The Alphabet Soup, The India Spice - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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30 OCTOBER 2007

I am numbed.
It has been 6 weeks since I wrote the first part of the ABCP (Asset Backed Commercial Paper) article.
To tell you the truth, the Honest Truth, there already was a Part Two ready in my computer to be sent out.
But it evaporated.
Into thin air.

Just like Merrill Lynch "lost" USD 3.5 billion in 19 days.

On October 7th Merrill announced it had losses of USD 4.5 billion from its investments in these Special Investment Vehicles (SIV's) which held all sorts of mortgages and ABCP.
On October 26th, they said, "oops, if Ajit can lose his Part 2 of his Honest Truth, we also have a confession to make: We lost another USD 3.4 billion on the SAME instruments that we own by just tweaking our assumptions on what those instruments are likely to be worth".
And this was on AAA rated securities. High quality stuff.
Where assumptions should be less risky.
Imagine the extent of write-downs on low quality stuff.

These SIV's are also giving Citibank a nightmare.
Their SIV's reportedly own USD 80 billion of them.
Given that these SIV's borrowed short term money and have purchased long term assets, there will be a re-financing that will need to happen in the next 6 months.
The lenders who gave loans in April, May, June will turn up at Citi's door and say, "Hi, folks, I lent you that USD 80 billion, can I have it back?"
Citi and their SIV will not have the money to pay.
They will have to sell the ABCPs owned by the SIV's.
Those ABCP's are nowhere close to the USD 80 billion they own the lenders.
Even if they can find a buyer for them.

So they will ask the lenders to extend the loan. To re-finance.
But no one wants to refinance this stuff anymore because the person giving the loan is not an idiot.
The lenders know that the USD 80 billion in assets held by these SIV's may be worth only USD 50 billion.
Or USD 30 billion.
Or less.
With the housing market in the US in any oversupply and over-borrowed situation, property prices are down, defaults on home loans and mortgages are high.
So all these ABCPs held by the SIVs are worth a lot less than they were yesterday.
And are likely to be worth less when the lender wants his money back in the future.

So, Citi did what every well-entrenched large financial institution does.
You know, the folks who belong to the "TBTF" category.
Too Big To Fail.
They went to the US Government and have their blessings for a USD 80 billion "SuperFund".
Citi can go to this SuperFund and dump its SIV's into that Fund, get cash, and repay the lender.
The SuperFund - owned by US taxpayers eventually - will be left owning junk assets and defaulted home loans.
Citibank shareholders will probably still get the USD 9 billion of dividends they get every year - from the profits made on packaging these junk loans and selling and re-selling them.

Imagine.
You take a loan to buy a house.
You cannot afford to pay the loan.
You call your banker and say, "Sorry, sir, I cannot repay my loan. Please can we talk about it?"
Chances are there will be a muscle-man holding your teeth with a pair of rusted pliers while you try to talk.
But not if you are TBTF.
Then the government comes to help you.
In USA. In Europe. In India.

The financial engineers have achieved Eureka.
They can turn your paper and my paper into their gold.
And if they fail - if that paper turns rotten - they turn to their central bankers.
They get bailed out.
They get to keep their gold.

As long as that system is in place, the risk takers will take risks.
They will circle the world to find any paper, any piece of rubbish, and turn it into gold.

In August when the ABCP mess first broke into the mainstream media, the risk-takers held back.
They no longer wanted risk.
Emerging market stocks were hit hard.
The risk-takers were nervous that their financial engineering and the biggest sympathisers to the financial engineers - the central banks - would act rational and say, "Sorry, just like Ajit lost his article, you have lost your capital. Go back to your shareholders and ask them to inject more capital into your bank. No more dividends to be paid out to them - start taking money from them".

For a few days the risk takers were on the edge.

Then the Fed cut rates, news of the SuperFund surfaced, and the best were back on the table.
Big Time.
"Big" with a B that would make our own Mr. B jealous.
The emerging markets are hot.
They scale new peaks every day.

India may have a shaky government.
The P-Notes may have thrown people off balance for 60 seconds and hit a -10% circuit.
But the gamblers are back.
Sorry, not gamblers (a gambler can lose money and go home to his wife with a hole in his pocket before she puts a hole in his head) but the financial engineers.
Don't let the news channels in India distract you with all their discourses on P-Notes and trading tips.
The RBI may have a lot of things to say on credit policy but their impact, like the 60 second fall in the Index, will be limited.
Save the earth, save a tree, write a letter to your editor not to print any of this stuff on Credit Policy, P-Notes, Karnataka governments, quarterly results - it is irrelevant.

Life is even more simple.
Follow what the Fed does.
If the central bankers support the risk takers, the Index will have all the buying it needs to go to any level.
You choose the number.

If the central bankers begin to bring some sense and balance back into the system, trading sessions will last for 60 seconds.
With the minus signs showing prominently.
Maybe 2 sessions in a day?
For a week?

While this madness plays out - in either direction - there is nothing you can really do.
Maybe have a quick look at your asset allocation - I hope you bought some gold.

Enjoy time with your family.
Let your mutual fund manager worry about this - you pay them for it.
Don't take any calls from commission-churning distributors (they, too, can turn your paper into their gold).
Be polite to your neighbour.
Offer a seat on a bus to the lady who is standing.
Go out for dinner.
If there is a foreign investor sitting on the table next to you, observe him.
From the look on his face you will know where the markets are: In a soup - or frolicking in a spicy Indian curry.


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