Stock Market Rally: First Stage Of A Primary Bull Trend?

“Sell in May and go away” may not be relevant this year. For a month commonly associated with disinterested stock market activity, we have seen a 36% jump in the benchmark S&P 500 from March’s 12-year low.

Economic reports turn out better than expected, swine flu has been downgraded to a harmless entity, and US banks have passed the stress test. No wonder, investors are seeing green shoots everywhere, even among a pile of stinking, toxic shit.

Speaking of the stress test, there are much debates on the methodologies, “adverse” assumptions or suitability of a 25-to-l leverage ratio for tier-1 capital, but it is undeniable that uncertainty has been eliminated substantially.

Since the test procedures are out in public, investors can extrapolate their own worst case scenarios based on current recommendations and findings. Unless the Treasury Department has prepetrated a fraud out of this stress test, it is the most authoritative guide to date.

Judging by the resilience in the stock market rally, the Obama administration has skilfully orchestrated leaks and pre-release discussions with banks to test market reaction. Come to think of it, there is no way the US government will let the banks fail, not when they have unwittingly become a major, if not the biggest, shareholder vested in the banks’ profitability. The auto industry will have given an arm to be in this position but apparently, life is full of inequality.

In the short term, technical indicators, measures of confidence, and volatility all suggest that the stock market rally could persist. We are now either in the last stage of the bear reign or the first wave of a primary bull market.

A representative measure of a stock market rally is the S&P 500 lying less than 50 points away from the 200-day moving average. If the S&P 500 closes above this closely watched metric (something not seen since December 2007), the trend reversal from bearish to bullish cannot be ignored.

The VIX index also slid to its lowest level since the collapse in September 2008 of the US investment bank Lehman Brothers. With market volatility abating, investors have grown accustomed to the effects of a tight credit market and are betting that the worst of the recession is over. They believe that a renewed stock market rally is taking root.

There is also lots of money, in the region of trillions of dollars in household cash, sitting on the sidelines. What began as a massive and impulsive short covering off a historically oversold bottom will now attract all these idle cash. Having missed out on the lucrative actions, value investors are keen to play catch-up in the stock market. As such, we can expect equities to move up another 15-20 percent from their current positions.

Strong technical indicators have formed not only in global stock markets but also for depressed commodities like oil, base metals and agricultural products. Nevertheless, after such a heady run in the stock market, a major correction is imminent. That will be healthy for consolidation purposes. Over the next 2-3 months, we should expect a range bound trading where the bulls and bears slug it out.

Optimists will use this period to buy the dips to accumulate positions providing strong support. On the other hand, any uptrend will face strong technical resistance as bears reposition for an anticipated decline by selling rallies. Longs which have their money trapped for a long time will also sell into these rallies.

I believe the overall effect will be the stock market hovering between the 50 and 200 EMA’s for several months. If the primary bull trend is to develop, the crossover has to happen convincingly. Meanwhile, economic reports must continue to show gradual improvement.

Since inflation is bound to return with a vengeance, we must prepare to move a portion of our money back into assets which provide strong capital gains and income. I don’t encourage any speculation in penny stocks as there are many companies with dubious balance sheets, still flirting with bankruptcy. They will continue with their scams under this illusion of wealth and prosperity.

To be sure, real economic progress must depend on increased productivity through technological innovation, not manipulation of stock market by hedge funds or financial engineering. Thus, all the money created out of thin air by the Federal reserve must be channelled properly to product tangible benefits, else we will face another super bubble in another few years time.

And not to forget, the most pivotal moments in the swine flu saga are yet to come. Will it roar back in the regular influenza season and affect the rest of the world. The fear is that it could evolve into a more lethal strain and bring all economic activity to a standstill.

Like the swine flu, the financial crisis may have another, and hopefully, the last outburst before exhausting itself. This will be violent, so stay focused on the technical and fundamental indicators if you decide to accumulate positions in the stock market aggressively.

If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!

6 Comments

Filed under Economy, Stocks

Bolster Your Emergency Fund In A Prolonged Crisis

I hope everyone has an enjoyable May Day. For those who work day in, day out, this is usually a well deserved break. But of late, nobody seems to be keen on taking leave, given the rise in no pay leave, shorter work hours (no overtime), pay cuts, and retrenchments.

In some countries, protests and demonstrations have broken out over job losses and poverty. In this moment of stress and uncertainty, the mood is sombre for governments around the world. How do they stem the burgeoning unemployment figures to ensure political stability?

To be sure, many bold steps have already been undertaken to boost their local economies with stimulus packages, cutting of interest rates and loan guarantees but nobody knows how effective these measures will be or how quickly they will work.

For Singapore, the MTI has downgraded growth forecast to between minus 6% and minus 9%. Singaporeans have to prepare for a prolonged crisis. And the swine flu (Hong Kong was infected recently and it is only a matter of time before Singapore is hit) certainly doesn’t make things better.

If the swine flu is not contained effectively, businesses are expected to suffer drastically (followed by more layoffs) if people avoid travelling or going to shopping malls and restaurants. The 1918 flu epidemic killed millions around the globe and while the current swine flu has not morphed into such a virulent strain, there are striking similarities for a severe pandemic.

To prepare for the worst, we should picture an unemployed scenario and get serious about bulking up our emergency fund to meet at least six to eight months of expenses. Now I know that saving up six months of expenses is no laughing matter, especially if you are a credit card junkie and have formed an onerous habit of living from paycheck to paycheck.
 
However, remember that there could be more months of job losses ahead before the economy emerge from its languidity. Hence, finding your next job could involve endless interviews and many weeks of waiting. Meanwhile, you need cash to put food on the table, pay off your mortgages, auto and credit card loans, insurance and kids’ education. Without cash flow, your assets could be stripped off for pennies on the dollar.

Just for sheer visual impact, look at the number of job applicants in China. They will be willing to do our jobs for less pay and work longer hours.

recession pics

To those who have always led an extravagant lifestyle, with no notion of an emergency fund and most certainly, laden with credit card debts, they are faced with tough choices. Do they pay off outstanding balances on their credit cards and avoid exorbitant interest charges or build up their emergency fund?

I believe any spare cash should be channeled into an emergency fund and credit card debts is the lesser of two evils. There is no point in paying off all your credit card debts if you jeopardise your cash flow and cannot meet your monthly mortgage payment. That could spell huge financial losses as banks force you to sell your house in a distressed market.

Credit card companies have no qualms about lowering your credit limit, revoking your card or raising interest rates, regardless of your impeccable record of timely payments. You have to appreciate the fact that you may not be in dire straits financially but they are. Thus, paying the minimum sum while bolstering your cash flow (read lifeline) will only strengthen your bargaining position.

Once you have accumulated your emergency fund, you should tackle credit card debts firing on full cylinders. Whittle down the highest-interest rate card first while continuing with minimum payments on the others. That way, you save on excessive interest payments.

It is also prudent to avoid maxing out your credit cards. I always maintain a safe buffer to prevent my credit cards from approaching their credit limits. That will result in higher interest payments as our risk profiles are inevitably higher. We can also try to bargain for lower interest rate by making a simple phone call to the credit card companies.

Take the first step in bolstering your emergency fund today. You will sleep better at night, even without a job, knowing that your assets are safe and creditors will not be knocking on your door.

More on this topic (What's this?)
How to Start an Emergency Fund
How to build an emergency fund
Read more on Emergency Fund at Wikinvest

1 Comment

Filed under Business, Economy, credit cards, saving money

Go Green and See More Greenbacks

It is now literally and figuratively true – the color of money is indeed green in every sense of the word.

People all over the world are waking up to the fact that now is the time to do all we can to save the environment, that it’s cool to be going green today, and that we can gain a lot personally (financially and emotionally) by initiating eco-friendly measures.

Some aspects of being environmentally conscious are quite expensive, like buying organic food and building green homes. But there are others that are both cost-effective and cost-saving, like:

• Cutting back on electricity usage: It’s pretty easy to cut back on electricity – all you need to do is set your thermostat a couple of degrees lower or higher, use compact florescent lamps, and switch off appliances when they’re not in use. You could also invest in buying Energy Star rated gadgets and appliances that save you power in the long run. Use solar power as much as you can.

• Recycling, repairing and reusing: You can make a little bit of money by recycling paper, aluminum cans and bottles and save on expenses by repairing and reusing your old stuff. Buying new products leaves a large carbon footprint because of all the energy expended in making the product, transporting it, and using it. When you’re not inclined to buy new gadgets at the drop of a hat, you’re more likely to take better care of what you do own and prolong its life in the process.

• Walking instead of driving: This is great in terms of both your health and your bank balance. When you ride a bike or walk to work, you’re saving on gas, reducing the amount of fossil fuels being burned, and getting a much-needed workout. If you live far away from your place of work, you could carpool and still save yourself some money because you’re going to share the cost of gas.

• Go online: Reduce your expenses on paper by not printing documents unless they’re really necessary. Subscribe to online journals, magazines and newspapers and cut back on your monthly expenses and save more trees in the process.

And consider working from home (if that’s an option) so you can save commuting costs, the cost of clothes (you’ll need nice clothes to go in to work everyday but not to sit around at home), and the cost of medical treatment (when you fall sick because of all the pollution out there).

This post was contributed by Claire Webber, who writes about the distance learning colleges. She welcomes your feedback at Claire.Webber1223 at gmail.com

3 Comments

Filed under environment, saving money

Bear Rally Refuses To Die But Don’t Get Carried Away

In case it is not glaringly obvious to you, the bear rally is still alive. Fundamentals have taken a back seat as investors continue to buy into the recovery story.

The rationale goes like this – the stock market is a barometer for the future and investors buy stocks based on future earnings power. If there are indications the economy is about to turn the corner, it is wise to invest heavily six to nine months in advance.

For those sitting on the sidelines, the temptation is overpowering. On one hand, they have significant funds to deploy and are itching to get their hands on long-awaited profits (or at least to cover losses from 2008) but at the same time, grossly worried that the uptrend is about to reverse in a drastic manner.

Actually, throwing money back into the stock market and engaging in some momentum trading is fine provided there is an exit strategy. You have to check your greed, sell into the rally and apply stop-loss orders.

Bank of America reported first quarter results that eclipsed its achievements in the whole of 2008. Its champange performance was promptly offset by news that it was adding $6.4 billion to reserves for bad loans.

In view of the larger provision, investors should exercise greater caution going forward. Nevertheless, the bear rally refuses to die. For that, we have to salute Wall Street for engineering such a robust stock rally. Do not forget though, that in the same manner this logic-defying rally is created, the liquidity can exit in a flash if the big boys pull the stop.

Over the past weeks, financials have led the charge on Dow Jones and S&P 500 but in all honesty, toxic asets are still lurking in the dark corners and we have yet to experience the worst of bank losses. Right now, the bank sector is propped by some loose interpretation of accounting rules, government intervention, undisclosed banks stress test results, a possible return of uptick rule and calling back of shorts in brokerage accounts.

Toxic assets are set to get even more skunky if housing prices nosedive and more foreclosures ensue. There is little chance of the banks getting their house in order (excuse the pun) without stabilising the housing market. Whether you like it or not, home prices and mortgages are closely interwoven with the fate of financial institutions and US economy.

And to dampen the bear rally further, we have the “authoritative” bank analyst Meredith Whitney offering a discomfiting forecast of home prices falling another 30%. That will surely spell crippling losses ahead for US banks and mortgage lenders. I will not be surprised if the battleground is littered with more carcasses of large to mid-sized US banks before we see the light of day.

Meredith Whitney opined that “home prices cannot bottom while liquidity is still contracting from the economy.” She predicts that peak-to-trough home price declines will average 50% nationally before the US housing crisis ends.

Whitney also believes that banks have not properly reserved against greater than expected losses in home prices. Her earnings forecasts for 2009 and 2010 are almost across the board lower than consensus. So, we can infer safely that the loss provision on BofA books is mild and its first quarter profits is an aberration.

To be sure, subprime crisis is going to pale in comparison to the next avalanche of losses from “good” loans which constitutes a much bigger percentage of banks’ loan portfolios. Banks will be forced to set aside more cash and subsequently cut into earnings. Already, prime mortgages delinquent over 60 days more than doubled in 4Q2008 to 2.4%, when compared to the first quarter 2008.

Commercial real estate losses are also a big concern, to the tune of an estimated $250 billion. General Growth, the second-largest mall owner in America, is a high profile casualty (in fact, the biggest real-estate failure in U.S. history) but it won’t be the last. Credit card losses are also mounting and could hit new highs in 2009. Capital One Financial just reported a loss of $112 million in the first quarter from defaults on credit card loans. Nobody can say for certain the impact of a full blown credit crisis on the viability of banks.

There is a strong likelihood of many highly leveraged financial instruments going awry in the coming months. The key priority for banks now should be to build up their loss reserves, since they stand at the apex of losses when their borrowers lose credit worthiness and default. If the banks cannot remain as a going concern, they have to go into liquidation. There is no two ways about it.

I mean, any normal business will be forced to do that by their creditors. Banks have shown no compunction in inflicting pain on business owners but they have been applying a double standard to their own state of affairs.

Banks are currently under no pressure to sell off their good or toxic assets to raise capital because they have a sugar daddy in the US Treasury standing steadfastly behind them which will bend the rules, recapitalize them covertly, underwrite all of their losses and pass them on to taxpayers.

Flushing out the toxic assets in banks takes time (especially when the definition of “orderly manner” has not been articulated) and reflating a bubble to achieve this objective is extremely dangerous. For the time being, I will stay clear from this mess as some astute economists have chosen to call such a situation “getting worse more slowly.”

1 Comment

Filed under Banking, Economy, Stocks

Credit Card Debts – Triggering off another credit crunch?

This is a guest post from Debtconsolidationcare.com, Internet’s first get out debt community.

Credit card debts are an increasing cause of concern and many are of the opinion that after subprime lending, credit card defaults is the second largest cause of the already existing economic slump. Defaults related to use of plastic money is adding fuel to fire. The number of credit card defaults is at an all time high and statistics suggest that this year the figure is likely to escalate in a remarkable manner.

Debts originating from US may be astronomical warns IMF

Debts could attain a figure of USD$4 trillion, the International Monetary Fund warned. It is also being anticipated that bad debts originating from the United States may reach USD$3.6 billion by mid 2010.

In fact statistical data suggests that in Q4 of 2008, household debt in United States was USD$13.8 trillion. The figure was released by the Federal Reserve. There is an increase by 8% from USD$12.8 trillion during Q4 of 2006. Studies reveal that a household has on an average debts worth USD$112,043 that include credit card debt, mortgages as well as other debts combined together.

Financial experts are of the opinion that the credit card industry is heading towards a situation similar to subprime mortgage crisis. It is being anticipated that unpaid debts will reach the USD$95 billion mark in 2009. Major credit card companies have announced write off volumes.

And one such credit card giant lost its credit rating soon after it declared debts that were not collected reached 8.7% in February 2009. Another credit card issuer reported that its default rate touched 9.3% in February this year. The figure was 7% in the month of January 2009. An escalation of 2.3% occurred in just one month.

Credit card issuers have changed payment policies to minimize risk

Credit cardholders have complained that many credit card companies have changed their payment policies and most of the credit cardholders were unaware. Owing to the credit crunch, lenders have become more apprehensive and have started exercising increased caution as far as lending is concerned.

The credit card issuers are taking all possible measures to reduce risks associated with lending. Credit card companies think credit cardholders will fail to make payments. And for similar reasons they are increasing the rate of interest, reducing the credit limits and making adjustments in their reward program etc.

The credit card issuers are not required to notify the consumers. As a result the consumers continue using the credit cards assuming that the terms and conditions are the same. It only adds up to their existing outstanding balance and consumers have to shell out late fees and extra charges.

When a credit cardholder accepts credit cards, there are a couple of cardholders who fail to realize what they are actually accepting as terms and conditions of credit card usage. So, before the credit cards take control of your life and finances, use them sensibly so that you don’t fall into a vicious debt cycle.

Leave a Comment

Filed under credit cards

Bullish Days Ahead But Bear Is Lying In Wait For The Kill

We are into the fifth week of upswing in the stock market. While stock valuations remain attractive for value investors, the market is overbought and a major correction is overdue.

That is not to say that this bear rally is all fluff. “Green shoots” are sprouting and there are positive long term implications for the general economy. From Ben Bernanke’s purchase of Treasuries and toxic mortgage based securities to the recently concluded G20 summit, where a $1.1 trillion stimulus for the International Monetary Fund (IMF) and other international institutions was announced, a bullish vibe has developed.

US retailers are also wearing a smile with improved sales, in a sign that shoppers may be regaining confidence to open their wallets after more than a year of recession. Of those which reported March sales, more than half topped Wall Street estimates, and a handful even raised their quarterly earnings outlook.

New jobless claims also fell more than expected by three percent last week. Nevertheless, the figure which is still above 650,000 and remains at a 26-year high is not pretty and is not enough to fuel the rally by itself.

What gave the rally extra legs was the announcement by Wells Fargo that it expected a “record” net income of 3 billion dollars for the first quarter. Following earlier reports by Bank of America, Citigroup, JP Morgan and Goldman Sachs that January and February were profitable months, investors were already upbeat on the financial sector’s earning reports.

Still, Wells Fargo took the cake by topping market expectations with a 50% surge in earnings as compared to a year ago. The main contributor was its newly acquired bank, Wachovia while the easing of mark-to-market regulations also played a part in lowering provisions for bad loans. The new rules allow banks to value their assets, instead of marking them at the price they will get in an open market currently.

There is a strong case that mark-to-market accounting undervalues assets and unreasonably hurts the balance sheets of financial institutions, especially when the market is frozen. Billions of dollars in assets have been written down and resulted in the credit crunch and worsening recession.

The banks have been lobbying left, right and center with a seductive argument that lending is curtailed because they cannot meet regulatory capital requirements. But they will have enough capital if they ignore the market and value assets at what they think they’re really worth. Congress swooned at their theory and have been pressuring the FASB to change or be changed.

FASB caved in, and financial institutions are now free to apply the new rules to their financial statements for the quarter that ended on March 31st. Knowing that Mr Market can be susceptible to mood swings and manipulations, having the “discerning” bankers exercise judgment in valuing their assets can reduce the irrationality. However, I am concerned that a practical idea can be taken to extreme in the hands of greedy and irresponsible people.

The banks could hide reality from investors under the pretext of distressed market and take matters into their own hands. Investors are no closer to knowing how much an asset is really worth. The banks can justify themselves with complex models by employing the best mathematicians and using the most advanced super-computers but we know how ineffective modelling can be when assumptions are flawed and the unexpected happen.

Will the banks assessing their own assets make them less toxic? Are the new valuation of assets based on what the banks could get selling it today or at a later time when the market comes up? Now, long run can be a misleading guide to current affairs by glossing over short term problems. Everything will even out in the long term, as any statistician will attest and the best thing is it doesn’t matter because “in the long run, we are all dead.”

There will certainly be more Enrons in the making which can only be countered by the implementation of effective disclosures. If the banks are not accountable and transparent, investors are taking huge risks by placing their faith in the balance sheets.

So far, no one can declare confidently that bear rally is over. It has the potential to last another couple of weeks and create higher lows before it hands back its gains. To be sure, bear market rallies that propel stocks 40% higher from their lows are a common occurrence.

But investors should note that fundamentals will not be rosy in the short term. In the case of Japan, exports are down 49% from a year back. Exports to the US, Japan’s largest trading partner, collapsed by 58.4% which is especially tough for small businesses. Industrial production was down 9.4% in February and the economy contracted 12.1% in the first three months of the year. Amid the gloom, companies are forced to cut jobs and salaries.

Japan is not alone and other export economies, including Singapore, are dealing with declining order books and massive job losses. The United States is the main source of demand for the world economy. Until American consumers are in a mood to buy goods or services, global trade and stock markets are not expected to boom.

Nevertheless, it is encouraging to note that Japan has unleashed another fiscal stimulus of 10 trillion yen to fight the economy’s deflation. This amounts to 4% of the GDP of the country being spent on stimulus. This is a further addition to the 12 trillion yen in spending planned under a previously announced stimulus package.

There is also a ton of bricks hanging precariously above our heads if the International Monetary Fund’s forecast (which will be announced on April 21) that toxic debts incurred by banks and insurance companies have could soar to $4 trillion materialize.

This assessment will be hugely anticipated because of the sheer size and is nearly double the worst estimate we’ve heard so far. It is an indication of how deep the global economy is mired in debt. The latest figure will include $900 billion for toxic assets that originated in Europe and Asia.

The Federal Reserve has also put the muzzle on banks on the ‘stress test’ results which are to be revealed after the first-quarter earnings season. In normal circumstances, investors should take the stress tests in their stride and should not cause disruption to the stocks… unless there are worms in the can or more bailouts in the pipeline.

There are still much uncertainties around. The bottom of a bear market is usually marked by extreme hardships in the streets. And in the event of a sustained bull run, investors must experience a period of relative calm for accumulation, where confidence can gradually be restored and convictions allowed to steadily build.

That has yet to occur. Meanwhile, enjoy the continuing rally which will be good while it last. Just don’t get stuck with delusional optimism and invest with abandon.

Blurb….
Some people are not yet used to the idea of using an internet bank for their financial accounts but if you’re one of these people you should reconsider. Internet banks usually offer better CD rates than your bank around the corner because their expenses are very low. If you don’t have an internet bank account your should consider getting one.

3 Comments

Filed under Banking, Economy, Stocks

Financial Regulation Only As Good As The Enforcer

Andrew Jackson illustrated his disdain towards international bankers in 1832 with this eloquent excerpt:

“Gentlemen, I have had men watching you for a long time, and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the eternal God, I will rout you out.”

Not surprisingly, Andrew Jackson was never the most popular guy in town. Since nothing much has changed since that outburst nearly two centuries ago, I don’t think Obama should attempt to be forceful in dealing with our modern bankers. The stakes are too high to have the general economy slide into Great Depression because of a “den of vipers and thieves”.

However, Obama has slain one sacred cow while placing the other on a pedestal. Rick Wagoner of General Motors was asked to step aside and Obama is inclinded towards structured bankruptcy. Thumbs up to Obama for being decisive but it shows up the contrast in his preferential treatment of financial institutions so far.

We are told they have attained “too big to fail” status (that should be the mantra for future coporations if they want to survive). For General Motors, a bankruptcy may resolve conflicting claims and burdensome contracts while shifting control away from incumbent management. But in a financial bankruptcy, the dense web of derivatives spread the toxic far beyond US shores, affecting investors, pension funds, government entities, etc. in Europe and Asia, as we saw in the case of Lehman Brothers.

Put in a clearer manner, it means US taxpayers can only wring their hands and pick up the tab. They can vent their frustrations but the bankers are not going to sacrifice their huge bonuses (there will be ways to get around the political pressure and legislation). It is a mentality of entitlement for those running the show, and if they happen to run the finanical institutions or economy into the ground, that is too bad but their time and effort must be compensated.

That is the way things supposedly work in our current model of a free market. Rewards are privatised but the risks are socialised. People are encouraged to behave like gamblers and only a fool will save money in the bank. A saver doesn’t share in the spoils but they certainly share in the cost of fixing the mess left by speculators.

How we tweak the free market to accomodate capitalism and responsibility is anothet topic altogether. My main concern is to avoid another financial crisis, and to do that, it is high time we get serious about financial regulation.

The ways things are developing, (look at the chart below, the monetary base has expanded nearly twice in this crisis alone), there will come a point when investors have had enough of paper backed by the US government, which is already trillions of dollars in debts. The US dollar’s status as a reserve currency is under siege, who knows, the Federal Reserve may not be able to contain the next financial crisis and may require a bailout of its own.

monetary base

Before the gold standard was abolished, the United States had modest debt and Americans were frugal and productive. Borrowings were used wisely to create tangible and useful products which translated into wealth. However, with unlimited fiat currency, it became much easier to use debt as a way of life. The wildly expansionary government policy encouraged ever-more complex ways to invent credit out of thin air.

Wall Street catered to this new appetite for debt and risk and inflated a series of financial bubbles which attracted a great deal of capital. Prices of assets soar and the most aggressive investors got rich beyond imagination. Unfortunately, such bubbles have been occuring with alarming frequency. In the 1980s, it was junk bonds. In the 1990s, it was tech stocks and this decade is about housing. Each bubble was bigger than the last (we progressed from billion to trillion dollars bailout, what is next?).

The current G20 summit has lots of noise, ranging from protectionism, reserve currency to regulation. Gordon Brown calls for strengthening of financial regulation while Nicolas Sakorzy threatened to boycott the event if no concrete actions materialize. Timothy Geithner, in anticipation of the belligerent reception America will be receiving, set the tone for a “meaningful” US participation last Thursday with some commendable proposals to tighten up the financial regulatory system.

Derivatives will be “standardised” while hedge funds and private-equity firms will be subjected to greater scrutiny by registering and providing confidential information to the federal government. A super-regulator will also be created to ensure against any systemic risk that menaces the financial system. This will likely to result in higher capital standards for large banks and nonbank financial institutions.

The Treasury Department also requested for resolution authority to seize and dismantle large financial institutions such as investment banks or bank holding companies, much like the Federal Deposit Insurance Corp.

All very promising indeed, but trust in the financial sector has plummeted to an all-time low and will not recover based on empty declarations. Though all these measures are formative steps in the right direction, the devil is in the details. Will the rules be crafted to appease Main Street but allow the grand larceny of Wall Street to continue? Even if Obama administration manage to make the rules watertight, will the regulators enforce them?

Fact is, the quality of the rules is only as good as the person who enforce them. Once the market goes on a bull run, it is like a locomotive travelling at top speed, whoever stands in the way gets flattened. It is hard to imagine a super-regulator having enough gumption to gatecrash the party and risk incurring the wrath of Wall Street.

A case in point is Bernard Madoff’s $50 billion Ponzi scheme. The SEC has reliable and comprehensive evidence virtually handed over on a platter. Its regulatory framework is well-established, given its birth out of the crucible of the 1929 Great Depression and subsequently refined over the years. Why was such an astronomical financial impropritey not fully investigated?

Paul Moore, former head of regulatory risk at HBOS, raised alarm bells on the lax risk management in his bank. Had the Financial Services Authority (FSA) pursued the matter, British taxpayers could be spared billions of pounds in bailout money. Well, no action was taken and Moore’s reward was an unceremonious dismissal. In fact, he is not alone, many analysts, managers, directors, auditors experience the same fate for being whistle blowers.

While regulators cannot force CEOs of financial institutions to rein in their reckless strategy (it is a free market after all, and people have the right to make their own decisions), the FSA and the SEC could have warned about the dangers. Shareholders, creditors, and depositors will then make their own decisions if they prefer to visit casinos themselves or let the banks gamble with their money.

Another conflict of interest comes from the need to recruit the best talents who have an intimate knowledge of the industry. This usually means regulatory agencies are staffed by former high-ranking employees of Wall Street. While industry ties (revolving door policy) are unavoidable, having CEOs or directors of investment banks wearing regulatory hats means there is nobody in the position to see, not to mention, stop the impending train wreck.

Sir James Crosby, as CEO of HBOS, was also on the board of the FSA which resulted in the head of a financial institution overseeing the regulator. Crosby can either stifle his bank or bend the rules backwards to facilitate the orgy. From the financial mess that was to become of HBOS, it is clear which choice Crosby made. How did such a conflict of interest goes unnoticed for so long?

In order to reduce risk of regulatory negligence or deliberate cover-ups, taxpayers who have an especially big stake in any bailout, have a right to expect regulatory bodies to be fully transparent with their tip-offs and outcome of investigations.

The public also needs information on industry connections of top management (both present and future), in order to ensure rigorous regulation will not be compromised. This clear policy on conflict of interest should be well publicized so that taxpayers can assess if the regulators have their best interest at heart.

Although now is not the time to talk about performance pay or bonuses, regulators should enjoy huge incentives, much like the fat cats on Wall Street. Else, they will not be motivated to take on financial institutions which can employ the best lawyers. Without regulators exercising the new powers that Congress will soon endow them with, we are back to square one.

This financial crisis has shown that light-touch principles-based regulation with an emphasis on banks’ internal risk controls cannot work. Even Alan Greenspan, the most prominent proponent of the free market where profit-maximising self-interest limit risk-taking, has also expressed regret that a mistake was made.

The momentum is there for some serious financial regulation and America must show its leadership and resolve, without which we should just brace ourselves for another devastating bubble.

Leave a Comment

Filed under Banking, Economy

HyperInflation Coming But Financial Crisis Not Over Yet

Ben Bernanke is indeed a man of his words. He not only stepped into a helicopter to drop money, he virtually flew a B-52 bomber and carpet bombed the skittish financial system with a trillion dollar payload.

The Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

In a single day, this “shock and awe” maneuver ramped up Treasury prices while driving down corresponding yields. The US dollar tumbled while gold spiked to $958, an impressive run considering its last traded price of $882 on Wednesday. Crude oil also rallied above $50 per barrel. Bonds and equities market also enjoyed a brisk rally.

However, I remain tentative of any sustainable momentum to turn around the major downtrend in stock markets. US economic conditions are not encouraging with the leading indicator index falling 0.4% and the number of Americans collecting unemployment benefits surging to a record. The US recession is deepening and when the US is in the doldrums, the rest of the world suffers.

IMF confirmed this view on Thursday with a grim warning: “The world economy is set to contract for the first time in 60 years, as the deepening financial crisis would lead to the global GDP shrinking by up to 1 per cent in 2009.” 

On the bright side, there is cause for celebration if our greatest enemy happens to be deflation. The US CPI data indicates that inflation is on the rise and trade gap has narrowed sharply. Spectre of deflation has faded with the rise in prices and considering all the money being minted at epic proportions, inflation will surely catch up with us in a massive way by 2010 or 2011. The dire impact on currencies makes gold a superior investment but I will not discuss gold any further today.

Meanwhile, the financial sector could be in for more punishment from short sellers. Moody’s is set to cut ratings on $241 billion jumbo mortgage debt. These are not subprime loans (our dear friend which wrecked havoc on global financial institutions and claimed the scalps of Countrywide and Bear Stearns) but prime-quality U.S. residential mortgages which are above $417,000 and only available to good-credit applicants.

The fact that they are also on the verge of defaulting shows that unemployment is a malaise that takes no prisoners. A credit-worthy person without a job (and hence income) cannot afford his monthly housing payments, goes into default for several months and subsequently foreclosure beckons. The financial sector has to brace for more write-downs with all these delinquent loans and profits seem to be a distant dream.

By the way, overpriced residential property in dubious hands is no longer the only disaster for banks. The US commercial property is very much of a black hole. With $4 trillion of debts involved (nearly half in America), the cost of saving irresponsible banks may be grossly underestimated if this sector goes into a tailspin.

Then, there is a credit cards time-bomb which any day now, could blow up in a nasty manner. US credit cards default rose to a 20 year high with losses particularly severe at American Express Co and Citigroup. Credit card charge offs could reach 10 percent this year (from 6-7% in 2008) and racked up losses of $75 billion.

Credit card lenders are trying to cushion losses by tightening credit limits, slashing rewards, raising interest rates and increasing fees to cushion further losses. American Express has even resorted to paying $300 to close accounts. Whether such measures are effective in averting this crisis is unclear but credit card companies only have themselves to blame for gouging subprime borrowers with attractive offers.

As a sideshow, a bill to impose steep taxes on employee bonuses at AIG and other TARP recipients has been passed quickly in Congress. 90% tax will be levied on bonuses paid to employees of companies that received at least $5 billion in federal bailout funds.

While the fury over bonuses is appropriate, the real issue is the money which AIG has paid out to counter-parties. Eliot Spitzer, former New York Attorney General who was disgraced in a high class prostitution scandal, says the AIG bonus issue is “penny ante” compared to the billions of the insurer’s bailout money funneled to bad banks.

Spitzer’s initial probes came from AIG’s effort from the very top to gin up returns whenever, wherever possible and to push the boundaries in a way that would garner returns almost regardless of risk. He described it succinctly that AIG is the center of the web. 

Many people are incredulous that AIG can take money from taxpayers on one hand to shore up balance sheet while rewarding their cronies with $165 million dollars on the other hand after reporting a $61 billion loss in a single quarter. I don’t blame Ben Bernanke (who has to act as a sugar daddy) for blasting the reckless behavior of AIG. 

AIG is a revered insurance company which we naturally assumed to be conservative but they betrayed our trust by behaving like a hedge fund and putting millions of insurance policy holders at risk. The “leaked” 22 page dossier by AIG to the Senate is breathtaking in its audacity. A company, granted it is big, holding the United States of America to ransom. With financial institutions like these, the United States doesn’t need enemies, or terrorists to be exact.

The Sept 11 terrorism took down the New York twin towers, causing global stock markets to be battered but none the worse once the shock wears off. Yet, the US and the world is staring at financial Armageddon because of the collapse of a single corporation. This makes Osama bin Laden looks like a convention nun and his devious plans looks like child’s play.

At least, the US can launch retaliatory attacks on terrorists for their inhumane actions but with AIG, nothing can be done. The US government and taxpayers can only submit meekly to their ravages. Maybe Osama bin Laden should invite all the derivative traders on Wall Street for lunch and then plan the next attack on the US. It should be easy since nobody wants to seriously regulate this industry, especially derivatives and credit default swaps.

That is all for my rant today. There could be a bear rally in the coming weeks and if you are nimble enough, this could be an opportunity to make money in the stock market. However, if you intend to hold for the mid to long term, I think it is wiser to conserve your cash. Stay tuned for more updates.

4 Comments

Filed under Banking, Deflation, Economy, Inflation, Stocks, gold