CITIC (#267) announced last night that a currency hedge transaction went wrong and the company may lose up to HK$15.5 billion.
This is a trading opportunity for those with "intestinal fortitude" i.e. guts. Based on the 2007 financials net equity was HK$59.8 billion. According to the most recent financials NAV is HK$66.73 billion (including net income in 1st 6 months of HK$4.38 billion). The no. of shares in issue is 2.193 billion; therefore NAV per share is HK$30.42 before any write-offs related to the "hedge".
Assuming the company loses all HK$15.5 billion, net NAV is HK$51.23 billion based on most recent figures, or HK$23.36 per share. If we assume that the company will earn another HK$4.38 billion in the 2nd half, the NAV would be HK$55.61 or HK$25.35 per share
At current market price of HK$8 per share, market value is HK$17.54 billion. The shares are trading at between 31% and 34% of projected and current NAV assuming total write-off.
The share price was down 41% from 7 Sept 2008 (when the problem was discovered) through 16 October 2008 (last Friday's price because trading was suspended on Monday 20 October 2008). During that time, the HSI was down only 23%.
Tuesday, October 21, 2008
Friday, October 17, 2008
China Update
In the first half of 2008, GDP growth slowed from 11.9% (2007) to 10.4% mainly due to slowing exports. During the first 6 months, exports grew at the rate of 21.9% (down 5.7% from last year) to US$666.6 billion.
During the same period, reatil sales more than made for the slowing export growth raising 21.4% to RMB5.1 trillion. Fixed assest investments increased 26.3% to RMB6.84 trillion.
After 5 years of double digit growth, it is expected that GDP will only grow 9% this year (the smallest growth rate since 2002).
The Chinese government will be aggressively cutting lending interest rates (by at least 0.81% to up to 1.35%), deposit rates (by 0.27% up to 0.81%), and reserve requirements (by 3.5% up to 5.5%) over the next 12 months. See previous article.
The cut in interest rates is important but there is no lack of borrowers even at the present rates. More important, the cut in resewrve requirments will mean that banks are at last being allowed to re-start their lending which had been put on hold since 2006.
China is the one bright spot in the global economy where is growth albeit slower than before.
NOTE: I have been asked if I got my numbers wrong. Why 0.27% and not 0.25% (which is a quarter point) for those more familiar with the Western system. The answer is that China use numbers divisible by 9 in calculating interest rates (360 days basis). It actually makes sense when you start working the numbers.
During the same period, reatil sales more than made for the slowing export growth raising 21.4% to RMB5.1 trillion. Fixed assest investments increased 26.3% to RMB6.84 trillion.
After 5 years of double digit growth, it is expected that GDP will only grow 9% this year (the smallest growth rate since 2002).
The Chinese government will be aggressively cutting lending interest rates (by at least 0.81% to up to 1.35%), deposit rates (by 0.27% up to 0.81%), and reserve requirements (by 3.5% up to 5.5%) over the next 12 months. See previous article.
The cut in interest rates is important but there is no lack of borrowers even at the present rates. More important, the cut in resewrve requirments will mean that banks are at last being allowed to re-start their lending which had been put on hold since 2006.
China is the one bright spot in the global economy where is growth albeit slower than before.
NOTE: I have been asked if I got my numbers wrong. Why 0.27% and not 0.25% (which is a quarter point) for those more familiar with the Western system. The answer is that China use numbers divisible by 9 in calculating interest rates (360 days basis). It actually makes sense when you start working the numbers.
Thursday, October 16, 2008
Perspective on China
Many economists predict that China will not be able to escape the contagion. It is significant that they all come from the US or Europe and are projecting their own despondency into their forecasts. It is difficult to be optimistic when the world as you know it is collapsing around you and your own job may not be there tomorrow.
China is the fastest growing of the so-called BRIC (Brazil, Russia, India and China) countries. All four countries have massive land masses and that is where the similarities end. Brazil, Russia and China have natural resources, and India and China are the two most populous countries in the world. But only China has it all - land mass, large population, natural resources, and most important of infrastructure.
The interior of China still lacks investment and infrastructure but the government is addressing this weakness ith major planned investments. Many predicted that China's economy will suffer the "post Olympics blues", and to some extent the stock market seemed to bear this out as it has retreated 60% from the October 2007 peak. However, this is due more to the sentiment and cpncerns about the subprime crisis in the US.
Many countries do suffer slowdowns in their economies after hosting the Olympics because so much has been spent on the required facilites. China spent US$42 billion over the past 6 years on Olympics related projects. However, this represents only 0.5% of the RMB51 trillion spent on fixed assets investments over the same period of time. Travel up and down the coastal region and you can see the results of this investment in infrastrucutre. Over the next 2 years, China has budgeted over RMB400 billion per year (ie the equivalent of the total spending on Olympics each year) for infrastrucure developments with much of the it aimed at the interior.
Can China afford it? You bet! the Chinese foreign currency reserves have just hit US$1.906 billion as of the end of September 2008 rising from US$1.809 trillion in August 2008. China has had fiscal surpluses since the 1985, and expect the surplus this year to to be RMB600 billion (US$87 billion). It is growing at the rate of 30% in the first 8 months of 2008.
China has room to stimulate growth. While the US was gorging on easy credit, China had raised lending interest rates 8 times since April 2006, raised deposit interest rates 6 times since August 2006, and raised banks' reserve requirements 18 times since July 2006 17.5% of deposits. In September 2008, China announced limited cuts to the lending rate of 0.27% to 7.2%, deposit rate cut to 4.14%, and cut reserve requirements to 16.5% for smaller banks to encourage them to lend to SME's (small, medium enterprises). On 8 October 2008, China announced across the board cuts to reduce lending rates to 6.93%, deposit rates to 3.87%, and reserve ratios to 17%.
Over the next 12 months, we can expect to see further cuts to the interest rates and reserve ratios as China stimulates the domestic economy to make up for any shortfalls from reduced exports to US and Europe.
China will celebrate its' 60th Anniversary on 1 October 2009, and we can expect it to put on a big birthday party!
China is the fastest growing of the so-called BRIC (Brazil, Russia, India and China) countries. All four countries have massive land masses and that is where the similarities end. Brazil, Russia and China have natural resources, and India and China are the two most populous countries in the world. But only China has it all - land mass, large population, natural resources, and most important of infrastructure.
The interior of China still lacks investment and infrastructure but the government is addressing this weakness ith major planned investments. Many predicted that China's economy will suffer the "post Olympics blues", and to some extent the stock market seemed to bear this out as it has retreated 60% from the October 2007 peak. However, this is due more to the sentiment and cpncerns about the subprime crisis in the US.
Many countries do suffer slowdowns in their economies after hosting the Olympics because so much has been spent on the required facilites. China spent US$42 billion over the past 6 years on Olympics related projects. However, this represents only 0.5% of the RMB51 trillion spent on fixed assets investments over the same period of time. Travel up and down the coastal region and you can see the results of this investment in infrastrucutre. Over the next 2 years, China has budgeted over RMB400 billion per year (ie the equivalent of the total spending on Olympics each year) for infrastrucure developments with much of the it aimed at the interior.
Can China afford it? You bet! the Chinese foreign currency reserves have just hit US$1.906 billion as of the end of September 2008 rising from US$1.809 trillion in August 2008. China has had fiscal surpluses since the 1985, and expect the surplus this year to to be RMB600 billion (US$87 billion). It is growing at the rate of 30% in the first 8 months of 2008.
China has room to stimulate growth. While the US was gorging on easy credit, China had raised lending interest rates 8 times since April 2006, raised deposit interest rates 6 times since August 2006, and raised banks' reserve requirements 18 times since July 2006 17.5% of deposits. In September 2008, China announced limited cuts to the lending rate of 0.27% to 7.2%, deposit rate cut to 4.14%, and cut reserve requirements to 16.5% for smaller banks to encourage them to lend to SME's (small, medium enterprises). On 8 October 2008, China announced across the board cuts to reduce lending rates to 6.93%, deposit rates to 3.87%, and reserve ratios to 17%.
Over the next 12 months, we can expect to see further cuts to the interest rates and reserve ratios as China stimulates the domestic economy to make up for any shortfalls from reduced exports to US and Europe.
China will celebrate its' 60th Anniversary on 1 October 2009, and we can expect it to put on a big birthday party!
Just How Much Is US$700 Billion?
Actually, not a lot as it represents only about 5% of GDP. By way of compariosn, Germany's rescus package of US$400-536 billion is 12-16% of GDP, and the UK's package of US$835 billion is 30%. Russia's package is 10% of its' GDP.
Can the US afford to add to the national debt? We were all treated to the news media's hysteria about there being not enough digits to show the new national debt. To put this in perspective, the total debt (including the package) is 62% of GDP, while the corresponding figures for the Eurozone is 75%, and Japan a whopping 180% of GDP.
More worrying is whether the US consumer can make it through the coming economic slowdown. In 1986, US household debt anounted to 80% of disposable income, growing to 100% by 2000, and 140% in 2007. US households do not have any savings to speak of, with many treating the built up equity in their homes as their savings which they have tapped regularly as housing prices moved up. Now that housing prices have fallen, many will be faced with diminhed savings and even calls from their banks to repay home equity lines. With money already spent or invested in additional real estate, the prospects are not good.
Bankers are now worried that the next crisis will be in consumer credit such as uncollectible credit card debts.
Can the US afford to add to the national debt? We were all treated to the news media's hysteria about there being not enough digits to show the new national debt. To put this in perspective, the total debt (including the package) is 62% of GDP, while the corresponding figures for the Eurozone is 75%, and Japan a whopping 180% of GDP.
More worrying is whether the US consumer can make it through the coming economic slowdown. In 1986, US household debt anounted to 80% of disposable income, growing to 100% by 2000, and 140% in 2007. US households do not have any savings to speak of, with many treating the built up equity in their homes as their savings which they have tapped regularly as housing prices moved up. Now that housing prices have fallen, many will be faced with diminhed savings and even calls from their banks to repay home equity lines. With money already spent or invested in additional real estate, the prospects are not good.
Bankers are now worried that the next crisis will be in consumer credit such as uncollectible credit card debts.
Thursday, October 09, 2008
Black Wednesday --- Interest Rate Cuts
Stock markets around the world fell as the credit crisis reduced confidence in the banking system leading to questions about the economic prospects with many economists forecasting recession and some even likening the current to the 1929 depression.
For the record, there are a number of similarities in how the crisis came about. No, they did not have sub prime and Alt A mortgages, and they did not have CDO's back then. But what they did have was a period of easy credit. The major difference between then and now is that our central bankers have learned their lessons and have intervened massively. Back then, the US government believed that government should not intervene in the market and kept this up until 1933.
Some may argue that the intervention came too late. Would it have been better to start intervening in 2007 when it became apparent that sub prime mortgages are being defaulted on? I guess we will never know. Still, better late than never.
The Hang Seng Index fell 8% to below 16,000 for the first time in 3 years. The HKMA cut interbank interest rate by 1.5% to 2%. The discount rate is 2.5% which is below the Hibor. In effect the HKMA and other central banks are acting a intermediaries to the banking system Banks with surplus funds are reluctant to lend to other banks and prefer to place the funds with the HKMA which then re-lends to banks needing short term funding.
Yesterday, the China announced that from today interest rates will be cut by 0.27% with lending rate at 6.93% and deposit rate at 3.87% (that's a spread of 3.06%, not bad if you can get it). At the same time, all banks will have their reserves requirements cut by 0.5% to 17% meaning that they will be able to lend more.
Some analysts on the mainland are negative on bank stocks because they believe that by cutting the lending rate this will cut into the banks profitability. Wrong! For banks, the most important drivers of profitability are the spread (i.e. the difference between the deposit rate it pays to depositors and the rate at which it lends to the borrowers) and the reserve requirement (i.e. how much they can lend out). As long as they maintain their spread, they will make more profits by lending more.
In fact, during periods of high interest rates, banks are actually less profitable because borrowers shy away from paying the high rates unless they are desperate (and therefore may be bad credit risks). Bad debts tend to rise when interest rates are high. So, low interest rates are good for the banks. Borrowers are more willing to borrow, investments make more sense because of the lower costs, and failure to repay is less.
By the way, China Construction Bank announced that 98% of their busines is in China and therefore their direct exposure to the credit crisis is limited.
For the record, there are a number of similarities in how the crisis came about. No, they did not have sub prime and Alt A mortgages, and they did not have CDO's back then. But what they did have was a period of easy credit. The major difference between then and now is that our central bankers have learned their lessons and have intervened massively. Back then, the US government believed that government should not intervene in the market and kept this up until 1933.
Some may argue that the intervention came too late. Would it have been better to start intervening in 2007 when it became apparent that sub prime mortgages are being defaulted on? I guess we will never know. Still, better late than never.
The Hang Seng Index fell 8% to below 16,000 for the first time in 3 years. The HKMA cut interbank interest rate by 1.5% to 2%. The discount rate is 2.5% which is below the Hibor. In effect the HKMA and other central banks are acting a intermediaries to the banking system Banks with surplus funds are reluctant to lend to other banks and prefer to place the funds with the HKMA which then re-lends to banks needing short term funding.
Yesterday, the China announced that from today interest rates will be cut by 0.27% with lending rate at 6.93% and deposit rate at 3.87% (that's a spread of 3.06%, not bad if you can get it). At the same time, all banks will have their reserves requirements cut by 0.5% to 17% meaning that they will be able to lend more.
Some analysts on the mainland are negative on bank stocks because they believe that by cutting the lending rate this will cut into the banks profitability. Wrong! For banks, the most important drivers of profitability are the spread (i.e. the difference between the deposit rate it pays to depositors and the rate at which it lends to the borrowers) and the reserve requirement (i.e. how much they can lend out). As long as they maintain their spread, they will make more profits by lending more.
In fact, during periods of high interest rates, banks are actually less profitable because borrowers shy away from paying the high rates unless they are desperate (and therefore may be bad credit risks). Bad debts tend to rise when interest rates are high. So, low interest rates are good for the banks. Borrowers are more willing to borrow, investments make more sense because of the lower costs, and failure to repay is less.
By the way, China Construction Bank announced that 98% of their busines is in China and therefore their direct exposure to the credit crisis is limited.
Monday, October 06, 2008
Another One Bites The Dust!
How appropriate! The Queens hit really hits the nail on the head. Over the past 2 weeks, we saw the demise of the "investment banking" business model.
Bear Stearns was acquired by JP Morgan, Lehman Brothers filed for bankruptcy protection under Chapter 11, Merrill Lynch was driven into the arms of Bank of America in a "shot gun" marriage, and Goldman Sachs and Morgan Stanley sought the protection of the Fed by applying for and being granted status as a "commercial bank".
Let's get something straight. These were never banks in the common useage of the word. They were merely securities dealers who grew too big and decided that that they needed a more exalted name. Banks usually take deposits from consumers and make loans. The so-called "investment banks" took no deposits, instead borrowing from banks and big investors through various vehicles such as bonds and "repo" agreements.
What does the change in status mean?
First of a;ll they will now come under the supervision of the banking regulators and will be able to access the Fed's discount window. Most important of all, as a bank they will be able to designate certain securities as "long term" holdings and therefore can value them at cost (less impairment) and not mark-to-market (and take the hit in their income statements).
What's the downside?
As securities dealers, they were not covered by the FDIC, nor were they regulated or supervised by the banking regulators. They will now be required to file financial returns to the banking regulators and maintain commercial bank reserves. Lehman Brothers was infamously geared at 35 times capital ie their borrowing are 35 times their paid up capital. Lehman owed US$613 billion as of 31 May 2008.
Commercial banks are required to maintain capital reserves of at least 8%. In China the China Banking Regulatory Commission (CBRC) requires commercial banks to have 16.5% reserves. HK securities dealers are required to have $40 of capital for every $100 they lend to clients for margin purchases.
"Investment banking" will never be the same again. The Glass Steagal Act forced banks to spin off their securities dealing arms in 1933, and regulation fell to the SEC which must shoulder a good part of the blame for not properly supervising the "investment banks" and their toxic products. Admittedly, it is difficult for supervisors earning US$80,000 a year to debate complex products with "investment bankers" earning tens of millions of dollars in bonuses.
The current agruments about "naked short selling" is a case in point. In HK, only certain stocks with sufficient market capitalisation are eligible for short selling. And, you can only "short sell" if you have already borrowed the stock before hand. If settlement is not effected on T+2 ie 2 days after the trade day, the seller is subject to "buy-in" at the then market and will be penalised. Borrowers will also be required to post and maintain a margin with the lender (usually around 105% of the market price).
In the US, sellers do not need to have borrowed the stock before the sale and therefore they do not need to post any margin unless the price goes up, and then only for any price difference. Thus, the number of shares that are sold short may be many times the number of shares available.
In HK, we learnt our lesson during the Asian Financial Crisis and have tightened the rules to ensure settlement on T+2 so that it is not possible to maintain open "naked short" positions for more than 2 days. Also, "short selling" must be disclosed.
I can remember Christopher Cox saying that the US is the "gold standard" in regulations and supervision when he took office as SEC chairman. I wonder if anyone still believes him. The performance of the Bernanke, Paulson ands Cox before the House says a lot. Bernanke was studious as a professor (which he was), Paulson was selling the package like the "investment banker" that he still is. Cox was totally out of his depth. I would not be surprised if he is replaced soon by someone who actually knows how the market works.
Bear Stearns was acquired by JP Morgan, Lehman Brothers filed for bankruptcy protection under Chapter 11, Merrill Lynch was driven into the arms of Bank of America in a "shot gun" marriage, and Goldman Sachs and Morgan Stanley sought the protection of the Fed by applying for and being granted status as a "commercial bank".
Let's get something straight. These were never banks in the common useage of the word. They were merely securities dealers who grew too big and decided that that they needed a more exalted name. Banks usually take deposits from consumers and make loans. The so-called "investment banks" took no deposits, instead borrowing from banks and big investors through various vehicles such as bonds and "repo" agreements.
What does the change in status mean?
First of a;ll they will now come under the supervision of the banking regulators and will be able to access the Fed's discount window. Most important of all, as a bank they will be able to designate certain securities as "long term" holdings and therefore can value them at cost (less impairment) and not mark-to-market (and take the hit in their income statements).
What's the downside?
As securities dealers, they were not covered by the FDIC, nor were they regulated or supervised by the banking regulators. They will now be required to file financial returns to the banking regulators and maintain commercial bank reserves. Lehman Brothers was infamously geared at 35 times capital ie their borrowing are 35 times their paid up capital. Lehman owed US$613 billion as of 31 May 2008.
Commercial banks are required to maintain capital reserves of at least 8%. In China the China Banking Regulatory Commission (CBRC) requires commercial banks to have 16.5% reserves. HK securities dealers are required to have $40 of capital for every $100 they lend to clients for margin purchases.
"Investment banking" will never be the same again. The Glass Steagal Act forced banks to spin off their securities dealing arms in 1933, and regulation fell to the SEC which must shoulder a good part of the blame for not properly supervising the "investment banks" and their toxic products. Admittedly, it is difficult for supervisors earning US$80,000 a year to debate complex products with "investment bankers" earning tens of millions of dollars in bonuses.
The current agruments about "naked short selling" is a case in point. In HK, only certain stocks with sufficient market capitalisation are eligible for short selling. And, you can only "short sell" if you have already borrowed the stock before hand. If settlement is not effected on T+2 ie 2 days after the trade day, the seller is subject to "buy-in" at the then market and will be penalised. Borrowers will also be required to post and maintain a margin with the lender (usually around 105% of the market price).
In the US, sellers do not need to have borrowed the stock before the sale and therefore they do not need to post any margin unless the price goes up, and then only for any price difference. Thus, the number of shares that are sold short may be many times the number of shares available.
In HK, we learnt our lesson during the Asian Financial Crisis and have tightened the rules to ensure settlement on T+2 so that it is not possible to maintain open "naked short" positions for more than 2 days. Also, "short selling" must be disclosed.
I can remember Christopher Cox saying that the US is the "gold standard" in regulations and supervision when he took office as SEC chairman. I wonder if anyone still believes him. The performance of the Bernanke, Paulson ands Cox before the House says a lot. Bernanke was studious as a professor (which he was), Paulson was selling the package like the "investment banker" that he still is. Cox was totally out of his depth. I would not be surprised if he is replaced soon by someone who actually knows how the market works.
Thursday, October 02, 2008
And While We Wait ....
Don't You Just Love The US Political System?
The US Senate has passed the bailout plan with a few changes, and this will go back to the House of Representatives for a vote on Friday night US Time. While we sit and wait for the US political system to decide whether to turn the life support system on or off, let's consider what happened.
The Dow fell 777 points (or about 8%) on 29 September 2008 after the House rejected the original bailout plan. This wiped out US$1 trillion of market capitalisation or wealth. This of course does not include the subsequent (consequent?) falls in the rest of the world and the wealth that was destroyed as a result of that decision.
But I Use A Professional Fund Manager!
Fund managers are just starting to realise that their much vaunted "asset allocation" models just do not work. Actually, they only ever worked in their own minds, and never did in reality. The world markets are so interlinked that they all fell (and sometimes rose, albeit not too frequently in the past few months) at the same time. Geographic allocations did not work, industry diversification did not work. Portfolio theory did not work. Why are we paying the fund managers to manage our money with their fancy theories and strategies if they cannot stay out of trouble any better than you or me?
The Chinese have a saying which goes, "When the tide rises, so does the ship". Conversely, when the tide falls, so does the ship. In other words it is easy to be a star when all markets are going up.
So What Is This De-leveraging?
Between 1980 and 2007, US household debt rose from 50% of GDP to 100%. At the same time, US financial sector debt rose from 21% to 116%. Everyone now knows that Lehman was leveraged at 35 to 1 i.e. it uses 1 dollar of capital and borrowed 35. Securities companies in HKG have to have $40 capital for every $100 lent out i.e. 1.5times leverage.
So Who's Minding The Store?
Well, it is obvious that Christopher Cox and the SEC were not. Because if they were, you would not have have Enron and WorldCom, and now Bear Stearns and Lehman. I can remembers when Christopher Cox became Chairman of the SEC, he was asked why Chinese companies chose HKG for their listing instead of NYSE. He answer was classic Western arrogance ... because the US is the GOLD STANDARD of regulations and companies that choose not to list in the US are engaging in regulatory arbitrage. That is a barely polite way of saying that HK not not properly regulated.
HK has remained relatively untouched by the sub prime mess. This is because we lived through the Asian Financial Crisis, the Dotcom Bubble, the Bird Flu Crisis, and the SARS Crisis. It seems that we went from one crisis to another after the handover of HKG by the British back to the Chinese in 1997. Maybe the fortune tellers were right after all, the handover did bring many crisis although they were unrelated to the change in sovereignty.
Anyway, we learnt from each and put in place appropriate measures to make sure that the problems doe not recur. An appropriate example, is the handling of short selling. Only certain stocks which are deemed to have sufficient liquidity are eligible for short selling, and short sellers have to have already borrowed the stock before they actually short sell. Sellers who are unable to deliver the stock they sold on settlement date (in HKG it is T+2) while be subject to buy-in by a broker nominated by the clearing house. At the very least, the short seller will be hit with additional brokerage and other charges, plus a penalty. If the market has moved up since the short sell, the seller will also incur a loss on the difference.
"Naked short selling" and delayed settlement means that short sellers do not incur the costs of borrowing the stock (with margins of 105% of the price and the need to post margin if the stock moves up. Of course, they object to the banning of "naked short selling".
China and HKG
The Shanghai index has fallen by over 60% from over 6,000 to as low as 1,800. Meanwhile, HK's Hang Seng Index has faller from 31,000 to as low as 16,000 intra day before reversing course to close flat. The "spike down" to 16,000 occurred twice and this appears to be the support level.
Separately, many shares which were listed over the past 2 years are trading at or near their IPO prices. This creates a problem for the Chinese authorities, as the major banks, insurance companies, and social security fund invested heavily in the IPO's of SOE's (state owned enterprises). Below this level, they will have take write downs and begin the downward spiral that we are now seeing in the US.
The Chinese government appears to understand this and has started making moves to limit the effect of the US slowdown. It had just cut interest rates after raising them since 2006 and also reduced banks reserve requirements to stimulate the economy. It is rumoured that an amount equivalent to the Olympics related spending of US$42 billion (which was spread over the 6 years of preparations) will be spent in the coming 2 years on infrastructure which will give the economy a boost after the clampdown over the past 12 months.
The Chinese has learnt that intervention must be quick and must early before the problem becomes intractable. It is easy to take the high moral ground when you are not feeling the pain. Asian governments were lectured on the evils of government intervention during the Asian Financial Crisis, and HK was pilloried for daring to intervene in the stock market to see off the hedge fund speculators who were using it as proxy for shorting the HK dollar. Now that the shoe's on the other foot, "how does it feel?"
I am waiting with bated breathe for the vote. Let's hope that US politicians can stop their posturing and selfish views for long enough to do the right thing!
The US Senate has passed the bailout plan with a few changes, and this will go back to the House of Representatives for a vote on Friday night US Time. While we sit and wait for the US political system to decide whether to turn the life support system on or off, let's consider what happened.
The Dow fell 777 points (or about 8%) on 29 September 2008 after the House rejected the original bailout plan. This wiped out US$1 trillion of market capitalisation or wealth. This of course does not include the subsequent (consequent?) falls in the rest of the world and the wealth that was destroyed as a result of that decision.
But I Use A Professional Fund Manager!
Fund managers are just starting to realise that their much vaunted "asset allocation" models just do not work. Actually, they only ever worked in their own minds, and never did in reality. The world markets are so interlinked that they all fell (and sometimes rose, albeit not too frequently in the past few months) at the same time. Geographic allocations did not work, industry diversification did not work. Portfolio theory did not work. Why are we paying the fund managers to manage our money with their fancy theories and strategies if they cannot stay out of trouble any better than you or me?
The Chinese have a saying which goes, "When the tide rises, so does the ship". Conversely, when the tide falls, so does the ship. In other words it is easy to be a star when all markets are going up.
So What Is This De-leveraging?
Between 1980 and 2007, US household debt rose from 50% of GDP to 100%. At the same time, US financial sector debt rose from 21% to 116%. Everyone now knows that Lehman was leveraged at 35 to 1 i.e. it uses 1 dollar of capital and borrowed 35. Securities companies in HKG have to have $40 capital for every $100 lent out i.e. 1.5times leverage.
So Who's Minding The Store?
Well, it is obvious that Christopher Cox and the SEC were not. Because if they were, you would not have have Enron and WorldCom, and now Bear Stearns and Lehman. I can remembers when Christopher Cox became Chairman of the SEC, he was asked why Chinese companies chose HKG for their listing instead of NYSE. He answer was classic Western arrogance ... because the US is the GOLD STANDARD of regulations and companies that choose not to list in the US are engaging in regulatory arbitrage. That is a barely polite way of saying that HK not not properly regulated.
HK has remained relatively untouched by the sub prime mess. This is because we lived through the Asian Financial Crisis, the Dotcom Bubble, the Bird Flu Crisis, and the SARS Crisis. It seems that we went from one crisis to another after the handover of HKG by the British back to the Chinese in 1997. Maybe the fortune tellers were right after all, the handover did bring many crisis although they were unrelated to the change in sovereignty.
Anyway, we learnt from each and put in place appropriate measures to make sure that the problems doe not recur. An appropriate example, is the handling of short selling. Only certain stocks which are deemed to have sufficient liquidity are eligible for short selling, and short sellers have to have already borrowed the stock before they actually short sell. Sellers who are unable to deliver the stock they sold on settlement date (in HKG it is T+2) while be subject to buy-in by a broker nominated by the clearing house. At the very least, the short seller will be hit with additional brokerage and other charges, plus a penalty. If the market has moved up since the short sell, the seller will also incur a loss on the difference.
"Naked short selling" and delayed settlement means that short sellers do not incur the costs of borrowing the stock (with margins of 105% of the price and the need to post margin if the stock moves up. Of course, they object to the banning of "naked short selling".
China and HKG
The Shanghai index has fallen by over 60% from over 6,000 to as low as 1,800. Meanwhile, HK's Hang Seng Index has faller from 31,000 to as low as 16,000 intra day before reversing course to close flat. The "spike down" to 16,000 occurred twice and this appears to be the support level.
Separately, many shares which were listed over the past 2 years are trading at or near their IPO prices. This creates a problem for the Chinese authorities, as the major banks, insurance companies, and social security fund invested heavily in the IPO's of SOE's (state owned enterprises). Below this level, they will have take write downs and begin the downward spiral that we are now seeing in the US.
The Chinese government appears to understand this and has started making moves to limit the effect of the US slowdown. It had just cut interest rates after raising them since 2006 and also reduced banks reserve requirements to stimulate the economy. It is rumoured that an amount equivalent to the Olympics related spending of US$42 billion (which was spread over the 6 years of preparations) will be spent in the coming 2 years on infrastructure which will give the economy a boost after the clampdown over the past 12 months.
The Chinese has learnt that intervention must be quick and must early before the problem becomes intractable. It is easy to take the high moral ground when you are not feeling the pain. Asian governments were lectured on the evils of government intervention during the Asian Financial Crisis, and HK was pilloried for daring to intervene in the stock market to see off the hedge fund speculators who were using it as proxy for shorting the HK dollar. Now that the shoe's on the other foot, "how does it feel?"
I am waiting with bated breathe for the vote. Let's hope that US politicians can stop their posturing and selfish views for long enough to do the right thing!
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