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And do you realy think Bailout Cash will be enough? Wake up and smell the coffee.....

Wed, 12 Nov 2008 11:03:55 EST

And do you realy think Bailout Cash will be enough? Wake up and smell the coffee..... - by Ziad

Morning folks:

I personally don't expect federal bailouts to help banks compensate for any losses as I am afraid that the $250 billion promised by the Treasury to support the banking sector won't be enough.

I am also afraid that banks will lose an additional $450 billion of existing capital over the next two years; which is basically equivalent to 3 percent of U.S. gross domestic product and 45 percent of existing bank capital.

Overall, we are talking about the U.S. economy shrinking 1.5 percent in 2009, with no growth in 2010.

It is a fact that the never-ending cycle of asset write-downs and mounting loan defaults is hemorrhaging cash from the banks and sooner than later they will be forced to either sell assets, seek fresh funds, or slash their loan books.

U.S. financial institutions have recorded more than $380 billion in losses since the crisis began last year and any prospects of solid earnings plugging the funding gap are very slim.

By offering the bailout, all the Treasury will manage to do is offset further losses and prevent capital adequacy ratios from falling.

As it stands, it is expected banks to shrink their loan portfolios by roughly 10 percent over the next couple of years, putting more downward pressure on economic activity.

Banks, thus, will find themselves competing with each other for cash as they try to raise needed funds.

I personally expect $350 billion to be raised by U.S. banks, with up to half of that new capital coming from the federal government.

If banks can't raise even more capital, from either public or private sources, they will ultimately be forced to curb lending.

In a worst-case scenario, if that were to happen, the fall in loans would rival the collapse in loans seen during the “Great Depression”.

I don't know what Goldman and Morgan Stanley will look like after they resize. I'm agnostic on those names right now. There is a lot they have to go through and don’t seem to have a clue of how to position themselves yet.

Talking about the best and brightest on Wall Street??? Go figure ….

Your feedback is always greatly appreciated.

Thanks much for your consideration.

A New Financial Order in the making?

Mon, 20 Oct 2008 20:19:40 EST

A New Financial Order in the making? - by Ziad

Morning folks

Hope you all had a great weekend….

I guess in the middle of a battle, it's hard to know what the landscape will look like after the smoke clears. But as the government wrestles with the credit crisis, I am afraid individuals and businesses will have a harder time getting loans in coming years, but also may be less eager to take on debt. There will be "more" financial regulation or "better" regulation, but definitely not less regulation. I am also afraid there will be intense efforts to see what is going on inside previously opaque areas like hedge funds, derivative markets and subsidiaries set up to evade restrictions. Instruments like credit default swaps, which helped bring down AIG and other big financial institutions, are likely to become more standardized, allowing them to be traded on centralized exchanges so that values will be easier to fix.

I think this crisis is bad enough that it has rung some alarm bells, but also there's a better chance of doing something right ... than there has been for decades.

The most obvious change I foresee in the financial markets is the government's new role as a major owner of the nation's banks, modeled on a British plan being adopted in much of Europe. While such partial nationalization is meant to be temporary, even its proponents are uneasy about excess government power in business.

It is without a doubt that the program will encourage risky behavior in the future by shoring up the banks to the benefit of current shareholders. When the government took over Fannie Mae and Freddie Mac, the shareholders were all but wiped out. It sets bad precedents for the future and it is clear that taxpayers could take a hit if the program does not work as well as advertised.

But overall, the plan, calling for a $250 billion investment in newly created bank stocks, has a better chance of success than the earlier plan to buy up mortgage-backed securities and other bad assets. That remains in force but probably will entail about $100 billion in purchases instead of $700 billion.

I think we can call this Plan B, and Plan B is substantially better than Plan A. Paulson was clearly clever in calling in executives of the nation's nine largest banks and essentially ordering them to participate so that smaller banks will not fear that taking part will signal failure.

The new plan can provide money much more quickly than the asset-purchase plan, which might take months, even years. Also, it provides more bang for the buck because it harnesses the power of leverage. Buying $1 worth of assets can give a bank $1 to lend, but buying $1 in stock can allow the bank to lend many dollars, since a bank could have an asset-to-equity ratio of 10 to one.

Taxpayers can profit under the initial plan if the government eventually sells assets it buys for more than it pays. But that might not happen because banks typically are more likely to sell their worst assets, such as securities backed by mortgages plagued by defaults and foreclosures.

In the new plan, if a bank's share price rises, taxpayers can recover their investments and even earn a profit. In addition, the government will earn a 5% dividend on its investment for the first five years and 9% afterward, and it will have the right to buy more shares. A lot of economists are in favor of it because they think there is more upside for the government….But the new plan does have risks. What bothers me about this is what I think bothered Henry Paulson from the beginning. It is to what extent the government is going to be in the business of picking and choosing which banks are going to survive.

And although the program aims to rekindle the lending from one bank to another, it will resolve the crisis only if that leads to more lending to companies and other non-bank borrowers. I guess even with plenty of money on hand, banks may keep the lending spigot closed for fear borrowers will not be able to pay back loans if the world tumbles into a deep recession.

On October 14, a day after announcing his plan, Paulson warned that banks receiving government investment will be expected to lend the money, not to "hoard" it. But the program might work better if the government offered guarantees to banks that lend to businesses. The injection of capital.... I don't regard that as an instant cure-all.

Assuming the cash infusion does get banks lending again, what happens next? I am afraid that Congress or other governmental bodies could use the public stake to advance social goals, pressuring banks to make risky loans to favored groups, for example.

To minimize such influence, Paulson said shares acquired by the government will not have voting rights. But risk could be reduced further with rules requiring the people overseeing the program to run it for the benefit of bank shareholders -- the taxpayer and others -- as is commonly done with investment trusts. The program should not be used "to try to conduct policy that should be conducted by the rest of the government," such as providing inexpensive mortgages to people with shaky credit. That kind of pressure from Congress contributed to the troubles at Fannie and Freddie.

Even with the program in force, borrowers will find money harder to come by than it was in the easy-money years leading to the crisis. Already, home buyers must come up with 10% or 20% down payments and prove they have sound incomes. Loans allowing borrowers to decide how much they want to pay back each month have all but disappeared, and people with tarnished credit are finding it much more difficult to borrow.

Businesses, too, find money harder to get, as lenders worry more about their ability to repay. The commercial paper market, used by businesses to obtain low-cost, short-term loans, has been frozen, and parts of the new bank-investment plan are designed to get it moving again.

Use of commercial paper has mushroomed in the past two decades, largely because the growth of money market funds furnishes a huge source of cash for these loans. Investors benefit because money markets pay higher interest than bank savings.

The commercial paper market is likely to revive, but the recent experience probably will make businesses more conservative about using it. Many companies have relied on it for long-term needs, repeatedly paying off each month's loans with new borrowing. That left many without a ready source of cash when the flow stopped in the recent crisis. I think the commercial paper market may shrink significantly. People are nervous about funding long-term assets with short-term paper. In the future, long-term needs are more likely to be funded with new stock or bond issues.

Another reason lending will tighten: Big investment banks have been sold to or converted to commercial banks, which have tougher capital requirements. While some investment banks gambled $30 for every $1 they had, the ratio for commercial banks is more like 10 to 1.

Most experts believe the current crisis is an extraordinary situation rather than an exaggerated plunge in the normal business cycle. Many of the causes need further study, but the consensus seems to be that the next president and Congress will need to reform the regulatory system, a patchwork built over the past seven decades. No one has a master plan now, but some themes are emerging.

To assess risks building up in the system, regulators are sure to demand more transparency. That will include a clearer look at how leverage is used and by whom, and which institutions are accumulating big positions in volatile derivatives like credit default swaps. What we need to know is how much macro risk is taken by various organizations and pools of funds that could, in a crisis, turn out to harm the economy. We need to bring transparency to the credit default swaps market and the derivatives market. That's got to happen, and it will happen.

While transparency is valuable, it is hard to get it just right. Casting too much light into a firm's affairs can undermine its competitive advantage, discouraging innovation and risk-taking. But requiring firms to make only generalized disclosures can give outsiders a distorted view. Reports on total derivatives holdings might make a firm look very risky, while some holdings actually may offset risks of others. I don't think ANYBODY has figured this one out yet.

Regulators also must wrestle again with the use of off-balance-sheet entities -- subsidiaries set up to skirt regulations affecting the parent company. While there was an effort to rein these in after the Enron debacle early in the decade, the recent crisis shows they had continued to be used to amass and conceal risky, highly leveraged positions. If activity X is prohibited among banks, what they do is set up a non-bank financial institution that can get into that activity. Since businesses will always look for ways to get around the rules, we've got to have a regulatory system that is just as imaginative…..wouldn’t you think so?

Oversight of different types of securities needs to be more consistent, as bets on individual stocks can now be made in various ways -- by purchasing the stocks themselves, or through futures, options or swaps contracts based on those stocks. The Securities and Exchange Commission oversees the stock market and the Commodity Futures Trading Commission regulates the futures and options market, but the swaps market, often involving individually tailored contracts, has virtually no regulation.

All securities that rise or fall according to the health of an underlying company should be treated the same. If it has payouts the same as an equity but we call it a swap, it's probably an equity. I always think of derivatives as something like very sharp knives. They are very good at parsing risk. Used properly, they are very valuable, and there shouldn't be anything to prohibit that parsing of risk. In the current markets, however, the regulations have not kept up with these new tools.

The poster child of the current crisis is the credit default swap, a kind of insurance policy. Like auto insurance, the buyer makes regular payments to the seller, which pays a claim if a given event occurs, like a specific company defaults on its debt payments or goes bankrupt. A buyer that has lent the company money, or a business awaiting payment from that company, can use a credit default swap to buy coverage in case the company fails to meet its obligations.

But these instruments can also be used by speculators to bet on companies' rising and falling credit worthiness. As the mortgage crisis deepened over the past two years, many firms' credit worthiness fell, leaving firms like AIG and Bear Stearns with huge obligations to pay swaps owners' claims. While insurance companies are required to keep enough money on hand to pay expected claims, swaps issuers are not.

You probably do want some capital requirements, since even if there is no regulatory requirement, investors may demand this.

Another problem: Credit default swaps and many mortgage-backed securities are so highly customized it is hard to assess their value from day to day. As the housing bubble burst -- and homeowners fell behind on payments -- swaps and mortgage securities tied to these payments lost value, but it was unclear by how much. Lenders, worried about unknown liabilities on borrower's books, became reluctant to lend, causing the credit crisis.

I believe the market needs better transparency and a better way to establish values as conditions change. That may be accomplished if the current over-the-counter trading system were replaced with a centralized exchange and a greater standardization among these products. The problem is we have no idea how large the swap market is, and there's no oversight of it. Would it be so terrible to have these instruments traded through organized exchanges? That's the question the new president is going to have to ask.

While there is some talk of doing this, it is not clear whether the marketplace will do it on its own or needs to be prodded by regulators. When things become commoditized they tend to gravitate towards a central trading place, and credit derivatives are becoming commodities. If the government facilitates that move to exchange-based trading, great.

Either way, it's likely these instruments will not continue to create the hazards that they have recently, because investors and issuers who were burned will be more careful. Indeed, the business world and financial markets are likely to become considerably more conservative and cautious.

I daresay that for the next few years, we are not going to have excesses in the financial markets. I don't think the markets are going to repeat the same follies that we have had in the last few years.

And that’s my take of it….so far. What do you say?

Your feedback is always appreciated

Thanks much for your consideration

The $700 Billion Bailout Question: Will it Work?

Thu, 02 Oct 2008 11:40:41 EST

The $700 Billion Bailout Question: Will it Work? - by Ziad

Morning folks…..Hope all is well.

I guess these are times we’ll remember for a very long time and that will affect our lives for at least the next decade.

The $700 Billion Bailout Question: Will it Work?

Economists and financial experts don't all agree that a taxpayer-funded purchase of troubled mortgage securities is the best way to attack the credit crunch. Some support it, while others prefer alternatives like a loan program for hard-hit financial institutions or a government-backed mortgage refinancing program -- strategies that could supplement the administration's plan or replace it if it fails.

Regardless of their take on the rescue, most experts agree there is a key unanswered question at its core:

How would the government know if it is paying the right price for the exotic securities it would buy from troubled firms? Pay too much and the taxpayer could lose hundreds of billions of dollars. Pay too little and the bailout would fail.

The big question is, at what prices will the Treasury buy the debt?. The problem with this crisis is that it's not just about confidence in the markets. It's also about the huge losses that banks, investment banks, insurance companies, hedge funds, etc…. have so far suffered. The Feds are betting that restoring liquidity will be enough. Maybe not.

Issues debated in the final days -- caps on executive pay, the makeup of an oversight board, a public equity stake in firms that are helped, and the pace at which funds will be provided to the program -- have little bearing on whether the asset-purchase plan could succeed. All described the financial situation as perilous and said some sort of government response is needed.

I personally believe the plan could channel enough money to enough banks to get them to resume lending. The principal benefit is that it establishes a market price for these assets that have no price. This will allow banks to write down losses appropriately, which is absolutely necessary to get capital flowing back into the banking system though I am also afraid the plan is not doing anything to remedy fundamental problems with the mortgage market. To work, a remedy must help homeowners renegotiate mortgages on properties now worth less than the owners owe. That fundamental problem is not being dealt with in this bailout.

The plan as we all know was proposed September 20 by Treasury Secretary Henry Paulson, with support from Federal Reserve chairman Ben Bernanke. Despite changes negotiated with Congress, the heart of the plan has survived for now, providing for the government to purchase assets like mortgage-backed securities from financial firms. Many of these have become impossible to sell because rising homeowner defaults on mortgage payments make the securities' values uncertain.

Banks and other financial firms have suffered enormous losses on these securities and may well lose more. That has left lenders wondering whether potential borrowers will be unable to pay loans back, causing a pullback in lending of many types.

By purchasing the risky assets, the government could reduce worries about hidden liabilities and furnish cash that firms could use for operations and loans, according to Paulson and other supporters of his plan. In theory, this will get the credit markets working again. The plan's proponents also argue that doing nothing would have even greater consequences, as businesses fail to get money they need and ordinary people who cannot get mortgages, credit cards and auto loans cut back on spending, undermining the economy.

While much of the debate has focused on the potential $700 billion "cost" to taxpayers, backers of the Paulson plan prefer to describe this outlay as an investment -- buying assets at depressed prices and hoping the markets will turn around. Eventually, the government would hope to sell those securities, recouping some or all of what it had paid, and turning a profit if prices rise enough. I'd be shocked if we spent anywhere close to $700 billion….I think the net cost to the taxpayer when all is said and done will be pretty modest.

If done right, I would even think the government could earn between $1 trillion and $2.2 trillion through the Paulson plan. It would buy distressed assets at discounts of 75% to 80% from their original prices, then push their values up by using the government's unlimited borrowing power to pump money into the economy to boost growth, which unlike hedge funds and other investors, the federal government has endless staying power and can outwait any downturn.

Government purchases will help establish asset prices, encouraging other investors to look for bargains, and possibly leaving the government spending far below the $700 billion called for in the plan. Because there is little trading and a great deal of panic, there may be securities trading at 30 cents on the dollar when they're really worth 50 cents. If this does facilitate price discovery and liquidity, then there will be less need for the government to come in.

One of the things that the government has not conveyed very effectively is the intellectual foundation of what they are doing. They believe the securities are mispriced ... values have broken away from fundamentals. I would agree with their view.

The underlying problem of mortgage delinquencies and foreclosures has not grown as bad as the tumbling prices of mortgage-backed securities suggests. A recent Bank of England study found that prices on AAA-rated subprime mortgage-backed securities reflect a 76% default rate on the underlying mortgages, far above actual default rates. This would require something worse than the Great Depression. Most other indicators suggest this is not the outlook.

When an asset bubble bursts, prices typically fall to excessive lows and then rise to a more rational level. If you believe the government's view, the risk to the taxpayer is small. It is quite likely they will get most of the taxpayers' money back. This has been the case in many crises before. Indeed, the government may even make a profit if it implements a plan to acquire stock warrants in firms it helps.

It is however very hard to know which securities are underpriced and which are not. Financial firms are unlikely to sell securities to the government that they think will rebound. Instead, critics say, they will dump the toxic waste, leaving the taxpayer to bear the loss.

The government is considering a reverse auction system -- "reverse" because there would be one buyer and many sellers instead of one seller and many buyers, as in a standard auction. The government would describe a category of securities it wanted to buy, purchasing them from bidders willing to take the lowest prices.

But these are not standardized securities like futures contracts for corn or wheat. Each is highly customized and unique. Given the government's need to buy them in huge blocks, it may have to use bidding criteria too broad to filter out the toxic waste.

Firms that create these securities typically start with bundles of up to 10,000 mortgages. Then they produce a series of securities of various qualities to pass homeowners' monthly mortgage payments on to the securities' owners. The lowest quality, a non-rated level, offers the highest yields but is the first to stop receiving payments if some homeowners fall behind. The top-rated, or AAA securities, pay the lowest yield but are the last to suffer from homeowner defaults. Three or four other qualities fall in between.

One problem is that the ratings turned out to be based on overly optimistic views of the health of the underlying mortgages, and default rates have been far higher than expected. Ratings labels now have little meaning.

Moreover, even securities carrying the same rating might be very different from one another. Often the AAA slice, or tranche, was itself divided in two. The higher-quality half would suffer no losses until the other half was wiped out. Hence, the high-quality portion might be worth 96 cents on the dollar today with the other half worth only 25 cents, despite carrying the same AAA rating and coming from the same bundle of mortgages.

To put a value on these securities, one needs not only to predict the rate of homeowner defaults, but the timing of the defaults. Defaults further in the future do less damage because investors receive payments in the meantime. In addition, two securities that appear nearly identical can be very different depending on the location of the underlying mortgages. Mortgages in hard-hit California are much riskier than ones in stable Idaho.

Basically, You have to get down to zip code-specific areas that are the collateral in the pool and project how severe the losses are and when they are going to occur in the pool. You need someone who knows what they are doing, and there's not too many of those around…..unfortunately.

What are some of the alternate approaches to the problem?

The government could loan money to troubled institutions, allowing them to use mortgage securities as collateral. This would pump needed cash into the financial system without having the taxpayer shoulder the cost.

Because the securities are so varied, the government would have "no way whatsoever" to know if it is paying a reasonable purchase price in the Paulson plan. I think the whole thing is inferior to a loan program. A loan program could rely on value estimates from agencies like the Federal Home Loan Bank, which already has experience with this. Because of the uncertainties today, the government would build in a safety margin by limiting loans to sums substantially below its estimate of the collateral's value. In addition, it would charge a high "penalty rate" of perhaps 10% to discourage unnecessary borrowing. Taxpayers would profit from the interest earnings.

Because of the collateral requirement, there would be no need to put a cap on the amount that could be loaned. In addition to pumping money into the system, a loan program would help restore private lending because lenders would know that borrowers could get government loans in a pinch.

Other approaches consist of attacking the root of the problem by helping homeowners avoid the defaults and foreclosures that are undermining the values of mortgage-backed securities. Democrats wanted the Paulson plan to give bankruptcy judges the authority to reduce homeowners' mortgage debt and interest rates. They failed. But even if they had succeeded, this case-by-case approach could not help enough homeowners fast enough to buoy the financial markets. It is very cumbersome and slow.

Some proponents have even proposed a government-run process that would allow homeowners to replace current mortgages, many with adjustable rates carrying high interest rates, with 30-year, fixed-rate mortgages charging less. A new mortgage would be based on a property's current value, and the original lender would take a loss if the original mortgage was for more. If a participating homeowner sold a property for more than was lent, gains would be shared with the government.

This idea is modeled on the HOPE for Homeowner's Act of 2008, passed in March. While that program made lender participation voluntary, some experts, especially consumer advocates, want a more forceful program to compel lender participation.

The difficulty with this approach is that once mortgages are converted into securities and sold to investors, there are many parties with a stake in the process, and not all would want to change the loan terms. It is far different from the days when a local bank kept mortgages it issued on its own books and could deal directly with a homeowner in trouble. The problem is that nobody in the chain of securitization has an incentive to renegotiate the initial price of the mortgage.

And that’s my take of it….so far. What do you say?

Your feedback is always appreciated

Cheers

Where are we headed from here ....in terms of capital pool allocations?

Sun, 28 Sep 2008 11:31:44 EST

Where are we headed from here ....in terms of capital pool allocations? - by Ziad

It is a fact that rapidly developing economies (RDEs) have increasingly become drivers of change -- and sometimes disruption -- in global financial markets. That has important implications for companies in the United States and Europe as new players emerge, including sovereign wealth funds, state-controlled entities and acquisition-minded corporations.

As these groups bolster their foreign exchange reserves, they will increasingly look to buy assets beyond their borders, including controlling stakes in foreign companies. At the same time, aging populations in the United States and in Europe will be seeking to liquidate some assets to finance their retirements. This combination of trends will present both opportunities and threats for companies in the developed world. Companies that do not run a tight ship could see unsolicited takeover bids from companies in countries with merchandise- or energy-related trade surpluses. Additionally, top executives at Western companies will need to understand sovereign funds' investment criteria and even get to know decision makers personally.

Seeds for this change date in part back to the Asian financial crisis of 1997 and 1998. Back then the International Monetary Fund got many countries in Asia to do drastic things in exchange for loans. Most decided they never wanted to undergo such economic austerity again and they started building large foreign exchange (forex) reserves as buffers. Even countries relatively unaffected by the crisis -- such as China and India -- took the lessons to heart. Today, forex reserves for those two countries have just become huge. China now has some $1.5 trillion in reserves, up from a few hundred billion dollars just a few years ago. India is building too -- nothing like the same scale but it is up to about $200 billion and rising rapidly.

This build-up in forex reserves by many RDEs gathered momentum through export-led economic policies, particularly in Asia. Leveraging comparative advantages in labor costs and other inputs, many RDEs transitioned from command-and-control to more deregulated, market-oriented economies, though not always with private ownership. Their success helped create some large trade surpluses, often with high savings and investment rates.

Asia's long-standing "model of prosperity" has concentrated on exports. Many of these countries are producing more than they are consuming and basically the government is expropriating the difference between the two. It is a mercantilist view. It is true of China and true of India.

That model has helped to create what Ben Bernanke, the Federal Reserve chairman, has labeled a "savings glut." Regardless of what happens to world economic growth this year, these trade surpluses are expected to continue to grow strongly in the foreseeable future.

Another key aspect of today's global financial imbalances is the large trade imbalances due to increases in commodity prices. You can see it in the Middle East, in Russia, and even in commodity producers such as Brazil. There's been a tremendous windfall due to this massive increase in commodity prices.

Whatever the source, the huge increase in global liquidity has helped moderate world interest rates and finance a large U.S. trade deficit and -- until the current economic slowdown -- a spending spree by U.S. consumers, who have reduced their savings rate to near zero. This is the other side of what some call a global financial imbalance: The world's richest country is borrowing from poorer nations.

Borrowing to finance the twin deficits (trade and budget) has come largely through issues of relatively low-yielding U.S. Treasury securities. That exchange looks likely to be redirected. China and others are not happy with the U.S. Treasury bond interest rates. As these investors seek higher returns, expect attention to turn to corporations in the United States and Europe. New money from the BRIC countries -- Brazil, Russia, India and China -- and other RDEs increasingly is seeking outward investments through mergers and acquisitions and other strategic stakes.

The most visible examples of these shifting capital flows came late in 2007 and early in 2008. That is when some of the biggest nameplates on Wall Street and in Europe turned to offshore money, largely sovereign funds, for bailouts from the severe credit crunch sparked by the U.S. subprime mortgage crisis. Investors from China, Singapore and Middle East oil-producing countries injected some $60 billion to $70 billion into Citigroup, Merrill Lynch, Morgan Stanley, Bear Stearns, UBS and Credit Suisse. Following the moves, some Europeans questioned how much foreign investment should be permitted in their banking systems. The United States took a more laissez-faire attitude -- at least initially. That contrasts sharply with the outcries over other recently proposed foreign acquisitions. Strong negative public and government reaction in 2005 derailed the China National Offshore Oil Corp.'s $18.5 billion bid to acquire Unocal, a U.S. oil company. The U.S. Congress helped torpedo that bid on strategic grounds. In 2006, similar politics blocked Dubai Ports World from gaining control of six U.S. port operations.

Unlike those oil company and port acquisition proposals, none of the recent investments in financial institutions by sovereign wealth funds involved a controlling interest. But against the background of a credit crunch and a real need for cash injections, the deals thrust sovereign funds onto center stage. U.S. and European companies realized they were blinking more brightly on the sovereign funds' radar screens and on the screens of flush -- and newly confident -- RDE and energy-producing firms.

Sovereign wealth funds in early 2008 totaled some $2.5 trillion. That compares with some estimates for private equity firm investment pools of $1 trillion, hedge funds of about $5 trillion, U.S. mutual funds of $10 trillion and pension funds of $60 trillion. Some projections peg sovereign funds at $15 trillion to $20 trillion within 10 to 15 years, possibly sooner. Morgan Stanley estimated in March that sovereign funds could soon bypass the forex reserves of central banks.

Sovereign funds investing in the United States appear to enjoy an advantage. Recent reports note that government-held investments in stocks and bonds and the like are exempt from taxation. Yet private foreign investors would face withholding taxes of up to 20%. Some think we should change our law and force the funds to pay tax on that.

The sheer scale of funds under management tells me those sovereign wealth funds are the new guys on the block. I believe they resemble the large mutual funds of 15 to 20 years ago, which went from "almost nothing" to wielding strong influence in corporate governance today. Managements have taken note that these big institutional holders will have 1%, 2% or sometimes 3% to 4% of a large publicly traded company. Shareholder activity levels vary, but their stakes have brought a new kind of power and influence ... especially when companies falter. Sovereign wealth funds could follow a similar path.

A common concern in the United States and Europe is that sovereign funds -- and similar capital pools tightly connected to governments -- might harbor noncommercial motivations. The rise of sovereign funds, along with hedge funds and private equity, has literally changed the balance of the global financial system. Sovereign wealth funds, which have become particularly important as rising oil prices and global economic imbalances have massively increased the foreign reserves of certain countries, present a new set of challenges, including relative lack of transparency over investment strategies, concern over possible political intervention and potential large-scale market moves.

Here is one example that causes some observers to worry: In 2006, a sovereign wealth fund from Norway shorted bonds from banks in Iceland having financial difficulties. The fund was forced to back off after strong protests from Iceland politicians. Whatever the fund's motivations, the incident was a reminder that other sovereign funds could one day act with strategic rather than financial purpose. Sovereign funds don't have to just follow monetary goals, although many do. They can pursue other goals. And since some have gotten so big, they have awesome power -- and not just in financial markets. If they concentrate that power in a certain industry, they have the potential to distort markets, such as in commodities.

Sovereign wealth funds contend they are passive investors seeking the best financial return. But concerns about them already run so deep that by March the European Commission, the IMF and other world financial organizations and nations were working on market-oriented best practices or codes of conduct for governance and transparency, in some cases in cooperation with the sovereign funds themselves. U.S. Sen. Charles E. Schumer of New York early this year was considering legislation targeting similar concerns.

Apart from such codes, would limiting the stakes that sovereign funds are permitted to hold reduce the risks of non-market-oriented influence? It would be difficult to limit stakes because the question with China, for example, is who are 'they?. The Chinese government controls many companies and investment funds. It could simply set up two entities instead of one and gain control that way.

Others view sovereign funds as important sources of capital that offer corporations new opportunities, even if -- perhaps especially if -- they were to concentrate investments in one area. Some in the media report on them as a threat, but I don't think that is the way to look at it. The funds could transform sectors for the good in a major way. Imagine if a number of sovereign wealth funds started taking large positions in venture capital investments in companies seeking alternative energy solutions. You'd have a large potential force which is complementary to a lot of other venture capital firms. Expect to see more partnerships involving Western companies and sovereign funds, including venture capital firms as the funds are great potential partners for large projects.

Companies from the BRIC countries and other RDEs pose additional challenges. They are on the hunt for acquisitions and merger partners with motives that range from a desire for growth, profit, scale, technology, natural resources or R&D expertise to a search to add new brands, customers and distribution channels.

In the 2008 BCG 100 New Global Challengers: How Top Companies from Rapidly Developing Economies Are Changing the World, The Boston Consulting Group updates its list of the 100 top challengers -- as competitors, customers, candidates for partnering in mergers or acquisitions, and as potential acquirers. Eighty of the 100 top companies hail from BRIC countries. The BCG 100 grew at a compound annual growth rate (CAGR) of 29% from 2004 to 2006, "close to three times the rate of companies in the S&P 500 and Fortune 500," bringing 2006 revenues for the select group to $1.2 trillion, according to the report. Still more impressive -- and perhaps more worrisome for managers defending their home markets -- the group's international revenues grew even faster, achieving a CAGR of 37% from 2005 to 2006. As a result, the BCG 100 generated 34% of their revenues offshore, compared with 32% in 2004.

Certainly, Indian companies are becoming a lot more assertive in making outbound mergers and acquisitions. Last year, in a huge M&A deal, India's Tata Steel acquired Anglo-Dutch steelmaker Corus Group for $13.6 billion. That made Tata Steel, a BCG 100 Global Challenger, the world's sixth-largest steelmaker. Tata's chief competition in the auction was Brazil's CSN, another BCG Global Challenger.

In the United States, companies are finally going to see the ramifications of the country's]huge cumulative trade deficit and relatively low savings rate. The main destination for the huge, RDE-related dollar holdings will be the United States. They will spend here, and not in retail, but they will want to buy assets, real estate and companies, because that is what we have here in the U.S., lots of wonderful companies.

Expect U.S. shareholders to welcome RDE participation, at least indirectly and if only at first. This all occurs as the Baby Boom generation enters the retirement years. They have lots of stock, but who is going to buy it all? The countries with all the dollars obviously.

As the aging of the developed world requires it to import goods from the much younger developing world, I believe we will get a huge shift of ownership of assets, from being Western-owned to being increasingly owned by investors from developing countries. That is the very long-run view. China is a little bit of an aging country, too, so that will be a slightly different dynamic, but it will happen with India and other developing countries. So there is a demographic component, a government trade-policy component, and an energy and natural resources component to the shift.

Expect RDE companies to follow the Japanese model and build manufacturing plants in their U.S. competitors' backyards. When the Japanese built their auto plants here, it was not about reducing shipping costs. They had revenues in dollars but expenses in yen. The only way to hedge exchange rates in the long run is to have revenues and expenses in the same currency.

One unwelcome result could be a backlash of financial or trade protectionism. Will Congress say, 'Wait a minute, Americans don't own anything anymore? What happens when the Saudis want to buy Boeing? What happens when Venezuelan President Hugo Chavez wants to buy up U.S. assets? If the U.S. wants to run a trade deficit of up to 7% to 8% of GDP, then there will be a lot of consequences. Foreign entities can come back and buy us.

In July, one high-profile purchase occurred when the Abu Dhabi Investment Council bought a 90% stake in the iconic Chrysler Building in New York City, investing some $800 million. The purchase was reminiscent of a similar deal in the 1980s when some Japanese investors, flush with export-generated cash, were buying up real estate and other assets in Hawaii and elsewhere in the U.S. But when they wanted to buy famous properties such as the Pebble Beach Golf Course in California and New York City's Rockefeller Center, the Japanese groups were met with negative public opinion (though both deals went through). Such politics could prove to be the biggest constraint to RDE investors seeking acquisitions in the U.S. Wouldn’t you think so?

There has not appeared to be any major reaction to the Chrysler Building purchase, at least initially. But the fact that the sovereign fund sought out a real estate investment was interesting on its own merits. Some sovereign funds had their "fingers burnt" by getting into the U.S. banking equity market too early, only to see the value of many of those investments fall, in some cases dramatically. The sovereign funds for now may look to avoid financial assets in favor of other asset classes.

As countries become enormously productive, they will without a doubt run trade surpluses, accumulate wealth and gain influence. A widely held concern exists about government-owned or government-controlled funds. But I guess that companies always have to worry about hostile takeovers by any investor, whether from Ohio or from France or China, particularly if they are underperforming. What matters is not so much the source of capital but the acquirer's intentions. If they just want the brand ... well, that sometimes happens with the takeover of one American company by another American company.

We've obviously had cross-nation M&A since World War II. Today there are however more players and most companies are not worried one way or the other. A GE or a Boeing would see great opportunities in the accumulation of great wealth around the world, and they would certainly reemphasize their global production and their global marketing, but it would not be a source of particular concern to the CEOs or CFOs of those companies….or would it?

Looking ahead, I think that companies should recognize the fact that their shares will increasingly be owned by foreign investors. There is really nothing they can or indeed should do about it. Why would you want to steer away a buyer? It is a huge opportunity If managers don't run their companies well, the stock price goes down and it could get unsolicited takeover bids financed from abroad. As with any takeover bid, management may or may not be happy about it, depending on the price. It could be their savior or it could be a hostile takeover.

Fifteen to 20 years ago, American CEOs and CFOs had to learn how to work with big institutional holders and equity analysts. To be an effective top team member today takes knowing how sovereign wealth funds work and building a relationship with their officers. It's important for top executives to know the funds' investment criteria, but also to get to know the people who are decision makers personally. It's very important to become personally acquainted. Personal relationships still matter a great deal in international business.

Either way, the playing field is shifting quickly.

Bottom Line:

I strongly recommend that companies consider the following to best prepare for the changes already under way:

1) Challenge-proof your business model by speeding innovation, lowering costs and revisiting how your company adds value.
2) Attack challengers on their home turf where economically viable.
3) Acquire fast-growing RDE-based players; and
4) Convert challengers into partners and customers.

In the meantime, expect sovereign funds and RDE-based companies from the BRIC countries and the Middle East to continue to tip the scales of capital flows.

What do you say? Your feedback is greatly appreciated

Thanks much for your consideration

Is America too big to fail?

Mon, 15 Sep 2008 12:07:11 EST

Is America too big to fail? - by Ziad

In the 1978 blockbuster Superman, Lois Lane falls from a rooftop in New York. The late actor Christopher Reeve, decked out in blue tights, swoops down to catch the falling Lane.

"Easy, miss. I've got you," he says with a trademark grin.

"You, you've got me? Who's got you?" replies Lane, looking down over his arms to the pavement below.

We could ask the Lois Lane question of our own government these days. They're stepping in all over the place to dig out banks and save investors. Yet the world's biggest economy is in no shape to write those checks.

In fact, the United States is harrowingly close to the same kind of utter financial collapse that Americans once thought only shaky Latin American regimes could suffer.

The Fannie and Freddie bailouts, monster entitlement programs for retiring baby boomers, Wall Street in flames, and sliding home values are coming to a head at exactly the wrong moment.

The chances we'll be able to muddle through are slimmer every day.

The earthquake will come via a collapse in the market for U.S. government bonds as domestic and foreign investors realize that the only way Uncle Sam can meet his future spending obligations is to print massive quantities of money.

The result will be sky-high inflation and interest rates and, most surely, a prolonged reduction in output and employment.

This could happen today. It could happen tomorrow. But it will happen here just as it has happened in every other country that tried to spend far beyond its ability to pay.

Exactly. Who's holding up Superman? Us, the taxpayers.

It's far too easy to confuse the shorter-term government deficit, which seems manageable at $407 billion, the latest Congressional Budget Office figures, with the real, larger outlay ahead.

But even that has a sad punch line. Goldman Sachs now says that the short-term number, once you figure in bailouts, military spending, and probable tax-receipt shortfalls, is likely to be $5.3 trillion over the next 10 years.

Nevertheless, the real total debt of the government right now is $70 trillion. Never mind the personal debts — credit cards, mortgages, cars, and other loans — Americans would face as our economy heads, potentially, into a deep recession.

Compare that figure to the entire U.S. economy, which amounted to $13.8 trillion in total economic output in 2007. Imagine if your personal credit-card debt was five or six times your annual paycheck. Scared yet?

Large-scale bank failures could cost hundreds of billions more, beyond the billions promised so far to save Indymac, Fannie, Freddie, and Bear Stearns. Automakers are begging Congress for cheap loans. Airlines won't be far behind them.

If we keep our promise to the retiring baby boomers, we'll be paying out $4 trillion a year that we don't have for decades.

I figure it would take a payroll tax hike equal to 15 percent of everyone's paycheck, immediately and permanently, to try to fix the problem.

Of course, that would be the equivalent of truck-bombing our consumer-driven economy.

We could just scale back benefits for retirees, right? Don't count on Congress to voluntarily tell tens of millions of elderly voters they're on their own after decades of promising to care for them, even if it bankrupts the nation outright.

Or shut down our military. That doesn't seem likely in a world where Russia feels it can just roll tanks into a neighboring country.

Certainly, if you read just the headlines, it sounds awful. Even companies with $1 trillion in assets are in jeopardy and growing fear is all around.

But remember, buy low. Be smart. Be contrarian.

Look around, analyze, stay cool and leve-headed....Opportunities this big come only once in a lifetime. It is just money changing hands; pure survival of the fittest and I wouldn't want to have it any other way.

Your feedback is greatly appreciated.

Thanks much for your consideration.

It's Time to Get Rich..er

Wed, 03 Sep 2008 11:55:03 EST

It's Time to Get Rich..er - by Ziad

Sell high and buy low. Makes sense, right?

You would think that such a simple idea would be impossible to forget. Nevertheless, it is a fact that millions of people regularly fail to understand this…..You might even say, predictably.

If you're serious about getting rich, now is the time.

We've entered without a doubt a period of mass-produced pessimism, when bad news is everywhere; and the best time to invest is when optimists become pessimists.

That's because if ordinary people think they are going to get rich quick on something, it's very likely too late.

It works both ways. They get in too late, and they fail to get in early, when the upside is massive.

As the market remains bearish, the optimists become pessimists, quit the profession, and return to their day jobs. This is when the real professional investors re-enter the market. That's what's happening now I guess. Sound familiar?

You might recall Warren Buffett's famous dictum, to be fearful when others are greedy, and greedy when they are fearful. The same principle is at work right now.

For instance, the 1987 stock market crash was harsh for everyone. It wiped out the savings-and-loan industry.

Things looked dark, but what happened next was most instructive. The government mopped up the mess and essentially gave away real estate at bargain basement prices.

For example, the S&L crisis helped make fortunes for those who snapped up commercial real estate on the cheap.

Two decades later, we are again heading through what can seem, in the very short term, like a horrible time to invest in anything.

Certainly, if you read just the headlines, it sounds bad. People have pulled millions out of the markets. Fear is all around.

But remember, buy low. Be greedy. Be smart. Be contrarian.

Bottom Line?

You have about two years to get into position. Opportunities this big don't come along often, so this is your time to get rich..

Having said that, I strongly believe that the best way to invest is privately as we at Blackhawk do.. Why? Because studies show that private investments perform better than public investments.

There are several reasons to explain this, but the important thing to know is that the most sophisticated and successful investors invest privately.

Your thoughts are greatly and always appreciated.

Thanks much for your consideration.

Are all the chickens coming home to roost?

Fri, 18 Jul 2008 16:32:52 EST

Are all the chickens coming home to roost? - by Ziad

The announcement by US Treasury secretary Henry Paulson, together with Federal Reserve chairman Ben Bernanke, that the US government will bail out the two largest guarantors of the country's housing mortgage debt - Fannie Mae and Freddie Mac - far from calming financial markets has confirmed that the financial tsunami that began in August 2007 in the relatively small "subprime" high-risk mortgage securitization market, far from being over, is only gathering momentum.

As with the tsunami that devastated Asia in wave after terrifying wave in December 2004, what we are witnessing now is a low-amplitude, long-wave phenomenon of trillions of dollars of financial securities being unwound, defaulted on, and dumped on the market.

The scale of the latest wave to hit, the collapse of confidence in the two government-sponsored entities, Freddie Mac and Fannie Mae, is a harbinger of worse to come in what will be the most devastating financial and economic catastrophe in United States history. The impact will be felt globally.

I personally expect the S&P-500 index of US stocks, one of the broadest stock indices in Wall Street used by hedge funds, banks and pension funds, to lose around 25% by September as all the chickens come home to roost from the excesses of the US-led securitization revolution that took hold after the dot.com bubble burst and then Fed chairman Alan Greenspan lowered US interest rates to levels not sustained since the 1930's Great Depression.

This will be seen in history as the disastrous Greenspan "Revolution in Finance" - an experiment in asset-backed securitization, a mad attempt to bundle risk into loans, "securitize" them in new bonds, insure them via specialized insurers called "monoline" insurers (which insured only financial risks in bonds), then rate them via Moody's and Standard & Poor's as AAA, or highest grade. All that was done so that pension funds and banks around the world would assume they were high-quality debt.

While he is getting praise in the financial media for his "innovative" and quick reactions to the unraveling crisis, Fed chairman Bernanke in reality is in a panic mode. His room to act is increasingly bound by the soaring asset price inflation in food and oil, which is pushing consumer price inflation to new highs even by the doctored "core inflation" model of the Fed.

If Bernanke continues to provide unlimited liquidity to prevent a banking system collapse, he risks destroying the US corporate and Treasury bond market and with it the dollar. If Bernanke acts to save the heart of the US capital market - its bond market - by raising interest rates, the Fed's only anti-inflation weapon, it will only trigger the next even more devastating round in tsunami shock waves.

The United States economy is in the early phase of its worst housing-price collapse since the 1930s. No end is in sight. Fannie Mae and Freddie Mac, as private stock companies, have gone to excesses in leveraging their risk, much as many private banks did. The financial market bought the bonds of Fannie Mae and Freddie Mac because they bet that the two were "too big to fail," that is, in a crisis the government - more accurately the US taxpayer - would be forced to step in and bail them out.

The two companies either own or guarantee about half of the $12 trillion in outstanding US home mortgage loans, or $6 trillion - which is also about half the combined gross domestic product (GDP) of the entire 27 member states of the European Union in 2006, or almost three times Germany's GDP that year.

In addition to their home mortgage loans, Fannie Mae has $831 billion in outstanding corporate bonds and Freddie Mac $644 billion.

Freddie Mac owes $5.2 billion more than its assets today are worth, meaning under current US "fair value" accounting rules, it is insolvent. Fair value of Fannie Mae assets has dropped 66% to $12 billion and may go negative next quarter. As home prices continue to fall across America, and corporate bankruptcies spread, the size of the negative values of the two will explode.

On July 14, Treasury secretary Paulson, former chairman of Wall Street investment bank Goldman Sachs, stood on the steps of the Treasury building in Washington, in a clear attempt to add gravitas to the occasion, and announced that the George W Bush administration would submit a bill proposal to Congress to make taxpayer guarantee of Freddie Mac and Fannie Mae explicit. In effect, in the present crisis it will mean nationalization of the $6 trillion agencies.

The bailout statement by Paulson was accompanied by an announcement by Bernanke that the Fed stood ready to pump unlimited liquidity into the two companies.

The Federal Reserve is rapidly becoming the world's largest financial garbage dump, as for months it has agreed to accept banks' asset-backed securities, including sub-prime real estate bonds, as collateral in return for US Treasury bond purchases. Now it agrees to add to that potentially $6 trillion in real estate debt.

Yet the disaster in the two private companies was obvious as far back as 2003 when grave accounting abuses were made public. In 2003, William Poole, then president of the St Louis Federal Reserve, publicly called for the government to cut its implied guarantee of Freddie Mac and Fannie Mae, claiming then that the two lacked capital to weather a severe financial crisis. Poole, whose warnings were dismissed by then Fed chairman Greenspan, called repeatedly in 2006 and again in 2007 for Congress to repeal their charters and avoid the predictable taxpayer cost of a huge bailout.

Meanwhile some investors are viewing the Paulson bailout not as a bid to rescue the US economy but a lifeline for his former Wall Street cronies as the country's big banks teeter towards a financial implosion. What until recently had been the largest bank in terms of loans outstanding, Citigroup in New York, has been forced to raise billions in capital from sovereign wealth funds in Saudi Arabia and elsewhere to remain in business.

In a statement in May, Citigroup's new chairman, Vikram Pandit, announced plans to reduce the bank's $2.2 billion balance sheet of liabilities. However, he never mentioned an added $1.1 trillion in Citigroup "off balance sheet" liabilities, which include some of the highest risk deals in the US real estate and securitization era it so strongly backed.

The Financial Accounting Standards Board in Connecticut, the official body defining bank accounting rules is demanding tighter disclosure standards. Analysts fear Citigroup could face devastating new losses as a result, with the value of liabilities exceeding the bank’s $90 billion market value. In December 2006, prior to the onset of this financial crisis, Citigroup had a market value of more than $270 billion.

I think it is great time to make obnoxious fortunes out of this horrendous debacle in the making.

Your feedback is always appreciated

Thanks much for your consideration

Speculators Are Not Responsible for the High Price of Oil

Fri, 18 Jul 2008 11:38:22 EST

Speculators Are Not Responsible for the High Price of Oil - by Ziad

Folks

Congress is blaming oil speculators for high oil prices and calling for tighter controls over futures trading. But speculators are not responsible for the skyrocketing prices of oil and gasoline.

Our government and other governments around the world, on the other hand, are directly responsible for restricting the production and the supply of oil, causing prices to rise today and in the future.

Speculators shouldn't be blamed for predicting, and trying to profit from disasters caused by politicians.

Speculators bet on the future price of goods according to their judgment, but they have no power to dictate prices in their favor.

Speculators stand to lose or profit depending on what the future might bring. They take risks--and take losses when their predictions turn out to be wrong. They don't determine the future, and they should be free to profit or lose from their decisions. Moreover, speculators serve the crucial function of signaling to the market what the future supply and demand for a given product is likely to be, which helps producers plan ahead accordingly.

Congressional attacks on speculators will not increase the supply of oil or drop its price. If Congress wants to lower oil prices it should deregulate the energy market and permit oil exploration throughout America.

Your thoughts are greatly appreciated

Thanks for your consideration

About Oil prices and the Economy Today

Sat, 05 Jul 2008 10:57:20 EST

About Oil prices and the Economy Today - by Ziad

Morning folks

Hope you all had a great 4th of July celebration

Coming to the serious stuff, I personally think the price of crude oil to continue to climb — reaching upwards of $200 per barrel — and for prices at the pump to reach $5.75 per gallon within the next two years, if not higher .

With the growth of crude oil supply “constrained,” prices inevitably will rise further as I am afraid spare capacity throughout the energy complex seems very limited, whether for OPEC crude oil, natural gas, or refining.

It is a fact that in all of those areas, capacity is limited. And it’s getting very difficult for companies and countries to boost supplies — something that has become increasingly apparent to us over the first half of this decade.

Add to the fact that the oil industries in some oil-producing countries, like Mexico, are in decline, and other sources of oil, like the North Sea, are now “mature.”

There are other problems as well.

The places that have large quantities of recoverable oil, notably Saudi Arabia, Iraq, Iran, Venezuela, and Russia, aren’t on track to grow their supply aggressively. It’s growing at a very moderate rate.

What’s more, the currently high prices of gas are creating economic disincentives for those countries to spend more money to expand capacity.

I strongly believe the price of oil and gasoline will continue to grow until we see either greater supply growth, which is unlikely, or demand reduction on a global basis.

This trend will obviously plunge the economy into a deeper recession and will get much worse — but this doesn’t mean that there won’t be fabulous opportunities in the crisis; like the subprime mortgage business.

Everything connected with construction and with consumer, I see weakness, and if anything, it’s accentuating a little bit.

In my adult lifetime, up until the last year or two, there’s been a huge amount of excess supply available. We don’t have excess capacity in the world anymore, and that’s why you’re seeing these oil prices.

Anf if you factor in a war with Iran (more of a likely scenario today) before the US Presidential elections, then the sky is the limit.

What do you think?

Your feedback is always appreciated

Thanks much for your consideration

Are we witnessing the greatest Oil Swindle of all times?

Tue, 03 Jun 2008 08:41:52 EST

Are we witnessing the greatest Oil Swindle of all times? - by Ziad

The Commodity Futures and Trading Commission (CFTC) is investigating trading in oil futures to determine whether the surge in prices to record levels is the result of manipulation or fraud. They might want to take a look at wheat, rice and corn futures while they're at it. It seems the whole thing is a hoax cooked up by the investment banks and hedge funds who are trying to dig their way out of the trillion dollar mortgage-backed securities (MBS) mess that they created by turning garbage loans into securities. That scam blew up in their face last August and left them scrounging for handouts from the Federal Reserve. Now the billions of dollars they're getting from the Fed is being diverted into commodities which is destabilizing the world economy; driving gas prices to the moon and triggering food riots across the planet.

For months we've been told that the soaring price of oil has been the result of Peak Oil, fighting in Iraq, attacks on oil facilities in Nigeria, labor problems in Norway, and (the all-time favorite) growth in China. I am afraid it's all baloney. Just like Goldman Sachs prediction of $200 per barrel oil is baloney. If oil is about to skyrocket then why has G-Sax kept a neutral rating on some of its oil holdings like Exxon Mobile? Could it be that they know that oil is just another mega-inflated equity bubble---like housing, corporate bonds and dot.com stocks-that is about to crash to earth as soon as the big players grab a parachute?

There are three things that are driving up the price of oil: the falling dollar, speculation and buying on margin.

I believe the dollar is tanking because of the Federal Reserve's low interest monetary policies have kept interest rates below the rate of inflation for most of the last decade. Add that to the $700 billion current account deficit and a National Debt that has increased from $5.8 trillion when Bush first took office to over $9 trillion today and it's a wonder the dollar hasn't gone "Poof" already.

According to a January 4 editorial in the Wall Street Journal: "If the dollar had remained 'as good as gold' since 2001, oil today would be selling at about $30 per barrel, not $99. (today $126 per barrel) The decline of the dollar against gold and oil suggests a US monetary that is supplying too many dollars." Wall Street Journal 1-4-08

The price of oil has more than quadrupled since 2001, from roughly $30 per barrel to $126, WITHOUT ANY DISRUPTIONS TO SUPPLY. There's no shortage; it's just gibberish. As far as "buying on margin" consider this summary from author William Engdahl:

"A conservative calculation is that at least 60% of today's $128 per barrel price of crude oil comes from unregulated futures speculation by hedge funds, banks and financial groups using the London ICE Futures and New York NYMEX futures exchanges and uncontrolled inter-bank or Over-The-Counter trading to avoid scrutiny. US margin rules of the government's Commodity Futures Trading Commission allow speculators to buy a crude oil futures contract on the Nymex, by having to pay only 6% of the value of the contract. At today's price of $128 per barrel, that means a futures trader only has to put up about $8 for every barrel. He borrows the other $120. This extreme "leverage" of 16 to 1 helps drive prices to wildly unrealistic levels and offset bank losses in sub-prime and other disasters at the expense of the overall population."

So the investment banks and their trading partners at the hedge funds can game the system for a mere 8 bucks per barrel or 16 to 1 leverage. Not bad.

Is it possible that gambling on oil futures might be a temptation for banks that are already underwater from a trillion dollars worth of mortgage-related deals that have "gone south" leaving the banking system essentially bankrupt?

And if the banks and hedgies are not playing this game, then where is the money coming from?

I have compiled charts and graphs that show that nearly two-thirds of the big investment banks' revenue came from the securitization of commercial and residential real estate loans. That market is frozen. Besides, this is not just a matter of "loan delinquencies" or MBS that have to be written off. The banks are "revenue starved". How are they filling the coffers? They're either neck-deep in interest rate swaps, derivatives trading, or gaming the futures market. Which is it?

Of course, there is one other possibility, but if that possibility turned out to be right than it would cast doubt on the legitimacy of the entire financial system. In fact, it would prove that the system is being rigged from the top-down by our friends at the Banking Politburo, the Federal Reserve. Here goes:

What if the investment banks are trading their worthless MBS and CDOs at the Fed's auction facilities and using the money ($400 billion) to drive up the price of raw materials like rice, corn, wheat, and oil? Could it be? Could the Fed really be looking the other way so it can bail out its banking buddies while they drive prices skyward?

If it is true; (and I suspect it is) it hasn't done much good. As the Associated Press reported yesterday:

"The Federal Reserve announced Thursday that it will make a fresh batch of short-term cash loans available to squeezed banks as part of an ongoing effort to ease stressed credit markets. The Fed said it will conduct three auctions in June, with each one making $75 billion available in short-term cash loans. Banks can bid for a slice of the available funds. It would mark the latest round in a program that the Fed launched in December to help banks overcome credit problems so they will keep lending to customers."

Another $225 billion for the bankers and not a dime for the struggling homeowner! The Fed is bankrupting the country with their permanent rotating loans to keep reckless speculators from going under. So much for moral hazard.

As far as speculation, there is ample evidence that the system is being manipulated. According to MarketWatch:

"Speculative activity in commodity markets has grown "enormously" over the past several years, the Homeland Security and Governmental Affairs Committee said in a news release. It pointed out that in five years, from 2003 to 2008, investment in the index funds tied to commodities has grown by 20-fold -- to $260 billion from $13 billion."

And here's a revealing clip from the testimony of Michael W. Masters of Masters Capital Management, LLC, who addressed the issue of "Commodities Speculation" before the Committee on Homeland Security and Governmental Affairs this week:

"Today, Index Speculators are pouring billions of dollars into the commodities futures markets, speculating that commodity prices will increase. ...In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels.8 Over the same five-year period, Index Speculators' demand for petroleum futures has increased by 848 million barrels. THE INCREASE IN DEMAND FROM INDEX SPECULATORS IS ALMOST EQUAL TO THE INCREASE IN DEMAND FROM CHINA.

Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years.

Today, in many commodities futures markets, they are the single largest force.15 The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets.

As money pours into the markets, two things happen concurrently: the markets expand and prices rise.

One particularly troubling aspect of Index Speculator demand is that it actually increases the more prices increase. This explains the accelerating rate at which commodity futures prices (and actual commodity prices) are increasing. The CFTC has taken deliberate steps to allow CERTAIN SPECULATORS VIRTUALLY UNLIMITED ACCESS TO THE COMMODITIES FUTURES MARKETS. The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.... The result is a gross distortion in data that effectively hides the full impact of Index Speculation." (Thanks to Mish's Global Economic Trend Analysis; the one "indispensable" financial blog on the Internet)

Masters adds that the CFTC is pressing to make "Index Speculators exempt from all position limits" so they can make "unlimited" bets on the futures which are wreaking havoc on the global economy and pushing millions towards starvation. Of course, these things pale in comparison to the higher priority of fatting the bottom line of the parasitic investor class.

Brimming oil tankers are presently sitting off the coasts of Iran and Louisiana. The Strategic Petroleum Reserve has been filled. Demand is flat. The world's biggest consumer of energy (guess who?) is cutting back . As CNN reports:

"At a time when gas prices are at an all-time high, Americans have curtailed their driving at a historic rate. The Department of Transportation said figures from March show the steepest decrease in driving ever recorded. Compared with March a year earlier, Americans drove an estimated 4.3 percent less -- that's 11 billion fewer miles, the DOT's Federal Highway Administration said Monday, calling it "the sharpest yearly drop for any month in FHWA history." (CNN)

I am afraid the great oil crunch is another fabricated crisis; another "smoke and mirrors" fiasco; another Enron-type shell-game engineered by bankers and hedge fund managers. Once again, the bloody footprints can be traced right back to the front door of the Federal Reserve. Don't expect help from the regulators either; they've all been replaced with business reps like Harvey Pitt or Hank Paulson. It seems the only time anyone in the Bush administration finds their conscience is when they're offered a multi-million dollar "tell all" book deal.

Your thoughts are greatly appreciated.

Thanks much for your consideration.

Are we witnessing a new geopolitical regime with oil?

Mon, 02 Jun 2008 09:11:31 EST

Are we witnessing a new geopolitical regime with oil? - by Ziad

Morning folks

Some food for thought starting this week where your feedback would be greatly appreciated if you care.

It is a fact that oil prices have risen so dramatically over the past year that they clearly began to have a major impact on the global geopolitical scene and it seems we haven't hit the peak yet. Recently, we have seen startling rises in the price of food, particularly grains. Apart from higher prices, there have been disruptions in the availability of food as governments limit food exports and as hoarding increases in anticipation of even higher prices. Oil and grains -- where the shortages hit hardest -- are obviously not merely strategic commodities. They are "geopolitical" commodities. All nations require them, and a shift in the price or availability of either triggers shifts in relationships within and among nations.

Most oil experts do not expect the price of either to fall to levels that existed in 2003. We will proceed in this analysis on the assumption that these prices will fluctuate, but that they will remain dramatically higher than prices were from the 1980s to the mid-2000s. If that assumption is true and we continue to see elevated commodity prices, perhaps rising substantially higher than they are now, then it seems we have entered a new geopolitical era....haven't we?

Obviously, the big losers are countries that not only have to import oil but also are heavily industrialized relative to their economy. Countries in which service makes up a larger sector than manufacturing obviously use less oil for critical economic functions than do countries that are heavily manufacturing-oriented. Certainly, consumers in countries such as the United States are hurt by rising prices. And these countries' economies might slow. But higher oil prices simply do not have the same impact that they do on countries that both are primarily manufacturing-oriented and have a consumer base driving cars.

On the other hand, it is clear that the biggest winners are and will increasingly be the Gulf countries. Although somewhat strained, these countries never really suffered during the period of low oil prices. They have now more than rebalanced their financial system and are making the most of it. This is a time when they absolutely do not want anything disrupting the flow of oil from their region. Closing the Strait of Hormuz, for example, would be disastrous to them.

Most political analysts I know foresee the Saudis, in particular, taking steps to stabilize the region. This includes supporting Israeli-Syrian peace talks, using influence with Sunnis in Iraq to confront al Qaeda, making certain that Shiites in Saudi Arabia profit from the boom. (Other Gulf countries are doing the same with their Shiites. This is designed to remove one of Iran's levers in the region: a rising of Shiites in the Gulf.) In addition, it seems the Saudis are also using their economic power to re-establish the relationship they had with the United States before 9/11. With the financial institutions in the United States in disarray, the Arabian Peninsula can be very helpful. It is clear the Saudis are and will be using their money increasingly to try to stabilize the region. With oil above $120 a barrel, the last thing they need is a war disrupting their ability to sell. They do not want to see the Iranians mining the Strait of Hormuz or the US trying to blockade Iran.

The Iranians themselves are also facing major problems. Despite being the world's fifth-largest oil exporter, Iran also is the world's second-largest gasoline importer, taking in roughly 40 percent of its annual demand. Because of the type of oil they have, and because they have neglected their oil industry over the last 30 years, their ability to participate in the bonanza is severely limited. It is obvious that there is now internal political tension between the president and the religious leadership over the status of the economy. Put differently, Iranians are asking how they got into this situation.

Suddenly, the regional dynamics have changed. The Saudi royal family is secure against any threats. They can buy peace on the Peninsula. The high price of oil makes even Iraqis think that it might be time to pump more oil rather than fight. Certainly the Iranians, Saudis and Kuwaitis are thinking of ways of getting into the action, and all have the means and geography to benefit from an Iraqi oil renaissance. The war in Iraq did not begin over oil -- but it might well be brought under control because of oil.

For the United States, the situation is largely a push. The United States is an oil importer, but its relative vulnerability to high energy prices is nothing like it was in 1973, during the Arab oil embargo. De-industrialization has clearly had its upside. At the same time, the United States is a food exporter, along with Canada, Australia, Argentina and others. Higher grain prices help the United States. The shifts will not change the status of the United States, but they might create a new dynamic in the Gulf region that could change the framework of the Iraqi war and even the US Presidential elections.

This is far from an exhaustive examination of the global shifts caused by rising oil and grain prices. The point is: High oil prices can increase as well as decrease stability. In Iraq -- but not in Afghanistan -- the war has already been regionally overshadowed by high oil prices. Oil-exporting countries are in a moneymaking mode, and even the Iranians are trying to figure out how to get into the action; it's hard to see how they can without the participation of the Western oil majors -- and this requires burying the hatchet with the United States. Groups such as al Qaeda and Hezbollah are hence decidedly secondary to these considerations.....

What do you say? Your feedback is greatly appreciated

Energy and Freedom

Tue, 27 May 2008 08:17:03 EST

Energy and Freedom - by Ziad

What do the following recent events have in common?

The President of the United States has prostrated himself for the second time in five months before the king of Saudi Arabia, pleading for more oil. Despite George Bush's inducements — an array of advanced, offensive arms; the promise of nuclear technology with which the Saudis can expect (like the North Koreans, Iranians, Pakistanis, etc.) to acquire the ultimate weapons; and U.S. help securing Saudi Arabia's borders (something the President has declined to do at home) — the American plea was spurned. The contempt felt by the House of Saud was captured in its oil minister's quip, "If you want more oil, buy it."

• The Senate rejected, by a vote of 56-42, an initiative offered by Republicans that called for opening the Arctic National Wildlife Refuge (ANWR) in Alaska and some offshore waters now closed to exploration and exploitation of their substantial oil reserves.

• In addition, that chamber's appropriations committee refused by a similar party-line vote to lift its moratorium on oil-shale production in Colorado. It seems that, if we want more oil, we will have to buy it at ever increasing prices from the Saudis and others even more unfriendly to this country's national security and economic interests — like Venezuela's Hugo Chavez or Russia's Vladimir Putin, perhaps even Iran's Mahmoud Ahmadinejad.

• One thing the Senate and House did agree upon, by overwhelmingly bipartisan majorities, was suspending purchases of oil to fill the remaining 3 percent of the capacity of the Strategic Petroleum Reserves. This action will have negligible (if any) impact on energy prices. But it will ensure that less oil will be available to us than would otherwise have been the case in the event, for example, the next terrorist attack on the Saudi oil infrastructure succeeds where others have failed and seriously disrupts world supplies.

• Then there is the newly formed coalition, ostensibly spearheaded by the Grocery Manufacturers' Association, that has launched a multimillion-dollar lobbying effort aimed at discouraging development of one alternative to oil: domestically produced or imported ethanol. Wrongly asserting that producing this transportation fuel from corn is largely responsible for rising food prices and the attendant global shortages, this instant grass-roots (read, "astroturf") coalition appears to want America to remain essentially dependent on oil. Wonder where the money for this campaign is coming from?

Answer: These actions — given soaring energy prices and the attendant hemorrhage of U.S. petrodollars to, among others, people who wish us ill — represent the sort of behavior in which only a nation utterly unserious about energy security could indulge.

In truth, no matter what we do, we will need oil for the foreseeable future. As a result, we should do our utmost to find and exploit it in places either under our control (for example, near where the Cubans and Chinese are getting it off the coast of Florida) or at least friendly to us (notably, Canada, Mexico and Brazil).

It is equally axiomatic that, no matter what we do, we almost certainly will have less oil than we need, certainly at prices we can afford. The question is: Are we going to do something to meet the shortfall? Or are we simply going to allow the economy and security of the United States to bleed out at the hands of the Saudi-led OPEC cartel?

The Set America Free Coalition — an initiative launched several years ago by unlikely array of national security-, environmental- and energy-minded people and organizations from across the political spectrum — is advancing practical, near-term alternatives to that unappetizing and unacceptable prospect.

At the moment, the Coalition is mounting its own campaign aimed at achieving in the immediate future, a simple yet far-reaching goal: Ensuring each of the 17 million new cars added to America's highways each year is capable of being powered by ethanol (from whatever source), methanol (ditto) or gasoline (or some combination thereof).

There are already some 6 million of these Flexible Fuel Vehicles (FFVs) on our roads today. Most of these are American-made (name another technology in which Detroit has a competitive advantage?) It costs less than $100 per car to equip new cars with this feature.

Ask yourself, and your elected representatives and would-be presidents: As each of these cars will last, on average, roughly 17 years, do we want any more of them built the old way — namely able to use only gasoline. Can we responsibly continue for another generation to lock our transportation sector (the principal, and most profligate, consumer of imported oil) into dependence on oil substantially imported from unfriendly places?

Robert Zubrin — a leader of the Set America Free Coalition and author of the terrific new book, "Energy Victory: Winning the War on Terror by Breaking Free of Oil" — notes that, at today's oil prices, we are allowing the Saudis and their friends to impose the equivalent of a 40 percent income tax of about $3,300 on every man woman and child in this country. We cannot afford to allow such lunacy to continue.

Sooner or later, Congress will adopt an Open Fuel Standard requiring every new car sold in America to be an FFV. The effect will be, in short order, to create an immense and highly competitive market for alternative, "Freedom Fuels" that we can make here or buy from friends. That will, in turn, will set America free by beginning to end its cars' present addiction to oil.

Why wait any longer?

Your feedback is greatly appreciated

Thanks much for your consideration

Your idea alone has no value.....

Thu, 15 May 2008 10:24:06 EST

Your idea alone has no value..... - by Ziad

Contrary to popular belief, great companies are not borne from great ideas alone. We'd all love to think that if we could simply invent the next Post-It note, we could sit back and watch the cash tumble in.

But if great ideas don't spawn great companies, what does?

The short answer is: you. The longer and far more complicated answer is how you specifically position yourself and your company to execute on an idea. Anyone who overhears your idea, has the same idea at the same time, or basically plans on doing anything similar, is already on the same playing field as you are.

In order to differentiate yourself and your idea, you don't need a patent or some proprietary method. You need a focused plan that allows you to execute above and beyond your competition every day of the week.

Think of your competition like your favorite professional sports league. There are dozens of teams which have talented players on them, but only one team that is going to perform better than everyone else. Your goal is to build that team.

Focus on Execution

There is a massive chasm between having a great idea and executing flawlessly on a business model for a great idea. Lots of people have great ideas, but very few people ever execute well on them.

Execution isn't just about showing up for work every day and punching a clock. For the team that wins, execution is about going above and beyond the call of duty each and every day.

It's about reaching out to your customer when there are no problems just to see how they are doing. It's about releasing a product feature faster than your competitor even when you're already ahead. It's being the first car in the parking lot in the morning and the last one to leave at night. It's doing what the guy next to you isn't willing to do.

Service the Heck out of your Customer

Even a product that's a total commodity, like food, can take on a whole new meaning when you compare the service that comes with it. In your city there may be a hundred places where you can order a filet mignon, but only a handful that are considered top notch.

The difference is that the top restaurants understand that in order to differentiate their product, they need to rely on better service. They pay attention to every detail of your experience, from the greeting you get at the host stand to whether you're given a white or black napkin based on your pant color.

Exceptional service is by no means a commodity. It's a rare and unusual thing that very few companies can deliver. Chances are your competition isn't going to go the extra mile to service the heck out of your customer, which creates an incredibly powerful competitive advantage for you.

Find the Weak Spot

It's not uncommon for a startup company to go toe-to-toe with a much larger company offering a very similar product. On its face, it looks like the startup is at a severe disadvantage. Surely the behemoth megacorp can provide better execution and better service with its vast resources than a scrappy little startup can.

If you were to try to compete against the behemoth on their own terms you'd get crushed. That's why startups tend to look for the weak spots in larger companies and exploit them. You can easily differentiate your product from a larger company by focusing on stuff large companies mess up all the time.

Unlike a large company, you can offer the personal service and attention your customers love and probably are missing from your bigger competitor. You can leverage your speed by releasing new versions of your product faster and responding to market conditions more quickly. You can offer talented managers founder's stock while a big company can only offer another bonus plan.

Every weak spot that you can exploit is another way to add value to your idea. Once you've identified the points, the more pressure you put on those weak spots, the more value you'll build for your own product.

Tying it Together

Outmaneuvering your competition isn't about doing any one of these things – it's about doing all of them consistently. If your idea is great and novel, the only guarantee is that it will be copied. If it's not, you have to wonder how great of an idea it really is.

When your idea does get copied, the only thing you'll be able to rely on is your team and your execution. All of the points about going above and beyond the call of duty, servicing your customer, and exploiting the weak spots will soon be used against you.

The only defense against the next up and comer and the only way to consistently create value around your idea is to stick to fundamental execution. Nothing else has value.

Your feedback is greatly appreciated

Thanks for your consideration

Lebanon and The Ten Fundamental Mega-Trends in the Middle East - Potential for Multiple Black Swans?

Sun, 11 May 2008 21:24:22 EST

Lebanon and The Ten Fundamental Mega-Trends in the Middle East - Potential for Multiple Black Swans? - by Ziad

Hope all is well and that you had a great weekend .....

Without being too imposing and just some food for thought during these challenging times we're all witnessing today: Have you ever wondered where we're heading and how will all of this affect us?

The international community is waking up to the shock of the "yellow topple" Hezbollah power grab which threatens to change the fundamentals in Lebanon as well as the Levant, and more broadly across the Middle East.

The situation in Lebanon is extremely tense after the Shiite movement -- Hezbollah -- seized control of west Beirut in what the ruling Western-backed coalition government brands as an armed coup orchestrated with the help of Iran and Syria.

As Lebanon stands at the brink of civil war, the United States and the European Union are urgently consulting Lebanon's neighbours and the United Nations Security Council to determine if there are any possible measures that can be taken to control Hezbollah at this stage.

After the exceptional meeting of the Arab League that will be held tomorrow, intensified international calls are likely to take place via the UN, the US and the EU to study possible solutions. UN Security General Ban Ki Moon has already called on the international community to take steps to avoid further deterioration in the Lebanese situation.

There is without a doubt a perfect storm brewing.

Along with the synchronized unfolding of the Fuel, Food and Finance -- the 3Fs -- global crises, we are witnessing the convergence of TEN fundamental mega-trends in the Middle East including the Gulf Cooperation Council (GCC) countries: Kingdom of Saudi Arabia, Kuwait, the United Arab Emirates (UAE), Bahrain, Qatar and Oman. These mega-trends hold the potential for multiple black swans, i.e., unforeseen off-the-radar events.

I thought I'd share with you these convergences when analyzing the unsettling events of the last few days in Lebanon; convergences that might indeed affect us all in a major way and maybe brainstorm with you your thoughts.

The TEN fundamental mega-trends unfolding in the Middle East are in my opinion as follows:

1. The huge petro-dollar finance surpluses of the GCC countries and Iran manifest partially as "Sovereign Wealth Funds (SWFs)";
2. Rising inequality within the GCC countries and Iran as well as without, i.e., with neighboring countries like Lebanon, Jordan, Egypt, Syria and Yemen;
3. Strengthening of strategic energy, trade and finance links with China and Singapore; Malaysia and Indonesia; as well as India and Russia;
4. The step-by-step shift away from the US dollar as de facto reserve currency and American financial institutions as keepers of wealth;
5. Accelerating food, commodities and household goods inflation;
6. Rising domestic demand for fuel leaving less oil to export and rising price of energy;
7. Water constraints including those induced by nature and humans;
8. Exploding demographics with a skew towards an extremely large young population;
9. Extremism-dominated politics; and
10. Concentrated urbanization.

The mega-trends are likely to create conditions that will be politically challenging, and in some cases destabilizing, in many countries in the years ahead.

It seems that the confluence of these trends is very similar to those that occurred in the Middle-East in the mid to late 1970s -- with the Yom Kippur war in 1973 -- when the current Islamist wave of social identity and confrontational politics was initiated, including Munich in 1972 and its orchestrated aftermath.

I am afraid however the challenges will be much more difficult this time, and the consequences could be worse for the Middle East with ripple effects for the rest of the world, especially in view of:

1. The Hezbollah showdown with the Government in Lebanon;
2. Iran's growing influence strengthened by petrodollars;
3. The perception of Western weakness induced by a long war in Iraq and Afghanistan;
4. The continued stalemate between Israel and Palestine; and
5. The weakening of some Arab governments as a result of the mega-trends.

Barring the rich GCC countries and Iran, most Middle Eastern countries cannot subsidize energy and food prices forever, given the divergence between rising global prices for most commodities and limited government finances.

With the price of oil around USD 125 a barrel at present, most countries are being forced to allow domestic energy prices to reflect actual market costs partially. This means that household energy and fuel costs are likely to double for most families in comparison with what they were paying a few years ago.

Lebanon, Jordan, Egypt, Syria and other GCC countries have announced wage increases for public-sector employees, partly in response to political pressures from restless populations but also because of the deteriorating value of the US dollar to which many currencies are pegged.

The wage increases and special allowances are unlikely to keep pace with rising costs, and governments will not be able to sustain their policy to keep increasing wages in parallel with inflation.

In this environment, the next step is likely to be rising chaos across multiple sectors of the economy and segments of society, which will be manifest as multiple black swans with several unintended consequences.

For the smart operators, this "perfect storm" may however well be the best time ever to create real obscene wealth......What do you think? What are you doing to position yourself accordingly and/or weather the storm?

Your feedback would be greatly appreciated.

As usual, thanks much for your consideration.

USD 200 Oil Super Spike - What are the Consequences?

Thu, 08 May 2008 10:05:45 EST

USD 200 Oil Super Spike - What are the Consequences? - by Ziad

Most analysts laughed when Goldman Sachs predicted that oil would go to USD 100 a barrel more than two years ago. Brent crude is around USD 124 a barrel at present. Crude prices have doubled in a year and risen six fold since 2002. Now Goldman Sachs is suggesting USD 200 on the upside of a super-spike within the next 24 months. This figure has also been mooted by some members of OPEC. Given the fundamentals on both demand and the supply side internationally there is a chance that the super-spike may well take place. The oil price is still rising and may get much higher than where we are at. World oil prices rose 1.4 percent on Wednesday, extending further into record territory amid intensifying worries over tight world supplies of diesel fuel. A US government report showed a decline last week in distillate inventories -- which include diesel and heating oil -- that brought stockpiles in the world's biggest energy consumer nearly 13 percent below a year ago.

Sovereign Stock-Piling

The growth in demand for oil in Asia -- particularly in China and India -- and amongst oil producers in the Middle East and other commodity producers in Africa and Latin America is still strong. Many countries are protecting their consumers through subsidies and controlled prices to a remarkable degree from the recent oil price increases so their consumers are not making the necessary downward adjustment. Despite the fact that the American economy is slowing down -- their petrol demand is down by about three percent over the past year -- it does not appear to have an impact on the global fundamentals and the oil price continues to rise because of Sovereign stock-piling in anticipation of rising demand. Beyond USD 100, the speculative component may be much smaller behind the oil price rise in comparison to the real demand and supply fundamentals, which are both severely constrained.

Rising Inflation

The inflationary implications globally of a super-spike in the price of oil are significant. After a couple of years of low single digit inflation many countries are suddenly into low double-digit inflation and it is eroding real purchasing power. Interest rates may have to rise to curb double digit inflation, which will create a real squeeze. A recovery in stocks and credit market assets since early April has shifted investor focus to inflation risks from surging fuel, food and other commodity prices, which can erode corporate profits and cause the world's central banks to raise interest rates step-by-step.

Demand Downturn

Given the supply constraints, the only development which is likely to see a pullback in the oil price is some kind of quite extended global recession that dampens demand significantly. With the possibility of a super-spike looming, most economic sectors, and especially the manufacturers, are finding it extremely difficult to plan for the future or even stand still in the hope that there will be an upturn in global forecasts. Many business plans, profit margins and budgetary allocations are under water in terms of viability. With every passing month, industry is facing ever harsher challenges, as the price of fuel and raw materials continues to climb.

Conclusion

There is an extremely synchronised concatenation of global risks manifest in the three way convergence of the fuel, food and finance crises. Far from being isolated they are extremely interlinked. On the financial side, the price of equities is based on forward earnings calculated on the back of discounted cash flows. If future profit margins are going to be severely eroded by the oil super-spike, then the price-earning ratios at present -- which look low based on historic data -- are in fact extremely high in terms of future projections. Especially as earnings are revised downwards. On the food side, the agriculture industry has an extremely high dependence on oil and oil-based products because of farm mechanisation as well as the use of fertilizers. Food processing, storage and distribution is also extremely energy intensive. The bio-fuel production is eating into human food supply chains. This is an extremely mis-guided development. All in all the convergence of the "3F" crises -- fuel, food and finance -- is going to be extremely difficult to out-manoeuvre without a severe reduction in growth expectations. On the positive side, humanity may adjust its efficiency and consumption of carbon-based fuel significantly post the oil super-spike and in the process help the global environment!

Your thoughts are greatly appreciated

Thanks much for your consideration

What's Ahead for the U.S. Housing and Economy at large?

Mon, 28 Apr 2008 21:04:30 EST

What's Ahead for the U.S. Housing and Economy at large? - by Ziad

It seems that everyone these days has an opinion on the recession. Some claim the worst is over and the economy is on a slow path toward recovery, others say things haven't begun to turn around yet. (There's even a third group that denies the U.S. economy is even in a recession.)

I am convinced that the economy is not only in a recession, but that the worst is still ahead of us rather than behind. You just have to look at the housing numbers for proof.

Just recently we saw another drop of more than 11 percent in housing starts. What's more, the excess supply of new, unsold homes is still rising.

Only by the end of the year will the decline in starts begin to show up. Right now, they're still way too high.

They have to fall significantly below new home sales — about another 20 percent — to start reducing the excess supply of new homes and for the housing market to stabilize.

I also think we should expect to see home prices decline another 10 percent in 2008 for a cumulative fall of about 25 percent to 30 percent.

The excess supply of both existing and new homes will worsen in 2008 for a variety of other reasons. For starters, the credit crunch has led to a collapse of origination of subprime and Alt-A mortgages.

That means consumers with weak credit ratings who were able to qualify for mortgages during the boom won't be able to get loans. It also means that homeowners who cannot refinance will be forced to sell their homes in short sales if the value of their home is lower than the balance on their mortgage.

Lastly, we can't forget about the homes that go into foreclosure and the "flippers," those who bought for speculative reasons with little equity and will dump their homes and condos into the market to reduce their capital losses.

All these factors imply that the excess supply of unsold new and existing homes will get worse rather than better, and that will put further significant pressure on new and existing home prices.

On the issue of the real economy, the International Monetary Fund recently estimated that credit losses on mortgages could come close to $1 trillion.

This means that total credit losses for the financial system could be as high as $1.7 trillion if you include all the other losses — notably credit cards and auto loans as well as corporate bonds, muni bonds, and losses on credit-default swaps, among others.

Just how many of these losses will be assumed by commercial and investment banks will depend on the allocation of these impaired assets.

The argument for a trillion dollars worth of losses on mortgages alone is based on three parameters, two of which are undisputed and a third that is subject to uncertainty.

First, let's conservatively assume that home prices fall by about 20 percent rather than 30 percent. That means only 16 million households are underwater on their loan.

This assumption is not very controversial since most experts now would agree that a cumulative fall in home prices of 20 percent is a floor, not a ceiling.

Second, let's assume — as Goldman Sachs does — that a foreclosed unit causes a loss of 50 cents on the dollar for the lender.

That might seem high, but consider that, in addition to the decline in the home price, you have to add the foreclosure costs, including legal fees, loss of rent on empty properties, risk of the property being vandalized, and the cost of maintaining an empty property before resale.

Third, let's assume — and this is more controversial — that 50 percent of households underwater on a home loan eventually walk away or get foreclosed upon. Since the average U.S. mortgage is $250,000, total losses from borrowers walking away from their homes would amount to $1 trillion.

Goldman Sachs makes the same argument on two parameters (that is, a 20 percent fall in home prices and 50 percent loss on a mortgages), but it is more conservative when assuming that only 20 percent to 25 percent of underwater borrowers will walk away.

In this case, mortgage losses would be "only" $500 billion.

But home prices may likely fall more than 20 percent, and with a 30 percent drop in home prices, 21 million households (40 percent of the 51 million with an outstanding mortgage) would thus be underwater.

So, there is a lot of uncertainty on just how many of those borrowers will walk away. But given the recent evidence of not only subprime but also near-prime and prime borrowers walking away even before they are foreclosed, one can be pessimistic, as I am, on this.

Over a year ago the Federal Reserve repeated three mantras that turned out to be totally utterly wrong:

First, the Fed argued that the housing slump would soon bottom out in late 2006. We know that didn't happen.

Second, Federal Reserve Chairman Ben Bernanke argued that the subprime crisis was a "contained" problem that would not affect the rest of the financial system. Instead, we have had a massive contagion and a massive liquidity and credit crunch that is getting more severe.

Third, the Fed argued that the housing crisis would not lead to an economy-wide recession. That myth was shattered as the combinations of three bearish forces — the housing recession, the credit crunch that ensued, and high oil prices — has now led to an economy-wide recession.

At an annual conference recently organized by State Street, former Fed chairman Alan Greenspan stressed that the adjustment in the housing market, driven by the excess supply of unsold homes, will continue to drive home prices down.

What's more, this adjustment is still quite far from being over, and it will in fact continue throughout 2008.

So it is obvious that this is a most severe crisis, and we may debate whether this is the worst financial crisis since the Great Depression of the 1930s, as I argue, or the worst since World War II, as Greenspan opines.

Either way, regardless whose corner you stand in, things are still very ugly and worsening in the U.S. housing market and the economy.

Your thoughts are greatly appreciated

Thanks much for your consideration