Life As It Goes By

The story of the US Big Three reminds me of the story of “Three Little Pigs”. The “Credit Crunch” Wolf is here to eat up the pigs. Only the pig with the best defense will survive the blow.

It’s amazing when you think about the decisions people (especially those in power) make in times of “crisis”. After acquiring Fannie Mae and Freddie Mac, the US government continue its aggressive strategy to buy up more holdings on AIG, Citicorp and now the U.S, national pride, the Big Three in the auto industry. Believe me, the list will not end here. What’s really annoying is that it’s almost painless for these lawmakers to spend our hard-earned, tax money. They knew all the while: those without power and wealth would always suffer.

Of the 3 pigs, my bet is on Ford ,which has the least of problems (at least from the surface), being the most honest and dignified, to survive this turmoil as a reward to its better defense. If Henry Ford is still around, I wondered what would be his decision like? To fight crisis himself or beg the goverment for help. I have a gut feeling that he would choose to fight till the end by himself (and his company staff, of course). But today’s crisis would be very tough. It’s not the operating expenses or poor sales that are killing the business, it’s the corporate debts. You can sell off all valuable assets and would have reduced the capital expenditure but with corporate debts such as bonds and pension funds around, there’s still little much you can do. Default the bonds and you will lose the trust from your shareholders. Losing the pension funds is like losing the loyalty of your employees.

The worst pig has to be GM. It is glut and greedy. It is so huge that by moving, it can shake the whole industry. It’s a phenomenon to be able to rank on both ends of the Fortune 500 (Top 10 in revenue and bottom 500 in income or profit) at the same time. Its problems are complicated. It’s so complex that if I were to choose for the US goverment, I would let it go. Yes, half or more of the industry would be gone and recession will advance further to depression. But we are talking about skilled labour here ya. People who can be employed in other industries, seeking for such talents. Of course, they have to accept lower wages now but who’s not. Smarter companies would by now not put all the eggs into one basket. Supplies for automobiles may mean the same for motor boats, helicopters, trains or heavy machineries. This will bring down the overall costs of supplies and develops competitive advantage. This is just the nature of business.

In my opinion, car sales will not pick up in next 2 years’ time. Car makers will fight for survival and start dumping inventories. This may trigger some sales but the cake will remain small. Only lean makers (which the Big Three are really not) will see the light at the end of the tunnel. I like elect-president Obama’s plans for new energy sources. It would be even good if he can see to that the jobless workers(as a result of GM’s fall) fill up the new vacanices he has created. I believe the group still possess the much desired skills (anyway, they have already been doing research for new engine types and for those in production, they should be able to find similar jobs in producing solar cells).

Another option might be great but it is still risky. If the government merges the 3 into 1, then things may seen less complex. However, I don’t believe in mergers. Internal fighting for power and resources will be greater and since they can run well separately, what makes you think that they will as one. Keeping 2 and letting go of one looks fine as well. It will slow the process and the impact down. Let the remaining 2 fight for their own survival. It’s jungle, not a zoo. So, they should be well-versed in all that are required.

If the US government chooses to bailout the three, then I wish the best of luck to America. There remains many icons of America such as McDonalds, Coca Cola, P&G, Du Pont, Walmart, Microsoft, Intel and so on. Why sacrifice the all for few? Just follow the song from The Beatle, “Let it Be”.

For the past few weeks, I have been juggling my time to read 3 most interesting finance books I have come across so far: When Genius Failed, Liar’s Poker and F.I.A.S.C.O. The books cover the span from 1992 to 1998 (though with some information on the late 1980s). This should give a very good understanding of how things are running on Wall St. Hence, they make a good primer on the Financial Crisis we face today. The misdeeds are still ongoing, I believe as there are no regulation or whatsoever to prevent them from happening again. No one wants to slow down the growth of the financial sector at the expense of the economy (for the common good).

“When Genius Failed” decribes the rise and fall of hedge fund Long Term Capital Management (LTCM) between 1994 and 1998. Tracing its roots back to Salomon Brothers (which also led me to the other book “Liar’s Poker), Roger Lowenstein laid the foundation of the style and culture that prevails in the hedge fund. Key concept that can be grasped is the idea of “spreads”. Using quantitative analysis, the group bet on the volatility of almost every type of securities available. This was very much aided by 2 Nobel Laureates based on their work on option pricing (using the Black-Scholes model). The chapter on Fed is particularly interesting. The bosses of the involved investment banks met up with the Fed to discuss ways to prevent the fall of LTCM to become a financial turmoil. These guys fought like children and displayed a very true side of Wall Street. It’s “dog eat dog” world. It’s a jungle out there, not full of monkeys really. The part on other investment banks holding onto their positions for LTCM’s losing bets also substantiates this point. Roger writes the story in such a flowing and easy-to-understand manner that you won’t find difficulty catching up. His research on the topic deserves credit. I didn’t hesitate to buy another book of his on Warren Buffett after reading halfway. I just get too used to his style after some time.

“Liar’s Poker” is the second book I read. I felt curious about Salomon Brothers and are more eager to find out more when I learnt that they created the first mortgage backed security (you can see the link now…). So, I bought the book and started reading the moment I put down the first book. No regrets. Michael Lewis was writing his own story as a salesman in Salomon brothers in the 1980s. The book was published in 1989 but it still a jewel. 2 key financial concepts can be learnt from his book: mortgage bonds and junk bonds (which led me to Drexel Burnham Lambert and hence books such as Predator’s Ball and Den of Thieves etc). Inner workings of the company were clearly described but in a more lively manner with on-and-off breaks of sarcasm. An Art graduate, Mike, has no problem of keeping his story clear and smooth throughout (comparable to Roger who is a journalist). One big getaway I have from this book is that the awareness of junk bonds or debts issued by corporations which are viewd to be less credible. The use of junk bonds was later upgraded to finance takeovers. This has an impact on the whole merger and acquisition industry. Private equity firms start springing up and bascially, any company can be a target for takeover. This means we, as the commoner, are affected…

“F.I.A.S.C.O” is the last book of the three. Similar to Mike, Frank Partnoy worked as a salesman in Morgan Stanley except that Frank is a law graduate. Frank tells a different story on derivatives. I am beginning to be convinced by the fact that today’s crisis is as much created by Mortgage Backed Security (MBS) as derivatives. You can learn about key technical details of derivatives on convexity, duration and spread (I need to check… Oops!) and how they are used practically. The house of Morgan has obviously changed its owners. You would not believe the stories told here and there is no reason why you should think that no more of such thing is still happening. There is simply, no regulation that prevent such acts from continuing and evolving. The book is dated back to the 1990s, about the same time as “When Genius Failed” (imagine there are actually many misdeeds happening at the same time). Today, the techniques and execution should have passed through the test of time. One funny thought crossed my mind:has this evolution grown to a stage that everyone in the firm is willing to give up the firm for his or her own profits? All I know, last year, everyone in the industry got a big, fat bonus, many times greater than the high paycheck he or she has.

I have attended Finance and a free elective, Security Analysis of my master course. To pursue further, I signed up for the CFA and took up the prep course. I am always overwhelmed by the amount of materials that I have to know by hard. I even think that this is really not my cup of tea. But after reading all these and realizing that getting a CFA is to serve this bunch of xxx. I lost all my motivation. Some money is not to be made. It’s ok to be considered dumb.

I wrote about the financial crisis a year ago on this website (it’s still posted except it’s without the actual date). At that time, everything still looked calm and hopeful (comparatively). However, the write-downs made by the banks are simply unbelievable. I should have sensed something terribly wrong had happened.

Well, it’s been a while since then. And many events have occurred. Companies with about 100 years of existence are no longer there (Bear Stearns and Lehman Brothers). More bankruptcies are expected to come (in 2009, I guess). The financial crisis is about to turn into an economic crisis (if not, already). There is actually a difference between the two though I am sorry that I can’t provide you with any figures. There can be an economic crisis without having a financial crisis. The only disturbing thing is that the probability of having an economic crisis out of a financial one is higher. This shows that growth of financial sector in the whole economy of developed industries is high. People care less on making products that they are proud of now. Instead, they care more about using the profits earned to re-invest for higher gains. This truly sounds like a sweeping statement but there are surely some undeniable facts in it.

Derivatives has definitely become the subject of this financial turmoil, with the subprime mortgage being its cover. A lot can be uncovered if you have read books like Liar’s Poker and F.I.A.S.C.O (I am proud that I have so in recent weeks). The U.S is so advanced in these financial tools that I believe the whole world has such a huge gap to fill up before they make sense of what is really going on. It’s like the U.S economy was the global economy. However, now they are paying the price of going too far over their heads. They will recover eventually for the dynamism, never-give-up and innovative culture they possess. For the moment, they would just have to put their heads down and admit their mistakes. Trust lost in their leadership has to be re-earned, and the same for the money (except that they are all in credit now, no use counting money, M1 and M2… They won’t be printing all those while promising you that environmental concern is a top priority).

So what’s going to happen next? As in every storm and tsunami, there will be times when the worst has passed. By then, it will be the time for licking the bruises and waiting for the wounds to be healed. Long or short is not for me to guess, it’s the speculators’ job (but they don’t really have to pay the price for guessing it wrong. On the contrary, they are paid big bucks for creating such a scene).

That’s all for today now. I leave you with a list of failed bank recorded by FDIC.

http://www.fdic.gov/bank/individual/failed/banklist.html