March 2009 Archives

TALF in action

By Kyle Napierkowski on March 22, 2009 8:20 PM | No Comments | No TrackBacks

It looks like I have a good chance of seeing TALF 2.0 in action this week. The program is a beautiful work of art in that it disguises a very basic subsidy for the banking industry using the veil of a complex "public-private partnership" arrangement. I'll hopefully be watching an asset management firm in action this week as they purchase these securities with a small amount of cash down, the remaining value made up of loans from taxpayers. This comment from a Naked Capitalism entry sums up the situation pretty well:

The Geithner plan is a scam designed to allow the investor to bid for the remaining coupon payments and leave the taxpayer holding all the losses. The key to the scam is the high leverage ratio COMBINED with a non-recourse loan:

Investor buys a CDO tranche at 50 cents on the dollar that is currently paying a 5% coupon. The investor puts up 20% and the govt provides the remaining 80% via a non-recourse loan. This highly leveraged CDO tranche will stay current on the coupon payments for 3 years and then default with zero residual value.

The end result is that the investor who pays 10 cents(20% X 50 cent bid) ends up walking away with 15 cents(.05 X 3) over three years and the government ends up losing the entire 40 cents of non-recourse financing. (Note that I haven't included the cost of the low interest financing, nor used present value discounting in order to simplify the point I'm trying to make.)

The beauty of the scam is that the losses on the govt's books won't show up for 3 years.

More details in Yves Smith's article here.

Brazil trip recap

By Kyle Napierkowski on March 18, 2009 5:46 PM | 1 Comment | No TrackBacks

For the past week and a half I've been in Brazil, first to São Paulo and then to Rio. Along with 35 other MBA, MSM, and MAcc students from Case, I explored a number of companies in very different industries, getting a good feel for the country's current economic climate and how business differs from the U.S. As you may guess, the trip was a blast and involved plenty of dancing, eating, and downing caiperenas (the traditional Brazilian drink made with sugar cane liquor and an excessive amount of sugar...), but in addition, I learned so much about the economy and wanted to share.

In order of our visits, the organizations we met with included:

Tekoha - a startup business that buys handcrafts from rural Brazil and sells them into the cities
Grupo Orsa - one of the largest paper products companies in Brazil; owns land in the Amazon the size of Connecticut and is recognized by environmental organizations as a green/sustainable logger.
Sherwin-Williams - with a strong tie to Cleveland and Case, Sherwin-Williams hosted our group in their Sao Paulo paint production site. The location sells to the South America region, mostly Brazil.
Developers Diversified Realty - the Cleveland company founded by Scott Wolstein has just entered the Brazilian shopping center market through a joint venture with a Brazilian development firm. We toured one of their shopping centers and heard from the operations manager, executives from Sonae Sierra (their Brazilian partner), and the DDR liaison who communicates back with headquarters.
Petrobras - The third largest company in the Americas, formerly the monopoly oil company in Brazil, and now the largest oil producer in their competitive market. The firm was partially privatized 10 years ago, with the government still holding 55% voting power of the $100 billion company.
Banco Central do Brasil - Brazil's central bank, operationally but not organizationally autonomous from the national government.
O Globo - the largest newspaper in Brazil, provided us with a presentation and tour of their production facility in Rio.

My major conclusion from the visits is that Brazil stands better positioned to weather the financial storm than any other country I've recently studied. While poverty still remains an issue, the country has a growing middle class that lacks the attitude of entitlement present in the U.S. I didn't realize the vast amount of resources Brazil has access to, including the highest amount of undeveloped arable land in the world and substantial oil reserves, nor the self-sufficiency of the economy. Real estate prices have not been impacted at all, and banks remain well capitalized, well above capital limits imposed by Basel. Lower prices are impacting manufacturers, but overall the economy continues to grow.

How has the economy fared so well? As a finance guy, the most important policy-related takeaway from the trip was Brazil's treatment of interest expense. Consumers receive absolutely zero tax breaks from mortgage payments, and companies cannot deduct interest expense from their Brazilian taxes. This may seem mundane at first, but think of the massive impact such a small policy change would have on the U.S. economy. We have too much debt, yet we subsidize debt over equity... it should be the opposite!

Another important financial highlight: banks are required to keep Collateralized Debt Oligations on their books for the purpose of measuring capitalization. While I do not know the specifics of the regulation, our presenter at the BCB, Renato Rosek, emphasized how this policy has protected the Brazilian financial system from the problems U.S. banks have experienced. It's a topic I will be looking at in more detail in the near future.

Green and sustainable development seems to be much more present in Brazil than in the U.S. Although we did look specifically for sustainable companies due to the importance of Case's sustainability MBA program, even the companies that were unrelated seemed to stress their environmental and social commitments. Petrobras and Grupo Orsa, two companies whose operations one would expect could be very damaging to the environment, demonstrated these commitments through specific programs, extra R&D spending on environmental issues, and donations to nonprofit organizations. More specifically, Grupo Orsa donates 1% of gross revenues to their non-profit arm, Fundação Orsa.

I was amused by our first visit, Tekoha. The entrepreneur who spoke to us spent one year as an investment banking analyst at JP Morgan before deciding that he needed more meaning in his work and left to start several companies. Certainly his story was a reflection of my own, a South American reaffirmation of my plans and decisions.

"Why the Meltdown Should Have Surprised No One"

By Kyle Napierkowski on March 18, 2009 5:26 PM | No Comments | No TrackBacks

After a long hiatus from posting, I'm back to bring you a (lengthy) lecture by Peter Schiff over at EuroPac. In the lecture, Schiff talks about the root of our economic crisis and the poor policies we've undertaken to address the crisis.

Since the talk is over an hour in length, here are the main points I picked up:

On risky banking activity: nobody cares about what banks do with their deposits as a result of FDIC insurance. The most important decisions of banks are how to invest deposits, yet competition no longer pushes banks to be more conservative when making these decisions. Were depositors to worry about whether or not their savings would be lost, every consumer would scrutinize banks. We could expect to see one or several "Consumer Reports"-type services for the banking industry, exposing the risky activities of bad banks and preventing a crisis of this magnitude from occuring

On the sub-prime market: Fannie and Freddie were the largest buyers of sub-prime mortgage assets, even though they did not originate them. While we are talking about more regulation for the private banks, Fannie and Freddie needed more regulation as a result of their implicit government guarantee. Instead, the companies were sheltered from this regulation, no doubt thanks to huge cash contributions to politicians in both major parties.

On our treasury secretary: Let's get rid of Geithner and appoint Bernie Madoff. He's good at all the things we're doing with our economy right now.

Stocks: still expensive on a historical basis, judging from high P/E's and low dividend yields. While I'm not sure I agree with Schiff's love of international equities in a mid-term basis, it is pretty clear that U.S. markets still have a ways to drop, especially with the uncertainty and inevitable slowdown related to the stimulus plan.

Monetary & fiscal policy: If you liked Bush/Greenspan, you'll love Obama/Bernanke. The same broad policies are being enacted now as they were in the Bush administration. We need high interest rates and deflated real estate prices to cleanse the economy, but the Obama/Bernanke approach is to provide exactly the opposite.

Inflation effects: Schiff expects price controls on energy, gas, and consumer staples to likely occur before the end of Obama's first term in office.

Historical comparisons: Bush is the modern day Hoover, vilified for being pro-market even when he took largely big-government, interventionist approaches to solving the crisis. Obama is the modern day Roosevelt, criticizing Bush's policies while simply expanding them.

Near the end of his presentation, Schiff made the remark that "we are not the engine of the world economy. We are the caboose." I respectfully disagree. Our markets, institutions, and relationships control the flow of capital throughout the world. We are not the engine, we are the conductor. What with the world's governments cooperating to maintain the financial status quo, it appears that only a massive geopolitical event will really be able to change this.

Continue reading "Why the Meltdown Should Have Surprised No One".

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March 2009 Archives

TALF in action

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"Why the Meltdown Should Have Surprised No One"

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