One of the difficulties which lay ahead for US Treasury Secretary, Henry Paulson, is the problem of valuing the toxic assets of the ailing banking institutions. Many are concern that the Government could ended up paying in excess of what these assets are actually worth. With the uproar surrounding the Emergency Economic Stabilization Act of 2008, a move which the financial institutions are seen gaining at the taxpayer’s expense will no doubt have grave political implications. Although the bailout plan had been enacted into law, several provisions were tied to the Bill before the US Congress agreed to pass it into law. Some of the main provisions include:
(1) Disbursement of the $700 billion funds in tranches with $250 billion being made available immediately to the Treasury Department.
(2) A provision requiring the President of the United State to propose a bill requiring the financial institutions to reimburse the taxpayers for any losses after the 5 years of the plan running its course. In addition, the Treasury is allowed to take up equity in the participating financial institutions.
(3) Provision for the curbing of excessive executive salaries of participating financial institutions.
(4) The provision of two oversight committee to oversee the execution of the program.
From an initial 3 pages proposal, the final Bill had ballooned to 450 pages to covers for all these provisions thus providing Treasury Secretary Paulson with enough incentives to ensure a proper execution of the program. With thousand of mortgages tied to each piece of financial instrument and with delinquency rates spiking in the housing market, to unveil the actual underlying value of these assets can be daunting indeed. To compound the problem of finding a market price for these assets, the market for these instruments is not transparent.
Furthermore, the structures of these types of instruments are intricately complex. With variables like how many homeowners will become delinquent and the recuperation rates of the foreclosures tied to the value of these instruments, these assets will continue to decline in value as long as the housing market are in a downward spiral. As if these mortgage backed securities aren’t complex enough, Investment banks have taken these instruments one step further by rebundling them into even more complex instruments called collateralised debt obligations (CDO). The fact is none of these assets are in any way the same to each other.
An additional difficulty which the Treasury Department will face is to strike a balance between maximising the taxpayer’s money as opposed to minimising the financial institutions losses. The depreciation of these assets has already left these banks financially weak and cash strapped. If the Treasury is to purchase these assets at discounted prices below book value, the bailout program may ultimately prove ineffectual in unlocking the credit squeeze. One way that the Treasury is considering to overcome these hurdles is to conduct reverse auctions to determine the market price for these assets. This way, the Treasury will let the financial institutions themselves decide the selling price.
Whatever method that the Treasury department will use to determine the market price doesn’t dull the fact that most Americans are angry at Wall Street. Many are still asking why the taxpayers, who are suffering at the hands of greedy and reckless financial institutions, are the ones who have to bail these banks out. Opposite the Globe in Australia, people are also asking the same questions as the bailout plan is not designed to help investors like Wingecarribee Shire and other local Australian local councils. The losses from these so called triple “A” investment will result in less monies for the local councils to spend on community development. The major American banks have their lobbyists to represent their interests but unfortunately tiny debt holders like the Wingecarribee Shire council will probably never see a cent of the Australian public money returned despite the bailout program.
This is one of the dire consequences of a globalised economy. Beside from the benefits of increasing trading opportunities, access to the world’s capital market, globalisation has also brought about intensification of risks even to areas which were traditionally regarded as safe. External factors, a few thousands miles away now has the abilities to influences and affect even what was considered the prime investment instruments, like the money market instruments, for many corporations, charities and even the conservative local councils to earn a reasonable yield on their surplus monies. However when greed takes precedence over prudence, the result is a proliferation of poisonous assets like the CDO’s and MBS’s which bears no relationship to the triple “A” ratings they carry in respect of their risks level. In the end, the victims are the investors who have no idea what they have brought.
Globalisation has also brought about changes in the ways of how share prices are being determined on the stock market as well. As increased competitions come about due to the integrations of markets, margins are being slashed. To make up for the loss of income, market traders are now resorting to market inefficiencies to generate additional revenues from declining trading margins. With technological advancements, computers are now programmed with algorithmic trading patterns to execute stock trades in a fraction of a second. In additions, trading systems like the TradElect on the London Stock Exchange can simultaneously process 3000 trade orders in a second. With these innovations and the use of quantitative analysis like statistical arbitrages, price differential as little as two decimal points allow market traders to reap billion of dollars in profits everyday. With the large volume of trades which passes through hedge funds, it is no wonder that hedge funds have the ability to move the prices of shares and create market sentiments.
Today stock prices are no longer valued based on their intrinsic values alone. The dividend yield of a share is no longer as important as the price differential which the market traders can isolate with their trading systems. It is for this main reason why hedge funds are the best performing managed funds in the financial markets. The downside however is that unless you have the financial capacity to develop and maintain such a system, this form of investing is off-limits to the ordinary investors who are bound to just follow market sentiments and like in the current credit crisis suffer the losses. Hedge funds, regardless of the direction of the market is heading, makes monies as their profits are based on mispricings of two complementary assets and not just one assets. Statistical arbitrages allow the market traders to almost reduce their risk levels to almost zero.
The upside is that as former London city stockbroker, Rajeev Shah pointed out, the arbitrage market is not the sole domain of the financial markets. Statistical arbitrage principles can also be applied to the world of sports betting. Using a software developed by him called the ArbAlarm, sports betting can no longer be regarded as gambling as one no longer places bets but “hedges bets” just like in financial markets with the risk level at zero level. (To learn more, read “Sports Arbitrage–How to place riskless bets & create Tax free investments”). In addition, capital gains from the world of sports betting are not subjected to capital gain tax according to the Australian Tax office. (See Australian Tax ruling TR2004/DR17).
The traditional models of investing based on the three main assets class like Bonds, Stocks and Money Market Instruments are already outdated as demonstrated by the fact that today, superannuation returns are declining due to the credit crisis which the global economies are facing today. Ultimately, the ordinary investors are the one who are suffering due to the greed and recklessness of Wall Street. Even with the $700 billion bailout plan, not all investors will benefit from the rescue package. In time like these, we seriously ought to rethink how we can secure our retirement’s funds which are not subjected to the whims and fancies of a foreign nation problem.
Tags: Australian Times