Compared to a year ago, the corporate bankruptcy rates in the US have raised by 42%.
(Source: BankruptcyData.com).
Firms are also finding it extremely difficult get credit to starve off bankruptcy due to the credit crunch crisis. A notable example is the auto parts maker Delphi Corp now fighting for survival from corporate insolvency. In addition, job losses, foreclosures, and stock market depreciations are engulfing the US economy. Never in the history of modern economics, have we ever seen bankruptcy the size of that of the Lehman Brothers case. The scale of government bailouts like the case of Fannie Mae and Freddie Mac are rewriting the rules of corporate survival as we plough through “uncharted waters”. No sector of the US economy is being spared as the financial market continues its deleveraging process. The domino effect of the crisis have spill over to the Retail sector, Home builders, Financial firms , Airlines and the Energy sector.
As the US economy is reeling in aftershocks, the FBI has launched investigations into firms which had triggered the US government involvement into bailouts for Wall Street. Some of the firms that have been under the inquiries of the FBI for possibilities of fraud are IndyMac Bancorp Inc, Countrywide Financial Corp, Fannie Mae, Freddie Mac, Lehman Brothers, and AIG. The Federal Reserve and the US Treasury department both agreed that the only way to resolve this crisis and bring stability to the financial market is to rid the books of these financials companies of their “Toxic Assets”. The bailout plan proposed by Treasury Secretary Paulson, requires a $700 billion injection into the market to soak up all the toxic assets. This is in order to unlock the credit squeeze the market is currently facing.
Even as the members of Congress debate over the bailout plan proposed by the Bush administration, leaders from developed countries are urging the US to quickly enacted the plan in order to stabilise the global financial market. The Canadian Prime Minister, Stephen Harper, have expressed worries about the fundamentals of the US economy. He acknowledges that the US economy had impacted Canada’s growth. At the United Nation meeting in New York, France and Australia joined in the chorus to call on the US government to quickly find a solution to the crisis. Australian Prime Minister Kevin Rudd said that it is time for the US government to act decisively to restore order in the chaotic financial market. Although the bailout plan may help to give the financial market a dose of confidence and help unlock the credit squeeze, no one had answered the question of what to do with the surplus homes in the real estate market. Furthermore, the positions of those mortgage holders on “Main Street” who are in a precarious situation have also not been addressed.
Many are demanding answers as to how the situation could have gone so bad. The hardest hit in Australia will most probably be the retirees. After the dot com bubble burst, many have shifted their investment focus towards Real Estate Investment Trust (REIT). Today, the REITs are also vulnerable to the credit crunch crisis. Centro, one of the largest property groups in Australia had announced a loss of A$3 billion for the year 2007/2008. Over a period of a year, up to 40% in values have been wiped off the Australian REITs. Another casualty of the crisis is the Superannuation funds. AMP, reported earlier in the year a 22 % drop in profits for the first half of this year alone. Voluntary contributions have also fallen considerably by as much as 33% since last year. In fact many retirees are turning to the aged pension for survival as the superannuation returns slide further. This number had increased by 40% since the last financial year.
Financial planners have advised that when it comes to investment, we should diversify. Another common advice we hear is that bricks and mortars are a safe bet. Many of those who took these investments from so called “experts” have ended suffering when they see their life savings disappeared into thin air. As early as last year, Australians had lost an aggregate of a billion to dubious investment schemes. The collapse of WestPoint, Fincorp and the Australian Capital Reserve (ACR), are all stark reminders that we need to really rethink our investment strategy. Today, in a globalised economy, none of our investments are insulated from any fallout from any major crisis in the world.
Successful investors like Warren Buffett do not follow what the rest of the pack do when it comes to investing. As early as 2002, he had warned of a “time bomb” that was waiting to go off in the US financial market. He had viewed the credit default swaps market as “financial weapons of mass destructions”. And true to his words, today, we are now reeling from the effects of that “time bomb”. The thing is that if we wish to be successful like Warren Buffett or George Soros, we have to adopt their mindset. There is no way to get rich quick. Everyone needs a plan, patience, and an investment vehicle to start with. Things like risk level and tax liability need to be considered and not just the returns. George Soros, uses statistical arbitrage, to hedge his bets whenever he invested in any assets. This way, he reaps a positive return regardless of the direction the market is going. In layman term, this is called riskless investment and it’s not just restricted to financial markets. (To know more read, Sports-Arbitrage - How To Place Riskless Bets & Create Tax-Free Investments). This system of investing was developed by Morgan Stanley Equity trading division during the 1980s. Today, statistical arbitrages have progressed to encompass technological improvements. With the use of software like the ArbAlarm, it is possible for one to execute a trade within mere seconds from the desktop computer.
Apart from the risk level which we have to consider, there is another aspect most of us tend to overlook, that is the tax liability of the returns. Incomes derived from Real estate are subjected to Capital Gain Tax (CGT). Likewise too are the dividends we get from the superannuation funds. Until the superannuation has become your retirement pension, all the returns are subjected to 15 % CGT unlike capital gains made from statistical arbitrages which are tax free. (For more insight, see ATO Tax Ruling TR2004/D17). At the end of the day, we ourselves have to decide how we will live out our retirement years. Many seniors are finding it extremely difficult to survive on the aged pension as many do not have any savings. Even those who have a retirement nest tied in the stock market are finding their returns shrinking day by day as the credit crisis get worse.