Aamer Ghaffar's Blog

I thought I would share something on a lighter note with you all… Here in Illinois (IL), the sales tax is a whopping 10.25%, however, necessities such as food items are exempt and are taxed at a lower 2.5%.  In prior years, candy was taxed at 2.5%. However, under the new regulation (set to increase revenue for the state) Candy is now being classified as a non-food item and thus moving up to the 10.25% bracket. How does one differentiate food from candy? Simple, anything with flour is considered food. Therefore, according to this law Twix and Kit Kat are food items and jolly ranchers are candy. Since it is only a state law, I do not think there is going to be much of a reaction from candy manufacturers, unless this becomes a trend with other states.

I do not really have an opinion either way except for the fact that the new regulation disagrees with everything my mother ever told me (Chocolate is NOT food).  If only this law had been in place when I was younger…

On a side note, my heart goes out to all the super market staffers that are going to have to re-program the scanners to reflect the new tax as well as move out the ‘food’ from the candy section.

Politics, The Economy

Too much of anything is bad, and government regulation is no different. I have been asked time and again why I fear and dislike too much governmental intervention. Though I have written about this issue a lot, an example of a double-jointed pendulum provides a nice visual which provides an analogy to my reservations about nationalization: It is easy to anticipate the path of the pendulum when the joint is locked. However, when the joint is released the movement of the pendulum is totally unpredictable. This is a great visualization of chaos theory – where a small change causes a large amount of uncertainty. In short, the more complexity we add to the financial system, the more the unpredictability and randomness.

The current administration is trying its best to mitigate risk in the markets in order to prevent another financial meltdown of this magnitude from ever occurring again. However, I do not think that throwing money at the problem is a viable solution. The premise of a Capitalist economy is based on the survival of the fittest. However, the current president has been the complete opposite. Bailing out companies without requiring them to change their business plans (the initial auto bailout) or the new cash for clunkers deal (in which case if you bought a gas guzzler you get a $4000 rebate) are a few of the governments policies rewarding those who made poor decisions. I can accept (to an extent) giving people second chances, but punishing those who make good decisions makes no sense to me. Why should a person ‘A’ who has a 1998 Nissan Sentra not be allowed to trade in her car (because it is considered fuel efficient) but person ‘B’ be qualify  for the program after buying a 2004 Hummer.

Lets look at the issue from a different perspective. The carrot and stick theory is a simple premise of how a market economy works (rewarded if you do well => Carrot, punished if you do badly => Stick). This theory has been completely violated in the past few months. One cannot reward good work with bonuses or let everyone get a rebate on a car due to government regulation, nor can one fire for inefficiency or incompetence due to Workers Unions. (I am completely in favor of what unions USED to stand for, but I find them a hindrance to business now a days). In short, throwing money at issues, legislating regulation favoring the few and curtailing business and bonuses is not the best way to approach the current situation. I am by no means saying that the bailout was not necessary, but we need to know when to say enough is enough.

It is important to understand that risk management is an evolving science and the current situation is unprecedented, the basic lesson remains the same – the more regulation and complexity that is added to the system, the less likely the risk managers are able to account for risk, making it a lot harder to remedy our current situation.

Finance, Politics

Nassim Taleb, the author of The Black Swan, and  Stern professor Nouriel Roubini are two people I admire a great deal. Recently they have proffered compelling arguments on either side of the debate on if the Chairman of the Federal Reserve, Ben Bernanke deserves to be reappointed. Both Roubini’s Op-ed andTaleb’s CNBC video provide some interesting insight into the reappointment cast against the backdrop of the current financial crisis.

I am on the fence with this issue. Both scholars make some great arguments, but the decision will come down to what the administration feels is the role of the Fed and whether or not its charter should be expanded. Is the role of the Fed just to control rates and make policy, or is the buying back of debt and bailing out companies going to be added to its charter? In short, Did Bernanke intervene because it was part of his job description (that he was expected to be ready for) or was it an emergency learn-as-you-go type of situation which he tried to make the best of? Depending on the view the government takes the Chairman should be shown either the deepest gratitude or the back door! I am keen to see how this plays out.

Note: Due to switching servers, I lost all my comments and had to reset the counter. Please continue to leave your thoughts, feedback is always appreciated!

Politics

The VIX is no where as high as it was towards the end of last year and the markets have been doing significantly better since then as well. However, that does not mean that the market and public are still not afraid of an over involved government. In these trying times everyone is tuning into the news and following every word coming out of Tim Geithner’s mouth. With such high scrutiny on every word uttered, I was astounded to hear about Tim Geithner’s simpleminded and pointless decison to regulate both Venture Capital and hedge funds. What surprised me more is the tepid response this issue has received both from the press and public. Secretary Geithner went onto justify his statement by mentioning the high risk and instability caused by these firms due to the high levels of leverage that they take on. Though I understand his concern regarding Hedge funds, Venture Capital (VC) by their very nature do not take on high amounts of leverage.

There is a significant difference between venture investment funds (what Berni Madoff ran) and venture capital (the kind of investing that started Amazon.com, Google, Microsoft and Apple to mention a few).

Where as venture investment funds, invest your money in the market and generate returns using their savvy investing skills (or Ponzy schemes). Venture capital invests money in small business without using much leverage (debt). Start ups traditionally don’t take on debt because they don’t have steady or at all predictable cash flows, they also make it clear from the outset that you may loose 100% of your investment if things don’t go as planned. Thus, it is not the average Joe that invests his life savings but wealthy institutions and investors that are looking to make high returns by ‘gambling’/investing a few hundred thousand.

Mr. James Freeman the author of the Op-Ed peace, makes a compelling case and there is little I can add to what he wrote.What I will try to do in this piece is try and understand what Secretary Geithner was trying to accomplish by making such statements.

I will give the treasury secretary the benefit of the doubt and assume that his intention behind the policy recommendation was not to regulate venture capital per se but to try and make it harder for hedge funds to pose as venture capital funds to avoid the vast umbrella of SEC regulation. We saw an example of such shenanigans at work with TARP 1.0, when insurance companies started to buy small and mid size banks in order to be eligible for TARP funds. However, what I don’t understand is why Mr. Geithner would explicitly go after VC funds, instead he could have made more caveats regarding hedge funds rather then explicitly talking about VC funds. The fact of the matter is that the NASDAQ has by far been the best functioning exchange this year. Small and medium sized industries suffered already due to the high expense incurred due to compliance with Sarbanes Oxley. Regulating VC funds is going to create more road blocks for start ups and make it harder for these companies to come up. By trying to mollycoddle the investor the administration is not encouraging risk (something the treasury secretary insisted he wanted to see more of) but instead is scaring people away from the mere thought of taking risk. This Results in the suffocation of yet another growth artery of the currently (growth) anemic economy.

I hate to quote fictional charecters such as Spider man’s grandad but the guy had a point when he told his grandson Peter Parker, “with great power comes great responsibility’. Think about it Timmy G!

Politics, The Economy

We have two items of good news. First, the administration has finally addressed what I consider one of the most important issues regarding the economic meltdown… Housing! I am happy that the issue is being addressed, but not how it is being addressed because of the possibility of a moral hazard – individuals that will be insulated from risk may behave differently after receiving the stimulus than they would if they were fully exposed to the risk.  Second, irrespective of where you stand on the issue politically or socially, I feel that it was a good move to lift the ban on stem cell research as it will further strengthen the (thus far) ‘recession proof’ bio tech industry.

Politics, The Economy

What was the goal of TARP 1.0? Some say it was a failure because the goal was to generate credit (which it failed to do). Thus, these people feel that the second installment will also be a failure. The opposing school of thought is that the program was successful  because the goal was to stabilize the financial sector and build confidence (which it did do to an extent). Thus, the second installment will aim to alleviate credit (build capital). Just to play devils advocate, it can be assumed that TARP 2.0 is either a failure or will be able to alleviate credit. However, wasn’t the high availability of credit the main instigator of the economic crisis as it gave rise to problems such as easy loans to unqualified customers in the first place?

If the banks collapse they face the same question as the auto makers: where does the TARP money stand relative to other debt? In case a ‘big bank’ is forced to file for bankruptcy, where does the government money rank (in terms of seniority). Though they initially bought preferred stock where will the second round of financing stand relative to other debt? Is the government looking for all-out nationalization? Will the government continue to manage the banks’ exposure to leverage, bonuses etc? These are some important questions that need to be addressed when the treasury comes out with its ‘detailed plan’ in a few weeks.

The problem is that this seems to be a recurring theme with the government. Though they are doing what they can to make the economy better, the lack of both details and clarity are making the situation a lot harder to understand and thus a lot harder to deal with. Help me out here, Timmy-G!

Politics, The Economy

The UAW has announced that they have made a tentative agreement to renegotiate their national contracts with the Big Three in order to make the domestic giants more competitive with their international rivals. As it stands today the difference between hourly wages of domestic and international manufacturer’s is between $4 – $7 an hour (not counting retirement and other benefits). The renegotiation of the contracts is expected to level the playing field and make for a more competitive economic landscape. Just as a reminder GM expects to repay the loan by 2012 and to be profitable by 2017. GM also envisions industry wide U.S. sales of 11 million units in 2009. This estimate is the latest revision from the initial projection of 12.5 to 13 million units that was released in December 2008. Of course, none of this will be possible without more of the tax payer’s money: on Tuesday, GM asked for a further $16.6 billion, while Chrysler asked for $5 billion dollars (a combined total of $21.6 billion)!

Just a thought: what happens if GM does not make its numbers due to the condition of the global economy?

In case you do not know what I am talking about, let me give you a recap of the events that took place on Tuesday, February the 17^th 2009. The Japanese index (Nikkei) closed extremely close to its 26 year low. Russia had to close its market (again), the Euro was at a 3 month low, the Dow neared its low from five and a half years ago (29 of the 30 stocks going south) and the S&P was down 4%. It is no surprise that with so much uncertainty surrounding the economy people are turning to safer havens such as Gold and Treasury bills. The increase in demand for Gold has caused it to hit a 7 month high (flirting with $1000) up 9% in 0’9. Furthermore, investors continued to seek safe investments by investing in extremely low yielding T-bills (in some cases investors are losing money with the brokerage fees but taking solace in the fact that the money they invest will still be there in the next few months.) In short, car buying is not really high up on the average Americans ‘to do’ list. If that was not enough to convince you of the condition of the global economy, Adi Ignatius (editor in chief of HBR) gives a wonderful synopsis of the sentiment surrounding the recently concluded World Economic Forum, discussing how the experts feel about the condition of the global economy.

Now that we have gotten that out of the way you can see why I feel that the auto makers will not be able to meet their sales targets. I now come to more pressing issues. Where does the government money that has already been granted go if one or all of the Big Three file for bankruptcy? Seeing how the companies are continuing to ask for more money and repeatedly revising projections, why is the government throwing  more money at the problem? What happens if the Big Three cannot achieve their projected sales? Will the tax payer get any money back?

Politics, The Economy

I pity the fool who thinks the nationalization will be the answer to all our problems. With Britain buying a majority stake in the Royal bank of Scotland and speculation that Lloyd’s and Barclays may follow, the pundits feel that nationalization is the answer to alleviating the troubles of banks today. I beg to differ!

The fact that the government will be running banks is a thought scarier than a slumber party at the Neverland ranch. There are around 8000 banks in the United States today. It will be close to impossible for one body (in this case the government) to run such a large-scale operation. One does not have to look any further than the DMV or the US postal service to see the “efficiency” with which the government runs its large operations.

All things aside, on a fundamental basis the nationalization of Wall Street seems like a huge mistake. What makes Wall Street so amazing is the collection of brilliant minds that can make magic happen (using the free market as a catalyst). Good or bad, what the investment banker can do is truly amazing. (Before you start rolling your eyes and muttering about people being overpaid, please take a look at a GM assembly line employee who gets paid $90,000 for relatively simple work (with full benefits of course). I digress. What makes Wall Street special is its competitive landscape and innovative thinking. Currently the government has already tied the banks’ hands behind their backs by: moderating bonuses, having the last say on the major capital (expenditure) decisions, controlling dividends and regulating the amount of leverage a bank can take on. Nationalization will be the final blow that will take the wind out of Wall Street’s sails.

You may think that it is not a big deal as financials are no longer as important as they once were. A few years ago financial stocks accounted for over twenty percent of the market cap of the S & P 500. Now they have dwindled down to roughly ten percent.  Though the size of the market cap may have diminished the effect on the market, if anything it has grown. In short, financials are without a doubt the trendsetter for the market. (Simply put, the market more or less moves up or down depending on how financials perform on that day.) I will be the first to admit that the condition of the economy is a worrying and that the government has a lot on its plate. However, a bigger role by the government (with little or no technical expertise in the field) is absolutely not the answer to these problems.

Update, Jan 26th: The New York Times has published an insightful article discussing both the pros and cons of nationalization.

Politics, The Economy

(The title seemed appropriate with the current state of affairs and the new B.I.G movie being released)

The government has offered to bail out Bank of America for a second time (helping them to be true to their name and really becoming America’s bank – using the tax payer’s money of course). The reason is simple: they did not expect Merrill to be this hard to digest. (Question, what do you expect with 48 hours of due diligence?)

Citibank is set to split up to form Citicorp and Citi holdings. To put it in simple terms, the former is the ‘good bank’ that will handle the traditional banking work, while the latter will take the role of the ‘bad bank’ and manage the firms riskiest assets. Citi is also selling one of its most profitable divisions, (its brokerage unit Smith Barney) to Morgan Stanley (I like the name Citi–Morg for the company). Furthermore, CitiGroup is planning to eventually cut down to be half or even one third of its current size. Food for thought: will Citi still be considered too big to fail and get continuous support from the US tax payer (as BOA has managed thus far)?

Seeing the conditions of banks one cannot help but agree with Mohamed El Eriam (co-head of PIMCO) that banks are just as good (or bad) as utility stocks.
If you have 15 minutes to spend, I highly recommend playing ‘ the bailout game’

Highlights for this week:

America swears in its 44th president. Though I am excited to see history being made, I am especially excited to see if treasury secretary Geitner will actually go through with his suggestion to let banks move from mark to market accounting to mark to model accounting. This should help banks improve their balance sheets as they will be able to put a reasonable value on assets that do not have a market.

Tech companies will be revealing earnings this week. I have to say I am more excited about the conference calls that will follow. I want to see what Apple has to say after their dismal handling of affairs regarding Steve Jobs health. What will their future guidance be with him on extended leave? Will Microsoft shed light on pursuing Yahoo, now that a new CEO is in place and finally will Google continue to show its resilience as a top firm.

Note: The Maddof scandal, bailouts and depressed condition of the economy makes us all feel like there are a lot of things wrong with the world. However, the spirit of the New Yorkers in aiding the US airways rescue mission and the courage of the pilot reassures you that there is still some good in the world.

Politics, The Economy

After seeing the extremely unprofessional (yet to an extent understandable) drubbing assistant treasury secretary Kashkari got from the senate oversight committee, I began to wonder how the new treasury secretary will be treated by Congress, the market, the media and the general American public. Surely after the presidential election this is by far one of the most important and exciting decisions and has got everyone talking. Since no one has any idea who President elect Obama is going to choose, I am going to go through the list of the people I feel are in the running and even be bold enough to make a prediction as to who will be chosen to take the hot seat and why….

Lets examine the choices:

Bob Ruben
The ex director of Citi as well as the assistant to the President for Economic Policy during the Clinton administration was a front runner but withdrew his name due to being too old (he is 70)

Larry Summers
A child prodigy who went to MIT when he was 16 and a tenured professor at Harvard university by the time he was 28. He is also the Former chief economist at the World Bank who would not be a stranger to the position as he was treasury secretary during the Clinton administration. However, he brings a lot of baggage with him (negative comments in regard to environmentalists, affirmative action as well as women will not sit well with the Obama cabinet or supporters who are looking for progressive ‘change’. The government cannot afford to be defending their treasury Secretary and focus on the economy at the same time.

Paul Volcker
The former treasury secretary under Carter and Reagan is a real task master and a true believer in doing whatever it takes to get the job done. He does not pay attention to the sentiments and reaction of the market, public or even the president for that matter. During the Carter administration he raised interest rates to 22 percent while inflation was at an unbelievable 16 percent. He was criticized and ridiculed for his actions but stood his ground. The long bull market that ensued for the next 20 years (starting in 1982) can be directly attributed to Volcker’s policies and his dedication to sticking to his guns and doing what he thought was right. Though this is such a time, I do not know if Obama or the rest of the country is ready for someone who has historically been very strong in his decisions, focusing on the long term benefit and sacrificing current comfort as well as the incumbents chance of being reelected. Furthermore, after the democrats made such a big deal about senator McCain’s age it will be tough to justify hiring an 81 year old man as treasury secretary.

Tim Geithner
The 9th president of the Federal reserve of New York is: young (same age as Obama), well traveled (lived his formative years abroad, again like Obama), dynamic, apolitical and is known to gets things done. He has been at the center of this perfect storm playing a key role in trying to unfreeze the current credit market. Geithner was a major player in the Bear Sterns deal, in bailing out AIG and in not bailing out Lehman (which may not have been the best decision. However in all fairness, hindsight is a perfect science).

Though not widely considered as a front runner, I have to admit that I am a fan of John Corzine, the current Governor of NJ. Known for his tremendous financial acumen, he started his career as a bond trader and made partner at Goldman Sachs within five years and Chairman and CEO after being at the company just nineteen years. His move up the ranks was justified and paid dividends (no pun intended) as he reversed the fortunes of Goldman that was going through a very tough time during the downturn of the bond market (in the early to mid 90′s).

All these men are accomplished smart individuals that bring a lot to the table. I feel Geithener is a smart man and will be the one to get the job, due to being young, apolitical and being recognized on Wall Street as someone who makes things happen. In my opinion I feel John Corzine would also be a great choice (maybe even slightly better) since he has been slightly removed from the current crisis and can bring a fresh perspective to match his seasoned knowledge. Admittedly that may be my bias and admiration talking, plus I do not think that Obama will want to go with another Goldman man.

On a side note Christopher Cox (Chairman of the SEC) is one funny man. He just came to the realization that more oversight is needed for credit default swaps….
“The virtually-unregulated over-the-counter market in credit default swaps has played a significant role in the credit crisis, including the now $167 billion taxpayer rescue of AIG,” Cox said in a statement. “Bringing transparency to this market is vitally important.” Great observation sir, just a few years too late.

Politics