Obama to Auto CEOs: You're fired! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Obama to Auto CEOs: You're fired! 

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In this issue:
» Japan's unenthusing third quarter GDP numbers
» Europe's keenness in reducing healthcare costs
» Auto bailout in the US imminent
» The Baltic Dry Index crashes
» ...and more!

Home grown US automakers or the 'Big 3' as they are popularly called will finally have a rope thrown at them, albeit a much smaller one, that is if everything goes as per plan. As per a leading US business daily, the congressional Democrats have submitted a rescue plan to the White House, which among other things calls for a taxpayer financed plan that could be regulated by an appointee of President Bush. The proposed corpus though stands at US$ 15 bn, vastly lower than the US$ 35 bn asked by the companies. What more, the help is also likely to come with an extremely strong emphasis on accountability and vigorous focus on enhancing the long term sustainability of the industry. Any failure on this front could well result in the halting of funding. Also, the use of corporate jets by the CEOs of these companies does not seem to have gone down well with the Democrats, as they have demanded a ban on leasing or owning any private aircraft.

Infact, President-elect Barack Obama accused auto executives of a persistent "head-in-the-sand approach" to long-festering problems and even said that the current management should be shown the door if it doesn't understand the urgent need to make changes in the industry. Looks like the time has come for the auto companies to really pull up their socks.

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Traders at Wall Street's banking and investment companies, who have earlier pocketed multi-million dollar bonuses as soon as they locked lucrative transactions, will now have to wait. They will have to prove the benefit of the trades to the company over a longer term before the bonuses get credited. In the meanwhile, the same will lie with their employers.

Morgan Stanley and other banks have come under criticism during the credit crisis for paying out record bonuses in recent years based on profits that turned out to be illusory. Much of the money that Wall Street earned during the bull market vanished in the form of executive payment leaving the entities with little capital to fall back on. The idea that Wall Street executives might collect any bonuses, let alone large ones, has angered many policy makers and ordinary Americans. Hence, the Wall Street biggies are now factoring in an accountability clause called 'claw-back announcement', which will make sure that the bonus pay can be retracted from workers who engage in conduct detrimental to the firm. In other words, if the trades cause a restatement of results, a significant financial loss or other reputational harm, the bonuses could be withdrawn. Although companies like Morgan Stanley already hold 35% to 60% of the senior executives' bonuses, in the past it was held entirely in the form of stock options. Going forward, a large portion will be held in cash.

"The scenario I fear is that we'll see for the whole world the equivalent of Japan's lost decade in the 1990s, that we'll see a world of zero interest rates and inflation and no sign of recovery and it will just go on for a very, very extended period." These are the words of Paul Krugman, the winner of the most recent Nobel Prize in economics. Addressing reporters in Stockholm, where he will receive the award later this week for his pioneering work on the impact of free trade and globalization, Krugman painted the above distressing picture for the world economy that is reeling under the impact of a global financial crisis. This of course seemed to be his worst case scenario. But this does not mean that the crisis will end anytime soon, as he went on to add, "We could easily be talking about a world economy that is depressed into 2011 and beyond." As far as the US economy is concerned, he seemed strongly supportive of the idea of infrastructure spending to boost job as well as economic growth. However, he also cautioned against the government running a perpetually huge budget deficit.

Lending by banks in the global financial world may have dried up due to the financial crisis, but the same seems to have picked up pace in Japan. As reported in the International Herald Tribune (IHT), growth in bank lending in Japan hit a record high in November, with companies tapping their credit lines as access to funds through financial markets narrowed in the wake of the global credit crisis. With exports and consumption slackening, Japan has already entered into its first recession in seven years and the scenario is likely to be grim next year too. According to data provided by Bank of Japan and published in the IHT, bank lending grew 3.2% from a year earlier in November, accelerating from revised growth of 2.1% in October. What stood out like a beacon in the sky was the fact that even blue chip companies were turning to banks for funding and taking on more debt on their books as other means of funding dried up. A meltdown in the Japanese stockmarkets and appreciation of the yen in October has not helped matters either.

Just like other developed nations, which have been announcing bailout packages to ease liquidity, Japan too has jumped the bandwagon with the Bank of Japan announcing that it will increase lending by about 3 trillion yen (about US$ 32 bn) and accept lower rated corporate bonds as collateral for its market operations. Expectations are high that there may also be further rate cuts on the anvil.

Meanwhile, Japan's third quarter GDP numbers are out and the scenario does not appear too rosy. The economy sank further into a deep recession than was originally envisaged meaning that the world's second largest economy will have to brace itself for its longest period of contraction ever. As per IHT, Japan's economy shrank at an annual rate of 1.8% in the quarter, three times faster than the contraction in the US economy in the same period.

It is a well documented fact that governments across the world including Europe are hell bent on reducing healthcare costs. But in recent times, this urgency has intensified manifold. Besides the rapidly rising aged population, the global financial turmoil has put further constraints on the resources of the governments. Global innovator companies, in the meanwhile, are leaving no stone unturned in protecting the patents on their drugs. As per the results unveiled by the European Commission and published in the Economist, the innovator drugs firms use a variety of unfair tactics to protect their expensive blockbuster drugs by delaying the entry of cheaper generic rivals.

Further, these firms are using other strategies such as 'patent cluster' to dissuade generic launches. According to this strategy, an innovator firm applies for a dozen or so patents for its drugs with the aim of confusing potential generic launches. Even out-of-the court settlements wherein the innovator pays a certain sum to the challenging generics company to delay the launch of its generic version till the patent expiry date nears, have come under the scanner of the European authorities. Thus, blaming these tactics, the EU contends that taxpayers paid about US$ 3.8 bn more than they would have had the generics come in the market immediately.

Europe: Generic penetration levels
Country Penetration* Price difference**
UK 55.0% 80.0%
Netherlands 35.0% 50.0%
Germany 45.0% 30.0%
France 5% to 15% 30.0%
Italy 5% to 15% 25.0%
Spain 5% to 15% 25.0%
* Average penetration (in volume terms) after 4 years
** Avg. difference between brand & generic price after 4 years
Source: IMS Health

While charges seem to have been labeled at these innovator companies, generics companies too are to be blamed for some issues. For instance, in the case of out-of-court settlements, it would be unfair to solely point fingers at innovators when generics companies have no qualms getting payments for delaying generic launches.

More importantly, the Economist states, "The real problem in Europe's generics markets is not that generic drugs arrive too slowly after branded drugs go off-patent, but that prices drop too slowly after generics are launched". This means that in the US, while prices drop by as much as 95% on day 1 of the branded drug going off patent, in Europe on an average, prices fall by 25% initially and by a further 40% after two years. On the whole however, generics companies (including India) definitely have the upper hand when compared to the innovators in view of the current scenario.

Here's a pop quiz: Which index, across activities and asset classes, has registered the sharpest decline this year? The Baltic Dry Index, which tracks the rates for shipping dry bulk commodities like coal, iron ore and grains, is a leading contender for the dubious title. As per a leading business daily, the index has fallen over 90% from its record highs in May this year, to a 22-year low.

How are the Indian shipping companies responding? They are laying up vessels. In other words, they are removing them from trading operations and selling the older ones. Chennai-based West Asia Maritime has laid up one ship last week. So has Shipping Corporation of India. Great Eastern Shipping on the other hand has sold 3 ships in the last two weeks and plans to sell 2 more. However, it may be noted that Great Eastern handles assets more actively than the others. 2008 has been a dramatic year for commodities to say the least. The shipping industry will be praying along with the mineral producers for a quick turnaround in commodities. After all, their fates are tied closely together.

Investment bankers, part of the community responsible for the contagion of the CDOs, are feeling the heat more than ever now. Other than the acrimony they have been receiving for their greedy actions, their commission and fees based revenues are drying up to levels unprecedented in recent times.

As per reports from Bloomberg, bankers at Barclays Capital and Nomura Holdings Inc. say the value of deals may decline 30% in 2009 to about US$ 2 trillion. Takeovers so far this year are down 36% from the same period in 2007, reducing the fees paid to banks by 34% to an estimated US$63 bn. The only trickle still coming their way is from the deals taking place due to forced sales demanded by creditors and government led transactions.

What's tango? It's a Latin American music and dance form. What's a contango? No, it's not another form of music. Not if you are an oil producer. When crude oil deliveries far out in the future (say 13 months ahead) are priced higher than prompt deliveries (say 1 month ahead), the market is said to be in a contango. And it's a sign of a glut in supplies.

The current oil market is perhaps in the worst contango since 1998 as per Bloomberg. And one reason the contango is set to enlarge is because there is no credit available for potential buyers who could buy the cheap oil and store it for the future. That's the reason why the self-correction mechanism of markets has not kicked into action. One set of players are active though. Large oil companies have contracted large supertankers as floating storage. Shell, for instance, has 16 such oil filled tankers floating on the sea. Another set of players, OPEC, is also likely to address the oversupply in its next meeting this month.

The Centre had projected a fiscal deficit of Rs 1,333 bn for FY09 or 2.5% of the country's GDP. However, in its eagerness to stimulate growth and sustain the magical growth rate of 8%, by the midyear (October 2008) itself, the government had made so much excess expenditure that the deficit figure reached nearly 88% of the budgeted sum. The market borrowings that the government will have to undertake to fulfill its obligations under the recently announced fiscal package along with the supplementary demands for grants and subsidies and revenue loss on account of tax relief will together lead to additional deficit to the tune of Rs 550 bn. A rough calculation therefore says that the government's deficit estimates are likely to go completely off the mark and touch nearly 5% of GDP (nearly double the budgeted figure) this year. Probably we not only need better policy makers but also better number crunchers for manning the affairs of the government.

While the Indian markets are closed today on account of Bakri Eid, as far as the Asian markets are concerned, barring China and Hong Kong, the other key indices closed in the green. The European indices are also trading in the positive currently. As reported on Bloomberg, crude oil traded near US$ 44 a barrel on speculation that the global economic stimulus plans will boost demand for raw materials. Gold traded little changed at US$ 772 an ounce as the dollar gained, eroding the appeal of the yellow metal as an alternative investment.

04:57  Today's investing mantra
"Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increase" - Warren Buffett
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