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!