Lumuhuku

I came about this quote in a newspaper…

Today’s “Take Home Salary” doesn’t even take you there!

Isn’t it the divine truth?? 

Here’s a very interesting anecdote that describes how an “asset bubble builds up and what are its consequences.”

THE ANECDOTE -

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

1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.

____

2) B decided to purchase the land from A for 1 dollar. So, A and C now each own 1 dollar while B owned a piece of land that is worth 1 dollar.

____

3) C thought that since there is only one piece of land in the country and land is non produceable 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 dollar.

A has a loan to C of 1 dollar, so his net asset is 1 dollar.

B sold his land and got 2 dollar, so his net asset is 2 dollar.

C owned the piece of land worth 2 dollar but with his 1 dollar debt to A, his net asset is 1 dollar.

The net asset of the country = 4 dollar.

____

4) A saw that the land he once owned has risen in value. He regretted selling it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollar from B and and acquired the land back from C for 3 dollar. The payment is by 2 dollar 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 dollar. But since he owed B 2 dollar, his net asset is 1 dollar.

B loaned 2 dollar to A. So his net asset is 2 dollar.

C now has the 2 coins. His net asset is also 2 dollar.

The net asset of the country = 5 dollar. A bubble is building up.

____

(5) 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 dollar.

The payment is by borrowing 2 dollar from C and cancellation of his 2 dollar loan to A.

As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollar.

B owned a piece of land that is worth 4 dollar but since he has a debt of 2 dollar with C, his net Asset is 2 dollar.

C loaned 2 dollar to B, so his net asset is 2 dollar.

The net asset of the country = 6 dollar.

Even though, the country has only one piece of land and 2 Dollar in circulation.

____

(6) Everybody has made money and everybody felt happy and prosperous.

____

(7) One day an evil wind blowed. 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 dollar in circulation, I think after all the land that B owns is worth at most 1 dollar only.”

A also thought the same.

____

(8) Nobody wanted to buy land anymore. In the end, A owns the 2 dollar coins, his net asset is 2 dollar. B owed C 2 dollar and the land he owned which he thought worth 4 dollar is now 1 dollar. His net asset become –1 dollar.

C has a loan of 2 dollar to B. But it is a bad debt. Although his net asset is still 2 dollar, his Heart is palpitating.
The net asset of the country = 3 dollar again.

Who has stolen the 3 dollar from the country ?

Of course, before the bubble burst B thought his land worth 4 dollar. Actually, right before the collapse, the net asset of the country was 6 dollar in paper. his net asset is still 2 dollar, his heart is palpitating.

The net asset of the country = 3 dollar again.

____

(9) B had no choice but to declare bankruptcy. C as to relinquish his 2 dollar 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 dollar. B is bankrupt, his net asset is 0 dollar. ( B lost everything ) C got no choice but end up with a land worth only 1 dollar (C lost one dollar) The net asset of the country = 3 dollar.

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 individual in a country to one another is also building up.
• This story of the island is a close 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 overdamped 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 loser. 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 refrain to take part in the game. At the end of the day, he will neither win nor lose. But he will see the value of his money or land go 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.
• Instead of land, the above applies to stocks as well.
• The actual worth of land or stocks depend largely on psychology.

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It is said that equities (stock markets) in the long run do give much better returns than other asset classes. So is it not good to have a lot of shareholders? Pretty good I say. But it is good only if everyone becomes a shareholder by his or her own decision.

Sooner or later, this big $700 Billion Bailout is going to be a reality. Even if it is not passed again, still a lot of taxpayers money has already been invested in the companies on verge of collapse. So is it not a case of “people being forced to become the shareholders of dying companies?”

Today, every tax paying American has a become shareholder. Whether he likes it or not.

Now if the taxpayers are saving the financial system by buying up risky organizations, they should also get the share in some of the upside at the companies thus bailed out.

Now just think about the following and you will see how complicated things will become, very soon…

1. Did you want to have share ownership of such temporary things? Will these survive even after the bailout?
2. How will you resolve the conflict between wanting the banks in which you invest to make a lot of money and not wanting them to charge you $200 or $500 for turning in your credit card payment a day late?
3. Does this mean that all Americans get to go to shareholder meetings?

So, lets see if the house of representatives pass the bill or not. Even if they don’t, the process of damaging the US economy was started 7 years back.

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It is said that nothing brings out the vultures like smell of death. We can use it for Mr Buffet too..

Nothing brings out Mr. Buffet [..to invest..] like the smell of a ‘undervalued’ company ready-to-die.

Warren Buffet’s through his ‘legendary’ Berkshire Hathaway Inc. is investing at least $5 billion in Goldman Sachs. Now this is a huge thumbs up for one of the survivors of the credit crisis that felled two of its investment banking peers.

But that’s not all. In addition to buying $5 billion in preferred stock, Berkshire also got warrants to buy another $5 billion in Goldman’s common stock. Goldman on its own, would raise another $2.5 billion in its own public stock offering.

I was actually planning to title my post as Warren Buffet Strikes Back. But I thought Mr. Buffet as the guardian angel of the market and so the title.

So why did  Mr. Buffet, buy into Goldman Sachs? This is what he had to say –

“Goldman Sachs is an exceptional institution. It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance.”

A very important point to note here is that Buffet’s latest investment comes two days after Goldman Sachs Group Inc. and Morgan Stanley, the last two independent investment banks on Wall Street, won approval from the Federal Reserve to change their status to bank holding companies. That is, Mr. Buffet invested in the model of banks and not investment banks. It seems he has no faith left in the investment bank model.

What would have happened if GS had not converted to a bank holding company? The question can best be answered by Warren Buffet himself…

By becoming commercial banks, Goldman Sachs gets broader access to borrow federal money and the ability to build a stable base of deposits. But it also comes with closer regulatory oversight that likely limit its ability to generate the kinds of sky high profits that were topped by few others companies.

Another major thing to notice here is that Buffet prefers to invest in organization that are usually present in ‘unregulated’ or partially regulated sectors. But here, Goldman will be under close watch of the Fed. So is Mr. Buffet changing his investment style?

To tell the truth I was really surprised to see Goldman Sachs panicking out, since Goldman stood alone among the investment banks in refraining from participating in the subprime market. Its balance sheet was the strongest, and it was still making money up to the present. Profits fell, of course, but at a time when others are writing off billions, a black bottom line should have kept its stock at healthy levels. When your competitors are all dying, hardy survival should point toward future dominance in your sector. But Goldman had other ideas…

Mr. Buffet was actually asked to buy its assets for 10% of their value; he wanted to pay just 5%, so it wasn’t a good enough deal. Buffet only commits his money when there is a very high chance of profit. He would have made money on even at 10%, and clearly the firm’s positions appeared to be eventual winners when the market settled down, but on short notice saw no reason to take on any risk. Buffet has passed on other potential deals as well, including Bear Stearns last year.

For a long time, Buffet had avoided Wall Street since he came to Salomon Brothers, when it was hit by a trading scandal in 1991.  He had bought a $700 million stake in the company four years before. He eventually turned a profit on the investment, but it was a long and difficult experience for him.

A really interesting observation of mine is that I think Warren Buffet’s $5 billion are much more important than Fed’s $700 billion. You must be thinking that I am out of my mind. But just think about it. Warren Buffet is THE MAN OF THE MOMENT.  He is a deep value investor and always picks the bottom. So he seems to have sensed the bottom. And that should be a very pleasant news for the people. 

And yes, during the credit boom, there were some idiots who kept on saying that Warren Buffet had lost his touch. Now the Berkshire Hathaway boss has collected what looks like a canny investment in Goldman Sachs. And those idiots are nowhere to be heard. Why? They have been crushed by their own stupid-high-risk portfolios.

Hail Mr. Buffet

“US government bails out insurer AIG with $ 85 billion of taxpayers money. “

Americans!! are you sleeping again? It was a terrible mistake to bail out Bear Sterns. Your government repeated it with Freddie Mac and Fannie Mae. And now AIG.

We thought China was a communist, but it seems USA is a bigger communist country.

Now most people don’t know what is written below –

When AIG ousted CEO Martin Sullivan back in June, he received a $47 million severance package.  Yes, after two quarters of record losses he still received $15 million cash, a bonus of $4 million for the portion of the year he worked, and held on to outstanding equity and long-term cash awards valued at about $28 million.

 

Exiting CEO, Robert Willumstad, who reigned for all of three months, joined AIG with a $1 million annual salary, and a possible $21 million in annual bonus and incentive awards. He also got restricted stock and options once valued at $36.5 million.  Word is he now leaves with nearly $9 Million in compensation.

$9 Million for three months at a company which has now been bailed out by Taxpayers.

Oh come on, bonuses should be tied to performance, not attendance.

And why should the tax dollars go to bailout companies and reward their executives for their failure in a free market? There is absolutely no reason or sense for government to interfere in a free economy. I agree that repercussions of the falloff giants would have been felt for long, but what the US is doing is, just delaying the inevitable. Wall Street has to pay for its mistakes. That’s the way a free market works!  And in time the market will correct itself, and it always does.

Government interference only delays the inevitable downfall and slows the market correction that is desperately needed to avoid a deeper recession or possibly a depression if the government does not get out of the way. 

Till now I was not very sure of the recession of US economy. But if the government continues its passionate ‘bailout‘ing, rest assured, recession will not be a part of your nightmares, but reality.

Now what’s wrong with recession. I say nothing! If it takes a recession or a depression for the market to correct itself, than so be it.  Time heals all wounds, and other businesses will be there to pick up the slack.People simply have to understand that you can’t have success without failure.  Simply put our federal government is trying to erase the concept of failure. And that is simply being stupid, very stupid.

And do you think this is the end? Then go and wash your face and move to another country, as your US is a sinking ship as of now. All these mistakes of the past are going to come back to haunt the US for long.

To quote a similar example from American history itself, I quote the story of  Chrysler, which was bailed out in 1979. Everyone knows what Chrysler does: they make cars. Yet the justification and impacts of the bailout are similar regardless of whether the firms produce a tangible car or intangible investment instruments.Congress bailed out Chrysler, which means the subsidized loans were paid for by taxpayers. AIG is being subsidized by the Federal Reserve, and since the Federal Reserve has the ability to “print money”, taxpayers will still pay for the bailout, but through higher inflation rates, not taxes.

And you need to know this too. This bailout of AIG is only a 2 year loan. If you have to bail someone out and pay the mortgage off, how can you expect it to pay you back in two years?. AIG will not pay back and the U.S. will own a bunch of nicely appointed offices around the world until a “buyer” comes along to buy it from the government at a discount.

Now isn’t it immoral that the bad investment decisions of Bear Sterns, Freddie Mac, Fannie Mae & AIG management had suddenly become the liability of American taxpayers?

My friends in America, the debate on whether your taxes will increase or decrease in the future has been ended. In addition to the rising cost of programs like Medicare, Medicaid, and Social Security, the recent government bailouts have just ballooned the deficit and there’s no end in sight. If this continues, there will be no choice in a decade or two of whether your taxes are raised or not. It will have to be hiked substantially to meet our debt burden. Your children will face an exorbitant tax burden to fund the mistakes made over the past decade.

According to insiders and analysts, the company will eventually be liquidated. Now no need to surprised. The bailout is just a trick to buy some time and make the process neat and tidy.

My suggestions (not many, as I am no expert)-

1. Why not bail out the American health care system instead and putting 85 billion dollars to save a firm that is bound to die anyway? Being all capitalist sounds stupid these days…
2. It seems that it is a government policy what it likes to think of as stability rather than allowing large scale companies that get into trouble to receive proper market discipline. The dramatic government bailout should prompt Congress to break up Fannie and Freddie and privatize them – and discard the model. Privatizing profits and socializing  losses is hardly a formula for increasing the blessings of prosperity.

So what more can I say to you friends, best of luck and hope there are no more bailouts. Keep praying…

So what happened on Sunday the 14th of September, 2008 that prompts me to make such a statement?

Nothing much, except that a number of major US financial institutions are on their way to die a ‘piece’ful death.

Continuing the destruction which started the last year, few more of the once-proud financial institutions have been brought to their knees as a result of billions of dollars in losses because of bad mortgage finance and real estate investments.

In what should be termed as one of the most disastrous and dramatic days in Wall Street’s history,

Merrill Lynch agreed to sell itself to Bank of America for roughly $44 billion to avert a deepening financial crisis.

Lehman Brothers, a prominent securities firm, hurtled toward liquidation after it failed to find a buyer.

AIG runs out of cash, talks to Fed and plans to sell automotive business, annuities.

A group of global banks and securities firms announced late Sunday a $70 billion loan program to help ease credit shortage.

Former Federal Reserve Chairman Alan Greenspan offered a woeful outlook of America’s economic situation on Sunday, saying the crisis with the country’s financial institutions was as dire as he had ever seen in his long career, and predicting that one or more of those institutions would likely collapse in the near future.

There’s no question that this is in the process of outstripping anything I’ve seen and it still is not resolved and still has a way to go and, indeed, it will continue to be a corrosive force until the price of homes in the United States stabilizes. That will induce a series of events around the globe which will stabilize the system.

Though the government took control of the troubled mortgage finance companies Fannie Mae and Freddie Mac only a week ago, investors have become increasingly nervous about the difficulties of major financial institutions to recover from their losses. How things play out could affect the broader economy, which has been weakening steadily as the financial crisis has deepened over the last year, with unemployment increasing as the nation’s growth rate has slowed.

Why is not possible to save Lehman now?

It was heard on the street that the bankers were told that the government would not bail out Lehman and that it was up to Wall Street to solve its problems. Lehman’s stock tumbled sharply last week as concerns about its financial condition grew and other firms started to pull back from doing business with it, threatening its viability.

Without government backing, Lehman began trying to find a buyer, focusing on Barclays, the big British bank, and Bank of America. At the same time, other Wall Street executives grew more concerned about their own precarious situation.

Bank of America eventually walked away from its talks with Lehman after the government refused to take responsibility for losses on some of Lehman’s most troubled real-estate assets, something it agreed to do when JP Morgan Chase bought Bear Stearns to save it from a bankruptcy filing in March.

For Lehman, the end essentially came Sunday morning when its last potential suitor, Barclays, walked away from a deal, saying it could not obtain a shareholder vote to approve a transaction before Monday morning, something required under London Stock Exchange listing rules, one person close to the matter said. Other people involved in the talks said the Financial Services Authority, the British securities regulator, had discouraged Barclays from pursuing a deal.

While offering to help Wall Street organize a shotgun marriage for Lehman, both the Fed chairman, Ben S. Bernanke, and Mr. Paulson had warned that they would not put taxpayer money at risk simply to prevent a Lehman collapse.

So what exactly did happen in Merrill Lynch & Bank of America Deal?

American finance, 94-year-old Merrill Lynch & Co. agreed late Sunday to sell itself to Bank of America Corp. for roughly $44 billion. The deal, which was being worked out in 48 hours of frenetic negotiating, could instantly reshape the U.S. banking landscape, making the nation’s prime behemoth even bigger. The boards of the two companies approved the deal Sunday evening, according to people familiar with the matter. Driven by Chief Executive Kenneth Lewis, Bank of America has already made dozens of acquisitions large and small, including the purchase of ailing mortgage lender Countrywide Financial Corp. earlier this year. In adding Merrill Lynch, it would control the nation’s largest force of stock brokers as well as a well-regarded investment bank. A combination would create a bank of vast reach, involved in nearly every nook and cranny of the financial system, from credit cards and auto loans to bond and stock underwriting, merger advice and wealth management.

It would also show how the credit crisis has created opportunities for financially sound buyers. At $44 billion, or roughly $29 a share, Merrill would be sold at about two-thirds of its value of one year ago, and half its all-time peak value of early 2007. Merrill shares changed hands at $17.05 each on Friday, after falling sharply in the wake of Lehman’s looming demise.

On Sunday morning, the deal of Merrill Lynch & BoA was cemented. Merrill’s “thundering herd” of 17,000 brokers will be combined with Bank of America’s smaller group of wealth advisers and called Merrill Lynch Wealth Management. For Bank of America, which this year bought Countrywide Financial, the troubled mortgage lender, the purchase of Merrill puts it at the pinnacle of American finance, making it the biggest brokerage house and consumer banking franchise.

What’s wrong with AIG?

Insurer American International Group Inc., succumbing to relentless investor pressure that drove its shares down 31% on Friday alone, is pulling together a survival plan that includes selling off some of its most valuable assets, raising more capital and going to the Federal Reserve for help, people familiar with the situation said.

The measures are aimed at staving off a downgrade by major credit-rating firms. AIG executives worried that such an action would set off a chain reaction that could be fatal to the firm. The insurer, which has already raised $20 billion in fresh capital so far this year, was seeking to raise an additional $40 billion to avoid a downgrade.

During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world.

The proposed option would have allowed the firms to acquire AIG for $8 billion under certain conditions. That price is just one-fourth of AIG’s current market value.

The assets AIG intends to sell include its domestic automotive business and its annuities unit, according to people familiar with the matter. It also looked into selling its aircraft-leasing arm, International Lease Finance Corp., but it isn’t clear whether action on ILFC will be part of the emergency steps. AIG also considered shifting assets from its regulated insurance business to its holding company, which would help the holding company respond to demands for cash or collateral.

Who is next to die?

The fate of both Morgan Stanley and Goldman Sachs will be front and center Monday morning, as the Street wakes up to a world where the independent broker-dealer are increasingly thin in number. This tumultuous year has made it clear that investment banks like Lehman and Bear Stearns face vulnerabilities that commercial banks such as J.P. Morgan and Bank of America are less prone to. The investment banks must constantly depend on short- and medium-term money markets to fund their operations. Commercial banks, meanwhile, can count on more stable consumer deposit bases. In a highly volatile market, some advantages accrue to banks that can rely on those more stable deposit bases.

So who is trying to help those who are still not ready to die like their bigger competitors?

A group of global banks and securities firms announced late Sunday a $70 billion loan program that financial companies can tap to help ease a credit shortage that threatens global financial markets.

The ten banks, which include JPMorgan Chase & Co. and Goldman Sachs Group Inc., said they were committing $7 billion each for the pool. The pool would act as a signal to the marketplace that banks, brokerages, and other financial companies can lean on the fund to take care of borrowing needs. The banks said the program will be available to participating banks which can get a cash infusion up to a maximum of one-third of the total size of the pool. The size of the loan program might increase as “other banks are permitted to join.”

All participating banks intend to use this facility beginning this week, the statement said. The banks also include Bank of America Corp., Barclays PLC, Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, Merrill Lynch & Co., Morgan Stanley and UBS.

The banks made the announcement to try to head off market disruptions after the possible failure of investment bank Lehman Brothers Holdings Inc. Lehman was expected to file for bankruptcy by Monday after succumbing to dwindling investor confidence due to losses from its real estate holdings.

What the new presidential candidates have to say on this?

Instead of trying to figure out what should be done by him to save the economy, Barack Obama took aim at Sen. John McCain’s economic message, saying his presidential rival does not have a vision for moving the economy forward.

He told -

You would be hard-pressed to explain to me what John McCain’s economic vision is about how he’s gonna get this economy back on track. That, I believe, is somebody who is out of touch with what is — should be the central question of this election.

So, can’t the government help bailout all of them?

Most economists say that bailouts are often bad economic policy because each rescue tends to encourage “moral hazard” — the tendency of institutions and investors to take even bigger risks because they assume the government will rescue them, too.

My view

To earn is human. To err is American . . . . . .  

The most expensive home. Yes. That’s the sobriquet that Reliance’s Mukesh Ambani’s new address Antilia has earned itself.

So what is the cost of such a costly project, an eye popping $ 2 billion !!!! The only remotely comparable high-rise property currently on the market is the 70 million dollar triplex penthouse at the Pierre Hotel in New York, designed to resemble a French chateau, and climbing 525 feet in the air. Ambani, chairman of Reliance Industries and ranking within the top 5 on Forbes’ list of the world’s richest people – with an estimated fortune of $43 billion can definitely afford to do it.  

The plan, drawn up by the firm Perkins+Will, reveals that the house will resemble a virtual glass palace, with entertainment centres, a health club, a swimming pool and various green spots thrown in for good measure. According to the plan, the house will rise to a height of 173.12 meters, equivalent to that of a regular 60-storeyed residential building. However, Antilia will have only 27 storeys in all, which means each floor will have a ceiling considerably higher than the current average of nearly three meters.