Book Review : The Trillion Dollar Meltdown

I just finished Charles Morris's The Trillion Dollar Meltdown which was published in January 2008. Since the book is based on an area of professional interest, I think it deserves a detailed review and not just an update.

Morris' book was one of the first texts on financial crisis to come to the market. In less than 200 pages the book covers a huge breadth of topics. Starting from the precedents and history of the recessions during the Lyndon & Reagan presidencies, it goes on to talk about the previous market crashes caused by portfolio insurance & the failure of Long Term Capital Management. He describes the current crisis starting of course from the usual CDO's and derivatives, predatory lending practices including the NINJNA (No Income, No Job, No Asset) loans, the cascading effects of high leverage at hedge funds and other financial institutions and the roles of  the raters, insurers and government bond market. He reconfirms my view that loose monetary policy at the time of Alan Greenspan was one of the leading causes of the crises. (Read my previous post here). Morris strongly approves Paul Volker's handling of the problem in 80's. But what really impressed me about the book is that it covers to the global distribution of money, trade deficits &surpluses and also reserves in countries like China, Russia & in the middle-east. By including the power of sovereign wealth fund of these countries and the recent academic debate about China's savings rate & currency valuations, the authors covers the issue from both domestic & international angles. Any review of the book must take into account that Morris was forecasting the future & not analyzing events.

But there are some drawbacks of packing too much into so few pages and shipping the first book and at some places it misses depth. But for a bird's eye of how thing went wrong and where, The Trillion Dollar Meltdown is great book. In fact I definitely recommend it for any bookshelf. Coming from the other side of the table, Morris sees huge limitations of free markets in cleaning up the current mess. According to him the only immediate option America had was to deleverage (and hopefully in an orderly fashion or things would turn really bad). With the benefit of hindsight, here is a passage from the book

The recent woes of the dollar are important for our story because they effectively take the Fed off the board. As credit crunch works its way through banks and investment funds over the next year or so, there will be no soothing fountains of new dollars coming out of Washington. The days of a universal put to the Federal Reserve are finally over.

Clearly even the best of people did not anticipate how many dollars the Federal Reserve and the government would be willing to print. Here are author's views about the $800 TARP in an interview in October 2008.

Book Update: Right now am reading 'The World is Flat' and 'Eat, Love Pray'.

Credit Bubble in a Slum ?

Far away from the credit boom of USA from 2004 - 2007, both in distance and in time.

A front page article in the Wall Street Journal states that the micro-finance push maybe creating a credit bubble in India. What started as a social initiative, caught the eyes of investors due to higher returns. Micro-finance loans have interest loans to the tune of 24% - 39% and are generally given to women (more than 90%) who are supposed to be better repayers. Apparently the RBI (Reserve Bank of India) does not regulate interest rates in this market except for advising organizations not to charge too high rates.

Today the number of lenders offering micro-finance has jumped almost 400% from 50 in 2004 to more than 200 in 2008. NBFC (Non Banking Financial Companies) have entered the fray. The loaned amount has grown from less than 0.5 million to 2.4 million. As a result, atleast in some towns and villages there are too many lenders are chasing few good borrowers and - funds loaned for starting business are being used to buy TVs or spent on marriages. Apparently in some over-crowded markets - lending practices are lax; it is often difficult for lenders to cross-check with each other or to verify the utlisation of funds. I just hope the stories of Ramanagram are not being repreated across the country.

This is not to the say that the credit needs to Rural India are being met. Rural Indian economy has very few sources of funds and an even lesser understanding of financial products. I know this by virtue spending an year scaling my organization's distribution beyond metros. It will be really unfortunate if poor lending practices deprive the region and the people their chance for development.

The article published on August 13, 2009 written by Ketaki Gokhale is titled - A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum. You can read it at the WSJ website, but a subscription is needed

Lessons from Jim Rogers' life - a gift to us & US

Take a guess as to which country is being mentioned in the following paragraph.

The country X enjoyed a huge bubble in the _____. When it burst in _____, prices collapsed, sending the economy tumbling. Regrettably, the government and the 'central bank of the country X' kept trying to halt the natural, cleansing effects of this recession by propping up many of the companies in trouble. Just as a forest fire serves to clear out deadwood and underbrush so that the forest can renew itself, recessions help to ensure healthy future growth. In 'the country X' , the business that should have been liquidated became "zombie companies" surviving, albeit barely, on government's artificial support. Everything was Band-Aided with quick fixes. While this delayed a decline, it also postponed the country's recovery. A country can actually spend more money trying to stave of a recession than the recession might cost.

You probably think that I am talking about USA. However this is a passage describing 'the lost decade' of Japan by Jim Rogers. Though Jim mentions in passing that America followed the same route in 1970's, he might as well be presaging what may be coming ahead, considering the way the American debt & fiscal deficit has ballooned. To use a cliche, "History repeats itself." As Jim mentions, a country can spend more money trying to avoid a recession than the recession might itself cost. Sounds even more familiar. After all, only last week the Fed chairman Ben Bernanke pointed out that US needs to control is spending & deficits. Of course he did not talk about the fact the balance sheet of the fed itself has been increasing in size as it has been buying just about anything - mortgage backed securities, corporate debt and the T-Bills issued every few days by the US government.

But, lets come back to Jim Rogers, the guy who made enough money to retire at the age of 37. The book in question, " A Gift to My Children - A Father's Lesson for Life and Investing," is packed with knowledge and wisdom. In his own words,
the book is different from his earlier books in the sense that its about the larger lessons distilled from his experiences. Lessons about thinking for yourself, using common sense, learning history, philosophy and languages and making the world a part of your perspective. Lessons, which we all could use. In less than 100 pages Jim packs lessons that can use at all stages of your life and earlier you learn these lessons, the more you can get from them.

As a aside note, according to Jim, 21st century belongs to China. He does not like India and Russia as investment options. So much so that he has moved to Hongkong & is making sure that his two daughters know Mandarin.

Money for free

Today the 'Bernanke helicopter' seems to have landed into uncharted territories. The chairman of Federal Bank who was expected to lower rates by 50 basis points actually reset it to 'ZERO'. Yes this is bizarre headline.  The fed chairman set the fed target rate from  zero to twenty-five basis points, effectively saying that banks will be able to borrow from fed at no price.  If this is not enough to make banks lend, he announced something more, that it will buy mortgage back securities from banks.  

The only other example in history of such low, or rather no interest rates is Japan. The example has not been successful. Money in USA now comes free. But think of this way, what if this does not work. Even if the cost of money is zero, no body wants it. There are two basic problems here

a) Even with money at no price, the banks don't want to lend it furthur. The balance sheets are so messed up that they need a clear head & some time to clean things up. Even in the case of America the previous cuts by the fed have not translated into lower interest rates for the end buyers. 

b) Then there is the gradual unwillingness to spend, the shaken confidence in the system with a lower number every week. Job cuts & threats of job cuts have taken the fun of holiday season and consumption other-wise.

On top of that all this actually reeks of the policy that actually built the bubble from 2002-2007. Isn't  this how the system built so much leverage in the first place. Years of administration policy providing people with easy money.America accounts for 60% of world's consumption and when the American consumer sneezes, no wonder the world catches a cold.  

But to put this in a perspective of time. Monetary policy moves generally take about two quarters (12 to 15 months is the accepted time frame) generally or more to play out. So the affect of these policy moves will be felt at the earliest only, in third quarter of 2009. But the stock markets have already given a thump up sign. The DJIA & S&P 500 & NASDAQ were all up more than 4%.

Another point here is where will fed get the money. Will it keep printing dollars, till it runs out of green ink, as one analyst said. What happens to the exchange rates then ? As of today the European Central bank & central bank of England have both stayed short of both what the Federal Bank has does done. No wonder the dollar fell against both currrencies.

Movie Update : 

'Gran Torino', (Clint Eastwood packs a so much straight forwardness , american-ness and intensity into this movie that even non-americans like me loved it). Read the new york times review here

Slumdog Millionaire  (A great movie, with amazing potraits of everyday life from India packed into a dramatic story) 

What could $ 700 bn do!

 $700 bn is only 14% of the $14 trillion of the Mortgage Debt out in the US market

A huge chunk of the problem is thus out in the open. With about $250 out to capitalise banks, there is not much of money left there. Money goes a long way & you can't really over emphasise the how far can $700,000,000,000 take the world. 

In America you could buy Universal Health Coverage & pay health insurance premiums for all US citizens for six years.

In Africa fight hunger and poverty for 10 years. They only need $72 bn every year in UN funding.

Pay salaries of 22 million american workers for an year.

Finance Germany's annual budget (@$ 420 bn) for more than an year or buy Denmark (GDP less than $350 bn), twice.

This and so many other things that can be done with $ 700 bn are here. But we will end up spending it to pay the price of the asset bubble that has gone burst.

Life is not fair afterall.

Are any assets classes worth anything anymore

Am trying to make sense of the events of the last few weeks. First the housing bubble burst - real estate was not worth too much anymore (specially if had bought anything in the last few years); then the real estate based securities - the CDO (Collateralised Debt Obligations) lost value ;  then the Stock market - not just companies that had anything to do with housing or related securities even all those which had nothing to do with them. Stocks as an asset class are not worth too much, nor are mutual funds. And then everything together, commodities , crude & Gold. Nothing seems to be worth anything anymore. Yes we all know cash is King,  the big problem, we are not too sure of the bank where we keep this cash anymore. 

If you are an ordinary citizen of the world, who is a little aware of financial planning & diversification of wealth into asset classes, the question is where do you keep networth, (whatever is left of it) to preserve it ? Not to mention the inflation rate back home in India has been in the 11- 12% for a while, meaning wealth has been eroding for those who have been cash heavy at a rate more than -10% every year.

The big question is knowing all this what am I going to do.  The answer precious nothing. I am planning to ride it out & wait for a financial scene, when the behaviour of people and hence assets is saner, something I can comprehend.

Global Financial Crisis : Coach Buffet, politicians & accounting

By the looks of it Warren Buffet is playing the role of saviour, an angel investor in quite a few big companies today. 

The Washington Post article compared Buffet to the man who saved the Wall Street in 1893 & 1907 & also loaned Gold to the US government, J P Morgan.  The world's richest man (Buffet) provided $ 3 billion as new capital to GE (now it strikes me GE was actually founded by JP Morgan) on ofcourse very sweet terms. He earlier showed his faith in Goldman Sachs. Interestingly the article also mentions the Buffet as the coach, guiding the US treasury secretary Henry 'Hank' Paulson. Buffet also backed the  $700 bn mentioning that it was such a great deal, he wants one percent of it, provided the troubled securities are bought at market price.

Think he puts 'the words' to assuage the concern and the take care the interest of ordinary tax payer. If you could convince (& ensure the corresponding action) that the troubled assets would be bought at right price, this proposed 'Bailout'-please-call-it-by-other-name actually becomes the great investment of 'American tax payer money'. All consequences of the 'bailouts-please-call-it-by-other-name then actually look good. Financial institutions are ready do business with each other and the with the consumers. Companies, banks & individuals are able to borrow money at reasonable rates for short periods (not at current levels which probably are the highest in decades). Government & taxpayer make money while we have liquity in this system. Lets face it we are used to faith & trust and the use of a currency. To think of going back to the barter system is just not possible.

This brings to me another of the much debated 'MTM'  rule.  Quite a few of politicians want me to believe that the 'mark to market rule' is the cause of all failure. That all problems of the world will go away if we pretended that they weren't there. Just ask financial institutions to showcase their assets through some tinted lens that makes them look healthier. If only we could make all of them sit in a Finance & Economy class. Ok its difficult to mark assets to market when there is no market but the fact of matter is an accounting 'fix' will furthur deepen the crisis of trust. It will send the institutions deeper into our current credit contraction because the balance sheets will be even farther from the truth than they are today.

As a matter of fact, financial institutions hold a lot of their assets for investment and hence do not mark them to market. The percentage varies for example in the case of failed Washington Mutual ,  75% of the assets were not marked to market. A WSJ article this morning analyses this well but the online content is only accessible through a subscription. Hence not posting here.

The Washington Post articles are here & here

Back home, there was a run on ICICI Bank's stock & the chairman KV Kamath, RBI , Indian finance minister quickly moved to control the damage after the stock fell 22% in one week to reach the price at which it issued equity almost three years ago. The interview by KV Kamath in Mint is here. ICICI BANK - Kamath sees agenda, says bank is safe

Books Update : 1984 by George Orwell 

The rescue all plan : Print more dollars or what ?

Have been following the US or rather now the global financial crisis closely. To lubricate the financial machinery US central bank and later others seem to have decided to provided the much needed oil, money. Am just wondering how much they think they can pump in and the medium long time effects. USA has the GDP of about a $14 trillion.

A US government decided to put its 'billions of dollars' as per the estimate of its Treasury Secretary on stake to take the risky illiquid assets off the balance sheets of Financial institutions.
The total cost of all the measures in last few weeks is expected to be dollar one trillion.

With a GDP of about $ 14 trillion with deficit of $500 bn which because of these and other measures would increase $650 billion in 2009. The bloomberg article with all the numbers.

I just hope they have a better plan to manage this than buying better and faster printing machines to print more dollars.

Here is funny stuff from the web

Businessweek article on how things would look on the first anniversary of the event with a real innovative idea on what to do about the unsold home inventory, pay people to destroy it for the next shooting Armageddon sequel :)

This shoe site for example has a page on US economy because 'someone has to educate the people in this corporate takeover of media' :)

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PS : Over with the book. Hannibal Lector is a real gentleman

Weekend Casualities : The Historical Credit Crisis

The Wall Street Journal headline this morning

Crisis on Wall Street as Lehman Totters, Merrill Is Sold, AIG Seeks to Raise Cash

For an investment banking firm thats more than 150 years old & survived the great depression that history in the making. Recording Lehman's history from its website, not sure how long the website would continue henceon,

All the material below has been taken from Lehman's official website here. The content is here just for record. And I guess another tab would be added on .

September 15, 2008
Lehman Brothers Holdings Inc. Announces It Intends to File Chapter 11 Bankruptcy Petition; No Other Lehman Brothers' U.S. Subsidiaries or Affiliates, Including Its Broker-Dealer and Investment Management Subsidiaries, Are Included in the Filing.

1840–1859
The history of Lehman Brothers parallels the growth of the United States and its energetic drive toward prosperity and international prominence. What would evolve into a global financial entity began as a general store in the American South. Henry Lehman, an immigrant from Germany, opened his small shop in the city of Montgomery, Alabama in 1844. Six years later, he was joined by brothers Emanuel and Mayer, and they named the business Lehman Brothers

1850
Henry, Emanuel and Mayer Lehman founded the Firm in Montgomery, Alabama.

1858
Cotton was the cash crop of the time, and the Lehmans accepted it from the local farmers as currency to settle accounts. The brothers traded the cotton for cash or merchandise, becoming brokers for buyers and sellers of the crop. In 1858, they opened an office in New York, which was the commodity trading center of the country.
Read more

1860–1869
The Civil War disrupted the Lehmans' business. When hostilities ended, the brothers moved north and concentrated their operations in New York, where they helped establish the Cotton Exchange.

The post-war period witnessed the rapid growth of railroads, sparking the transformation of the nation from an agrarian to an industrial economy. At the time, Lehman Brothers' future merger partner, Kuhn, Loeb, was underwriting much of the financing for railroad construction. Railroad bonds represented a significant advance in the development of capital markets. Their affordable price attracted a great number of individual investors and Lehman Brothers, recognizing a trend, expanded its commodities business to include the sale and trading of securities. The Firm also moved into the area of financial advisory, which provided the foundation for underwriting expertise.

1880–1889
During the vigorous economic expansion of the second half of the 19th century, Lehman Brothers broadened its expertise beyond commodities brokerage to merchant banking. Building a securities trading business, they became members of the New York Stock Exchange in 1887. Setting the stage for future global growth, Jacob Schiff, a Kuhn, Loeb partner, led the Firm to establish investment-banking relationships in Europe and Japan

1887
The Firm acquires a seat on the New York Stock Exchange

1889
Lehman Brothers underwrites its first stock offering

1900–1909
At the turn of the century, Lehman Brothers was a founding financier of emerging retailers, including Sears, Roebuck & Company, F.W. Woolworth Company, May Department Stores Company, Gimbel Brothers, Inc. and R.H. Macy & Company.

1920–1929
In the 1920s, Robert Lehman perceived dynamic changes occurring in the nation's economy, and focused the company on rapidly developing consumer industries such as retailing, airlines and communications. Lehman Brothers was a strong supporter of the entertainment sector and advised on the consolidation of major movie theater chains. Start-up ventures, including film studios RKO, Paramount and 20th Century Fox, benefited from financing arranged by the Firm. Triggered by the stock market crash of 1929, the Depression placed tremendous pressure on the availability of capital. Lehman Brothers was one of the pioneers of innovative financing techniques such as private placements, arranging loans between blue-chip borrowers and private lenders. These loans offered strict safeguards and solid returns for lenders, while enabling borrowers to raise much-needed capital

1929
The Lehman Corporation is created, a prominent closed-end investment company

1930–1939
The 1930s witnessed the explosive growth of radio and experimentation with a developing technology called television. Lehman Brothers underwrote the initial public offering for DuMont, the first television manufacturer, and helped fund the Radio Corporation of America, known as RCA. Beginning in the 1930s, the increasing demand for oil set off waves of wildcat drilling in search of the resource. Companies like Halliburton and Kerr-McGee relied on Lehman Brothers for capital to fund their activities

1940–1949
The end of World War II ignited an unprecedented era of prosperity, fueling the growth of consumer industries such as home appliances and auto manufacturing. Lehman Brothers became an important financial advisor and underwriter for many growing companies and established a number of long-term relationships that are still active today.

1949
The Firm establishes its 10 Uncommon Values® Portfolio

1950–1959
Economic expansion accelerated in the 1950s with the dawn of the Electronics Age, and Lehman Brothers arranged start-up financing for companies such as Litton Industries. The Firm also lent its expertise and advisory skills to Burlington Mills, Schenley Industries and American Export Lines.
This period was also the beginning of the computer era, and Lehman Brothers provided IPO underwriting for industry pioneer Digital Equipment. The Firm later arranged the acquisition of Digital by Compaq. The travel industry benefited from the sustained economic growth of the period, and Lehman Brothers sponsored the IPO of Hertz Rent-a-Car. The focus on transportation and travel continued into the 1960s, with Lehman Brothers advising Ford Motor Company, TWA, American Airlines and Continental Airlines.

1975
The Firm acquires Abraham & Co.

1980–1989
In the 1980s, Lehman Brothers played an important role in the dawn of the Information Age, helping fund such companies as Intel and new technology businesses of the period, which later became the leading players in the high-tech revolution. During the robust merger and acquisition activity of the 1980s, Lehman Brothers advised companies such as Chrysler, American Motors, General Foods, Philip Morris and Hoffman-LaRoche on expanding domestic and international operations. In the mid-1980s, breakthrough research in the life sciences introduced the biotech era, revolutionizing the healthcare industry. Lehman Brothers assisted a number of new businesses in obtaining the capital needed to fund research and development. A leading advisor to the healthcare sector, the Firm worked with major pharmaceutical companies during the international consolidation and globalization of the industry.

1984
American Express acquires Lehman Brothers and merges the Firm with Shearson.

1990–1999
American Express divested Shearson in 1993, and the independent Firm once again became known solely as Lehman Brothers

1994
The Firm becomes independent through a public stock offering and Lehman Brothers Holding Inc. common stock commences trading on the New York & Pacific stock exchanges. Lehman Brothers opens an office in Tel Aviv, Israel, building upon its long-term presence in that country. At this time, consumer-driven companies such as General Foods, Campbell Soup and Philip Morris turned to Lehman Brothers to help finance the growth necessary to satisfy burgeoning demand for their products.

1995
The Firm earns recognition as "Global Bond House of the Year" by International Finance Review.

1998
Lehman Brothers joins the S&P 500 Index and establishes its 10 Uncommon EuroValues portfolio

1999
Lehman Brothers establishes its first venture capital fund and celebrates the 50th year of its 10 Uncommon Values® portfolio. Lehman Brothers establishes an alliance with Bank of Tokyo-Mitsubishi for Japanese M&A.
The Firm passes the $1 billion mark in annual net income for the first time.

2000+
Lehman Brothers celebrates its 150th year anniversary. The Firm joins the S&P 100 Index and its stock price hits $100 for the first time. Lehman Brothers becomes the first firm to underwrite corporate debt on the Internet. The Firm launches LehmanLive®, a Web site that offers clients around the globe access to a vast array of services and proprietary information 24 hours a day.

2001
The Firm resumes fixed income trading two days after Sept. 11 and equity trading when U.S. markets open.
Lehman Brothers brings the first IPO, Given Imaging, to market after Sept. 11. The Firm buys 745 Seventh Ave. for its new global headquarters in Midtown Manhattan and purchases additional space in New York City and New Jersey. Lehman Brothers becomes a member of the Amsterdam Stock Exchange.

2002
Lehman Brothers moves into its new global headquarters in Midtown Manhattan. The Firm establishes the Wealth and Asset Management Division*. Lehman Brothers executes the largest financial services IPO in history for CIT Group, and the largest European leveraged buyout in history for KKR and Wendel Investissement. The Firm lead-manages the largest-ever U.S. dollar denominated debt issue for GECC.
Lehman Brothers acquires Lincoln Capital Management's fixed income business*. * In 2005, the Wealth and Asset Management Division was renamed the Investment Management Division and Lincoln Capital Fixed Income Management Company, LLC was renamed Lehman Brothers Asset Management LLC.

2003
Lehman Brothers acquires Neuberger Berman, positioning the Firm as an industry leader in the wealth and asset management business. The Firm moves to its new European headquarters at 25 Bank Street in Canary Wharf. Lehman Brothers acquires The Crossroads Group*, expanding the Firm's private equity fund investment management business. Moody's Investors Service raises the Firm's long-term credit rating to A1 and the LBI broker-dealer credit rating to Aa3, representing the third ratings upgrade in the last four years.
* In 2005, Lehman Crossroads Investment Advisers, LP (d/b/a The Crossroads Group) was renamed Lehman Brothers Private Fund Advisers, LP

2004
Lehman Brothers moves to its new Asia headquarters in Tokyo's Roppongi Hills. The Firm advises on two of the top five announced Mergers & Acquisitions transactions worldwide: Cingular Wireless' acquisition of AT&T Wireless Services; and Sprint's acquisition of Nextel Communications. Lehman Brothers executes the largest capital markets transaction in the history of the U.S. utility industry for Pacific Gas & Electric and the largest IPO globally in 2004 for Belgacom SA. The Firm posts record financial results, including best-ever net revenue, net income, and earnings per share. The Firm increases its dividend by 33%. Assets under management at the Firm's Investment Management Division rise to a record $137 billion.

2006
Lehman Brothers achieves record net revenues, net income and earnings per share for the third consecutive year based on record results across all business segments and regions. Ranks #1 in the Barron's 500 annual survey of corporate performance for the largest companies in the U.S. and Canada. #1 dealer on the London Stock Exchange by trading volume. Advises clients on the three largest global M&A deals announced in 2006: AT&T's acquisition of BellSouth; Gaz de France's merger with Suez* (pending); Endesa's defense mandate resulting from E.ON's takeover offer** (withdrawn). The Lehman Brothers Centre for Women in Business officially launches at the London Business School. All transactions appear as a matter of record only.Source: Thomson Financial, 1 Jan 2006 - 31 Dec 2006* Advisor to the Republic of France, Gaz de France's majority shareholder** Also acted as advisor to Endesa on a consortium's (Enel and Acciona) subsequent takeover offer in 2007

2007
Lehman Brothers ranks #1 "Most Admired Securities Firm" by Fortune. Achieves record net revenues, net income and earnings per common share (diluted) for the fourth consecutive year based on record results in all three business segments. Acts as financial advisor on largest-ever M&A transaction in financial institutions sector: $98 billion acquisition of ABN AMRO by a consortium of the Royal Bank of Scotland, Santander and Fortis.* #1 dealer on the London Stock Exchange by annual trading volume for the third year in a row.
Creates the Lehman Brothers Center for Global Finance and Economic Development at Spelman College, the #1 ranked institution among historically black colleges and universities by U.S. News & World Report.
Establishes the Council on Climate Change to bring together leaders from industry, policy and academia to facilitate constructive dialogue regarding climate change policy formulation and its impact on business.
*Financial advisor to ABN AMRO