will secure the DIP loan.

The other benefit of bankruptcy will be that all the UAW contracts will be null and void. GM workers are currently paid higher wages than those [for the record: all of them are American workers, in the US] workers at Toyota, Honda and the like. Coupled with that are high health benefit costs, pension costs and labor restrictions as part of the UAW deal. While GM has been able to negotiate some of these liabilities with UAW, they are far from being optimal.

Another aspect of the bankruptcy will be its effect on GM's pension liabilities. When a company in the US files for bankruptcy, all of its pension obligations are transferred to a independent corporation called the Pension Benefit Guaranty Corporation or the PBGC. As the name would suggest, the job of the PBGC is to guarantee pensions. While this will place a cap on the maximum amount of pension paid out and restructure [read: impair] the pension payments, I am sure that is not the first thing that is there on management's mind. At least, it should not be. Bloody capitalist you may scream. Well, no. When the boat is sinking, the captain of the ship has to take tough decisions.

There is sufficient pressure on the government to act on this matter. The government is likely to give its current bailout of USD 25Bn to the Big Auto companies. However, this is more like pocket change, especially given that it will be split three ways. GM's problems are far more grave than most people realize. Definitely more grave than a third of USD 25Bn for sure. The other option that the government has is to double the bailout package to USD 50Bn. Even in this scenario, GM is only likely to postpone judgement day. All it will achieve will be that it will live to fight another day. What GM and Big Auto need are policies that go beyond this.

Let us take a step back and see what GM is doing as a firm to address its problems. First of all, it has been working very hard on the technology front. While it was the last kid on the block when it comes to smaller and cleaner cars, it is desperately trying to play catch up. From what we hear, it is on the right track. Business is fairly diversified. The Latin America Africa Middle-East or LAAM business actually posted a profit on increase in sales. China, India and rest of Asia have seen a bit of slowdown, mostly due to decreased consumer spending in this region. In the US, the firm has been hit in a multi-fold problem: lower consumer demand, difficult financing options, financial crisis and oil prices.

On the financial side, the firm has tried to free USD 15 Bn. in cash to support these challenging times. This includes measures such as stopping dividend payments, reducing capital expenditures, streamlining processes and earmarking labor efficiencies. They have also looked at asset sales and raising money from the debt markets, though that has been the most difficult part. At the end of their previous quarter, they increased their self-help targets from USD 15 Bn to USD 20 Bn. These measures will significantly reduce the cash burn and free up additional cash for the firm.

These are merely short-term measures. One of the four scenarios are likely to happen.
General Motors gets NO bail-out: Highly unlikely, though a probability. The firm uses its self-help measures to sustain itself. Car sales go down drastically because customers are worried about the status quo and what that means to the future of GM, their cars and spare-parts and after sales services for them. This seems like a business killer.

General Motors gets a bail-out: This is what the firm is lobbying for. In Washington and through voters, the firm is trying to drum up support for this idea. This may work only if the credit market are back in time before GM has exhausted its new resources. However, the firm is still saddled with the possibility that this could mean a reduction in customer demand for their products, owing to the uncertainty.

Credit Markets get back to good ol' days: If the credit markets get back into shape before GM has to cry 'wolf', GM could potentially tap the credit markets to raise operating capital. Credit markets are probably the single most important reason that GM is facing the crisis of today. I agree that a lot has to do with sub-standard products and strategies in the past and a late realization of their fallacies. Nevertheless, GM would not have been in such a bad shape, if the credit markets were in a better shape. The possibility of credit markets coming back soon is remote, purely based on the manner in which they have broken down. That said, they will eventually come around. The question is: will it be in time? A million dollar question that I [and most economists] don't have an answer to. The general perception though is a flat NO.

General Motors files for Chapter 11: Firm gets the money to restructure, liabilities are pushed into the future and the firm comes out of bankruptcy [whenever it does] leaner and fitter.

The final option seems to be the most plausible, reasonable and most likely to work towards a long term solution. Nevertheless, we need to consider the impact it will have on the US markets. While it will in no way match the mayhem seen in the aftermath of the Lehman Brothers bankruptcy, it will be perceived as a major failure. While most people expect it to happen, when it finally dones, it will be seen a major stamp on the malaise that the US markets are seeing right now. This is likely to adversely affect other major corporate names on Main Street.

It is interesting to note that the management is pushing very hard for a bailout package from the government. All they say is that they are doing what they can from their end. And they are looking towards Washington for help. As Rick Wagoner said, 'Bankruptcy is not an option'. All of this leads me to wonder why the firm is so shy of courting bankruptcy.

First of all, there is the point of a tarnished image. There are a lot of costs associated with the bankruptcy. This will spell difficult times. Brand value will decrease. This could result in a reduction in their sales. Suppliers and dealers will not provide credit [assuming that they do right now] and may not be ready to stock up inventory as well. Overall, this will have a negative impact on the business. The question is whether it will be more than we currently see right now.

Another factor is that the firm believes that this is a credit market phenomenon and if credit facilities are made available, they should be able to tide this time and come out stronger. This goes in line with the live to fight another day belief.

I personally believe that the biggest factor in this 'No Bankruptcy at all costs' pitch is the fact that management will most definitely lose their jobs in such an eventuality. Rick Wagoner is unlikely to be around, even if he is an inside man and may be the person best suited for the job. Simple reason is that he sat over this current crisis and did not see it coming.

With DIP financing in place, with our without government support, there will be a strong clamor for the management to be replaced. On the other hand, if the management are able to secure a bailout or are in any manner able to hold off bankruptcy, they will be hailed as messiahs. This, even though they were the people who got them into this mess in the first place.

When management starts talking about the burden on PBGC in the scenario that GM were to go bankrupt, you know that there is more to it than meets the eye. When management talks about bankruptcy not being an option, you know that there is more to it than meets the eye. Or when they talk about shareholder value or fallout on labor for that matter. Corporate Governance? I think otherwise. Each one for himself if you ask me.

Greed and Short-Selling

An article on the Icahn Report which talks about the need for better control, the overwhelming effect of greed and the need to ensure and maintain short-selling as a market-equilibrium force.

Some interesting statements:
An unfortunate aspect of human nature is that some people will always try (and succeed) at "gaming" the system, no matter how prescient and attentive our regulators. - MaxSpeak: Sounds very familiar. Seems like someone that we know. Some people never learn.

The next time Warren Buffett labels something..., he could instead tell us which companies to bet against. - MaxSpeak: Would he rather not use it to his own personal benefit. And for the benefit of his firm. And once he has, its a moral dilemma.

Reproduced in verbatim from the Icahn Report
By Dylan Ratigan

Warren Buffett recently urged us all to follow his lead in buying American stocks during this fear-driven down market, invoking his common sense wisdom of being greedy when others are fearful and being fearful when others are greedy.

While I appreciate and agree with Buffett that it may be a good time to invest in this great country's long-term future, I also think there is a lot the Warren Buffetts of the world can do right now to help ensure a prosperous future.

First, we need to take a realistic view of how we got into the current financial calamity.

Instead of creating a society that harnesses the powerful force of capitalism to benefit us all, which resulted in the development of light bulbs, automobiles and computers, we have created a system in which the spirit of innovation has been hijacked to find better ways to cheat society for personal gain.

We have to face the reality that regulators alone can never keep ahead of the cheaters. An unfortunate aspect of human nature is that some people will always try (and succeed) at "gaming" the system, no matter how prescient and attentive our regulators.

I believe the solution to the current and historical problems with capitalism is to enact two pieces of regulation.

First, we must never again allow any company to become "too big to fail." Companies, by their very nature, take risk. Because of the competitive nature of capitalism, there is no amount of regulation, transparency or prudence that can successfully prevent companies from occasionally failing. This is especially true of banks, which will always be tempted to increase profits by pushing the risk envelope and will always find ways to do so.

Just as traditional commercial bank regulators have the authority to curb an excessively risky bank, we need to enforce a limit on the size of non-bank financial entities. This measure could help stop the inevitable failures that cause the systemic failures for which we are all now paying.

Second, and the most pertinent to Mr. Buffett, is that we need to promote, not stamp out, short-selling. It is only through the use of the skeptical force of short selling that those who would seek to inflate their company’s value by hiding or manipulating information will be forced to provide transparency that regulations could never mandate.

The wonderful thing about a stronger system of upward and downward pressure is that it forces companies to be more accountable. And if there is anything lacking these days, it is accountability among managements.

So instead of an activist like Carl Icahn trying to take over the board of a company, he could simply raise a "short" fund to target companies that have loaded their boards with cronies and yes-men.

Or the next time Warren Buffett labels something like derivatives as "financial weapons of mass destruction," he could instead tell us which companies to bet against. This will force these companies to change their behavior more than any government regulation ever can.

There is a reason why CEOs who helped get us into this mess regularly blame short sellers for their failures.

It is because short selling forces CEOs to either disclose what they are doing or suffer consequences for their secrecy. But rather than admit to 40-1 leverage, they loudly stigmatize those who would dare to bet against their companies.

Unfortunately, merely choosing "not to buy a stock" is not enough to force this kind of necessary transparency, for there is always a "greater fool" down the road to buy it. We need to actively punish these companies and managers in our role as profit-minded investors.

In simplest terms, choosing not to buy a stock because you don't like the company is like refusing to be friends with a drunk. But shorting a stock is like sending a drunk into rehab. Many of these companies, drunk with money and neglectful of risk, should have been sent to rehab a long time ago.

Obviously, we can never again allow the system to become so vulnerable to inevitable future corporate failures. But just as obviously, we can also no longer trust government alone to catch the cheaters and liars that have bastardized American capitalism.

Let's apply the human nature that creates these problems to expose and punish them financially. We must no longer pay heed to disgraced CEOs who falsely claim that their downfall was caused by "those evil short sellers."

Let’s face it - sober people do not mistakenly end up in rehab because it is so easy to prove that they are sober. But when we discover they are regularly drunk at lunch, that's where we can send them.

I can think of no one better than Warren Buffett to be that kind of friend to both our country's companies and its citizens.

Dylan Ratigan has established himself as a top financial anchor and reporter through his work on CNBC shows such as "On the Money" and "Closing Bell" as well as during his tenure at Bloomberg News, where he served as a Global Managing Editor and host of its "Morning Call" program. He is the anchor and co-creator of CNBC's "Fast Money"and the co-anchor of "The Call" and the 3 p.m. hour of the "Closing Bell."

The tough go to Dubai

Picture Source: Sumera's Blog on wordpress.com

An article that tells the tale as we know it. People are flocking to the GCC in hope of the fortunes that have dried up in New York.

Reproduced in verbatim from the NY Times Dealbook.

The global economy may be in the doldrums but many young, adventurous Americans — especially those in the floundering finance industry — think they know a place where the good times will keep rolling. The latest issue of New York magazine reports on how college graduates and recently laid-off young professionals are flocking to Dubai in hopes of finding riches and riding out the credit meltdown.

The Mideast emirate, a kind of desert-turned-theme-park, is sending out signals that it is still booming despite the downturn in the world economy. The young Americans are coming to do deals, hawk condos and create marketing ads touting Dubai’s benefits.

“For the first couple years I was here, I didn’t have any American friends at all,” one Emirati, munching lasagna at his Monday-night football watching party, told the magazine. “I’ve met more Americans in the last six or seven months than in all the time before that.”

But the article points out that Dubai has not been immune from the troubles in the larger financial system: Stock and real estate prices there have dropped sharply in recent months.

The article suggests that Dubai’s status as a safe haven may be closely linked to someplace else: Abu Dhabi. “The conventional wisdom now is that what ultimately safeguards Dubai’s future is not its near-mythical energy and savvy,” the article said, “but its oil-drenched sister up the coast.”

Now its JPMorgan's turn

Picture Source: CNN.net
An article on how JP Morgan is going to reduce its work-force. Just a reflection of the times ahead I guess. It does not matter if you are Jamie Dimon, if the economy is bad, you too will have trying times.

Article produced in verbatim from the DealBlogs on NY Times.

As JPMorgan Chaseconducts a global review of its operations, analysts told The Telegraph that the bank could cut about 3,000 jobs.

The review is slated to be completed by year’s end with the layoffs to follow in subsequent months, said the paper.

“Banks are being forced to right-size their businesses as they face the fact that clients are going to be doing a lot less business over the next 12 months,” one source close to JP Morgan told the Telegraph.

Those 3,000 jobs cited by analysts amount nearly 10 percent of the bank’s near-31,000 global workforce.

CDS and their perils

Interesting article by Prof. Figlewski and Prof. Roy Smith on Credit Default Swaps or CDS and how they wrecked the system. Prof. Smith often talks in class about how these instruments were supposed to diversify risk and be good for the system, only to be abused and misused beyond repair.

Reproduced in verbatim from the Forbes.com

Commentary
Credit Default Swaps Are Good For You
Stephen Figlewski and Roy C. Smith, 10.20.08, 12:55 AM EDT
What is dangerous is their misuse.

Warren Buffett has said that "derivatives are financial weapons of mass destruction," and in a credit crisis like the one we're in, many people think he wasn't kidding.

Recently, an auction was held to determine the size of the settlement on "credit default swaps" (CDS) that were written on the outstanding debt of Lehman Brothers. Each of these swaps was a contract between one party wanting to insure against the risk of a Lehman default and another willing to sell that insurance. (Lehman had nothing to do with the contracts, but the over-$600 billion of debt for which it was responsible had attracted about $400 billion in outstanding swap contracts).
About 350 different counterparties to the Lehman CDS contracts attended the auction, where it was determined that Lehman's debt would be worth only 8.62 cents on the dollar in bankruptcy. Those who sold insurance against Lehman's default (the "protection sellers") therefore must pay out 91.38 cents for each dollar of debt they insured. This is the largest payout ever in the $55 trillion credit default swap market. After netting out offsetting positions, cash payments will be approximately $270 billion, a huge amount even for this crisis, which has seemed to know no limits on the size of write-offs. And all this for just one default!
What Buffett didn't say was that while derivatives come in many sizes and shapes, every one of them is a zero-sum game for the users--for every loser, there is always a counterparty who wins an equal amount. Such contracts don't eliminate risk, and they don't increase it. They just transfer risk from one counterparty to the other. But this enables those who bear a risk to protect themselves against it, and considering the huge volume of risk-taking that occurs daily in financial markets, the ability to redistribute risk has to be seen as very useful.

Receiving the payments on the Lehman CDS contracts (which offset losses they had insured against) were a number of banks, brokers and other financial intermediaries. They had extended credit to Lehman but wanted to hedge the risk that it might default, an unlikely event at the time perhaps, but one with serious consequences if it occurred.

On the other side of the contracts, making the payments, were end-user investors such as insurance giant AIG [NYSE: AIG], PIMCO, the world's largest bond fund, and Citadel, a large hedge fund group. They took on the Lehman credit risk in exchange for a regular quarterly payment that seemed at the time to be a fair premium for insuring a default that probably would never happen.

For diversification, protection sellers maintain large portfolios of credit default swaps, just as an automobile insurance company insures a lot of cars. They lose on those that crash, but make it up on those that don't. Apparently none of these insurers have been buried by their Lehman exposure. But if there had been no credit derivatives and the banks and other intermediaries had been unable to hedge the risk, they would either refused to lend to Lehman at all or, more likely, they would now be adding these losses to the others they have already endured in this unusually difficult credit cycle.

Banks and investment banks function as both market makers, which requires them to carry inventories of risky securities for brief periods, and also as proprietary investors. They manage credit exposure in a number of ways, including hedging with credit default swaps. This transfers the risk to other investors, often outside the banking system (whose safety and soundness may benefit). A competitive market in credit default swaps contributes to the transparency of price-setting and thus to the efficiency of the whole process. This lowers the cost of financial risk management in general.

The vast majority of transactions in the credit default swap market are straightforward, insurance-type transactions. But losses on ordinary insurance contracts are sometimes much higher than expected, for example, when an unusually severe storm causes a lot more damage than was provided for when the homeowners insurance premiums were set. Such a storm may wipe out the insurer's reserves and even its capital, as appears to be AIG's unfortunate experience with its financial products insurance business. But that's the risk of providing insurance on events with low probability of occurring, but which result in large losses when they do.
A big problem in the over-the-counter credit derivatives market is the risk of counterparty default. The protection seller may be unable to fully cover the loss it is insuring against. To mitigate this risk, the protection seller may have to post collateral, but amounts and terms are negotiated between the counterparties and not standardized. When AIG's credit rating was cut from AAA to A in mid-September, it was suddenly obliged to post more than $14 billion in collateral against its CDS positions. This is what drove them over the edge. When Bear Stearns was teetering on the brink, the Fed examined the extent to which the firm was connected to other firms through their extensive web of OTC derivatives contracts and decided that it would be too disruptive for the market to let Bear fail.

These problems are significantly reduced for exchange-traded derivatives like futures and options. The exchange and its Clearing House establish high standards for the contracts, provide a centralized marketplace for them, establish and enforce rules on posting collateral and making payments and act as a guarantor that trades will be money-good and that users will not have to rely on individual counterparties to pay what they owe.

The over-the-counter credit default swap market needs such an exchange. Over-the-counter markets are too fragile, too loosely regulated and too opaque for such an important financial derivative as credit default swaps. What makes these swaps dangerous is misuse; an orderly exchange would help make them safer.
There have been informal efforts by the industry to organize such an exchange, which would have to operate globally in view of the size and breadth of the market, but so far, the effort has not been successful. It would benefit greatly by having the governments of the leading banking countries--which will soon be taking up a broader regulatory framework for banks after the current crisis--to require one to be established and regulated banks and broker dealers to participate in the credit default swap exchange.

Stephen Figlewski and Roy C. Smith are professors of finance at the Stern School of Business at New York University

No to Detroit?

Interesting article by Prof. Yermack on the auto industry and his perspective on the same. Academically sound and theoretically the right thing to do. Practically, impossible that Democrats will allow anyone to go down this road, especially after all the promises that have been made to this effect.

As usual, a question that I ask: Why did they not think when Lehman Brothers was going under. It could have saved them so much grief.

Produced below in verbatim from the Wall Street Journal.

NOVEMBER 15, 2008 Essay
Just Say No to Detroit
Given the abysmal performance by Detroit's Big Three, it would be better to send each employee a check than to waste it on a bailout, says David Yermack.

Before Michael Moore became famous for documentaries like "Fahrenheit 9/11" and "Sicko," his first big success came in 1989 with "Roger and Me." In that film, Mr. Moore followed General Motors chairman and chief executive Roger Smith with a camera crew, asking him why the company was closing plants and producing low-quality vehicles. Mr. Smith looked flustered and inartfully avoided Mr. Moore's camera crew while it lingered outside his country club or GM's executive offices.

Debating the Bailout "Roger and Me" was entertaining, but it missed the real story about Roger Smith, who turned out to be a forward-thinking genius. Mr. Smith made big investments in information technology and satellite communications, acquiring Electronic Data Systems in 1984 for $2.5 billion and Hughes Aircraft in 1985 for $5.2 billion. Mr. Smith's successors divested those businesses at huge profits -- EDS was taken public in 1996 for more than $27 billion, and Hughes, renamed DirecTV, went public in 2003 for more than $23 billion. (The man who sold EDS to Roger Smith at a bargain price was H. Ross Perot, who then convinced many people that the experience qualified him to be president.)

Mr. Smith understood all too well that GM shouldn't continue investing in its failing automobile business. That was 25 years ago. Today, our government is being asked to put tens of billions of dollars in GM, Ford and Chrysler, but we would be much better off if Washington allowed these companies to go bankrupt and disappear.

In 1993, the legendary economist Michael Jensen gave his presidential address to the American Finance Association. Mr. Jensen's presentation included a ranking of which U.S. companies had made the most money-losing investments during the decade of the 1980s. The top two companies on his list were General Motors and Ford, which between them had destroyed $110 billion in capital between 1980 and 1990, according to Mr. Jensen's calculations.

I was a student in Mr. Jensen's business-school class around that time, and one day he put those rankings on the board and shouted "J'accuse!" He wanted his students to understand that when a company makes money-losing investments, the cost falls upon all of society. Investment capital represents our limited stock of national savings, and when companies spend it badly, our future well-being is compromised. Mr. Jensen made his presentation more than 15 years ago, and even then it seemed obvious that the right strategy for GM would be to exit the car business, because many other companies made better vehicles at lower cost.

Roger Smith, who retired as chairman in 1990, seemed to understand that all too well, and so did Chrysler's management, which happily sold their company to Daimler Benz for $30.5 billion in 1998. That deal, one of the savviest corporate divestitures ever, ended very badly for Daimler, which essentially paid Cerberus a few billion dollars (by agreeing to retain pension liabilities) to take Chrysler off its hands in 2007.

Over the past decade, the capital destruction by GM has been breathtaking, on a greater scale than documented by Mr. Jensen for the 1980s. GM has invested $310 billion in its business between 1998 and 2007. The total depreciation of GM's physical plant during this period was $128 billion, meaning that a net $182 billion of society's capital has been pumped into GM over the past decade -- a waste of about $1.5 billion per month of national savings. The story at Ford has not been as adverse but is still disheartening, as Ford has invested $155 billion and consumed $8 billion net of depreciation since 1998.

As a society, we have very little to show for this $465 billion. At the end of 1998, GM's market capitalization was $46 billion and Ford's was $71 billion. Today both firms have negligible value, with share prices in the low single digits. Both are facing imminent bankruptcy and delisting from the major stock exchanges. Along with management, the companies' unions and even their regulators in Washington may have their own culpability, a topic that merits its own separate discussion. Yet one can only imagine how the $465 billion could have been used better -- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen.

The implications of this story for Washington policy makers are obvious. Investing in the major auto companies today would be throwing good money after bad. Many are suggesting that $25 billion of public money be immediately injected into the auto business in order to buy time for an even larger bailout to be organized. We would do better to set this money on fire rather than using it to keep these dying firms on life support, setting them up for even more money-losing investments in the future.

Two main arguments are being raised to justify a government rescue of the auto industry. First, large numbers of jobs may be at stake, perhaps as many as three million if one counts all the other firms that supply the Big Three. This greatly overstates the situation. Americans are not going to stop driving cars, and if GM, Ford and Chrysler disappear, other companies will expand to soak up their market share, adding jobs in the process. Many suppliers will also stay in business to satisfy the residual demand for spare parts even if the Detroit manufacturers go under. If the government wants to spend $25 billion to protect auto workers, it would do better to transfer the money to them directly (perhaps by cutting each worker a check for $10,000) rather than by keeping their unproductive employer in business.

Second, it is suggested that the failures of the U.S. financial industry, which have cost us something like $700 billion, justify bailouts of other sectors of the economy. This makes no sense. If the government diverts our national savings into businesses that have long track records of destroying investment capital, eventually we'll end up with an economy like France's -- or Zimbabwe's.

Other arguments are on the table as well. Some see the troubles at GM and Ford as opportunities to retool the auto industry to produce environmentally friendly cars. Given their long track records of lobbying against fuel economy standards and producing oversized gas guzzlers, this suggestion seems ridiculous, sort of like asking cigarette companies to help with cancer research.

Not many of my students today remember "Roger and Me" (many confuse the film with another picture from the same era about the cartoon character Roger Rabbit). However, Roger Smith's example casts a long shadow over the auto industry today. It's time to cut our losses and let society's scarce investment capital flow to an industry with more long-term potential to create jobs and economic value.

David Yermack is a professor of finance at New York University's Stern School of Business.

Scrap the car

Interesting article by Ed Altman on what he thinks to be the future of General Motors and how it should be handled.

I had an interesting discussion with Prof. Roy Smith after my Global Banking class on what he thought to be the way forward for General Motors. I am happy to have access to professors such as him who have a thorough and indepth understanding of the matters at hand. I am sure that he will soon publish his views in the press and hence will not divulge the details of our conversation.

Financial Crisis explained

If you could read patiently and understand, it's a great knowledge!

Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollars as there were only two pieces of 1 dollar coins circulating around.

- There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
- B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.
* The net asset of the country now = 3 dollars.

- Now C thought that since there is only one piece of land in the country, and land is non producible asset, its value must definitely go up. So, he borrowed 1 dollar from A, and together with his own 1 dollar, he bought the land from B for 2 dollars.
* A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.
* Thus, the net asset of the country = 4 dollars.

- A saw that the land he once owned has risen in value. He regretted having sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C. As a result, A now owned a piece of land that is worth 3 dollars. But since he owed B 2 dollars, his net asset is 1 dollar.
* B loaned 2 dollars to A. So his net asset is 2 dollars.
* C now has the 2 coins. His net asset is also 2 dollars.
* The net asset of the country = 5 dollars. A bubble is building up.

- B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollars. The payment is by borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.
* As a result, A has got his debt cleared and he got the 2 coins.. His net asset is 2 dollars.
* B owned a piece of land that is worth 4 dollars, but since he has a debt of 2 dollars with C, his net Asset is 2 dollars.
* C loaned 2 dollars to B, so his net asset is 2 dollars.
* The net asset of the country = 6 dollars; even though, the country has only one piece of land and 2 Dollars in circulation.

- Everybody has made money and everybody felt happy and prosperous.

- One day an evil wind blew, and an evil thought came to C's mind. "Hey, what if the land price stop going up, how could B repay my loan. There is only 2 dollars in circulation, and, I think after all the land that B owns is worth at most only 1 dollar, and no more."

- A also thought the same way.

- Nobody wanted to buy land anymore.
* So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
* B owed C 2 dollars and the land he owned which he thought worth 4 dollars is now 1 dollar. So his net asset is only 1 dollar.
* C has a loan of 2 dollars to B. But it is a bad debt. Although his net asset is still 2 dollars, his Heart is palpitating.
* The net asset of the country = 3 dollars again.

- So, who has stolen the 3 dollars from the country ? Of course, before the bubble burst B thought his land was worth 4 dollars. Actually, right before the collapse, the net asset of the country was 6 dollars on paper. B's net asset is still 2 dollars, his heart is palpitating.

- B had no choice but to declare bankruptcy. C as to relinquish his 2 dollars bad debt to B, but in return he acquired the land which is worth 1 dollar now.
* A owns the 2 coins, his net asset is 2 dollars.
* B is bankrupt, his net asset is 0 dollar.. (He lost everything)
* C got no choice but end up with a land worth only 1 dollar
* The net asset of the country = 3 dollars.

There is however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.

A few points worth noting
- When a bubble is building up, the debt of individuals to one another in a country is also building up.

- This story of the island is a closed system whereby there is no other country and hence no foreign debt. The worth of the asset can only be calculated using the island's own currency. Hence, there is no net loss.

- An over-damped system is assumed when the bubble burst, meaning the land's value did not go down to below 1 dollar.

- When the bubble burst, the fellow with cash is the winner. The fellows having the land or extending loan to others are the losers. The asset could shrink or in worst case, they go bankrupt.

- If there is another citizen D either holding a dollar or another piece of land but refrains from taking part in the game, he will neither win nor lose. But he will see the value of his money or land goes up and down like a see saw.

- When the bubble was in the growing phase, everybody made money.

- If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A ) and take part in the game. But you must know when you should change everything back to cash.

- As in the case of land, the above phenomenon applies to stocks as well.

- The actual worth of land or stocks depend largely on psychology

Source: Email forward

Using knowledge Effectively

Over the past one year, I have learnt a lot at business school. As a Finance and Accounting major, obviously those aspects of the business. Besides that, I have also learnt a lot about Business Strategy, Marketing and Operations. However, that knowledge is useless, unless you know how to use it effectively. Here is an account of the one chance that I got to use this information for personal gain.

I needed to transfer cash from my home country. I have an education loan that takes care of living expenses and I replenish it periodically depending on my own needs. Close to more than a month back, I saw that my funds were dipping low and I needed to get some more money. I also saw that the exchange rate to the dollar was much higher than it was in recent memory.

The US dollar has been appreciating since the FED rates have been dropping in this country [the US]. This has also been accentuated in a way by the increase in interest rates by the central bank in my own country as it attempts to fight the rising levels of inflation in the country. Inflation there is currently higher than it has been in recent memory, a classic case of the workings of supply and demand. The demand for food and foodgrains has increased, and has not been met with corresponding supply in recent times. A drop in supply, combined with astute [and illegal] black marketeering by business(wo)men have ensured that inflation is significantly high.

Then there is the effect of oil prices. Oil has ensured that the local inflation rate in my country has gone higher. This also indirectly affects other prices as it shoots up transportation costs at all levels of the marketplace. Oil prices has also ensured that the demand for the US dollar is higher and that has appreciated the dollar even further, making it more expensive to buy.

When I thought about asking for money, I astutely [in my belief] thought that this was a bubble waiting to burst. Oil prices were at unsustainable levels. With the winter arriving, there was no way that the US could afford to go into a oil-guzzling-heater weather at such expensive levels. There had to be a decrease. Also, with the price of gasoline at such high levels, demand had predictably dropped as people moved to restricting its usage. Ford and GM, promoters of the guzzlers in the US reported huge drops in demand for their SUVs and vans as the US general public moved to cleaner, greener cars.

The OPEC also noticed a sudden drop in the demand for oil. This was accompanied by loud rhetoric to explore and exploit alternative sources of energy which would reduce the dependence on oil, bring prices down and be more environmentally friendly. Suddenly you had Barack H. Obama, John McCain and even Paris Hilton commenting on their green policies. You saw legendary investor T. Boone Pickens coming out with the PickensPlan with a strong focus on wind energy as the source of the future.

Having followed companies in the alternative energy industry space myself, I saw the importance and relevance of solar, wind and other alternative energy companies. The OPEC saw it too. They saw this as a potential drop in the demand of their mainstay product. This warranted even Hugo Chavez, the Venezualian premier who has been trying hook, nail and sinker to ensure higher prices of oil, to comment that oil prices were not sustainable at these levels.

As you must have guessed, I predicted with fair certainty that oil prices were almost certainly going to drop. Levels were not real and then had to get to a sense of normalcy. Midway through the time that elapsed, economists at major investment banks and financial gurus began to chant this mantra as well. I followed USO, an ETF on the American Stock Exchange [AMEX:USO] very closely and found it to be behaving as previously predicted.

I was of the belief that if oil dropped as was predicted [and corroborated by the gurus], this would reduce the demand for the US Dollar. This would also drop the inflation rates in my country [to some extent, this could be lagging or stuck in govt. bureaucracy]. The net effect would be a depreciation of the US dollar to my own local currency and that would buy me more dollars for the same amount of money.

I held out, not telling my parents the real reason. I also thought that it was unlikely that the dollar would appreciate any more than it currently had. It was unlikely to go any stronger. In a way, I did take a bet; a bet in a situation that I should not have taken one [ as a debt ridden b-school student, you dont want to take one]. Yet, as I saw it, it was better to do this than to leave myself to chance. In a normal situation, I would have taken the prevelant rates and transferred the money without giving it a second thought. Atleast this way, I was better informed that there was a higher likelihood of the prices going lower than going higher.

The bet paid off. I waited until I could no longer hold out and needed the money. After that, I asked for the money to be transferred. A net gain of 400 basis points. Not a lot some would say, but then again, it was something. You really cannot expect to make that much of a bet on such non-volatile instruments in such a short period of time anyway.

I am just happy that the knowledge at business school is helping me think like a real business leader who makes his/her decisions based on the prevelant conditions in the market.

For all those undecided, take the plunge. B-school will be the single best investment that you can make in yourselves [ short of getting married rich :-D ]

Lessons in Management

Some interesting lessons in people management.

Retail Sector in India

Here is a short presentation on our take on the future of the retail sector in India!
This was for the final project in the Global Economy class that I took this semester.

Banking Jokes

Heard a lot of banking jokes! Saw this cartoon and thought I should share it.

Reproduced from Christian Baxter's website



I obviously don't subscribe to the view. But, its nice to laugh at oneself once in a while.

C'est la vie!

My fortune reads:
You are soon going to change your present line of work



I find that interesting given that I am going to interview tomorrow for a function that I am not particularly keen on doing. Yet, it is something that I have gotten myself into.

I didnt apply. They called me and asked me if I would be interested. I told them where my interests lay. They were persuasive. They said they didnt mind being my second option. I said... 'What the hell!'

I have been running around to ask people to consider me. And here I was in a situation where people were calling me and asking me if I could come along. That even after I told them what was on my mind.

I didn't apply and yet they invited me for an interview. I was surprised. So were a lot of other people. I didn't have much of an interest and that was obvious given my lack of interest in the whole profile and the firm. A firm that is a great firm in its field of expertise. A field that a lot of people are dying to get into. Good for them. That is what they want. That is not what I want. It is not a bad field. It is infact a great career to have. It is just that it is not a career that I wish for myself.

I have long believed in doing what my heart tells me. I go by what my instincts say. And my instincts tell me that I should pursue what I am currently pursuing. The road looks tough and there are a lot of obstacles in the path. But that is okay. It is what interests me and it is what I want to do. It is what I want to see myself doing. Why do you ask? Interesting question. A fair one too.

I have never worked in the field before. As much as I have tried to understand and learn about the field, the fact remains that I have not worked in it. Hence, it is not likely that I truly and fully know what it is all about. Yet, it is in a field that is an area of interest. It involves a challenge that is hard to pass. It is a challenge that few other profiles can offer. I dont know any other profile that comes nearly as close. It will give me great exposure and access. Tangile results that make the news... for the right reasons.

But first and foremost, it offers a challenge. A challenge to work in an environment where you start with knowing nothing and learning everything there is to know. And I am not talking about a lifetime. I am talking about one task. It is the challenge of learning, understanding and performing in such an environment. The power and ability to make a difference in such a manner that few people can imagine, being twenty something guys.

The money is there too. It is obvious and I won't deny it. But, I will add that I don't do things that are necessarily for the money. Ofcourse, nobody works for charity and I am not nobody. But, I also do not work for the money. It is a criterion, but it is not the criterion for me. Satisfaction is more important for me. At the end of the day, I need to know and understand that what I am doing is something that is important, critical and I am making one hell of a difference to what I am doing.

And yet, destiny chooses to play hide-n-seek. It offers things that I don't want and denies things that I don't have and want badly. C'est la vie!

I just hope that the fortune that I mentioned does not come true. I hope that I get where I want to be... I dont mind the pitfalls and the hardships (before or after).