Life in the time of meltdown
It seems we are in for a long and dreadful economic slowdown. In the Philippines. In Asia. In America. In Europe. Throughout the world.
The International Monetary Fund forecasts economic growth as measured by the rise in the Gross Domestic Product (GDP or the total output of goods and services in a given year) to be 4.4 percent for the Philippines during 2008 and 3.8 percent during 2009. The 4.4 percent 2008 GDP growth will be the lowest for the country in six years and the lowest among the ten member countries of the ASEAN, except Brunei. In 2009, however, Singapore will grow slower than the Philippines – 3.5 percent vs. 3.8 percent.
Still, the 4.4 percent 2008 GDP growth remains far better than the 2.8 percent average growth during 1990-1999 which was one of the worst decades for the Philippine economy. Having gone through the worst, Filipinos should be able to breeze through 2008 and 2009 suffering damage no worse than having shallower pockets and a more frugal lifestyle.
According to the IMF, developing Asia will grow 8.4 percent in 2008 and 7.7 percent in 2009, down from 10 in 2007 and 9.9 percent in 2006. China will grow by 9.7 percent in 2008 and 9.3 percent in 2009, down from 11.9 percent in 2007 and 11.6 percent in 2006. The US will grow by 1.5 percent in 2008 and by 0.1 in 2009; Japan by 0.7 percent in 2008 and 0.5 in 2009, down from 2.1 percent in 2007 and 2.4 percent in 2006. The world output will grow by just 3.9 percent in 2008 and 3.0 percent in 2009, down from 5.0 percent in 2007 and 5.1 percent in 2006.
There has never been a time like it. My advice: Enjoy it. Make the most of it. During times like these, the fixed income people will do better than the so-called entrepreneurs or businessmen. If you have a well-paying job, keep it. Work hard. Be useful. Be productive. Be creative. This is no time to malinger or absent yourself from work. As a professional manager, you will do better than the SOB – son of the boss.
As I keep saying, an economic slowdown will be good for the Philippines. It will force Filipinos to return to basics. Save rather than spend. Buy the cheaper goods rather than the exorbitantly priced models.
At Greenhills, you can buy a decent brand-new Nokia phone with SIM card included for just P1,500. Compare that with the P50,000 being charged for an iPhone which is nothing more than a glorified iPod MP3. Panasonic plasma tv sets are selling at 30 to 40 percent lower than the overpriced models of Samsung and Sony. Buy the A650 Panasonic series. They are as good, if not better, than the Series 6 of Samsung and the W series of Sony. True, Panasonic panels are plasma, not LCD, unlike those of Samsung and Sony. Plasma tvs are good in the dark and watching movies is still best in the dark. By the way, do not buy HDMI Blu-Ray DVD players. They cost eight to ten times the ordinary HDMI players.
There has never been a time like it. My advice: Enjoy it. Make the most of it. During times like these, the fixed income people will do better than the so-called entrepreneurs or businessmen. If you have a well-paying job, keep it. Work hard. Be useful. Be productive. Be creative. This is no time to malinger or absent yourself from work.
cregular HDMI players.
Izod has been selling 100 percent cotton non-iron dress chino pants at 50 to 60 percent off. They are much better designed and look better on you than Dockers or Armani pants. Nikon’s D40 cameras are as good and as competent as the Nikon D300 or D700 at a third of the price. The Nikon D700, whose body seems to have been crafted from a tank, is as heavy as a checked-in luggage. Heavy too is the price – at least P125,000, body only. The Mazda3 drives as excellently as the BMW Series 3 at a fifth of the latter’s price, with a better service to boot. The Nissan Patrol to me remains the best buy in high-end SUVs. They are priced just half of and are far more durable than the marquee brands of Europe. You also get better service.
You can have a life and a lifestyle and still have some savings stashed in the bank.
Stocks? Share prices of major Philippine companies are selling at their 52-week lows and below book value. There has never been a better time to invest in stocks than now. Buy chunks of the companies of Henry Sy, Jaime Augusto Zobel de Ayala, George SK Ty, Lucio Tan, Andrew Tan or even Manny Villar at 60 to 70 percent discount. Come the time for annual meetings next year, you will be glad you did because you will be able to heckle these people and ask them to explain just what they did in 2008 that made their companies do so well --- or do so badly.
biznewsasia@gmail.com
Monday, October 27, 2008
Four positive things for the Filipino
There are four things positive you must remember despite or because of the so-called financial crisis. Oil prices are down 60 percent. Rice prices are down 30 percent. The peso is down 17 percent, from P42 to P49. The real estate business remains robust or is up. There is no way all those four factors can be negative for the economy, for the people, for you and me.
Oil is a bellwether product. It determines the price of your electricity, your diesel, your gasoline and many other things. Oil was $147 per barrel in July. It is now hovering at $60. Utilities–fuel, light and water–constitute about 7 percent of the consumer price index (CPI). For every P100, utilities constitute P7 of expenditures.
Food is even weightier. It is 55 percent of the CPI for low-income families. If food goes down by 30 percent, its contribution to CPI goes down to just 38.5 percent. If oil goes down by 60 percent, its contribution to the CPI goes down to just 4.2 percent so that the total effect of both food and oil to the CPI declines to 42.7 percent, from 62 percent, a drop of 19.3 percent. Multiply the 19.3 percent to the 12.5 percent inflation rate and immediately you bring down inflation rate to single digit.
Since the CPI is also used by the banks, by the telephone, water and cellular companies in pegging their prices or rates, the prices of these services should likewise go down. The only two industries that have refused to respect the law of supply and demand and to down their prices are the giant oil companies and the Meralco. Their pricing is excessive by now. Your local gasoline or diesel price is overpriced by at least P10 per liter or by 25 percent. Your electricity rate is overpriced by at least 20 percent per kilowatt hour.
On the other hand, the 17 percent peso devaluation means an additional purchasing power of P112 billion in the hands of the country’s ten million OFWs. The $16 billion they remitted last year was worth only P672 billion at P42 to $1. This year, when they remit that same amount of dollars it is worth P784 billion. The P112 billion if translated back into dollars is worth $2.3 billion–an amount far bigger than any local rescue fund the Bangko Sentral can assemble if our banks become beleaguered and far bigger than the so-called economic stimulus package of the government.
Now for real estate. It was up almost 22 percent in the first half. Hans Sy tells me demand for the SM residences that sit cheek by jowl with their SM malls remains strong, so strong, in fact, that prices have doubled from two years ago to about P100,000 per square meter. The SM units are small, about 40 sq. m., or P4 million per unit. Two factors explain why they sell well. The OFWs and an emerging phenomenon–people want to live near their places of work or schools.
Don’t believe the BS that OFWs will be hurt by the so-called financial crisis. The Filipino OFWs are unique–highly educated, easily trainable, very skilled, and English speaking and therefore, they will remain in demand. Next to perhaps Mexico, the Philippines is now the largest exporter of expatriate manpower and the world’s biggest earner. Also, in the last five years, the number of OFWs has doubled. So any reduction in income has been made up for by the rapid rise in the volume or number of OFWs.
This year, the Bangko Sentral ng Pilipinas projects remittances of $18 billion from OFWs. Divide that by ten million (the number of OFWs) and you get $1,800. Ten million of the country’s 16 million households have an additional per family income of $1,800 per year or $327 per capita. Add the $327 to the $1,600 average domestic per capita income and you have ten million families having per capita income of $2,000—usually the benchmark income for middle class.
Ten million Filipino families are middle class! Unlike the American middle class whose wealth is built on vapor—house on credit, car on credit, credit card bills on credit, wealth on credit—our Filipino middle class has real assets–a concrete house on a lot averaging 200 sq. m. for which a 20 percent downpayment has been made, a jeepney or a Revo or Innova or an Urvan for which at least 20 percent downpayment has been made and some savings in the bank, an average of P200,000. Now, that’s what I call the real economy.
biznewsasia@gmail.com
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Oil is a bellwether product. It determines the price of your electricity, your diesel, your gasoline and many other things. Oil was $147 per barrel in July. It is now hovering at $60. Utilities–fuel, light and water–constitute about 7 percent of the consumer price index (CPI). For every P100, utilities constitute P7 of expenditures.
Food is even weightier. It is 55 percent of the CPI for low-income families. If food goes down by 30 percent, its contribution to CPI goes down to just 38.5 percent. If oil goes down by 60 percent, its contribution to the CPI goes down to just 4.2 percent so that the total effect of both food and oil to the CPI declines to 42.7 percent, from 62 percent, a drop of 19.3 percent. Multiply the 19.3 percent to the 12.5 percent inflation rate and immediately you bring down inflation rate to single digit.
Since the CPI is also used by the banks, by the telephone, water and cellular companies in pegging their prices or rates, the prices of these services should likewise go down. The only two industries that have refused to respect the law of supply and demand and to down their prices are the giant oil companies and the Meralco. Their pricing is excessive by now. Your local gasoline or diesel price is overpriced by at least P10 per liter or by 25 percent. Your electricity rate is overpriced by at least 20 percent per kilowatt hour.
On the other hand, the 17 percent peso devaluation means an additional purchasing power of P112 billion in the hands of the country’s ten million OFWs. The $16 billion they remitted last year was worth only P672 billion at P42 to $1. This year, when they remit that same amount of dollars it is worth P784 billion. The P112 billion if translated back into dollars is worth $2.3 billion–an amount far bigger than any local rescue fund the Bangko Sentral can assemble if our banks become beleaguered and far bigger than the so-called economic stimulus package of the government.
Now for real estate. It was up almost 22 percent in the first half. Hans Sy tells me demand for the SM residences that sit cheek by jowl with their SM malls remains strong, so strong, in fact, that prices have doubled from two years ago to about P100,000 per square meter. The SM units are small, about 40 sq. m., or P4 million per unit. Two factors explain why they sell well. The OFWs and an emerging phenomenon–people want to live near their places of work or schools.
Don’t believe the BS that OFWs will be hurt by the so-called financial crisis. The Filipino OFWs are unique–highly educated, easily trainable, very skilled, and English speaking and therefore, they will remain in demand. Next to perhaps Mexico, the Philippines is now the largest exporter of expatriate manpower and the world’s biggest earner. Also, in the last five years, the number of OFWs has doubled. So any reduction in income has been made up for by the rapid rise in the volume or number of OFWs.
This year, the Bangko Sentral ng Pilipinas projects remittances of $18 billion from OFWs. Divide that by ten million (the number of OFWs) and you get $1,800. Ten million of the country’s 16 million households have an additional per family income of $1,800 per year or $327 per capita. Add the $327 to the $1,600 average domestic per capita income and you have ten million families having per capita income of $2,000—usually the benchmark income for middle class.
Ten million Filipino families are middle class! Unlike the American middle class whose wealth is built on vapor—house on credit, car on credit, credit card bills on credit, wealth on credit—our Filipino middle class has real assets–a concrete house on a lot averaging 200 sq. m. for which a 20 percent downpayment has been made, a jeepney or a Revo or Innova or an Urvan for which at least 20 percent downpayment has been made and some savings in the bank, an average of P200,000. Now, that’s what I call the real economy.
biznewsasia@gmail.com
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Monday, October 20, 2008
Buyers beware
Oct.9, 2008
Buyers beware
If you are buying a condominium, be sure to measure the size of the unit you are buying. A friend of mine bought a unit at Lancaster Condominium on Shaw Boulevard and found to his dismay the unit is about a square meter less than what the developer stated in the contract to sell. My friend is complaining but so far, the developer, Pacific Concord Properties, has been giving him a runaround.
***
I never thought in my lifetime I would see a country going bankrupt. But there it is – Iceland. It is trying to borrow $5.4 billion from Russia because its western neighbors and friends are not willing to lend it money. With a population of about 350,000, Iceland apparently is nothing more than all steam, all glacier, and all volcano. It has no real resources to brag about.
And yet, the western world has consistently rated Iceland the most developed country in the world (meaning the richest), according to the UN Development Index; the fourth most productive country per capita, and one with among the highest levels of economic and civil freedom. In other words, its rankings are nothing more than hot air.
Yet, the same people who have rated Iceland very highly in degree of development and level of economic and civil freedoms rate the Philippines very poorly in degree of development, economic and civil freedoms. The ratings given the Philippines are nothing more than BS.
Another country that should be bankrupt by now is the United States. The US is the No. 1 country in the world in terms of competitiveness, meaning it has the most developed economic and financial system and the highest degree of economic and civil freedoms. Philippines is No. 71. Yet, the US is on the brink of bankruptcy.
TV reports indicate the US government’s liabilities have reached $10 trillion. The size of the US economy is $13 trillion in purchasing power parity. US debts equal the value of its entire economic production in a given year. George Bush is supposed to be the first Harvard MBA president. That guy is the most unpopular president in history and has brought his country to the lowest level of economic despair in 80 years. Should Harvard be blamed? Should his MBA training be blamed? Or the blame is Bush’s and Bush’s alone?
The Philippines has total foreign debts of $54 billion. The size of the Philippine economy is $300 billion. Our economic production can pay for our foreign debts almost six times over. From these figures, you can see who has got more cash and which is the one on a very solid financial footing.
During this 21st century, what is important are people and their intelligence and talent. By this token, Filipinos will conquer the world. The rest of the world is aging and running out of jobs to take care of their young and their elders. The Philippines is getting younger and smarter by the day. And by the way, the Philippines will survive the current financial turmoil. This country has been in a much worse situation and survived mightily.
In the meantime, what do the few banks of Iceland, enjoying among the highest degree of economic freedom in the world do? The banks took the money of the Icelanders and invested n the money abroad in some fancy higher paying derivative investments. When those investments evaporated, Iceland ran out of money.
***
Philamlife has been running daily two-page spread ads intended to assure the public that it is a solid financial institution – “the crown jewel of AIG and has built an excellent brand equity”.
The owner of the jewel, AIG, is gone. It went bankrupt because it bet wrongly on so-called credit default swaps (CDS). The CDS market has risen to $62.2 trillion, nearly five times the size of the US economy. AIG is believed to have bet up to $450 billion in CDS. Then the CDS market collapsed because of the collapse in home mortgages.
CDS is a kind of financial derivative. It provides “insurance” on risky mortgage bonds. If the mortgage turns sour, the insurance company pays for the loss.
Philamlife is reported to be claiming a value of P92 billion for buyers to pay. To me, Philamlife is worth no more than P12 billion. It incurred about P1.5 billion in forex losses derivatives last year, resulting in a 63 percent decline in its profits to P887.6 million from P2.37 billion in 2006.
You are better off buying First Holdings which owns majority of Meralco. First Holdings has a market value of less than P8 billion. You buy First Holdings and you control the Philippines’ largest power distributor and the second largest company in sales.
biznewsasia@gmail.com
Buyers beware
If you are buying a condominium, be sure to measure the size of the unit you are buying. A friend of mine bought a unit at Lancaster Condominium on Shaw Boulevard and found to his dismay the unit is about a square meter less than what the developer stated in the contract to sell. My friend is complaining but so far, the developer, Pacific Concord Properties, has been giving him a runaround.
***
I never thought in my lifetime I would see a country going bankrupt. But there it is – Iceland. It is trying to borrow $5.4 billion from Russia because its western neighbors and friends are not willing to lend it money. With a population of about 350,000, Iceland apparently is nothing more than all steam, all glacier, and all volcano. It has no real resources to brag about.
And yet, the western world has consistently rated Iceland the most developed country in the world (meaning the richest), according to the UN Development Index; the fourth most productive country per capita, and one with among the highest levels of economic and civil freedom. In other words, its rankings are nothing more than hot air.
Yet, the same people who have rated Iceland very highly in degree of development and level of economic and civil freedoms rate the Philippines very poorly in degree of development, economic and civil freedoms. The ratings given the Philippines are nothing more than BS.
Another country that should be bankrupt by now is the United States. The US is the No. 1 country in the world in terms of competitiveness, meaning it has the most developed economic and financial system and the highest degree of economic and civil freedoms. Philippines is No. 71. Yet, the US is on the brink of bankruptcy.
TV reports indicate the US government’s liabilities have reached $10 trillion. The size of the US economy is $13 trillion in purchasing power parity. US debts equal the value of its entire economic production in a given year. George Bush is supposed to be the first Harvard MBA president. That guy is the most unpopular president in history and has brought his country to the lowest level of economic despair in 80 years. Should Harvard be blamed? Should his MBA training be blamed? Or the blame is Bush’s and Bush’s alone?
The Philippines has total foreign debts of $54 billion. The size of the Philippine economy is $300 billion. Our economic production can pay for our foreign debts almost six times over. From these figures, you can see who has got more cash and which is the one on a very solid financial footing.
During this 21st century, what is important are people and their intelligence and talent. By this token, Filipinos will conquer the world. The rest of the world is aging and running out of jobs to take care of their young and their elders. The Philippines is getting younger and smarter by the day. And by the way, the Philippines will survive the current financial turmoil. This country has been in a much worse situation and survived mightily.
In the meantime, what do the few banks of Iceland, enjoying among the highest degree of economic freedom in the world do? The banks took the money of the Icelanders and invested n the money abroad in some fancy higher paying derivative investments. When those investments evaporated, Iceland ran out of money.
***
Philamlife has been running daily two-page spread ads intended to assure the public that it is a solid financial institution – “the crown jewel of AIG and has built an excellent brand equity”.
The owner of the jewel, AIG, is gone. It went bankrupt because it bet wrongly on so-called credit default swaps (CDS). The CDS market has risen to $62.2 trillion, nearly five times the size of the US economy. AIG is believed to have bet up to $450 billion in CDS. Then the CDS market collapsed because of the collapse in home mortgages.
CDS is a kind of financial derivative. It provides “insurance” on risky mortgage bonds. If the mortgage turns sour, the insurance company pays for the loss.
Philamlife is reported to be claiming a value of P92 billion for buyers to pay. To me, Philamlife is worth no more than P12 billion. It incurred about P1.5 billion in forex losses derivatives last year, resulting in a 63 percent decline in its profits to P887.6 million from P2.37 billion in 2006.
You are better off buying First Holdings which owns majority of Meralco. First Holdings has a market value of less than P8 billion. You buy First Holdings and you control the Philippines’ largest power distributor and the second largest company in sales.
biznewsasia@gmail.com
Bailout money for the rich, crumbs for the poor
Bailout money for the rich;
nothing for the hungry poor
Albay Governor Joey Salceda, an economic adviser to President Arroyo, laments that the world’s richest countries, notably the United States and England, are spending a total of $6.8 trillion to bail out banks and investment houses made bankrupt by the financial crisis sweeping through America and Europe.
Yet, when food prices doubled early this year bringing to the precipice of hunger up to 130 million very poor, all these rich countries could scrounge was $850 million to bail these people out of hunger.
“The elite controls governments and in a crisis, they save their ilk first,” sneers Salceda who made his pile as one of Asia’s leading analysts. With the multi-trillion bailouts, the rich countries will be piling up huge debts chargeable to their taxpayers. Salceda frets that “funds for social services and international development will be displaced, causing income inequality to deteriorate.”
How true.
***
That the small people will be the biggest victims of the financial crash in America is amply demonstrated by the way Philamlife is treating its plan holders in the Philippines. Philamlife is the subsidiary of global insurance giant AIG which went bankrupt on Sept. 15 and had to be bailed out by the US government with $85 billion in expensive rescue fund plus another $37 billion later.
A harried mother of three went to Philamlife offices on Dasmariñas, Cavite to inquire if she can cash in her Brilliance University educational insurance. She was told she wouldn’t get anything. Zero. Zilch. For her P87,000 initial payment, she will get a cash surrender value of P1,055 -- but only in the second year.
By any measure, this seems to me like a big swindle. Even banks, if you place a time deposit and want to get out, you pay a termination fee of just 20 percent. With Philam, the pretermination fee is 100 percent. You lose all your money. They take away your money. Just like that. Cannot the Insurance Commission or the SEC do something about this?
What grates the poor housewife is that the people at Philamlife sounded and acted even cold, impersonal, haughty and arrogant. Something like, “if you want your money back, maghintay ka, bruha!”
Wow! And to think that Philamlife is for all practical purposes bankrupt. Its mother company, AIG, owes the US government at least $122 billion, money it cannot possibly raise considering the debts it has piled up, about $450 billion in credit default swaps (CDS) much of it can no longer be converted into cash. To raise money, AIG has to sell its assets including Philamlife.
The sale clearly obscures the outlook of Philamlife. What are the chances of the new owners of Philamlife honoring Philamlife’s obligations?
***
Sen. Chiz Escudero has filed a bill increasing the insurance cover of deposits to P500,000 from the present P250,000. The measure also mandates the Philippine Deposit Insurance Corp. (PDIC) to tighten supervision over banks, check abuses of bank owners and executives as regards pay and bonuses, and ensure regular, prompt and transparent disclosure of financial condition.
The bill affirms the power of the PDIC to invest in banks. This is the Philippine equivalent of a contingent bailout if the financial crisis abroad worsens and starts sweeping through Manila.
In the meantime, our banks and financial houses seem to be on a sound financial footing. Banking, however, is a confidence game. Once a bank loses the confidence of its clients and depositors, the institution, no matter how old, venerable and seemingly stable, can be toppled overnight.
Also, clients, depositors and investors remember who treated them well in good times. And bad.
biznewsasia@gmail.com
nothing for the hungry poor
Albay Governor Joey Salceda, an economic adviser to President Arroyo, laments that the world’s richest countries, notably the United States and England, are spending a total of $6.8 trillion to bail out banks and investment houses made bankrupt by the financial crisis sweeping through America and Europe.
Yet, when food prices doubled early this year bringing to the precipice of hunger up to 130 million very poor, all these rich countries could scrounge was $850 million to bail these people out of hunger.
“The elite controls governments and in a crisis, they save their ilk first,” sneers Salceda who made his pile as one of Asia’s leading analysts. With the multi-trillion bailouts, the rich countries will be piling up huge debts chargeable to their taxpayers. Salceda frets that “funds for social services and international development will be displaced, causing income inequality to deteriorate.”
How true.
***
That the small people will be the biggest victims of the financial crash in America is amply demonstrated by the way Philamlife is treating its plan holders in the Philippines. Philamlife is the subsidiary of global insurance giant AIG which went bankrupt on Sept. 15 and had to be bailed out by the US government with $85 billion in expensive rescue fund plus another $37 billion later.
A harried mother of three went to Philamlife offices on Dasmariñas, Cavite to inquire if she can cash in her Brilliance University educational insurance. She was told she wouldn’t get anything. Zero. Zilch. For her P87,000 initial payment, she will get a cash surrender value of P1,055 -- but only in the second year.
By any measure, this seems to me like a big swindle. Even banks, if you place a time deposit and want to get out, you pay a termination fee of just 20 percent. With Philam, the pretermination fee is 100 percent. You lose all your money. They take away your money. Just like that. Cannot the Insurance Commission or the SEC do something about this?
What grates the poor housewife is that the people at Philamlife sounded and acted even cold, impersonal, haughty and arrogant. Something like, “if you want your money back, maghintay ka, bruha!”
Wow! And to think that Philamlife is for all practical purposes bankrupt. Its mother company, AIG, owes the US government at least $122 billion, money it cannot possibly raise considering the debts it has piled up, about $450 billion in credit default swaps (CDS) much of it can no longer be converted into cash. To raise money, AIG has to sell its assets including Philamlife.
The sale clearly obscures the outlook of Philamlife. What are the chances of the new owners of Philamlife honoring Philamlife’s obligations?
***
Sen. Chiz Escudero has filed a bill increasing the insurance cover of deposits to P500,000 from the present P250,000. The measure also mandates the Philippine Deposit Insurance Corp. (PDIC) to tighten supervision over banks, check abuses of bank owners and executives as regards pay and bonuses, and ensure regular, prompt and transparent disclosure of financial condition.
The bill affirms the power of the PDIC to invest in banks. This is the Philippine equivalent of a contingent bailout if the financial crisis abroad worsens and starts sweeping through Manila.
In the meantime, our banks and financial houses seem to be on a sound financial footing. Banking, however, is a confidence game. Once a bank loses the confidence of its clients and depositors, the institution, no matter how old, venerable and seemingly stable, can be toppled overnight.
Also, clients, depositors and investors remember who treated them well in good times. And bad.
biznewsasia@gmail.com
Turmoil to last at least a year
Turmoil to last at least a year
The world remains in turmoil. Share prices in Asia and the rest of the world are nose-diving to their five-year lows.
Meanwhile, capitalist bastions America and England will end up owning much of their banking systems as they reassure depositors and clients their money is safe and prod banks to begin lending to each other.
In true only-an-SOB-knows-another-SOB fashion, banks don’t trust each other. Since they don’t trust each other, banks don’t want to lend to each other although the interest for interbank lending is at near-record high. Since they don’t want to lend to each other, there is no confidence and credit remains in the Ice Age. Since credit is frozen, no manufacturing, no business activity, no housing sale is moving.
The result is an economic paralysis that is bringing the US economy to near recession. In turn, the global economy is in slowdown. Major suppliers of products and services to the USA like Japan, South Korea, Taiwan and Europe will suffer drastic cuts in their growth rates.
The IMF says the US economy grew by a paltry 1.5 percent in the three most recent quarters and will likely contract in the current quarter and into early 2009, “with recession now increasingly likely.”
In America and England, politicians, finance and central bankers took the easiest way to solve the crisis – print and give away taxpayers’ money.
The UK Treasury will inject up to $87 billion into British banks to shore up their capital. It will also guarantee up to $435 billion of borrowings by banks using commercial paper. For its part, the Bank of England will provide cash of $348 billion in Treasury Bills which banks can swap for their less saleable assets. That’s a total rescue package of $870 billion, British style. The UK government had to act fast because share prices of British banks had declined by as much as 40% by October 7, thus eroding public confidence in their banking system.
The US Congress, meanwhile, approved a $700-billion bailout law that will buy so-called toxic assets which were used as collateral for loans that went sour.
The US Federal Reserve doubled to $900 billion the amount of money it will lend to banks on a short-term basis. It will also lend directly to private companies by agreeing to buy their commercial papers or IOUs. The Fed is also buying shares of stocks of banks. In less than a month, the US government has become America’s – and the world’s – largest commercial bank, investment bank, and mortgage lender. Very soon, the US government will also take over ailing General Motors and Ford so they can sell more vehicles. US vehicle sales are the lowest in 16 years.
Or maybe the US government take over Boeing, which has been hit by a strike for a month, so it can sell more planes and compete better with Airbus which is owned and supported by various European governments. For its unique version of free enterprise, the US government has incurred liabilities reaching $10 trillion –money which generations of Americans, including the unborn, will pay somehow.
The IMF says balance sheet repair in the US “will be long and arduous. It will take considerable time before losses are fully recognized, banks are recapitalized, leverage is reduced, and market confidence is regained.” Bank lending, already tight, “is likely to remain tight throughout 2009.” US consumers have less income. House prices have declined five to 17 percent in one year, the deepest since the Depression, and will drop another 10 percent by yearend. More than 10 million households owe more than the market value of their homes. Employment since January has dropped. The average work week has shrunk. Unemployment has risen by a full percentage point. Wages have stagnated. Gas prices remain high. IMF estimates the wealth of US households to be down 10 percent as a ratio of the GDP. US has a GDP of $13.8 trillion.
Intervention has become global. The US Federal Reserve, the European Central Bank and the Bank of England all cut their interest rates by half a percent. They were joined by the central banks of Canada, Sweden, Switzerland, Hongkong, South Korea and Taiwan and Australia. China’s central bank joined the choir and cut its lending rate by 27 basis points, not much but good enough for China to be considered part of the global banking barkada. Among all the countries in crisis or near-crisis, China has the deepest pocket. It has $1.7 trillion in foreign reserves—more than the bailout money combined of UK and the US. The only problem is that $1trillion of that is invested in America.
The IMF says recovery will begin in late 2009 and even so it will be very gradual.
biznewsasia@gmail.com
The world remains in turmoil. Share prices in Asia and the rest of the world are nose-diving to their five-year lows.
Meanwhile, capitalist bastions America and England will end up owning much of their banking systems as they reassure depositors and clients their money is safe and prod banks to begin lending to each other.
In true only-an-SOB-knows-another-SOB fashion, banks don’t trust each other. Since they don’t trust each other, banks don’t want to lend to each other although the interest for interbank lending is at near-record high. Since they don’t want to lend to each other, there is no confidence and credit remains in the Ice Age. Since credit is frozen, no manufacturing, no business activity, no housing sale is moving.
The result is an economic paralysis that is bringing the US economy to near recession. In turn, the global economy is in slowdown. Major suppliers of products and services to the USA like Japan, South Korea, Taiwan and Europe will suffer drastic cuts in their growth rates.
The IMF says the US economy grew by a paltry 1.5 percent in the three most recent quarters and will likely contract in the current quarter and into early 2009, “with recession now increasingly likely.”
In America and England, politicians, finance and central bankers took the easiest way to solve the crisis – print and give away taxpayers’ money.
The UK Treasury will inject up to $87 billion into British banks to shore up their capital. It will also guarantee up to $435 billion of borrowings by banks using commercial paper. For its part, the Bank of England will provide cash of $348 billion in Treasury Bills which banks can swap for their less saleable assets. That’s a total rescue package of $870 billion, British style. The UK government had to act fast because share prices of British banks had declined by as much as 40% by October 7, thus eroding public confidence in their banking system.
The US Congress, meanwhile, approved a $700-billion bailout law that will buy so-called toxic assets which were used as collateral for loans that went sour.
The US Federal Reserve doubled to $900 billion the amount of money it will lend to banks on a short-term basis. It will also lend directly to private companies by agreeing to buy their commercial papers or IOUs. The Fed is also buying shares of stocks of banks. In less than a month, the US government has become America’s – and the world’s – largest commercial bank, investment bank, and mortgage lender. Very soon, the US government will also take over ailing General Motors and Ford so they can sell more vehicles. US vehicle sales are the lowest in 16 years.
Or maybe the US government take over Boeing, which has been hit by a strike for a month, so it can sell more planes and compete better with Airbus which is owned and supported by various European governments. For its unique version of free enterprise, the US government has incurred liabilities reaching $10 trillion –money which generations of Americans, including the unborn, will pay somehow.
The IMF says balance sheet repair in the US “will be long and arduous. It will take considerable time before losses are fully recognized, banks are recapitalized, leverage is reduced, and market confidence is regained.” Bank lending, already tight, “is likely to remain tight throughout 2009.” US consumers have less income. House prices have declined five to 17 percent in one year, the deepest since the Depression, and will drop another 10 percent by yearend. More than 10 million households owe more than the market value of their homes. Employment since January has dropped. The average work week has shrunk. Unemployment has risen by a full percentage point. Wages have stagnated. Gas prices remain high. IMF estimates the wealth of US households to be down 10 percent as a ratio of the GDP. US has a GDP of $13.8 trillion.
Intervention has become global. The US Federal Reserve, the European Central Bank and the Bank of England all cut their interest rates by half a percent. They were joined by the central banks of Canada, Sweden, Switzerland, Hongkong, South Korea and Taiwan and Australia. China’s central bank joined the choir and cut its lending rate by 27 basis points, not much but good enough for China to be considered part of the global banking barkada. Among all the countries in crisis or near-crisis, China has the deepest pocket. It has $1.7 trillion in foreign reserves—more than the bailout money combined of UK and the US. The only problem is that $1trillion of that is invested in America.
The IMF says recovery will begin in late 2009 and even so it will be very gradual.
biznewsasia@gmail.com
A crash in confidence
A crash in confidence
It is now becoming increasingly clear that what the United States is suffering from is not a financial crisis, not a credit crisis, not a meltdown, but a leadership crisis. You can see the global damage of what incompetent leadership can do. The meltdown in confidence in the present American leadership is so deep and so widespread it will take at least two years for confidence to return.
The American public, and indeed, much of the world public, have lost confidence in George Bush, in his vice president, Dick Cheney, in his central bank and Treasury leaders, in America’s banking and financial leaders. Treasury Secretary Henry Paulson lost much credibility when he allowed Lehman Brothers (long-time rival of Goldman Sachs, where he was CEO for many years) to go bankrupt and rescued Bear Stearns, Merrill Lynch and AIG. The closure of Lehman added to the fear of investors which spread worldwide.
Bush and Cheney are the two guys who spent the present value equivalent of $2 trillion to invade and occupy Iraq using a lie – that Saddam Hussein had weapons of mass destruction. And all the while, the enemy they should have been looking for was hiding in Pakistan, in its northwestern frontier. Bush gave the unlamented Pakistani dictator Musharaf $12 billion so he would cooperate. Instead, Pakistan descended into a political and economic crisis.
Bush and Cheney also engaged in mass arrests without warrants of hundreds of suspects, many of them found to be innocent later, and jailing and torturing them in some far away place called Guantanamo. Only the vigilance of the New York Times and the US Supreme Court slowed down Bush and Cheney in committing more mass violations of human rights. This is unprecedented in the history of America.
The irony is that Bush and Cheney didn’t realize that right inside America were the financial equivalent of weapons of mass destruction – the so-called derivatives known either as credit default swaps (CDS) or collaterialized debt obligations (CDOs). The value of CDS rose to a steep $62 trillion, more than the value of the world GDP which was $54.34 trillion in 2007.
Can you imagine that, US banks and financial houses accumulating debt papers whose value is more than the combined economic output of all countries of the world in one year?
Surely, somebody should be penalized for all this recklessness. As it turns out, it is the American taxpayer. Not just the American taxpayer. All the old people whose pension money has just evaporated. All the children of working Americans whose future has now dimmed because their parents have lost their jobs and therefore, the money to send them to school. All of them will suffer. As do all of us here in Asia.
***
I was looking at the stock market prices of some listed companies. Based on their closing prices on Friday, Oct. 10, many of these companies have lost more than half of their market values compared with their 52-week high, opening opportunities for a buy.
Here are some of the price declines (as of Oct. 10, 2008; stocks rose marginally Monday, Oct. 13 so the values still hold) – Ayala Corp. 65 percent; Metrobank 64 percent; Ayala Land 60 percent; JG Summit Holdings 57 percent; RCBC 56 percent; PNB 53 percent; Banco de Oro 50 percent; Bank of PI 49 percent; Meralco 47 percent; China Bank 43 percent; and SM Investments Corp. 43 percent.
The best performer is terms of bucking the trend is San Miguel Corp.. At P49, its share price has lost only 20 percent from its 52-week high of P61.50. Henry Sy’s companies are also holding well.
Surprising to me is the weakness of the Ayala companies Ayala Corp. and Ayala Land as sell as BPI.
In any case, it may be time to go and buy stocks. It is not clear, however, where the bottom is. I feel the market still has a downside of about 20 percent, until after the November 4 US elections. Remember the cardinal rule of stock market trading – buy when blood is in the streets. Blood here meaning carnage and massive losses in values.
biznewsasia@gmail.com
It is now becoming increasingly clear that what the United States is suffering from is not a financial crisis, not a credit crisis, not a meltdown, but a leadership crisis. You can see the global damage of what incompetent leadership can do. The meltdown in confidence in the present American leadership is so deep and so widespread it will take at least two years for confidence to return.
The American public, and indeed, much of the world public, have lost confidence in George Bush, in his vice president, Dick Cheney, in his central bank and Treasury leaders, in America’s banking and financial leaders. Treasury Secretary Henry Paulson lost much credibility when he allowed Lehman Brothers (long-time rival of Goldman Sachs, where he was CEO for many years) to go bankrupt and rescued Bear Stearns, Merrill Lynch and AIG. The closure of Lehman added to the fear of investors which spread worldwide.
Bush and Cheney are the two guys who spent the present value equivalent of $2 trillion to invade and occupy Iraq using a lie – that Saddam Hussein had weapons of mass destruction. And all the while, the enemy they should have been looking for was hiding in Pakistan, in its northwestern frontier. Bush gave the unlamented Pakistani dictator Musharaf $12 billion so he would cooperate. Instead, Pakistan descended into a political and economic crisis.
Bush and Cheney also engaged in mass arrests without warrants of hundreds of suspects, many of them found to be innocent later, and jailing and torturing them in some far away place called Guantanamo. Only the vigilance of the New York Times and the US Supreme Court slowed down Bush and Cheney in committing more mass violations of human rights. This is unprecedented in the history of America.
The irony is that Bush and Cheney didn’t realize that right inside America were the financial equivalent of weapons of mass destruction – the so-called derivatives known either as credit default swaps (CDS) or collaterialized debt obligations (CDOs). The value of CDS rose to a steep $62 trillion, more than the value of the world GDP which was $54.34 trillion in 2007.
Can you imagine that, US banks and financial houses accumulating debt papers whose value is more than the combined economic output of all countries of the world in one year?
Surely, somebody should be penalized for all this recklessness. As it turns out, it is the American taxpayer. Not just the American taxpayer. All the old people whose pension money has just evaporated. All the children of working Americans whose future has now dimmed because their parents have lost their jobs and therefore, the money to send them to school. All of them will suffer. As do all of us here in Asia.
***
I was looking at the stock market prices of some listed companies. Based on their closing prices on Friday, Oct. 10, many of these companies have lost more than half of their market values compared with their 52-week high, opening opportunities for a buy.
Here are some of the price declines (as of Oct. 10, 2008; stocks rose marginally Monday, Oct. 13 so the values still hold) – Ayala Corp. 65 percent; Metrobank 64 percent; Ayala Land 60 percent; JG Summit Holdings 57 percent; RCBC 56 percent; PNB 53 percent; Banco de Oro 50 percent; Bank of PI 49 percent; Meralco 47 percent; China Bank 43 percent; and SM Investments Corp. 43 percent.
The best performer is terms of bucking the trend is San Miguel Corp.. At P49, its share price has lost only 20 percent from its 52-week high of P61.50. Henry Sy’s companies are also holding well.
Surprising to me is the weakness of the Ayala companies Ayala Corp. and Ayala Land as sell as BPI.
In any case, it may be time to go and buy stocks. It is not clear, however, where the bottom is. I feel the market still has a downside of about 20 percent, until after the November 4 US elections. Remember the cardinal rule of stock market trading – buy when blood is in the streets. Blood here meaning carnage and massive losses in values.
biznewsasia@gmail.com
Good news: Prices are down
Good news: Prices are down
The best news about the so-called global recession is that prices of major commodities have declined dramatically in recent months.
Rice has dropped to about $735 per ton in price from the record $1,038 per ton for the Thai 100 percent grade B set on May 21, 2008.
This week, oil crashed to below $70 per barrel at $69.85, the lowest in 14 months. In just three weeks, oil has tumbled by $40 a barrel. Demand for energy will decline with the slowdown in economic production because of the so-called global recession. There is no recession actually. Global growth in 2009 will be 3.0 percent.
On July 17, oil hit a high of $147. Yet, the 52 percent drop has not been reflected by the local petroleum companies.
After hitting a high of P60 per liter, Manila gasoline should be priced around P30 per liter today. Assuming the peso has devalued against the dollar by 20 percent, the current price should be no more than P36 per liter. So if gasoline is priced at P48 per liter when it should be selling only at P36 per liter, the oil companies are making excessive profits of about 25 percent. What is the government doing about this obvious price gouging? Nothing.
In America, retailers have reflected the 25 percent price drop. Gasoline is now about $3.08 per gallon (3.8 liters in one gallon), down from $4.11 per gallon from last summer (July and August).
The cut in oil prices should also result in lower electricity bills, not higher. The Malampaya gas pricing is pegged to crude prices, as are coal used by local power plants operated by foreigners.
When oil exceeded $100 per barrel, energy began to cost more as a component cost of production than labor. Energy has eaten up about 15 to 20 percent of the cost of producing goods. For households, fuel, light and water (lumped as utilities) were burning up to 20 percent of total household bills, up from the eight percent average.
The sharp price cuts for rice and oil mean a dramatic fall in the inflation rate after hitting a 16-year record-high of 12.5 percent in August 2008. More than half of the consumer basket, measured by the consumer price index, is food (mainly rice) while another seven percent is utilities. The price declines for food and utilities should lop off at least 2.3 percentage points from the inflation rate in the coming months, bringing the rate down to 10 percent, if not lower.
Meanwhile, world prices for steel billets are down 70 percent since May. Major steel producers like ArcelorMittal of India, Severstal of Russia, and Boasteel of China are cutting back production by 10 to 20 percent beginning in the third quarter. Prices of iron ore, copper, and nickel have nosedived 50 percent and aluminum by 30 percent.
What these price cuts, dictated by the law of supply and demand, mean in the short and long run, are much, much lower prices of goods --- of cars, appliances, furniture, and construction materials. This Christmas season, then, when shopping for your long dreamt of plasma or LCD tv sets and DVD player, ask for a discount. Very likely, you will get it.
With prices of most goods down in the coming months, expect a robust Christmas shopping season, perhaps the best in many years.
***
Philamlife President Joey Cuisia called me up the other day (Oct. 16) to protest what I wrote in my previous column, claiming that Philamlife is, for all practical purposes, bankrupt. He said Philamlife is not bankrupt and that it is an institution in the Philippines. Philamlife is being sold by its mother company, the giant New York-based insurer AIG.
I made the bankruptcy remark based on what has happened to Philamlife’s mother company, AIG which went bankrupt on Sept. 15 just before the Federal Reserve took it over with an $85 billion bailout money, plus another $37.8 billion later. AIG has already used up $82.9 billion of the $122.8 billion bailout money.
In New York, AIG share prices have hit a low of $1.25 a share, 98 percent down from the 52-week high of $66.64. AIG’s market cap based on its Oct. 16 closing price of $2.43 per share, is $6.53 billion. At its low $1.25 a share price, AIG was worth only $3.17 billion. Philamlife, reports say, is claiming it is worth $2 billion. If this is true, you are better off buying the mother company, AIG. You get the mother and you get the subsidiary, Philamlife.
Bloomberg quotes analysts expressing doubt that AIG CEO Edward Liddy can garner enough from selling units to repay the government loan.
biznewsasia@gmail.com
The best news about the so-called global recession is that prices of major commodities have declined dramatically in recent months.
Rice has dropped to about $735 per ton in price from the record $1,038 per ton for the Thai 100 percent grade B set on May 21, 2008.
This week, oil crashed to below $70 per barrel at $69.85, the lowest in 14 months. In just three weeks, oil has tumbled by $40 a barrel. Demand for energy will decline with the slowdown in economic production because of the so-called global recession. There is no recession actually. Global growth in 2009 will be 3.0 percent.
On July 17, oil hit a high of $147. Yet, the 52 percent drop has not been reflected by the local petroleum companies.
After hitting a high of P60 per liter, Manila gasoline should be priced around P30 per liter today. Assuming the peso has devalued against the dollar by 20 percent, the current price should be no more than P36 per liter. So if gasoline is priced at P48 per liter when it should be selling only at P36 per liter, the oil companies are making excessive profits of about 25 percent. What is the government doing about this obvious price gouging? Nothing.
In America, retailers have reflected the 25 percent price drop. Gasoline is now about $3.08 per gallon (3.8 liters in one gallon), down from $4.11 per gallon from last summer (July and August).
The cut in oil prices should also result in lower electricity bills, not higher. The Malampaya gas pricing is pegged to crude prices, as are coal used by local power plants operated by foreigners.
When oil exceeded $100 per barrel, energy began to cost more as a component cost of production than labor. Energy has eaten up about 15 to 20 percent of the cost of producing goods. For households, fuel, light and water (lumped as utilities) were burning up to 20 percent of total household bills, up from the eight percent average.
The sharp price cuts for rice and oil mean a dramatic fall in the inflation rate after hitting a 16-year record-high of 12.5 percent in August 2008. More than half of the consumer basket, measured by the consumer price index, is food (mainly rice) while another seven percent is utilities. The price declines for food and utilities should lop off at least 2.3 percentage points from the inflation rate in the coming months, bringing the rate down to 10 percent, if not lower.
Meanwhile, world prices for steel billets are down 70 percent since May. Major steel producers like ArcelorMittal of India, Severstal of Russia, and Boasteel of China are cutting back production by 10 to 20 percent beginning in the third quarter. Prices of iron ore, copper, and nickel have nosedived 50 percent and aluminum by 30 percent.
What these price cuts, dictated by the law of supply and demand, mean in the short and long run, are much, much lower prices of goods --- of cars, appliances, furniture, and construction materials. This Christmas season, then, when shopping for your long dreamt of plasma or LCD tv sets and DVD player, ask for a discount. Very likely, you will get it.
With prices of most goods down in the coming months, expect a robust Christmas shopping season, perhaps the best in many years.
***
Philamlife President Joey Cuisia called me up the other day (Oct. 16) to protest what I wrote in my previous column, claiming that Philamlife is, for all practical purposes, bankrupt. He said Philamlife is not bankrupt and that it is an institution in the Philippines. Philamlife is being sold by its mother company, the giant New York-based insurer AIG.
I made the bankruptcy remark based on what has happened to Philamlife’s mother company, AIG which went bankrupt on Sept. 15 just before the Federal Reserve took it over with an $85 billion bailout money, plus another $37.8 billion later. AIG has already used up $82.9 billion of the $122.8 billion bailout money.
In New York, AIG share prices have hit a low of $1.25 a share, 98 percent down from the 52-week high of $66.64. AIG’s market cap based on its Oct. 16 closing price of $2.43 per share, is $6.53 billion. At its low $1.25 a share price, AIG was worth only $3.17 billion. Philamlife, reports say, is claiming it is worth $2 billion. If this is true, you are better off buying the mother company, AIG. You get the mother and you get the subsidiary, Philamlife.
Bloomberg quotes analysts expressing doubt that AIG CEO Edward Liddy can garner enough from selling units to repay the government loan.
biznewsasia@gmail.com
Why AIG collapsed
Why the collapse of AIG
The best explanation on how and why giant New York-based insurer AIG collapsed comes from David Paul of The Huffington Post. In his article, “Credit Default Swaps, the Collapse of AIG and Addressing the Crisis of Confidence” of Oct. 18, 2008, David explains what happened to AIG and why it is now being broken up and sold to pay for huge debts. AIG overexposed itself in so-called credit default swaps (CDS).
David says “credit default swaps are financial products that allows for the transfer of the default risk related to owning a corporate bond from one party to another.”
For example, he explains, “imagine that before the current market meltdown, CalPERS -- the large California public pension fund -- owned $100 million of IBM bonds, but wanted to insure against the risk of a bond default. CalPERS could accomplish this by negotiating a $100 million, five-year credit default swap with AIG -- which up until a month ago was a global, triple-A rated financial institution.”
“Under the terms of the swap, CalPERS would make an annual swap payment to AIG equal to -- for example – one percent of the $100 million swap notional amount. In return, AIG would pay CalPERS the amount of any losses that CalPERS realized in the event of a default by IBM. For example, if IBM went bankrupt during the contract period, and bondholders were only repaid twenty cents on the dollar, AIG would pay CalPERS $80 million. And to secure AIG's obligations, the swap contract would require that if AIG were downgraded from triple-A level to below double-A, AIG would post collateral equal to 20 percent of the notional amount of the swap contract, or $20 million.”
Then came the AIG collapse.
David says the AIG collapse “was a direct consequence of AIG's CDS exposure. Four weeks ago, AIG was a triple-A rated insurance company. Today, it is being dismantled. If AIG had large investment losses in mortgage-backed securities, but no CDS exposure, AIG would still be in business today.”
David says AIG's collapse came as a result of the following sequence of events:
“1. In the wake of the decline in real estate prices, the market value of mortgage-backed securities declined. 2. Under accounting rules that were established after the downfall of Enron -- implemented to require rapid disclosure of investment losses -- AIG marked down the value of its mortgage-backed securities portfolio. 3. These investment losses resulted in a reduction of AIG's capital reserves -- the core measure of its financial strength. 4. As a result of the decline in AIG's capital reserves, Standard & Poor's and Moody's Investors Service downgraded AIG from triple-A to the single-A level. 5. These rating downgrades to the single-A level triggered collateralization requirements under AIG's CDS contracts. 6. The amount of the collateral that AIG had to produce under its estimated $450 billion of CDS contracts approximated $100 billion.
“And AIG did not have $100 billion in available funds.
“This was the explosive event that destroyed AIG. It was not the market losses on its investments in mortgage-backed securities. It was not payouts on CDS contracts where default events had actually occurred. It was a collateral call.
“The AIG story illustrates two important aspects of the current crisis of confidence within the financial markets. First, AIG's collapse in a matter of days resulted from the collateral requirements under the terms of contracts that are opaque, unregulated and difficult to track on corporate financial statements. As Buffett and others have suggested, the risk in the AIG derivatives portfolio was explosive -- and ignored until it was too late.
“Second, the AIG story illustrates how a collateral call under a CDS contract can have the effect of positioning the CDS counterparty -- the institution on the other side that claims rights to the collateral -- senior to the AIG policy holders and bondholders.
“As US and European central bankers are working to define a collective strategy to rebuild confidence in the financial system and to reinvigorate inter-bank lending, the destabilizing impact of the CDS market remains one of the central problems to be addressed.
“The problem seems straightforward. After the AIG collapse, how does one institution trust its exposure to another? If CitiBank seeks a loan from JPMorgan, how does JPMorgan know whether some event might be looming that will result in a collateral call under some of the myriad derivatives contracts to which CitiBank is a party, a collateral call that in a matter of hours could bring Citibank to its knees.”
Now, my good friend Joey Cuisia insists AIG didn’t go bankrupt. AIG’s Philippine subsidiary, Philamlife, also did not go bankrupt, he asserts. I leave it to my readers to make their own conclusions.
biznewsasia@gmail.com
The best explanation on how and why giant New York-based insurer AIG collapsed comes from David Paul of The Huffington Post. In his article, “Credit Default Swaps, the Collapse of AIG and Addressing the Crisis of Confidence” of Oct. 18, 2008, David explains what happened to AIG and why it is now being broken up and sold to pay for huge debts. AIG overexposed itself in so-called credit default swaps (CDS).
David says “credit default swaps are financial products that allows for the transfer of the default risk related to owning a corporate bond from one party to another.”
For example, he explains, “imagine that before the current market meltdown, CalPERS -- the large California public pension fund -- owned $100 million of IBM bonds, but wanted to insure against the risk of a bond default. CalPERS could accomplish this by negotiating a $100 million, five-year credit default swap with AIG -- which up until a month ago was a global, triple-A rated financial institution.”
“Under the terms of the swap, CalPERS would make an annual swap payment to AIG equal to -- for example – one percent of the $100 million swap notional amount. In return, AIG would pay CalPERS the amount of any losses that CalPERS realized in the event of a default by IBM. For example, if IBM went bankrupt during the contract period, and bondholders were only repaid twenty cents on the dollar, AIG would pay CalPERS $80 million. And to secure AIG's obligations, the swap contract would require that if AIG were downgraded from triple-A level to below double-A, AIG would post collateral equal to 20 percent of the notional amount of the swap contract, or $20 million.”
Then came the AIG collapse.
David says the AIG collapse “was a direct consequence of AIG's CDS exposure. Four weeks ago, AIG was a triple-A rated insurance company. Today, it is being dismantled. If AIG had large investment losses in mortgage-backed securities, but no CDS exposure, AIG would still be in business today.”
David says AIG's collapse came as a result of the following sequence of events:
“1. In the wake of the decline in real estate prices, the market value of mortgage-backed securities declined. 2. Under accounting rules that were established after the downfall of Enron -- implemented to require rapid disclosure of investment losses -- AIG marked down the value of its mortgage-backed securities portfolio. 3. These investment losses resulted in a reduction of AIG's capital reserves -- the core measure of its financial strength. 4. As a result of the decline in AIG's capital reserves, Standard & Poor's and Moody's Investors Service downgraded AIG from triple-A to the single-A level. 5. These rating downgrades to the single-A level triggered collateralization requirements under AIG's CDS contracts. 6. The amount of the collateral that AIG had to produce under its estimated $450 billion of CDS contracts approximated $100 billion.
“And AIG did not have $100 billion in available funds.
“This was the explosive event that destroyed AIG. It was not the market losses on its investments in mortgage-backed securities. It was not payouts on CDS contracts where default events had actually occurred. It was a collateral call.
“The AIG story illustrates two important aspects of the current crisis of confidence within the financial markets. First, AIG's collapse in a matter of days resulted from the collateral requirements under the terms of contracts that are opaque, unregulated and difficult to track on corporate financial statements. As Buffett and others have suggested, the risk in the AIG derivatives portfolio was explosive -- and ignored until it was too late.
“Second, the AIG story illustrates how a collateral call under a CDS contract can have the effect of positioning the CDS counterparty -- the institution on the other side that claims rights to the collateral -- senior to the AIG policy holders and bondholders.
“As US and European central bankers are working to define a collective strategy to rebuild confidence in the financial system and to reinvigorate inter-bank lending, the destabilizing impact of the CDS market remains one of the central problems to be addressed.
“The problem seems straightforward. After the AIG collapse, how does one institution trust its exposure to another? If CitiBank seeks a loan from JPMorgan, how does JPMorgan know whether some event might be looming that will result in a collateral call under some of the myriad derivatives contracts to which CitiBank is a party, a collateral call that in a matter of hours could bring Citibank to its knees.”
Now, my good friend Joey Cuisia insists AIG didn’t go bankrupt. AIG’s Philippine subsidiary, Philamlife, also did not go bankrupt, he asserts. I leave it to my readers to make their own conclusions.
biznewsasia@gmail.com
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