As President Bush signed the bailout plan into law, the majority of the Americans are now watching closely the effects of the bill on the financial market. Most of those on main street are afraid to spend as they are unsure whether the bailout plan will work or not. The bailout plan calls for the acquisitions of toxic assets held in the books of ailing financial institutions. The goal is to help unlock the credit squeeze which is gripping the global economy. Under the Emergency Economic Stabilization Act of 2008, the Treasury Department is allocated $250 billion to buy up the mortgages and CDOs. If this amount is inadequate, at the President’s discretion, another hundred billion can be made available. A final $350 billion is also provided for subjected to the US Congress scrutiny.
The entire dominos effect began with the demise of the Lehman Brothers followed by the bailout of American Insurance Group (AIG) by the US Government. From there onwards, for the 3 weeks prior to the passing of the bailout plan, the world’s financial markets had been on a roller coaster ride. The effects were felt globally as stock markets all over world nosedived. Many had hoped for that the bailout plan will provide for a calming effect on the market. However since a week had passed, in a climate of mistrust, Banks are still holding on tight to their cash worried which is the next bank that will collapse. This has prompted shares prices to continue falling, slowly wiping out the values of retirement funds resulting in even less consumer spending. In fact the US president has asked Americans to brace themselves as he warned that the bailout plan will take time to be effective.
Already analysts are warning that more banks are likely to fail by next year. The question on many peoples mind now is how many of these banks will fail and also the manner with which these banks will be disposed off. The reason for this anxiety is due to the dwindling deposits of the Federal Deposit Insurance Corp (FDIC). Under the bailout plan, the liability of the FDIC is increased from $100,000 to $250,000 per account. It follows as to whether there are enough funds to meet the obligations of the FDIC. Granted that the bailout plan will save some financial institutions from insolvencies, a substantial numbers of banks will still face failures as the deteriorating assets which they hold are not covered by the bailout plan. For example, constructions loans are not covered in the list of assets which the Federal Government will take off from the books of ailing banks.
With the turmoil in the financial markets, despite being covered by the FDIC, many depositors are wondering whether their savings are secured. With the failure of Washington Mutual several weeks prior to the enactment of the Emergency Economic Stabilization Act of 2008, this has not aided in boosting confidence in the minds of depositors. The current trend is a flight of money to quality institutions. The problem is that no one really knows which banks are on a strong footing when banks like Washington Mutual, are not even immune to failure.
Although Australia is on the opposite end of the globe, the fallout from the US has not left Australian banks unscathed. Earlier during the year, the National Australian Bank (NAB) was forced to write down 90 percent of its holdings on American CDOs to the tune of A$1 billion. The write down had forced the NAB to cancel its £550 million bond sales by 70 percent as investors shy away from investing in the NAB bonds. In addition analysts are predicting that the NAB will need to further write down an additional A$500 million to A$1billion to cover its losses in the US mortgage investments. Even the Wingecarribee Shire council is not spared from the fallout of the US credit crisis. Like many of the charities and churches in Australia, the council had purchased millions of dollars worth of these toxic assets as investments. A lawyer acting for the council commented that it is unlikely that the bailout plan will benefit the Wingecarribee Shire council.
The New World Order brought about by the globalisation of the world’s economy has resulted in many positive benefits like ever increasing trading among the various nations of the world. Corporations are also able to raise funds easily on worldwide capital markets with lower cost. The unfortunate consequences of a globalised economy are that risks are also amplified even to areas seemingly unrelated to the global economy. Today, because of the world dependencies on the US economy, even its domestic problems have the cascading effects on a local council like Wingecarribee Shire council. Today, investing is no longer a simple and clear cut matter as Money Market Instruments are packed and repackaged so many times that no one know what their real risk levels are despite of their triple “A” rating.
In addition, globalisation has also revolutionised the way Share prices are being determined on the stock market. A company shares used to be determined by the amount of dividends that it paid out to shareholders. Today shares prices bears no relation to its intrinsic value but rather to its earning potential based on forecast. With a little bit of creative accounting like what the previous management of the demised Enron did, a company is able to show earning potential much higher than it actually is able to earn. Secondly, with increased competitions among the market traders, trading margins are becoming increasingly lower. To compensate for the decline in margins, market traders are now resorting to alternative ways to generate revenues. One way which the market traders have gone about doing this is by taking advantage of inherent market inefficiencies. Using a system pioneered by Morgan Stanley’s Desk Trading Operations during the 1980s, market traders are able to use statistical arbitrage to profit for temporary mispricings of assets to gain profits from as low as two decimal points. With computers programmed with algorithmic blueprints, market traders are able to isolate these “mispricings” within a fraction of a second and capitalise on them before the market readjust itself. By the sheer volume of shares traded, hedge funds are able to move the prices of shares which they deal in thus creating the market sentiments.
Due to large volume of shares traded by hedge funds to capitalise these mispricings of assets, they are able to profit by the billions daily. Their profit taking abilities are not curtailed by the direction of the market movements. Regardless of whether the market is moving up or down, hedge funds are able to profit from their trading. Statistical arbitrage is able to remove the element of risk from the equation. Because these computerised systems requires substantial amounts of money to develop and to maintain, these systems are beyond the reach of the ordinary investors.
Nevertheless, Rajeev Shah, former London city stockbroker, pointed out those situations of arbitrages is not just limited to the financial market. In the world of Sports betting, the same mathematical principles of statistical arbitrage can be applied to betting. With an algorithmic computer program called the ArbAlarm, placing bets cease to become gambling but rather as hedging because statistical arbitrage reduces the element of risk to zero. (To know more, read “Sports Arbitrage–How to place riskless bets & create Tax free investments”). Furthermore, the profits from Sports Arbitrage are not subjected to tax. (See Australian Tax ruling TR2004/DR17).
Although this is an unorthodox method of investing one’s funds, in comparisons, the traditional model of investments based on shares, bonds and money market instruments are no longer fail safe to fund one’s retirement plans. Of late, returns on superannuation funds are declining with many resorting to the aged pension instead. In additions, brick and mortar are also no longer reliable as place to park one’s money. The collapse of ACR, Fincorp all seek to show that the real estate market is also subjected to manipulations by unscrupulous developers. With the current situation, perhaps it really time that we think outside the box to seek an alternative way to fund our retirement without it being at risk to factors beyond our control.