May 032009


By Kalidas Ref: 0905-027 of 4-May-2009

So they did it again. The investors applauded. CNBC reported that the financial sector appears to have bottomed out, and the market is up 10% in just under 3 days. The market could not have been wrong. They say the market is ahead of the events by 6 months. If that was so, why did we lend into deepest recession in post-war history. Who remembers that? The people’s memory is like RAM (Random Access Memory) which remains so long is the power up and running. The moment the power is switched off, the memory is gone forever.

It was carefully planned conmen’s game. The crooks are always suggestive so that the target does exactly what is required of them.

Look at the past events, only 2 months back. Note the following:

1.      Citigroup was in dire trouble. The President and Senate were obliged to release $ 45 billions in cash in the form of Preferred Perpetual Shares with 10% coupon. It was Paulson’s brilliant idea. He may have told the President, Senators and American tax payers that they would earn 10% income by way of dividend, in addition to rights to subscribe to Citigroup’s shares under warrants attached.

a.       Everyone believed them. Wow, we are getting 10% return when we are getting only 1% while lending to various banks. Excellent. And we will make money in equity too. What a fantastic idea.

b.      No one asked them how Citi is going to earn when dividend servicing cost of this deal alone will be $ 4.5 billions annually. This is in addition to similar servicing costs payable to other large Middle East investors.

c.       Money was released in the name of TARP. As soon as this purpose was achieved and the money was already in the kitty, these guys allowed a few days to pass. They observed that direct injection of cash was not helping them. The losses will have to be written off in the books of the bank and any money they receive from the Fed or Treasury will straight away go to write off that debit. No money will go to the market by way of lending.

d.      The trio thought that this was a problem. We do not want to write off the amount from the Citigroup’s books. It also needs another does of $ 300 billions. The President and Senate will not simply release more funds if Citi goes on showing more and more losses.

e.       The devil’s mind started working. Target: to get $ 300 billions; Aim: Not to show any losses in the books of Citigroup, otherwise it will be officially bankrupted. What to do?

f.         IDEA – a Great Idea – Paulson appears to have screamed in the sound proof cabin.

i.  Hey, Pandit – you do the following:

1.      We will not give you cash, because it is impossible.

2.      We have given you $ 45 billions. You better give the treasury $ 7 billions of guarantee premium and we (US government) will guarantee your obligations falling due.

3.      Those junk assets when backed by the AAA rating of US government will soar. Those holders can discount those bonds with their bankers because they are backed by the guarantee and full faith of the US government.

4.      Since these bonds have become realizable assets, you do not have to make any provision in your books. Although it is your bad assets, it will not be bad assets any more. They are now fully insured by the US government.

5.      So you will not write off these bad assets in your books. They will now be US government’s troubled babies.

6.      When you get the demand for payment under these bonds, simply redirect them to US government and ask them to pay under the guarantee for which you paid guarantee premium of $ 7 billions.

7.      Pandit: Wow, great. You gave us the brilliant idea; we no longer have to write off any more bad assets. But US government will have to write them off one day in their books.

8.      Paulson : Yeah, one day. By then, you will not be there, I will not be there, and perhaps this Bernie too may not be there.  And who cares?

9.      Pandit: Excellent. But what do I do for $ 45 billions already borrowed. I do not have money to pay even 10% dividend, forget the principal.

10.  Do not worry… Bernanke will take care of it. Hey, Ben, you better convert those PPS (Perpetual Preferred shares) into common equity immediately so that Pandit does not have to bother about the dividend servicing.

11.  DONE. I will take care of that. Said the Bernanke

12.  Now Pandit, since you do not have to make any provision for $ 306 billions and you do not have make any payment of dividend on preference shares, you can write a memo to your staff that you have the best quarter since 2007. Your stock will soar.

13.  Did you buy any? Pandit asked.

14.  I have the right to remain silent, said the other guy.

This is what appears to have happened a day before.

When the Citi lost $ 45 billions and Fed gave them $ 45 billions as capital, following entries could have been passed.

1. Debit     :     $ 45 billions -Cash account (being sum received from the Fed)
2. Credit    :     $ 45 billions -Perpetual Preferred Share Capital (to US government @10% div CPN)

3. Debit     :     Profit & Less Account $ 45 billions (Amount written off)
4. Credit    :     Toxic Assets (Toxic debt assets – also contra of Toxic liability)

5. Debit     :     $45 Billions – Toxic Liability to Customers (could be X? We do not know)
6. Credit    :     $45 billions – Cash withdrawn to make the payment to the creditors

7. Debit     :     $45 Billions – Perpetual Preferred Shares (to US Government) to convert to common.
8. Credit    :     $45 Billions – Common Stocks issued to US government

9. Debit     :     $45 Billions – Common Stocks Issued to US Government (Capital written off)
10 Credit  :     $45 Billions – Profit & Loss Account (Under Item 3)

Final result – TARP fund issued by US government for issue of Perpetual Preferred Shares is finally written off by first converting into Common stock and then by way of reduction of capital of common stock to write off the debits in profit & loss account (now intangible assets)

Under above scenario, the losses are written off in the books of Citigroup because the TARP fund issued for PPS capital were required to be shown in the books of Citigroup. Also note that there was no need to convert Perpetual Preferred Shares into Common Stock in the name of boosting capital of Citigroup because both were Capital – one was Preference shares and other common stock. (Equity). Under the law, both were acceptable form of the capital, ranking subordinated to debt. What was the motive? Here is the possible answer.

While seeking approval of $ 700 billions under Paulson’s Plan, the Senators and President were told that they were going to give the funds to Citigroup with 10% dividend coupon. That is, US government was to earn 10% from Citigroup, that is, $ 4.5 billions per year (on $45 billions lent). By transferring to common stock, the dividend coupon was compromised, and the US government’s priority for preferential treatment of asset distribution in the event of insolvency was also compromised or watered down.

So first, these guys tell the Senators and President that US government or Tax Payers will earn 10% on amount lent to obtain their approval under TARP funds. Then, these guys convert PPS to common stock to forego 10% dividend, and then reduce the Equity capital to write off the debit in the Profit & Loss Account. In short, US government loses $45 billions within 6 months.

Now, see the interesting part for guarantee of $ 306 billions issued by US government for toxic debt held by the Citigroup.  In this case, the guarantee was designed in such a way that the losses are not written off in the books of the Citigroup. As result, the Citigroup would not be showing any losses for next 4 quarters. The losses would be ultimately written off in the books of Federal Reserve as under:

Current Position in the books of Citigroup:

11. Debit   : Toxic debt of $306 billions held by the bank (market value Zero)
12. Credit : Toxic liability of $ 306 billions payable to other creditors (could include X)

The item under 11 will need to be written off to the debit of Profit and Loss account if direct funds were received from US government under TARP.

To avoid the writing off such huge amount in the books of Citigroup, Paulson/Bernanke designed the guarantee route. They showed to US government that Citigroup would give $ 7 billions as guarantee premium to US government for arranging its guarantee. The US government is led to believe that it is just getting the income without letting out actual funds, because the guarantee does not involve movement of funds until it is invoked.

It is like we pay insurance premium to insurance company to obtain their guarantee for insured act. If the insured act materializes into real liability, then only the insurance company would be required to pay.

So these guys Paulson and Bernanke showed “moon” to the US government that they will get a premium income of $ 7 billions without telling them what it was getting into – massive deferred liability of $ 306 billions in near future.

As soon as the Toxic debt is guaranteed, the worthless junk securities are elevated to AAA credit due to the guarantee of  US government.

When the Citigroup faces the claim from creditors for $306 billions,

  1. It will hand over the corresponding toxic debt now guaranteed by US government to the creditors.
  2. It will pass the contra entry in its own books as under:

a.       Debit   : $306 billions Creditors Account in discharge of obligations

b.      Credit  : $306 billions of Toxic debt transferred to the creditors.

c.       In short, the Citigroup balance sheet size is reduced by $ 306 billions (both assets and liability of equal amount are reduced)

  1. The creditors have two options –

a.       either to demand the repayment of the Citigroup’s liability

b.      OR sell the Toxic debt to the market.

  1. When the ultimate market beneficiary of the guaranteed toxic debt needs payment, it will approach the Citigroup for payment. Citigroup, instead of making payment, will direct the claimant to the US government to demand the payment under its guarantee.
  2. In short, Citigroup will no longer need to write off the massive loss of $306 billions from its own book.  There will be no longer losses every month. It will begin to show the profit showing the world that recovery process has started working for Citigroup which is a myth.
  3. The US government when facing the claim of $ 306 billions under the guarantee, will need to write off the amount in Fed’s balance sheet. In short, the debit-able losses of Citigroup will be finally written off in the Fed’s balance sheet, not Citigroup’s balance sheet.
  4. Supposing a top Investment Bank (X) is owed by Citigroup by, say, $ 30 billions. Citigroup will hand over the US government guaranteed debt to X. X has two choices:

a.       To seek the payment of  $30 billions from Fed under its own name. However, it will expose its name for scrutiny later in the event of any enquiry.

b.      To sell the securities of $30 billions  to the market players say, A, B, C, D. These market players will ultimately demand the payment from Fed under their own respective names. Even if there is any enquiry, the name of the penultimate holder, that is, X, will not be disclosed. It can therefore avoid any scrutiny.

c.       The name of X as one of the creditors or counterparty of Citigroup is strongly suspected because the Treasury Secretary Mr. Paulson belonged to that group earlier in highest executive capacity.

d.      In short, Citigroup (and possibly X or its associates) were saved by the above exercise of “US government guarantee of Toxic debt held by Citigroup”. But the final victim would be the US government or American Tax Payers. They were obviously defrauded by the antics of Bernanke, Paulson and Pandit without the knowledge of the Senators, the President of the United States of America. Or American Tax Payers.

e.       When the $306 billions become finally payable, no further approval of Senate or the President would be required because the deal was already approved earlier for guarantee. US government, Senators or the American Tax Payers would not know what had hit them when they have to ooze out $ 306 billions at that time. It may happen 6 to 9 months from now on depending on the maturity profile of guaranteed debt.

It will be observed that good quarterly numbers of Citigroup or JPMC or BOA are not necessarily due to easing of credit crisis or recovery of the economy. These are the acts of window dressing. The balance sheets of most of the large banks are being white washed to look them better and more palatable to the investors. The credit crisis is in fact worsening.

It is therefore not too much to say that the “Citi is saved, the nation is destroyed”. It is a fact.

Kalidas, Hong Kong

4-May-2009 Ref: 0905-027

Feb 212009


Do you know why almost all coins in the world are Round shaped? Because money always roll.  That is the nature, function or character itself. If a coin does not roll, it is not money.

0902-025-must-rollThe coins – from dollar to dime – are always Round. They have to roll. If they don’t, they stop and with that the life of all citizens comes to a screeching halt.  That is what is known in modern parlance as “Stoppage of Economy”.  Some call it Recession; some call it Depression if the stoppage is prolonged.

Some call this activity as “freezing of liquidity” or “Credit Freeze”. The money becomes in short supply, its real demand increases, the real supply does not match the demand, and it’s borrowing cost increases. The FED tries to revive the economy by pumping in trillions of dollars where only 5% would have been enough. But it is not. Fed’s disbursement is not target specific.

With interest rates narrowing to zero only on paper, no money is available in the market place. Even Goldman and GE borrow $ 8 Billions @ 10% from Warren Buffet.

The banks remain open with cash drawers closed. Jobs are lost; so the workers do not get recurring wages to spend. The whole nation comes to a standstill.

Where the money has gone? With over $2 trillions being printed by bearded Bernanke, the question arises where have they gone?  They do not know the answer.  Here is my explanation.

The liquidity is not only the quantum of money or Mass alone. It has speed, also called “Velocity”. When they get together, it is called “liquidity”.

If $ 1 million rotates or changes hand from one to another 12 times a year, the liquidity is $12 Millions. Instead, if $12 Millions are printed, but they remained in banks vault, or do not circulate, the resultant liquidity is Zero.

The first lean and mean $1 Million is more powerful than the subsequent fat and obese $12 Millions.

In short, Mass (Money in Quantity) x Velocity (the speed at which it changes hands) = Liquidity

If there is…… $    1 Million (Mass) x 12 Velocity (Money’s speed)………… = 12 Units of Liquidity
If there are …$ 12 Millions (Mass) x 0 Velocity   (Money is stationery)… =   0 Units of Liquidity

The recent mass printing of $ 2 trillions by reckless Bernanke has no effect. They have become a dead inventory.  It has no storage cost, however. It is not real money which is called “legal tender” – they are electronic money or plastic money, changing not hands but the accounts in which they are credited. They are mostly book entry money.

If Bernanke had printed $ 2 trillions in physical paper, over 6 lanes High Way 500 Miles long would have been covered by $ 10 notes lying neck to neck or in bumper to bumper traffic in auto terms.

For over 2 decades, the “Physical Money” has been increasingly replaced by “Electronic Money “or what we call the Plastic Money. ATM Card, Credit card, debit card, insurance card, travel card, or name anything you like. While the real money or legal tender is issued by the Federal Reserve, the plastic money is being issued by any Tom, Dick and Harry bank.

Bernanke’s largesse of $ 2 trillions or $ 2000 Billions is sort of “blotter money” similar to “tissue papers”. There is so much of red ink in the large banks’ balance sheets, that the moment the Fed gives them these “Blotter Billions, they soak up the “red ink” in their balance sheets and become instantly useless. The new Bernanke and Paulson brand money act as “butt wiper” and goes down the drain.

Often you may have experienced the car skidding into a wet ground. The wheel rolls, but the car does not come out of the ditch. You need 2 or 3 persons or simple tricks to place a wooden plank in the front of the wheel and then need a gentle push from behind. There you are – the car is out of the ditch on the road again. The economy needs such deft handling.

Both Bernanke and Paulson are the greatest dumb heads America has ever produced. The universities that awarded them degrees should seriously consider recalling them from these mutt heads for causing chaos in the money markets with utter display of lack of common sense.

Look at these mutt heads. They would give $430 billions of assistance to bankrupt Citigroup, who then fires 75,000 employees, $127 Billions to AIG and billions of dollars to worthless banks or brokers. However, they would not give even $ 34 billions to Auto makers, who provide millions of jobs to the employees of auto industries, dealers and distributors.

How to disburse credits to needy and get the economy moving again?

1.      Disqualify the commercial banks from receiving aids from Federal Reserve if they do not use at least 80% of new credits for new lending.

2.      Make target specific reimbursement of credit needs of the banks as under:

a.       Say, FED will lend $100 Millions to the banks @ 3% (or any rate FED may chose) for incremental housing credits. That is, if their housing finance increases by fresh lending, only that portion will qualify for refinancing at lower rates subject to Home Mortgage rates not to exceed 2% over FED refinancing rates. This will ensure that the benefits of lower credit costs are passed on to the consumers.

b.      Say, FED will lend $100 Millions to the banks @ 3% (or any rate FED may chose) for Auto Financing in respect of incremental Auto financing line to the borrowers who buy the NEW automobiles made by 3 troubled Auto makers subject to Auto Financing Rates do not exceed 3% over FED refinancing rates in respect of incremental credits to Auto finance sectors.

i.      This will serve two purpose – one, it will ensure cheaper Auto finance to the consumers direct

ii.      And two, it will generate demand for new automobiles made by 3 Auto manufacturers who are facing sagging demand for their vehicles. This will save jobs in auto industry, ancillary industries, dealers and distributers ends.

c.       Say, FED will lend $ 100 Millions to the banks @ 3% (or any rates FED may chose) for incremental credit in the form of fresh credit card advance subject to charged interest  rates do not exceed 3% over FED refinancing rates for regular credit card advance and 5% over irregular credit card advance.

i.      This will encourage fresh lending to consumers who are the backbone of the economy.

ii.      Good borrowers with regular repayment records are encouraged by limiting interest rates to 3% over FED refinancing rates.  If FED rates are 3%, the interest to consumers will be limited to 6% only.

iii.      Worsening borrowers who are not able to repay in time, will be discouraged by making them pay higher rate of interest by extra 2% (or more). However, their outstanding under Credit Card do not get inflated by usurious rate of interest or hidden charges levied by the bank. This will serve as “automatic control” on bank’s lending practices.

iv.      Defaulting borrowers, who are not able to repay their debt under credit card may be asked to pay higher rates than normal. Such defaulters take lot of management time of the lender. They should be compensated for carrying potentially bad advance. Exceptions may be made by the lender to convert the advance into MIL or Monthly Installment Loan if the borrower had lost the job  and searching for new one.

3.      Make target specific reimbursement of credit @ 3% of all incremental fresh credit lines to

a.       Large corporate borrowers by way of direct loans, trade financing, bills discounting subject to such loans bearing interest rates 3% above FED refinancing rates.

b.      Large corporate borrowers by buying their 180 days to 270 days commercial papers subject to interest rates not exceeding 3%, 4% and 5% above FED refinancing rates to A, B and C category borrowers.

c.       SME and other smaller companies @ 3% provided the  bank makes any kind of incremental loans, overdrafts or Cash Credits, secured or unsecured,  at rates not exceeding 2% and 4% over FED refinancing rates for secured and unsecured portion of financing.

4.      Extend the existing Mortgage loans period by 5 years by law on following basis:

a.       Extend Interest only mortgage loans by 2 years on existing rates.

b.      Extend Interest + Installment repayment by 3 years on existing rates and rework the installments

1.      This will ensure that those facing Interest reset clause will be able to continue existing interest only loans by additional 2 years without inviting installment payment along with interest amount. Thus, there will be no pressure on borrowers to default. It is expected that in 2 years the economy will be on four cylinders again.

2.      By extending overall mortgage period of repayment from say, 30 years to 35 years, the monthly installment amount will be brought down. This will reduce the probability of default.


5.      Extend the funding to the State and Local Governments, who are in severe monetary squeeze, as under:

a.       Buy new Bonds from SLG sector @ 6% on monthly basis to help them refinance the maturing obligations. Such bonds may be bought subject to monthly limit of 70% of their monthly deficits. This will keep the SLG moving and continuing to provide local services without causing major interruptions.

b.      Such funding may be continued for 15 months only from Jan 2009, so that the state may raise other resources from the market when the credit market gets moving again. 15 months will be a cushion period.

c.       Such bonds may be collateralized by future taxes or revenue of the concerned state as “last resort.”

i.      This will inculcate some discipline into the SLG sector and a fear that if they default on these bonds on maturity, the local tax revenue will be paid to the federal government in discharge of their obligations.

ii.      The “last resort” proviso ensures that Federal government will not interfere into the State affairs so long as the SLG honors its obligations on regular basis (such as Interest Payment on quarterly basis).

iii.      The SLG may be required under the Debenture terms to set aside appropriate portion towards “sinking fund” as a measure to build its reserve on ongoing basis so that it does not face redemption pressure near expiration basis.

6.      With all credit needs of Consumers, Small Businesses, Large Corporate, Industries, Commercial markets, and State and Local Government funding needs addressed, and also reducing burden of current Mortgagors by extending loan period under the law by 5 years, the credit freeze will start melting, and the economy will start flourishing again.

Of course, the entire range of problems of CDO, CDS and CLN may continue to haunt for some more time, there will be no further accumulation of new or existing credit related problems. There is no reason why should not this approach work. It will work with 100% guarantee.

Kalidas, Hong Kong

Ref: 0902-025 of 2009/02/19