Cash For Clunkers

SAW simply can't figure out the rationale for this silly scheme in the US, now the latest recipient of government largesse. Cash is handed out for returning an old non-fuel-efficient car, which is then applied as part payment for the purchase of a newer fuel-efficient car.

Given that vast swathes of the American population are now in debt, all this scheme does is add debt on debt.

© 2009 Sanjeev Aaron Williams All Rights Reserved

Lessons From Michael Jackson

1. OK, you've got tons of talent - but your 2 biggest assets are your health and your time. Let either of those slip, and you've had it.

2. Should those in your organization even be there?

3. How did they get into the organization in the first place?

4. Are you clear on what authority they actually have, as opposed to the authority they think they have?

5. Who's paying them? For what? And Why?

6. What's your cashflow burn rate? Per Week? Per Month?

7. How strong is your ability to draw on new sources of funding?

8. Are your contractual commitments clearly spelt out?

9. Will you be able to keep those commitments?

10. What are your financial, logistical and creative resources to stage a commercial comeback?

11. Do you have the physical, emotional and mental stamina to see it through?

12. What's your corporate succession policy after you've left the scene or the planet?

13. Just how much drama will you tolerate before creativity dies?

14. Your business legacy will be ..........what, exactly?

© 2009 Sanjeev Aaron Williams All Rights Reserved

US Bank Stress Tests

The 19 - bank stress tests in the US are unconvincing and predictable. While the intent might have been laudable, the heavy back room politicking that triggered the abandonment of mark-to-market accounting weeks beforehand, laid the groundwork for an equally creative outcome of the tests. SAW remains wary – there’s still the weak state of the commercial real estate market, the default rates of prime mortgages, the true extent of the reset of Option ARMs and a potentially major credit card default. The latter if it materializes, would dwarf the combined capitalization of some well known credit card issuers.

So…..what are price earning ratios on banks worth these days? As we wait for the next shoe to drop, the tension in the bank balance sheets is between retained earnings and writedowns.

And guess which one is going to win? Yeah, the writedowns, since retained earnings will drop as current earnings shrivel. It's a little premature to point out "green shoots" or to claim that the financial system is "healing" (per Tim Geithner).

© 2009 Sanjeev Aaron Williams All Rights Reserved

Humility & Humongous Banks

SAW having kept his mouth shut for a few weeks to see which way the financial winds of change were blowing, has discovered that other than shaking like leaves in a hurricane, the global elite of bankers and the hapless politicians don’t have a clue.

Davos 2009 was a washout, with some CEOs too embarrassed to attend.

The European Union has discovered to its horror that it’s not unified at all, but consists of 3 distinct economic blocs: firstly Germany France and the U; secondly the southern European countries like Portugal, Spain, Italy and Greece whose real estate bubble has burst; thirdly the impoverished Eastern European countries to whose toxic debt the other European countries were exposed in addition to the US garbage. With Germany emerging as a reluctant central banker to the EU, there are pleas to avoid protectionism within the Eurozone which carries with it the spectre of a new Iron Curtain between rich and poor Europe.

Obama grins while throwing trillions at an unquantifiable problem and simultaneously promises new infrastructure projects and increased government stakes in Citigroup and others that still pretend to be banks. How he proposes to spread the wealth back to the middle and working class in the face of the greatest and utterly fraudulent engineered scam, that for 7 years sucked the wealth into the hands of the (unprosecuted) banking elite, remains to be seen.

No doubt as part of his inclusive policies, he’ll have to defer to those bankers complaining that they’re being unfairly bashed. The American Bankers Association bleated to Obama that very few banks were involved in the toxic debts. Numerically, that may be true. But those on Wall Street and elsewhere who were involved, leveraged their exposure to outrageous levels and sabotaged the real economy. Any good that came out of it was the realization that merging fractional reserve banking with the debt addiction of US consumers, for whom repayment was a novel concept, was bound to affect the banks Balance Sheet sooner or later – no matter how exotic the debt instrument or the credit default swap daisy chain that purportedly backed it.

Case in point, AIG that insured those credit default swaps and is now described as a “systemic risk”, is back for a second bite of US30 Billion the government cherry after its first chomp of US150 Billion. It faced a credit downgrade in the face of a US 61.7 Billion loss for the last 3 months of 2008 (apparently the largest quarterly loss in corporate history).

It’s right up there with the talent to be found at RBS.

Or HSBC, whose sub-prime exposure to the US market necessitated a cash call of US 17.7 Billion through a rights issue in the UK (the biggest in UK history), the closure of its consumer lending business in the US, and a cut in dividend.

What really cracked SAW up were HSBC’s statements of contrition, which included this gem that there had to be a reversion to some of the older principles of banking in terms of a simpler sense of providing good customer service, good relationship management and a sensible approach to liquidity.

“Reversion”???!!! why on earth would an apparently prudent bank diverge from those principles?

Oh yeah……….unbridled greed coz everybody else was doing it.

© 2009 Sanjeev Aaron Williams All Rights Reserved

A Whiter Shade Of Pale

So let’s see..........World Emperor Bush rode into the sunset and hopefully, will be consigned to the trash bin of history. 44 is in, sternly warned the planet that things wouldn’t be easy, partied all night, went to church and started work.

Meanwhile US, UK and Hong Kong markets – and markets pretty much everywhere else, tanked and still are. Bank of America, which swallowed Merrill Lynch is throwing up, divested its “strategic” shareholding in a Chinese bank and screamed for a cash bailout from the Feds. They got it – US138 Billion for them, US118 Billion in guarantees for Merrill’s crap err….assets.

Citibank, the world’s global bank, is a global embarrassment with a share price to match. It’s disembowelling itself and donating part of a vital organ, the brokerage arm, into a joint venture for a capital infusion.

Royal Bank of Scotland proudly announced it had scored another first: a 28 Billion Pound loss, the biggest in British history. One assumes that its overpriced leveraged acquisition of ABN AMRO for 49 Billion Pounds – at the time the largest banking acquisition in UK history –might have contributed to its backhanded stellar performance.

The British government is all set to open the floodgates of liquidity with 350 Billion Pounds of cash. They already have precedent on their side. First it was Northern Rock’s bailout of 55 Billion Pounds in September 2007, then Bradford & Bingley in September 2008, then credit guarantees, a liquidity scheme in October 2008, something about a toxic asset buy up plan etcetera, etcetera…….plus the hint that the Bank of England could be given license to print money, effectively at will to enable “quantitative easing”. That’s assuming that buying up the crap with UK Treasury Bills doesn’t work. And remember, British interest rates are the lowest they've been in 314 years.

Australia is not looking so thrilled. Access Economics reported that the country is heading towards the sharpest recession in its history. Plumetting commodity prices mean a decrease in government royalties, taxes and increasing budget deficits.

With the scale of the toxic debt instrument creation belatedly becoming coherent, both the US and the UK governments have announced plans to set up a special bank to absorb those assets, in exchange for equity in the surrendeing banks.r

Great….so we have creeping trans-Atlantic nationalization, the Fed prints money at will, the Bank of England can print money at will and soon the European Central Bank, given the mess that Eurozone is in, will also be printing money at will. Effectively, every white country is up the creek and the loss of confidence is damaging emerging economies. It’s worth remembering that this scale of money creation, whether individually or jointly, has never been done before. We’re all watching an experiment in which nobody knows what’s going to happen and nobody can predict how much confidence there will be in all this freshly minted cash.

© 2009 Sanjeev Aaron Williams All Rights Reserved

Politicians, Ponzi & Prayer

So for the moment, the 3 US auto companies were rejected by the Senate in their media circus application for a multi-billion dollar bailout. Accusations and blame are being exchanged as pre-Christmas gifts amongst the management, union and politicians.

Whilst the quality of management and overall competitiveness of the US auto industry is debatable, it’s important to point out that at some level they are also victims of Wall Street’s financial engineering debacle. This is because the 3 US auto companies rely on short term financing via the commercial paper market, which seized up.

The politicians played tough with the auto CEOs – demanding oversight, cutbacks in wages and executive pay, then crashed their bailout in the Senate. It was the same song they sang to the investment bankers but then handed over hundreds of billions with no oversight in sight.

Those politicians screaming for greater financial regulation will no doubt be fortified in their views by the now collapsed, decades long, multi-billion buck Ponzi scheme run by Wall Street grandee, Bernie Madoff under the nose of the SEC (to whom he was an adviser) and NASDAQ (of which he was Chairman). Just how many complaints are necessary before the SEC will act? Ask them. There were complaints about Madoff since 1999.

Call Madoff the aftershock to the main financial earthquake. The best that can be said about him is that he appeared to be an equal-opportunity scammer, targeting the ultra-rich and charities. It’s all great news for the lawyers.

There are lessons to be learned for SMEs. It’s been widely reported that Madoff was under financial and emotional stress. Even a Ponzi scheme requires cash flow. SME Directors facing cash flow pressures frequently resort to paying off favoured creditors at the expense of others. Cooking the books is another option, but both are a zero sum game.

Cash is king and cash flow is the true measure of business success. Like Madoff, a business may be showing a profit, but is in reality insolvent.

With US interbank lending rates now cut to 0.5%, the hope is this will translate into widespread consumer lending so that the average American can once again, enjoy his drug of choice – debt.

SAW’s suspicion is that the US consumer has been so traumatised, they might actually start doing the unthinkable – save.

© 2008 Sanjeev Aaron Williams All Rights Reserved

The Bigger The Trough

…..the larger their snouts…..

The US auto companies didn’t quite get the warm political reception they’d hoped for as part of their grubbing for US25 billion. Given that all 3 claim to be on the verge of bankruptcy, it didn’t help their case that the CEOs arrived in private jets. In mitigation, General Motors is returning 3 of its leased jets while promising greater use of video conferencing…..

Oh, and being asked by politicians to spell out exactly why they need capital, what they intend to do with it, over what time frame and what kind of returns to expect, was hardly a surprise. Any SME, whether looking for factoring funds, seed capital, mezzanine financing, venture capital or a bank loan would be asked exactly the same questions. What gave the auto companies’ CEOs the temerity to think they’d be exempt from the basic criteria of accountability?

Probably the fact that to date neither the US Federal Reserve nor the Treasury will disclose exactly what securities they have accepted as part of the now scrapped “cash for trash” deal that was the original TARP. The new plan to directly take equity in the banks (and potentially anyone else) has already been derided as incipient nationalization and crony capitalism. Oversight provisions as to how the government funds will be dealt with once injected, are non-existent, other than a bland assumption that the funds will be deployed for lending.

Meanwhile, according to Calculated Risk, as of 21 November 2008, 22 US banks have failed this year – so far. In fairness, some banks in the US, particularly those that stayed well away from the financially engineered toxic debt instruments, are doing just fine and are happy to continue and extend lines of credit to well managed commercial clients.

And the boys at Citigroup – whose share price is now that of an enhanced penny stock - are working overtime negotiating a government bailout or a sell off (of their lucrative credit card business, the Smith Barney brokerage, or their recently appointed CEO Vikram Pandit who announced jobs cuts totalling 82,000).

The joys of being an international conglomerate like Citigroup, allow for a degree of self-righteousness flatly denied to private companies: Citi is too big too fail and must be “saved” to end the hysteria; as a US company operating all over the world overseas governments should help bail it out; Citi is a victim of short sellers whose stock price has a reached a level that necessitates government intervention by way of cash injection, absorption of bad loans and an assisted merger.

Um… OK… government intervention for whose benefit? The shareholders or the financial system?

© 2008 Sanjeev Aaron Williams All Rights Reserved

Global Interest Rate Cuts

Earlier today, Hong Kong time, there was a coordinated response from the US Federal Reserve, Bank Of Canada, Bank of England, European Central Bank and the Riksbank of Sweden to cut interest rates by 50 basis points. All banks issued public statements in similar form, pointing out the need to take action in a slowing global economy.

Would it be impertinent to point out that interest rates are already low, have been for sometime and still the US economy, the European economies and the Asian economies are slowing or are expected to slow?

Is SAW missing something? How do lowered interest rates deal with the 2 fundamental issues of institutional decapitalization and deleveraging?

And if the problem is one of outrageous consumer debt and shoddy bank lending, are lowered interest rates going to make the banks thrilled to lend again to consumers who turned out to be lousy credit risks?

Not likely.

One of the widely read blogs, Mish’s Global Economic Trend Analysis, asserts in a posting, Global Coordinated Rate Cuts Won’t Solve Economic Crisis dated 8 October 200,8 that the root cause of this crisis is fractional reserve lending. Interesting……SAW is no economist just a simple lawyer, who in his previous post entitled What Crisis dated 1 October 2008 suspected the same thing.

As MIsh put it:

“The world is heading for a global recession and a sure bet is that it will be blamed on a subprime crisis in the US. The reality is the greatest liquidity experiment in history is now crashing to earth.

The root cause of this crisis is fractional reserve lending, and micromanagement of interest rates by the Fed in particular and Central Banks in general. The Fed started the party by slashing interest rates to 1%, but Central Banks everywhere drank the same punch to varying degrees.

The Greenspan Fed lowering interest rates to 1% fueled the initial boom, but like an addict on heroin, the same dose a second time will not have the same effect. The Fed, the ECB, etc. could have slashed rates to 0% today and it would not have mattered one bit.

The reason is simple: There is no reason for banks to go on a lending spree with consumers tossing in the towel, unemployment rising, and rampant overcapacity everywhere one looks with the exception of the energy sector.”

© 2008 Sanjeev Aaron Williams All Rights Reserved

What Crisis ?

It gets tedious after a while, reading all the political and media spewing espousing the need for an apolitical solution to an economic – and legal- problem. Superlatives are everywhere: “financial Armageddon”, “global meltdown” “catastrophic failure”….ad nauseam.

Yeah, it’s kinda fun watching history being made, and even more fun attempting to make sense of it. All this talk about the need to protect assets, to ensure credit markets don’t freeze and the risk of sharp inflation - even though SAW suspects that the term “inflation” is a misnomer. It’s probably sharp depreciation in purchasing power caused by too much US Dollars aka Funny Money swilling around.

And talking about Funny Money and credit, exactly what is seizing up? Here’s one theory from a simple lawyer. What is seizing up is the grossly over-inflated, exponentially grown, debt- based supply of money that was, literally, created, out of thin air without reference to anything else.

Whilst greed, fraud, conspiracy and tacit governmental approval are all in the mix, SAW suspects that the (presently legal) practice of Fractional Reserve Banking was exploited to the Nth degree with monstrous effect.

If Customer A deposits $1,000 in the bank, the bank has the legal right to lend the majority of that $1,000 to someone else. So the bank might lend say, $900 to Customer B. That is recorded as an electronic transfer of funds into Customer B’s bank account. Therefore, it is technically a deposit of $900.

That allows the bank to then use that “deposit” of $900 to make a loan of the majority of it to Customer C. So, Customer C might get a loan of say, $800. That would also be by way of an electronic transfer of funds into his account and would technically be regarded as a “deposit” of $800.

Again, the bank would lend the majority of that $800 dollars, say, $700 to Customer D….and the process would be repeated ad infinitum.

All this money (technically “currency” not “money” – there is a difference) is created out of thin air without reference to any underlying asset values. It operates solely as a debt-based creation i.e. the more debt that is created, the more money can be created out of thin air for lending. On that view, the creation of sub-prime mortgages made perfect sense. They were the perfect debt-creation vehicle upon which Fractional Reserve Banking could grow exponentially – and did.

And those sub-prime mortgages were subsequently, sliced, diced, repackaged and resold as “Asset Based” or “Mortgage Based Securities” to Investment Banks and Hedge Funds.

The simple point being made is that the money supply, created out of nowhere and based entirely on debt, was so outrageously large that it bore no relationship to the value of goods and services in the real economy. Putting it another way, the actual hard core assets did not exist to support that level of lending.

If that is correct, the widespread practice of shoving the exotic, and now toxic, debt instruments Off-Balance Sheet (and in many cases Offshore), also made perfect sense. Bringing them onto the Balance Sheet would result in an erosion of actual bank capital –which is exactly what is now happening. That explains the reluctance of banks to lend to each other and the recent spike in LIBOR.

Which is why a US Federal Government Bailout is such a lousy idea: the US Dollar is nothing but a debt-based fiat currency. In its crudest terms, the bailout is debt compounding debt.

Perhaps what we are now seeing is not a credit crisis, but a spectacular and necessary implosion of the debt bubble contracting to a level where the debt is backed by capital assets. Will there be severe restrictions on personal and commercial borrowing in the near term? Yes.

Will there be a change in Wall Street’s mentality? Dream on. People got filthy rich on this scam.

What’s a bet they created this situation up to this point plus the frantic requests for a bailout, in order for the next instalment of their grand scheme to kick in? SAW finds it impossible to swallow the notion that Wall Street is spiraling out of control or has been caught by surprise.

© 2008 Sanjeev Aaron Williams All Rights Reserved

US700 Billion Bailout

The startling thing about the US700 Billion Dollar bailout is the assumption that the Federal Reserve, the US Treasury and the folks on Capitol Hill have the patent on the solution. Despite so much incisive commentary in places like RGE Monitor by Nouriel Roubini, Money Morning and others, the bailout appears to be exactly that – a handout, albeit in tranches with Congressional oversight, whatever that means.

The Calculated Risk blog, in its posting for September 28 2008, sets out a summary of the proposals, via a document that emanated from the Office of the Speaker of the House, Nancy Pelosi. There are 3 critical components:

1. Re-invest in the troubled financial markets to stabilize [the US] economy and insulate Main Street from Wall Street

2. Reimburse the tax payer through ownership of shares and appreciation in the value of purchased assets

3. Reform business-as-usual on Wall Street through strong Congressional oversight and no golden parachutes.

There are repeated uses of the phrase “participating companies”. That’s a warning bell right there. If conditions (2) and (3) are taken at face value, those companies on the receiving end of government largesse, risk increased public interference at Board level, at macro and micro levels, including the scrutiny of executive contracts. Given the propensity in the US to unilaterally assume and extend jurisdiction wherever possible, SAW would not be surprised if, pursuant to the bail out, “participating companies” and not just the US Treasury would find themselves subjected to examination from the General Accounting Office (GAO). In the Pelosi document, the GAO is to have a presence at the Treasury, together with an Inspector-General. (No mention as to how much that would cost).

If anything, conditions (2) and (3) might later deter companies from participating in the bailout and send them down the road of a private re-structuring to maintain their independence, executive compensation and more importantly, the business-as-usual on Wall Street which condition (3) seeks to reform.

The reference to small and mid-sized companies is ominous: the Pelosi plan wants to help save small businesses that need credit by aiding small community banks hurt by poor quality mortgages, by allowing them deduct their losses by investing in Freddie Mac and Fannie Mae.

Why is it ominious? It implies that the smaller banks will be next to implode. That frustrates the intention to insulate Wall Street from Main Street. Secondly, it’s an open question whether the Federal Deposit Insurance Corporation is adequately capitalized to deal with the failure of a host of smaller banks. The irony is that the FDIC might need a bailout.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Thanks For The Memories

“The reality is that the financial system has been operating as if it were an off-balance-sheet vehicle of the government. Private-sector companies and individual bankers have been making huge profits in the bubble. Their risk appetite has been enhanced by previous bail-outs and, in the case of Fannie and Freddie, by the government’s implicit guarantee. Yet their market pricing does not reflect the potential cost to the system of their own collapse.”

John Plender, “Capitalism in Convulsion: Toxic Assets Head Towards The Public Balance Sheet” published in the Financial Times, 19 September 2008.

OK agreed…something very exciting has been going on in the model of Western capitalism, at least in the US which will probably have to reconsider it’s claim to be the bastion of free market capitalism.

In case anyone forgot, back in 1933 commercial banks (i.e. the ones that take deposits from Joe Public) and investment banks (i.e. the ones that create financial instruments for primarily institutional investors) were required by law in the US, to keep their operations separate. The excesses of the investment banks via over-leveraging and speculation was one of the reasons for the stock market crash in 1929 and the start of the Great Depression.

Back to the present, at last count, 3 of the 5 biggest investment banks in the US have gone: 2 by self-sacrifice, Bear Stearns and Merrill Lynch; and one by insolvency, Lehmann Brothers, whose operational entrails are now being picked by Barclays Bank PLC and Nomura

The remaining 2, Morgan Stanley and Goldman Sachs have been offered the status of “bank holding companies”, allowing them to take deposits from Joe Public. Funny how history repeats itself. Once again, investment banks are morphing into commercial banks……

….and for 2 good reasons (at least for them): First, they will have access to Federal funding should they find themselves in a distressed situation again. Secondly, garden variety retail deposits, boring and predictable as they are, constitute a stable source of capital. It’s now clear that over the last few months, investment banks saw a massive erosion of their capital base when they were forced to bring in Off-Balance Sheet debt instruments over which they had no hope of getting paid.

Or to put it another way, Joe Public stands to fund Morgan Stanley and Goldman Sachs privately, via his retail deposits; and publicly as an over-indebted taxpayer through government largesse.

But the investment banks have to pay a price. First, a reduction on leveraged finance and debt ratios. Second, a submission to greater governmental regulation. Third an obligation to separate retail deposits from capital market activities.

What does all this mean in practice? With their newly re-capitalized status, expect Goldmans and Morgan to go on a predatory spree to acquire small distressed commercial banks – of which there must be lots.

Although the figures for bailouts have been gargantuan, the lesson for SMEs remains easy to digest. If your Balance Sheet is riddled with debt that you have no hope of collecting, your cash flow dries up, your capital base erodes and you go out of business.

And the government couldn’t care less.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Sleight Of Hand - Just For You

Regulation is inherently prophylactic and cannot be properly created in the crises it seeks to prevent. Today calls for a single coherent and transparent approach to falling house prices (destined to continue), asset write downs (destined to continue) and liquidity crises (destined to continue). We simply cannot have Sunday closed-door meetings deciding the fates of tens of thousands of jobs, life and death for industries and billions in investor losses. Want to see what that creates? Pick up a newspaper.

Max Fraad Wolff
Editor of the Global MacroScope Website
From the article “US At A Turning Point” published in Asia Times Online 20 September 2008


Yes indeed……” a single coherent and transparent approach…..”

It’s not necessary to rehearse the hype or the horror that’s been seen on the streets and the media. More entertaining is how funny money i.e. the US Dollar (removed from the gold standard 37 years ago by Richard Nixon) continues to be printed at record rates to fill financial potholes created by Wall Street and their political cronies.

Having satiated themselves financially, they are now calling for regulation and the creation of a “Bad Bank”. The single coherent and purportedly transparent approach is a super-sized entity, by way of a fund of US800 Billion that will buy all the toxic debt and hold them indefinitely until they can be sold off at some point in the future. Effectively, it nationalizes the mis-managed, corrupt, criminally negligent results of the biggest fraud in modern history……..

…..with apparent legal immunity from prosecution.

There’s a trans-Atlantic threat to go after the short sellers and a temporary ban on short selling in the shares of some listed financial companies. But short sellers did what they do best – responding to rumour and fact by taking an opportunistic position against banks, hedge funds, insurance companies and investment banks who consciously leveraged risk to outrageous amounts then resorted to Sovereign Wealth Funds, private equity and carefully crafted press releases to buy funds and buy time. All this to allow them to dance around the perimeter of their rapidly growing pool of un-saleable, off-Balance Sheet, offshore-held, “asset”-backed and mortgage-backed securities.

If short sellers knew what they were doing, so too did the companies who were shorted.

There’s no denying that short selling abruptly stalls over-valued stocks and might crash their price, but that’s the inevitable flip side of overblown asset valuation, whose prices were allowed to bubble unchecked for……..7 years.

Quoted in the BBC’s online report of 19 September 2008, entitled, “Who’s In The Dock For The Financial Turmoil?” Professor Richard Portes of the Centre For Economic Policy Research said,

“A key issue is the opacity of the banking system. If no-one can truly assess the liabilities of a given financial institution, how can they confidently lend it money? But this has helped people make money.

"You make money when it is opaque, you make money when you have got information that other people don't have.”

The extraordinary dereliction of duty by regulators and central banks fuelled the opacity. The creation of the super-sized “Bad Bank” centralizes the opacity. True transparency requires the full disclosure of actual or suspected toxic debt instruments, the use of criminal sanctions and the refusal to cave in to financial industry demands for lenient accounting standards and waivers.

Granted, the devil is in the details, but just how do you value opaque debt instruments? If banks looking to offload to the “Bad Bank” are forced to declare their toxic mortgage and non-mortgage based assets at a discount, won’t that affect their capital base and drive them into insolvency?

Perhaps SAW is too philistine in his views, but a true meltdown is required to flush this garbage out. We now risk being drowned not in a sea of toxic debt, but in a foam of political blather, half-baked regulations and the cherry picking rescue of those institutions deemed too important to fail. It appears that free market capitalism that made a certain clique rich beyond belief, has now morphed into emergency socialism with the express intent of limiting their losses, while purporting to act for the public good.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Fannie & Freddie

Yet again, it pays to shut up.

For weeks.

Anyone who read the assertive and incisive comments over the last few months by Nouriel Roubini in the RGE Monitor, would have reacted with déjà vu on hearing about the impending implosion of the US organizations Fannie May and Freddie Mac.

In case you didn’t know, Fannie & Freddie are privately owned organizations operating under the mandate of the US Government. They perform a dual function.

Firstly, they provide funding for home loans, not by lending directly to the consumer, but by buying up tranches of mortgages from approved lenders, re-packaging them as investments and selling them off to Wall Street and internationally (sound familiar?).

Secondly, they are the guarantors of last resort of about half of all US home loans. That’s about US6 Trillion out of US12 Trillion at the moment. The figures start getting a bit silly at this level of debt.

The theory is that in their role as middlemen between mortgage lenders and investors, more money would be available at cheaper rates to allow people to buy their homes.

It’s their role as guarantors of an increasing number of crappy and defaulting mortgages that sent their share price plummeting, amidst fears that Fannie & Freddie would run out of cash. Both issued statements that their capital base is strong – although Freddie is scheduled to sell US3 Billion in short term debt right about now.

Predictably, the US Government made patriotic noises about how they must not be allowed to fail. Their line of credit was extended (about time too: Fannie has US800 Billion in debt, Freddie has US740 Billion in debt) and the US Treasury may even buy equity in them. It doesn’t get much sweeter than that. And who would ultimately be paying for all this? The dear taxpayer of course. And what would they get out of it? Nothing, except for continued intransigence and reluctance to lend to individuals and SMEs citing the “global credit crunch” as the excuse.

Problem was, as the New York Times pointed out, for years nobody in the US government would even acknowledge the existence of the line of credit, even though it amounted to an implicit guarantee that a Fed bailout would always be there, while in the meantime the Government didn’t have to show mounting losses on its Balance Sheet for what was in effect, a subsidy.

Again, as the New York Times put it on 13 July 2008:

The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions.

Back in the real world of SMEs, there isn’t the luxury of government insulation that gives the business owner discounted rates on the money markets, covers up lousy management, arguably encourages “moral hazard”, imposed lax capital standards – which went unsupervised for years - and aided and abetted the packaging of toxic debt instruments to private investors. Since you can’t pay for lobbying, the best you can do is network.

Who really benefits from this? It ain't the consumer or the SME. It's those investors in collateralized debt instruments, originated by Fannie and Freddie, seeking to have their returns guaranteed by the state. Or, put it another way, a prime example in the sub-prime saga where profits are privatized and losses are socialized.

© 2008 Sanjeev Aaron Williams All Rights Reserved

What Lehman Did, You Can't

The Lehman Brothers saga in the US gets more interesting, although it’s unclear whether it’s a story in the making or simply rumour and innuendo attempting to create a story.

An online report by Randall W. Forsyth writing in Barron’s published on 4 June 2008, stated that less than 24 hours after the investment bank was reportedly mulling issuing US$3 – 4 Billion in common equity, it went into the market and bought back its shares.

The obvious question was asked: can a company be under-capitalized one moment, only to be over-capitalized the next? Not likely. Clearly something was going on. In certain situations where the stock price of a company is low and capital cannot be usefully employed for shareholder benefit, it might make sense to buy back the shares. The effect of a share buy-back is to stabilize or lift the share price. While that is what happened in LEH’s case, the stock still sits at its lowest level since August 2003.

SAW agrees with Forsyth’s view that it is arguable whether a share buy-back was the best thing to do, given that LEH’s Balance Sheet is purportedly riddled with (CDO-based?) assets of dubious value and limited liquidity. But, if, as it’s CEO is on record as saying, that LEH’s intention was to hurt those engaging in the short-selling of its shares, then a share buy-back using whatever liquidity a company has, would be a defensive move.

As a publicly listed company, LEH has the option of immediately going into the stock market and buying back its shares. They’re millions of them out there, they have an immediate market value and they’re liquid. Buying them back is a snap. If that’s what it takes to maintain a semblance of solvency and liquidity, so be it.

An SME faced with pressing liquidity and solvency issues as well as a Public Relations problem, does not have those quick options. As a private company, its shares are held by a handful of people, possibly a mix of family members venture capitalists or angel investors. There may be a Shareholder’s Agreement with rights and obligations, a mechanism covering notice of intention to buy back the shares, clauses covering how the shares are to be valued and an arbitration procedure if things get really ugly between a shareholder and the company.

Whilst it is possible for an SME to buy back its shares, it’ll take a while. Lehman still has billions of bucks worth of liquidity on its Balance Sheet and could afford to take an immediate bold move to spend some of that cash on a buy-back. The average SME with a looming cash flow problem, couldn’t do it. Either it has to deal with its Receivables properly, or tighten up on its debtors, or reduce the credit period currently extended to its customers, or get a bank loan (good luck with that, at the moment) or offer equity to outside investors.

Doing nothing will just erode shareholder value. And that opens another can of worms.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Mortgage Defaults & Mortgage Insurance

2 interesting stories on the Calculated Risk blog caught SAW’s eye today. The first quoted a report from Housing Wire that mortgage delinquencies in the US are quickly spreading beyond sub-prime borrowers into prime borrowers. The second is that mortgage insurers are twitchy in anticipation of one or more of them failing.

Essentially increasing numbers of supposedly solvent or ‘affluent’ middle and upper middle class borrowers are now finding they can’t afford their properties. Ed McMahon, Johnny Carson’s sidekick, is the poster boy for this phenomenon. He’s reportedly fending off foreclosure on his multi-million dollar California home, having tapped himself out on a home equity line of credit.

Remember that “prime borrowers” have been hit on 2 fronts:

Firstly, chalk it up to financial inexperience, ignorance, greed, lousy budgeting, a proclivity to take on more debt that can be serviced and the habit of using the home as an ATM machine – while regarding it as the largest asset on the assumption that its value would continue to rise indefinitely.

Secondly, it’s well documented just how greedy mortgage lenders became when sub-prime Adjustable Rate Mortgages initially proved hugely profitable. They quickly pushed the product onto unsuspecting prime borrowers who found themselves downgraded into the sub-prime category, saddled with a mortgage they couldn’t understand or afford.

So, if mortgage defaults are now spreading up the affluence chain, it must mean that the cash flow from their jobs or from their own businesses are patently insufficient. Expect relocations and more SME failures in the US.

The increasing number of defaults would predictably make mortgage insurers twitchy. They are also exposed on 2 fronts: the insurance of individual mortgages; and more ominously, the insurance of the exotic alphabet soup of Collateralized Debt Obligations.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Heard It Through The Grapevine

They’re baaa…cckkk…!! Lehman Brothers is back in the news. The Wall Street Journal of 4 June 2008 and one of SAW’s favourites, the Naked Capitalism blog, are reporting that LEH’s appears to be on track to report a quarterly loss larger than the US$300 million predicted by analysts.

And they’re not the only ones making predictions. Investors have bet huge amounts on puts that LEH is gonna sink,sooner rather than later. Their debt rating was downgraded and their stock downgraded to “underperform”.

And what’s LEH said to be doing? Looking for US$3 - 4 Billion worth of new capital to shore up its Balance Sheet.

Effectively, a tsunami of rumour and predictions are driving perception and behaviour. At least the big boys have PR departments, press statements and the luxury of resorting to slick financial euphemisms.

LEH’s denials that it had funding problems and that it did not borrow money from the US Treasury, failed to convince the market and its shares closed down 10%. Let’s not forget that it was in March 2008 that LEH raised US$3 Billion from investors in order to refute reports that it was in the same predicament as Bear Stearns.

For SMEs, any rumour and predictions by outsiders, or insiders, on solvency, are potentially fatal. If cash flow is erratic, intermittent or eroded and debt ratings downgraded in the face of contracting credit, expect to be doing what some SMEs in the US are already doing – taking their goods to the pawnshop in an urgent attempt to raise capital. (Or, to use a Wall Street euphemism, “to shore up their Balance Sheet”).

The problem with rumour is that it takes on a life of its own. For SMEs, even at the best of times, it’s a delicate balance between Accounts Receivables and Accounts Payable. Inevitably, the worst aspect of any rumour reaches the SME’s most intransigent creditors first and encourages the SME’s debtors to delay payments to the last. But the phone calls demanding an explanation keep coming thick and fast.

What a bind. Crippled cash flow in a hurricane of innuendo. What’s an SME to do?

Factor the Receivables immediately if possible – even just a portion of them.

Ironically, shoring up the Balance Sheet through Off-Balance Sheet financing (another term for Factoring) is the quickest way to get cash flow, without giving up equity or sinking further into debt.

One more thing. The reputable Factoring companies are acutely sensitive to outsiders’ perceptions of Factoring and adopt the role of Receivables Managers. It’s all part of the Factoring service. Their ability to make it clear to the SME’s creditors and ultimate debtors that the SME is raising working capital through ongoing cash flow management, often goes a long way in assuaging potentially suspicious parties.

© 2008 Sanjeev Aaron Williams All Rights Reserved

What Due Diligence?

In Factoring deals, the most important aspect is the due diligence conducted by the factoring company on its prospective client and on the client’s customer to whom the invoice was sent. This is because the client’s customer is the ultimate payor. The willingness of the Factor to purchase the invoice at a discount from its face value and to receive full reimbursement from the ultimate payor, is based on risk assessment.

In other words, is the client and the client’s customer worth the risk?

Frequently, SAW gets clients whining that the Factor is asking too many questions, or the questions are too intrusive about the company’s operations, or why is it necessary for Directors to disclose information about themselves and their finances? (the answer is to determine whether the Directors might be stripping the company to line their pockets).

Yet when a bank asks those questions – and more – just for a loan, the Directors meekly comply. After all it’s a “bank” right? The notion that an institution like a “bank” and all its credit checks, is somehow more “authoritative” and “trustworthy” than a private funding source, runs very deep.

And it is deeply misplaced.

The banks’ role in the residential sub-prime drama is history. What is now unfolding is Stage 2: the banks’ and their co-conspirators compounded greed in the exotic securitization and creation of mortgage-backed, debt-fuelled instruments with purportedly stellar credit ratings. These are now unraveling with billions of dollars of losses in the pipeline.

To say that consumers and SMEs have been hurt by the sudden indefinite contraction in credit, is an understatement. What’s really galling is the utterly feckless credit risk analysis supposedly undertaken by banks, investment banks and credit rating agencies as they fell over themselves to slice and dice these securitized instruments in order to push them onto hedge funds and other “sophisticated investors”.

It’s clear that the credit risk analysis of inherently dodgy instruments was a sham at worst, a formality at best. A nudge and a wink was the order of the day at Wall Street. And they have very thick skins. The effect of shoddy and virtually non-existent risk analysis is now blamed on a computer error. That error apparently led Moody’s to assign Triple-A ratings to billions of dollars worth of complex debt product. The error was discovered in 2007, but the debt instruments’ AAA credit ratings remained until early 2008. And it doesn’t end there. The suspicion is that Moody’s may have tweaked its computer model to arrive at the same result as Standard & Poors, in order to keep business as “a second opinion”.

Of course, Moody’s is now doing “a thorough review” of its derivatives ratings.

To which SAW would add, Really?? A computer error that lasted errr……………….7 years???!! Remember it was after US interest rates were slashed in September 2001 that sub-prime mortgages and their securitized derivatives took off.

So….back to Factoring companies and the questions they take the trouble to ask during due diligence. SAW’s humble advice is to stop complaining, be grateful they’re doing their job (properly) and answer their questions fully.

Your future cash flow depends on it

© 2008 Sanjeev Aaron Williams All Rights Reserved

A Prompt Delay

It’s all getting farcical and paradoxical. Hence the title of this post. An online report in the International Herald Tribune dated 8 April 2008, said that the International Monetary Fund (“IMF”) warned that sub-prime losses could reach US$1 Trillion broken down as follows: US mortgage losses, securities tied to commercial real estate, loans to consumers and companies.

Since the total losses and asset write-downs reported by banks and other flakes are in the region of US$232 Billion, the forecast of US$1 Trillion suggests the worse is still to come.

“There was a collective failure to appreciate the extent of leverage taken on by a wide range of institutions - banks, monoline insurers, government-sponsored entities, hedge funds - and the associated risks of a disorderly unwinding.”

Interesting choice of words. A “collective failure to appreciate……”??? Garbage. It was a conscious act of cumulative greed, going back 7 years.

As one commentator put it, this wasn’t a problem on Main Street, it was manufactured by Wall Street.

Personally, SAW prefers the following quote taken from Byron King’s article, “The Flipping Industry” published online in The Daily Reckoning dated 8 April 2008:

“It is apparent that much of the old way of doing business - particularly in the realm of lending money - was rotten to the core. In my view, it begins with the dollar itself. The dollar has been steadily deteriorating in value for decades, so inflationary expectations are part of the worldwide consciousness. That is, just because of the long-term decline in the value of the dollar, most people expect most things to go up in price most of the time.

So is it any wonder that people developed a "speculation expectation"? This fed into an entitlement mentality, as well, that tainted every rung of the credit ladder. A lot of people wanted to buy and flip, whether it was houses or stocks or commodities. So other people lent to people to enable buying and flipping. Flipping became a dominant, if not defining, element of the financial "industry," of sorts.

But what an industry! For example, in the past five years, many people just plain lied through their teeth on everything from credit card applications to mortgage applications to the lending documents for multibillion-dollar takeovers. It was pure and brazen fraud in many instances, verging on burglary in plain sight. The next level up the food chain - the brokers and loan officers - often just looked the other way and rubber-stamped the papers. "Hey, not my problem."

This kind of bad buck-passing went all the way to the top of some firms, many with familiar names. There in the ethereal reaches of the nice office buildings in Irvine, Calif., and Fort Lauderdale, Fla. - let alone Wall Street - the chief executives knew, or should have known, how risky the portfolios were becoming……”

There’s no lack of wishful thinking in the IMF report either suggesting that banks improve disclosure and take write-downs "as soon as reasonable estimates of their size can be established."

Yeah right. In case nobody noticed, the banks are taking their own sweet time to disclose the size of their losses, apparently operating on the assumption that a periodic drip feeding of their loss disclosures would be easier for their shareholders to stomach – and in the meantime, sugaring the pill by begging from Sovereign Wealth Funds and, if they’re in the US, sucking from the Federal Reserve’s discount window in exchange for tendering worthless securities on a “no-questions-asked” basis.

Oh yeah, the new IMF boss who took office in November 2007 admitted that the organization,

“was not as vocal as it could have been about the risks that a subprime collapse posed for the global financial system.”

Maybe that’s all he should have said.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Double Or Nothing

So it’s now official. Swiss bank UBS, Europe’s biggest investment bank, felt it needed to become truly famous and announced not only a 2^nd consecutive quarterly loss, but further sub-prime related write-downs of US$19 Billion – basically doubling its losses. It catapulted itself to the top of the loser’s league with total losses of US$37 Billion. See the earlier post, And The Winner is…2, dated 3 April 2008.

In addition, it is raising 15 Billion Swiss Francs by issuing new shares to Sovereign Wealth Funds from Singapore and the Middle East who had earlier thrown money at it.

Now here’s an interesting spin: the SCMP Business News, published in Hong Kong on 2 April 2008 quoted a fund manager at Mizuho Asset Management who said:

“The fact that the latest [news] from UBS is a combination of capital increase and write-down should be welcomed to some extent because it’s a reflection that they are speeding up their write-offs.”

Alternatively, it could be viewed as a sober realization that their mammoth write-offs had truly eroded their capital base and they had to act fast. So fast, that they are setting up a new business to handle their US property assets that are now worthless. That’s a pretty clear indication that a huge level of Receivables cash flow had just plummeted from the Current Assets column of their Balance Sheet to the Bad Debt column.

This blog has repeatedly warned SMEs that poor or inefficient management of Receivables cash flow would have a similar result. Unlike UBS, whose Chairman is not seeking re-appointment (and will leave suitably compensated of course), a CEO of an SME doesn’t always have that luxurious option. A Director’s failure to monitor the risks inherent in the company’s cash flow is a breach of fiduciary duty both to the company and to its shareholders. With shareholders of well known investment banks and Wall Street titans getting burned left, right and centre, it can be expected that shareholders of SMEs (often family members) and venture capitalists, will sit up and take notice of exactly how their business is performing – particularly in this time or rollercoaster uncertainty.

With banks reportedly reluctant to lend to SMEs, Directors of SMEs can expect to be asked hard questions by their shareholders about the company’s positive cash flow and the risk models in place to protect and guarantee that cash flow, the company's working capital and the Returns On Investment.

If the SME's Receivables are badly screwed up through reckless inefficiency and the Directors (to quote the UBS Chairman) promise that the next chapter will be one of "discipline and determination", don't expect them to last very long.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Stating The Obvious

“If you’re a smaller player, you need more capital to do business in tough times. They now need to show that they can keep churning profits in this environment”

David Hendler, CreditSights analyst, quoted in the Business News, South China Morning Post, 2 April 2008.

He might as well have been talking about SMEs. He was actually talking about Lehman Brothers having raised US$4Billion from a special offering of 4 million shares. The proceeds are slated to increase its capital base and provide greater financial flexibility.

Sounds familiar doesn’t it? Some of the best known names on Wall Street are scrambling to raise working capital and giving up equity to outside shareholders, despite the bravado.

Whilst this blog is not exclusively about Factoring, the pain on Wall Street is a nice contrast to Factoring, the potential benefits of which can be found by going to the Labels column on the Right Hand Side of this blog.

© 2008 Sanjeev Aaron Williams All Rights Reserved