The US needs a Bailout, not a Sellout!

Last night, the US Congress correctly rejected the proposed $700 Billion Sellout package for the troubled Financial sector. It is my opinion that American taxpayers simply do not want tax dollars, generated through their own hard work, to be used to absolve greedy financial firms of their irresponsibility and recklessness, without asking for something in return. Anything else would set a bad precedent and allow the problem to recur in the future.

The US Democratic Senator for Ohio, Dennis Kicinich explained his own reasons for rejecting the bailout in an interview with the community media network, Demoracy Now!.

I agree with the need to stabilize the market, but it should be done in a way that is fair to the American public. Just as when a criminal is released on bail, he or she is subject to stringent conditions, so should the corporations being bailed out.

If a corporation wishes to receive some kind of Government assistance, e.g. the Government taking over its bad debts, there is no way that they can be permitted to keep any of the ‘booty’. Possible conditions could include the following:

• NO payouts for executives that choose to resign or retire
• Cancellation of all outstanding stock options issued to executives
• Any stock issued to executives in the last 5 years should be returned to the corporation
• Confiscation of personal assets purchased with bonuses awarded to executives over the last 5 years

This of course should happen independently alongside a comprehensive investigation of all lending and risk management practices with criminal charges laid against those suspected of fraud.

ASIC Bans all Short Selling in Australia

In a surprise move last night, the Australian Securities and Investments Commission (ASIC) has banned ALL short selling in Australia – both naked short selling and covered short selling. This came as a surprise to many people [including myself] considering their previous statements that expressed their satisfaction with their previous restrictions, which only affected naked short selling.

The ban commences from the start of trading this morning (Monday 22nd September).

In their statement, ASIC expressed concern that short selling bans that have recently been enacted in a number of markets around the world may result in hedge funds moving their activities to Australia and increasing “unwarranted activity” here.

These new restrictions are more extensive than those enacted elsewhere, which have generally only targeted financial stocks.

Short Selling Bans Imposed in UK and USA

In response to the recent unprecedented volatility in the financial markets, the US Securities and Exchange Commission (SEC) and the UK Financial Services Authority (FSA) have both imposed temporary bans on the short selling of financial stocks.

For those not in the know, short selling is the act of selling stock one does not own, with the aim of buying it back at a lower price and profiting from the difference. This strategy is used to make money in a falling market, or when one expects a fall in the near future.

Large hedge funds have been blamed for abusing short selling to manipulate the market and contributing to the deterioration of world stock prices. 

The US ban applies to 799 stocks, and will initially last for 10 days, but may be extended. The UK ban applies to 32 companies and will last until the beginning of January 2009.

In Australia, our own so-called regulator ASIC has stated that we already have restrictions on short selling. Many people would consider this laughable.

I have an article that’s been sitting on the back-burner concerning my opinion of the role of short selling in the world stockmarket turmoil. It will follow next.

Google News Aggregator Causes $1.14 billion loss

A deeply concerning post, courtesy of slashdot.org.

Google News erroneously reprinted an old article from 2002 concerning United Airlines, which faced deep financial problems at the time. This caused a run on its NASDAQ-listed stock UAL, leading to its share price falling from $12 to $3, after which the stock was suspended from trading. This caused a drop in its market capitalisation of $1.14 billion. The stock has since recovered to over $10, but its market capitalisation is still down over $300 million from before the old article was published.

Google News regularly searches and indexes online news sites around the world. In turn, many other online news sites grab headline from Google News. The automated nature of this process provides many opportunities for false information to be widely disseminated.

With the growth of Social Bookmarking sites and News Aggregators, people wishing to manipulate the market, or spread any kind of propaganda now have a very powerful tool at their disposal.

I Am Rich!

In these difficult economic times, people have to be creative to get ahead.

An enterprising fellow by the name of Armin Heinrich, capitalised on conspicious consumption centred around Apple’s much-hyped iPhone, released last month.

He created an iPhone application named “I Am Rich”, whose sole function is to display a computer-generated image of a glowing red ruby, as a status symbol in order to flaunt the wealth of the owner.

Apparently, 8 people purchased this application, for the listed price of $999.99, before it was removed by Apple, following a complaint from a purchaser who claimed he accidentally clicked on the buy button.

The LA Times has a fantastic article, with pictures of the Apple store advertisement and an application screenshot.

Tipping Sucks

Hello Everyone,

First of all, I am alive and well. I have been away on vacation recently in the USA. I had naively hoped to return home to better economic news, but it turns out that the opposite is true. The price of oil has continued to climb, more American Banks have become insolvent and the repercussions are being felt worldwide.

Most people have found few things to be positive about, but I can think of one thing. The weak US dollar made my vacation far more affordable. I can’t say that I lived or travelled like a king, but I certainly ate like one. Even in the most touristy areas, such as Niagara Falls, I was able to get a satisfying meal for $10. In contrast, last weekend in Sydney, I paid that same amount for a mere tomato bruschetta in a cafe, located on Broadway.

Two things however did annoy me very much about the USA. These are the practices of quoting prices ex-tax and the need to pay an additional tip for table service at restaurants. Tax was usually around 10% and tips averaged to 15%, so the menu price would be inflated by 25% in most cases.

Here in Australia, these practices do not exist. You pay the advertised price and that is that.
I expressed my feelings of frustration to other travellers I ran into, who would often answer “When in Rome, do as the Romans”. I did, but I really didn’t like it. Here are my main reasons:
Read more

Comparative Advantage for Everyone

One very interesting topic in economics is the principle of comparative advantage. This topic is traditionally taught in the context of teaching the justifications and benefits for International Trade between countries, even if one trading country could produce all of its desired goods at a cheaper price than its trading partners.

When I have asked economics students to explain it, I have found it to be poorly understood. I have come up with my own analogy to explain the principle. Furthermore, it also explains how this principle applies to individuals in everyday life. Here is my example:

Let’s say I have a day job as contract web developer for which I get paid $50/hr. After work, I can either eat out for dinner or buy ingredients and cook at home.

When I go out to eat, my favourite meal is a Thai stir fry which has meat, vegetables and rice, which I can buy for $10. The restaurant takes care of all the preparation and cleaning. All I do it eat and leave.

When I eat at home, I might prepare something in the kitchen with frozen vegetables, beef and potatoes, and the ingredients for that will average out to $5/day over the course of a week.

On the surface, it seems that I am saving $5/day when I eat at home, but this is not the whole story.

In addition to the time spent shopping, I will also have to spend time to unpack and prepare the ingredients, wait for them to cook and clean up afterwards. Let’s say that the total time from preparing to washing up takes 1 hour.

What If instead of doing that, I worked for an additional hour per day and decided to always eat out?

I would earn an extra $50, spend $10 on the Thai meal, leaving me up $40 from my starting balance, and $45 ahead of cooking at home. Amazing.

I can extend this further to the Thai restaurant itself. Let’s say the owner/head chef wants to promote the restaurant by creating a website. She could either close the shop, read web design books and learn how to use HTML editing software, or she could hire me. The website the chef wants is simple – it just has the restaurant’s name, phone, address, a street map and the current menu.

I could hammer this out within 2 hours, for which I would charge $100. The chef is also clever, but she might take 5 hours as she has to perform software installation, read documentation and debug common beginner mistakes.

What should the chef do? Let’s say the restaurant serves 20 people per hour, and makes an average margin of $5 on each meal, the restaurant’s hourly income is $100/hr.

If the chef builds her website herself during restaurant hours, she would forego $500 in earnings. If she hires me, her total out of pocket expense is $100. Hence, she is $400 better off by hiring me to build her website.

For this example, we would conclude that my comparative advantage is in web development, and the restaurant’s comparative advantage is in preparing food.

This principle can be used to justify why a multi-talented business owner may be justified in hiring a graduate fresh out of university for clerical tasks, or why one would hire an accountant to do a simple tax return.

Of course this example makes a few assumptions. If I were in a permanent job, perhaps I would not have the ability to work an extra hour. Also, some people might in fact like cooking at home or spending time with family. Also, some Thai restaurants use excessive amounts of oil which could lead to weight gain.

Bank Shares

Earlier today, I was asked whether I thought Australian Bank shares are a good investment in current market conditions.

For the sector as a whole, I expect Capital Gains to be subdued for the next few years as our economy is slowing, interest rates are high and people are borrowing less (or paying back debts). Profit growth will be very small, however I do not expect any cuts in dividends.

For individual banks, the situation is not so clear. ANZ has been in the news due to having increased its provisions for bad debts, as well as the OPES Prime fiasco. NAB has also copped some flack due to exposure to the US mortgage crisis. SGB and WBC have done better, both reporting strong single digit earnings increases.

I am not going to make a call, but I can tell you how I would start my analysis – I would examine each bank to determine the proportion of income from each of the bank’s activities, e.g. Retail banking, business lending, wealth management/financial advice and others. Also, I would look at the proportion of income earned in Australia and the proportion earned overseas. I can then make my own judgement on the future prospects of each activity.

Commonwealth Securities provides research from Aspect Huntley on its website. The above information can be found under the ‘Analysis’ tab.

Be cautious about PEG estimates provided online. These are purely guesses made by the research company’s analysts. It is better to read each bank’s earnings guidance in their annual report and use your own critical thinking skills to see what assumptions lie behind them.

For me, banks are now an income investment, as they pay large, stable, fully-franked dividends. I have been holding ANZ and NAB since last year. Do not consider this a recommendation.

‘Undervalued’ Capital Notes

Someone I know recently went to an investment course conducted at an evening college.

The presenter pointed out a number of ASX-listed debt securities (often called Capital Notes) that are trading below their Net Present Value (NPV), by between 5-12%. I was asked for my opinion.

For those that don’t know what these are, these are much like bonds – they are normally issued by public companies, e.g. banks/insurance companies to the public in order to borrow large amounts of money, e.g. to facilitate expansion.

Each bond/note that is issued has a given face value, e.g. $100. They pay a certain interest rate periodically for the duration of their lifetime, i.e. 8% per annum for 10 years,  after which the bond matures and the face value is paid back.

The underlying value of a bond at a given point in time is the Net Present Value (NPV) of its future cashflows. We take each pending payment (interest income and the face value paid upon maturity), discount them back to today’s dollars using current market interest rates and then sum them together to produce the NPV.

This is why when the RBA raises interest rates, the value of bonds falls, and if interest rates fall, the bonds rise.

OK, here’s a far better written explanation from Investopedia:

http://www.investopedia.com/university/advancedbond/advancedbond2.asp

OK, so does this mean that if a bond/note is currently being traded below its NPV, that it is a risk-free investment? The answer, as always, is in the fine print.

I checked out a couple of product disclosure statements. I noted the following:

• One product gave the company the right to indefinitely delay maturity of the bond.
• One product stated that in the event of the company getting into financial trouble, note holders would rank above shareholders, but below other debtors.
• Some have other conditions that make returns dependent on the movements of the company’s normal shares.

Such conditions may potentially pose risks and should be factored into your investment decision.

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