Chlorophyll Inc

ARROYO GRANDE, Calif. (MarketWatch) -- "Charlie and I believe Berkshire should be a fortress of financial strength" wrote Warren Buffett. That was five years before the subprime-credit meltdown.

"We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

That warning was in Buffett's 2002 letter to Berkshire shareholders. He saw a future that many others chose to ignore. The Iraq war build-up was at a fever-pitch. The imagery of WMDs and a mushroom cloud fresh in his mind.

Also fresh on Buffett's mind: His acquisition of General Re four years earlier, about the time the Long-Term Capital Management hedge fund almost killed the global monetary system. How? This is crucial: LTCM nearly killed the system with a relatively small $5 billion trading loss. Peanuts compared with the hundreds of billions of dollars of subprime-credit write-offs now making Wall Street's big shots look like amateurs.

Buffett tried to sell off Gen Re's derivatives group. No buyers. Unwinding it was costly, but led to his warning that derivatives are a "financial weapon of mass destruction." That was 2002.

Derivatives bubble explodes five times bigger in five years

Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends:

Sarbanes-Oxley increased corporate disclosures and government oversight
Federal Reserve's cheap money policies created the subprime-housing boom
War budgets burdened the U.S. Treasury and future entitlements programs
Trade deficits with China and others destroyed the value of the U.S. dollar
Oil and commodity rich nations demanding equity payments rather than debt

In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession.

Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier's window at a racetrack or casino, where you'd place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.

To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data:

U.S. annual gross domestic product is about $15 trillion

U.S. money supply is also about $15 trillion U.S. government's maximum legal debt is $9 trillion
U.S. mutual fund companies manage about $12 trillion
World's GDPs for all nations is approximately $50 trillion
Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
Total value of the world's real estate is estimated at about $75 trillion
Total value of world's stock and bond markets is more than $100 trillion
BIS valuation of world's derivatives back in 2002 was about $100 trillion
BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion

Moreover, the folks at BIS tell me their estimate of $516 trillion only includes "transactions in which a major private dealer (bank) is involved on at least one side of the transaction," but doesn't include private deals between two "non-reporting entities." They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average.

Also, keep in mind that while the $516 trillion "notional" value (maximum in case of a meltdown) of the deals is a good measure of the market's size, the 2007 BIS study notes that the $11 trillion "gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets."

Bubbles, domino effects and the 'bad 2%'

However, while that may be true as far as the parties to an individual deal, there are broader risks to the world's economies. Remember back in 1998 when LTCM's little $5 billion loss nearly brought down the world's banking system. That "domino effect" is now repeating many times over, straining the world's monetary, economic and political system as the subprime housing mess metastasizes, taking the U.S. stock market and the world economy down with it.

This cascading "domino effect" was brilliantly described in "The $300 Trillion Time Bomb: If Buffett can't figure out derivatives, can anybody?" published early last year in Portfolio magazine, a couple months before the subprime meltdown. Columnist Jesse Eisinger's $300 trillion figure came from an earlier study of the derivatives market as it was growing from $100 trillion to $516 trillion over five years. Eisinger concluded:

"There's nothing intrinsically scary about derivatives, except when the bad 2% blow up." Unfortunately, that "bad 2%" did blow up a few months afterwards, even as Bernanke and Paulson were assuring America that the subprime mess was "contained."

Bottom line: Little things leverage a heck of a big wallop. It only takes a little spark from a "bad 2% deal" to ignite this $516 trillion weapon of mass destruction. Think of this entire unregulated derivatives market like an unsecured, unpredictable nuclear bomb in a Pakistan stockpile. It's only a matter of time.

World's newest and biggest 'black market'

The fact is, derivatives have become the world's biggest "black market," exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations. And in today's slowdown, plus a volatile global market, Wall Street knows derivatives remain a lucrative business.

Recently Pimco's bond fund king Bill Gross said "What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August." In short, not only Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't "figure out" the world's $516 trillion derivatives.

Why? Gross says we are creating a new "shadow banking system." Derivatives are now not just risk management tools. As Gross and others see it, the real problem is that derivatives are now a new way of creating money outside the normal central bank liquidity rules. How? Because they're private contracts between two companies or institutions.

BIS is primarily a records-keeper, a toothless tiger that merely collects data giving a legitimacy and false sense of security to this chaotic "shadow banking system" that has become the world's biggest "black market."

That's crucial, folks. Why? Because central banks require reserves like stock brokers require margins, something backing up the transaction. Derivatives don't. They're not "real money." They're paper promises closer to "Monopoly" money than real U.S. dollars.

And it takes place outside normal business channels, out there in the "free market." That's the wonderful world of derivatives, and it's creating a massive bubble that could soon implode.

Comments? Yes, we want to hear your thoughts. Tell us what you think about derivatives: as "financial weapons of mass destruction;" as a "shadow banking system;" as a "black market;" as the next big bubble dangerously exposing us to that unpredictable "bad 2%."

By Paul B. Farrell, MarketWatch

News Highlights (5)

by Chlorophyll Inc July 13, 2009

Is there still trust in Reits?

Real estate investment trusts do look attractive in the long term at current prices, but investors must choose carefully and diversify their investments accordingly.

With lower prices, S-Reits (Singapore listed Reits) now offer dividend yields of around 12.4%, compared with around 7.3% a year ago and 4% in june 2007. Sibor rates have also fallen, from 2.7% in June, to the current 0.7%. Dividends yield premium has thus improved to 11.9%, from just 1.4% two years go. Prices of Reits are also at more affordable levels now. For etc, the prices of CMT (CapitalMall Trust), A-Reits and Mapletree were at $1.40,$1.59 and $0.56 respectively as at june 30 2009, around half the prices in june 2007. Do also note that, even though the prices of Reits have almost halved, it doesn't mean its a value buy because systemic perceived risk have more or less doubled in 2009 as compared to 2007. -Akat

Most importantly, the good and bad Reits are now easier to differentiate. How is this so? The lower "tide" (which means the current economical problems of the world) has exposed Reits that have bad assets and have been poorly managed making investment decisions easier then two years go.

Reits do look attractive in the long term at current prices, but investors must choose carefully and diversify their investments accordingly. Here are a few important factors to consider:

1)A Reit's (Not A-Reits) ability to raise funds, especially in times of turmoil, will determine its ability to thrive and survive. This is an important factor. In good times, most Reits will enhance their yields through higher leverage , but only well managed ones will be able to reduce this leverage, in challenging time or risk being challenged themselves. Without this ability, badly managed Reits will find it difficult to refinance or raise sufficient equity to repay their loans, putting them in danger of liquidation.

2)The quality of assets is another important factor, and Reits that own properties beyond just Singapore would be a plus. Too much emphasis has been put on dividends and too little on assets. Investors must bear in mind that they are buying the underlying assests hen investing in Reits-the dividends are the result of the ownership and management of the assets.

However, good assets can produce poor returns if poorly managed.

3)The quality of the managers or management is therefore another vital factor. Good managers will continuously enhance the yield of the assets and use an appropriate debt-equity mix at all times.

A sudden fall in rental revenue (poor assests? or business model), rental collection issus (High recievables) and below average rental yields (Industry not resilient) are some signs of poor management. Such Reits should be avoided.

4)Last but not least, investors must check if a counter is a Reits or a business Trust, such as CapitalMall Trust vs India Bulls Property Investment trust. The difference between the two is that the former is required to pay 90% of distributable income to unit holders, the latter has no such requirement, thus investors should therefore look closely at what they are picking to ensure the counter they choose is in line with their investment intention.

Article written by Roger Tan as at 11th July 2009

NewsHighlight

News highlight (4)

by Chlorophyll Inc July 05, 2009

Heading for inflation or deflation?
Senior correspondent Teh Hooi Ling says that specialists and experts on these topics are divided and are most likely unsure which notion will take place in the future, therefore it is sensible for investors to hedge their bets. She goes on to say that those in the deflation camp are befuddled by reports of Singaporeans queuing and rushing to snap up new properties. The enthusiasm is lifting the prices of resale properties off recent low. Leaning more towards the deflation camp, her basis is that demand is too weak to fuel inflation, in addition the horrible unemployment rate in the US with a staggering 9.5% in the month of june, suggests that inflation and unemployment are inversely related (when inflation is up , unemployment is down and vice-verse).

However she adds that as of May 2009, deposites of non-bank customers with domestic banking units and finance companies amounted to $374billion, with another $158.6billion with CPF board, in total, the sum of these three cash hoards is equivalent to the total market capitalization of all the stocks listed on the Singapore exchange. To some fund managers , a high cash holding relative to stock market capitalization is an indication of market UNDER-VALUATION.
The rally of the past few mths has brought the ratio back to levels seen at the end of 2003, when Singapore then was emerging from the slowdown caused by SARs. But now despite relatively high cash holdings, investors are not rushing into the stock market and rightly so, given the uncertain economic outlook.
Things are also never crystal clear at ths part of the recovery because by the time they are, markets would have moved even higher, leaving those on the side lines to either hope for another retracement in prices or regret not having to act fast.

Ms Teh then advice the sensible thing to do is hedge your bets, positioning your portfolio to cater to an inflationary environment and some to deflationary.
Gold commodities and inflation-linked bonds and real estates (Reits too) are natural inflation hedges.
Good Reits to consider are CapitalMall Trust/Ascendas Reits/ Frasers Centre point Trust/ and CapitalCommerical Trust are expected to be the most resilient against external shock.
But in a deflationary environment , cash and cash equivalents are king.

News information was collect from Business Times as of 04 july 2008, writers by Teh Hooi Ling/Wong Sui Jau and S&P data

Subscribe to: Posts ( Atom )

Chlorophyll Inc

Portfolio Update :July 2009

The next coming crisis. Beware.

Derivatives bubble explodes five times bigger in five years

Bubbles, domino effects and the 'bad 2%'

World's newest and biggest 'black market'

News Highlights (5)

News highlight (4)

udemy

My Blog List

Popular Posts

Blog Archive

Categories

Translate

SmallCapAsia

SGX REITDATA

Total Pageviews

Recent Posts

Contact Form

Weather

Tags

Featured Post

Make Your Money Work Harder For You

My favourite Links