Will this really make you wealthy?

Jan 15, 2010

In this issue:
» Foreclosures continue to haunt US homeowners
» TBTF banks come under 10-year tax scanner
» The biggest economic risk for 2010
» Oil companies left with another year of losses
» ...and more!!

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The US government pretence to be shareholder friendly seems to have rubbed off on its Indian counterpart as well. Proudly claiming to be enabling wealth creation amongst retail and HNI investors, the government has declared allocation of 50% of the follow-on share sale in three state-run companies to them. After all, it was part of its election manifesto. But more importantly, the 'marketing' of these offers seems to be on solid ground as retail investors get lured by the promise of large subscription. What they might end up ignoring here are the potential use of the IPO funds, the future fundamentals of the company and the valuations at which the money is being raised.

The IPOs listed in the past 5 years show that for the listings at higher market valuations, the long term annualized gains have been rather disappointing. However, in the short term, the offerings may seem to give the impression of wealth creation (as is the case so far in FY10). The government is thus trying its best to cash in on this trend. More importantly, by enticing the least empowered and knowledgeable investors. It is therefore left to the retail investors to do as much homework as possible before subscribing to such issues and not get drawn into dubious offers.

Infact, even as we were compiling this wrap up, another such incident that raises concerns over Government's intention of creating wealth for minority investors seems to have come to light. As per reports, Engineers India Ltd, where the government is planning to divest its 10% stake, will now issue two bonus shares for every one share and will also undertake a 2:1 stock split. What more, EIL will also declare a 1,000% special dividend just before the offer goes live. We will be really obliged if someone in the government can tell us how the above mentioned measures would create wealth for shareholders. All that it would do is increase liquidity and make the shares more speculative.

 Chart of the day

Data source: Bank of International Settlements

As the skeletons came out of the superficial growth in global financial markets, insurance against credit defaults came to the fore. These derivatives linked insurance papers also known as Credit Default Swaps (CDS) nearly tripled between FY07 and FY08. More importantly, even after the collapse and bailouts of the worst cases of financial distress, the risk of defaults have not subsided. As today's chart shows, the market value of CDS papers bought in FY09 were only 6% lower than those in FY08. Hence as we read the 'worst is behind us' theories, we probably need to check some other facts as well.

The property market in the US was in shambles last year with 2.8 m households being threatened with foreclosures. To make matters worse, the chances of this scenario improving this year also look rather slim. This is because more homeowners are expected to fall behind on their mortgages. Between 3 and 3.5 m US homes are expected to enter some phase of foreclosure this year. High rate of unemployment and lack of sufficient incomes are expected to be the key catalysts. For instance, the number of households that received a foreclosure-related notice rose 21% in 2009 from 2008. Not just that, 1 in every 45 households got at least one filing last year. This is almost four times that of 2006. It is a catch-22 situation for the US government. Reducing foreclosures is a necessary step for the real estate market and the economy to recover. But unless the economy recovers and unemployment reduces, people will continue to fall behind on their mortgages. Therefore, in what way the US government breaks this deadlock is anybody's guess.

The woes of the public sector oil marketing companies continue. They are forced to sell fuels at below cost. When the time comes for compensating them for their losses, everyone tries to wriggle away. Currently, the losses for the auto fuels are supposed to be borne by upstream companies like ONGC, OIL and GAIL. Losses on kerosene and LPG are supposed to be compensated by the government. But as per a leading business daily, the Finance Ministry is willing to pay less than half of the Rs 317 bn as sought by the Oil Ministry. We wonder how long this situation can continue. The government doesn't want to pass on high crude oil prices to the people. But it cannot shoulder the burden given the concerns over fiscal deficit. The oil marketing companies cannot handle it given their financial health. Given the unfortunate situation, we continue to advice investors to keep a safe distance from the oil marketing companies.

The US is turning out to be a classic case of what goes wrong when one tries to mix economics with politics. Earlier, it mixed crony capitalism with politics and allowed bankers to run amok. It granted them liberty to take as much leverage as they want and practiced very little oversight. The world, as we all know, had to pay a very dear price for it. The entire global financial system came on the brink of a collapse. And now, in order to atone for its sins, the US Government is trying to mix populist economics with politics. Yesterday, President Obama told US banks that they should brace themselves for paying a new tax to recoup the cost of bailing out firms at the height of the financial crisis.

As per Moneynews, the tax, which would require approval from the Congress, would last atleast 10 years and generate about US$ 90 bn over the decade. Clearly, if the banks are in good enough shape to dole out hefty bonuses to its executives, they are in good shape to pay the new tax as well, Obama is believed to have said. However, the banks are not amused at all. They have a feeling that they are unnecessarily being made the scapegoats, especially given the fact that most of them have already repaid the TARP money lent to them in full, including interest and dividends.

For once, we would like to agree with the bankers. Taxing institutions in order to punish them is certainly not good economics. Moreover, there is every chance that the banks would pass on this cost to the end consumers, thus once again leaving the taxpayers to bear the brunt of it. Clearly, the US polity seems an extremely confused lot right now.

Let us know your comments on the US government's decision to tax banks.

The World Economic Forum in its annual Global Risks report has zeroed in on sovereign debt default as the biggest economic threat in 2010. This is alongside underinvestment in infrastructure and chronic diseases driving up health costs and reducing economic growth. The fact that debt levels have risen from 78% of GDP (in 2007, before the crisis) to 118% of GDP in the G20 economies seems to be the gravest concern. Infact worries over Dubai, Ukraine and Greece have now spilled over to global markets. The threat of debt default now seems to be reigning high even for the economies of "irrational exuberance" namely the US and UK.

We completely concur with the WEF's warning that already fragile economies, particularly in the developed world are at the risk of overleveraging. These trends if sustained could potentially lead to full-blown crises with inevitable social and political consequences. The governments therefore could at best stop fighting unemployment and recession using the easy route. Building unprecedented levels of debt and therefore stoking the risk of sovereign defaults could only make matters worse.

Meanwhile, Indian markets witnessed a volatile trading session today after a positive start. The BSE-Sensex was up nearly 18 points at the time of writing. Strength in stocks from the realty and power sectors helped the benchmark indices stay above the dotted line. Amongst global indices, while the Hong Kong markets were the only losers in Asia, Europe has also opened in the positive.

 Today's investing mantra
"If you are a know-something investor, able to understand business economics and to find five to ten sensibly priced companies that possess important long-term competitive advantage, conventional diversification makes no sense for you." - Warren Buffett

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17 Responses to "Will this really make you wealthy?"

prasanna venkatesan

Jan 20, 2010

you are right. first of all, the banks did not need the funds infusion, so desperately. They wold have raised it, themselves, from HNIs and othercountries, with some effort.Obama, just buckled under the pressure of the Jewish Wall st., lobby and bailed them out. now they are back, to their old game.
This is ridiculous, as in a famine ridden village, it is like fiancing the village money-lender, so that he can resume lending, instead of giving rice and gruel, to the hungry. Much more was expected of Obama and he has failed his voters, his country and the world.
It will be no surprise, if he ends up, as a single term president. Massuchussets, demo. loss, is pointing that.


Amish Saraiya

Jan 19, 2010

Dear Sir,
As per my knowledge, it is not crony Capitalism, but crony Socialism that US seems to have engaged itself in, since the time they started Medicare and Social Security, and lately, allowing State supported Banks viz., Fannie Mae and Freddie Mac to give loans on unexpectedly easy terms. Private Banks had no option but to resort to similar practice to remain in the game. This is the prime reason of the whole chaos that happened in the name of Sub-Prime.


Yazdi Bilimoria

Jan 17, 2010

President Obama's stand for taxing the US banks at this late stage is, in my opinion, a political game meant to appease the "aam aadmi" in the US.

Both the banks as well as the President realise that this "fee" of USD 90 billion, for the group of banks as a whole, is chicken-feed. But by broadcasting this news the President is, in fact, telling the "aam aadmi" in the US not to feel offended with the huge bonus payouts by these banks as he has already punished them adequately for their intrasigency.

Whoever advised the President of this move is not only an astute banker but also a very seasoned politician.


ramesh shetty

Jan 17, 2010

Extra ordinary bonuses that are being paid to top management should be subject to some sort of luxury tax without recourse to the end customer. Such a regulation would help all.



Jan 16, 2010

It is rational for banks who indulged in excesses in the past and brought the system to the brink of default should pay a premium in future for their past sins. They can and should be restrained from passing it on to customers.It is akin to a default protection policy premium. The Government has to handle this collection separately and invest it prudently instead of adding it to the normal revenue pool.



Jan 16, 2010

It seems a case of somebody's gotta pay, sometime!
See the economist.com for the story America's banks
Turning the tables
You have to remember that its the Fed's good economics that has bailed out the banks. Striking a balance between politics (read populism) and sound economic policy is not so easy!



Jan 16, 2010

No comments. I can't understand. not experienced.



Jan 15, 2010

The taxing of banks by the US Govt. is going to put additional pressure on an average consumer, who is already facing the misdeeds of their banks for the last two years. Most of the bank executives, who were responsible for the World financial crisis are being rewarded with bonuses from the tax payer's money. As there is no improvement in data for unemployment in the US, the average consumer will have to bear the brunt of this new taxation, as rightly said, the banks will leave no stone unturned to pass it on to the consumer in one way or the other.



Jan 15, 2010



Vijaykumar R Swami

Jan 15, 2010

For once, we would like to agree with the bankers. Taxing institutions in order to punish them is certainly not good economics. Moreover, there is every chance that the banks would pass on this cost to the end consumers, thus once again leaving the taxpayers to bear the brunt of it. Clearly, the US polity seems an extremely confused lot right now.
The US Polity need not be a confused lot because They can resume taxing the institutions and they must also ensure that the banks and institutions will not pass on this cost to the taxpayers. the recovery should be made on long term basis from all the senior employees resposible for decision making on role since the time of origin of the mess and ask them to return all the bonuses they have been paid. In addition penalise the bankers by stricter punishment so that the new generation become more responsible in future decision making. there is need to train the so called intelligent financial wizards on their responsibility towards the taxpayers. Government alone cannot come to their rescue every now and then.

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