Jan 202010

Ref: 10-003 of 19-Jan-2010 by Kalidas PDF Download from ScribD

READ or watch any media report in Uncle Sam’s America – newspaper, magazine, Business channels on TV or any interview of senior executives of large corporate. They talk about only Top Line and Bottom Line. Top-bottom, top-bottom, top-bottom……… they go on lecturing for hours using above words in different contexts. In the process, the body, the substance, is lost.

What happens when a person with blood group A+ is on operating table and is in need of blood. Will any other group of blood be acceptable? Of course not. He will die if he is injected with different blood group.

Same thing applies in the field of finance and economy. Those of you who has read my book “Sub Prime Resolved” and the primer series “How to Invest into anything…” would have known that “Long term assets should be financed by long term liability which could be in the form of capital such as Equity or Preference shares and long term borrowings from banks, financial institutions, public issues in the form of Term Loans, Bonds, Debentures or perpetual instrument.

Thus, if you grant a loan on 10 year basis, it should be financed by either equity or 10 year long term borrowings. The borrowings have to necessarily match the maturity profiles of the financed assets. If a bank or Mortgage financing institution is granting a fixed rate mortgage on 30 years basis, he should have capital or borrowing on matching terms and maturity, those who finance the long term assets with short term liabilities are bound to fail sooner or later.

This is what is going to happen in America. The banks and mortgage institutions, with a view to boosting stock prices of their company, lent mortgages at incredibly low rates, often not exceeding 3 or 4%, and financed them from short term borrowings from Fed under Federal funds rate program or in discount windows at near zero rates. In reality, they were arbitraging between short term borrowings and long term lending rates.


Let us take a concrete example:
Suppose Banker A grants $ 250,000 Fixed Rate Mortgage loan @4% repayable in 30 years. The rates are fixed, without recourse (unique in America) and without escalation clause. See the stupidity of the American banker. How could they take the view of Interest rate for 30 years? How could they lend on such incredibly low rates for 30 years?

He does not have enough capital. He borrows short term (monthly rollover or Libor based) either from Fed or inter-bank market. He pays at the most 0.25% and lends at 4% netting interest differential of 3.75% or $ 3,750 per $100,000 per borrower per year. It is his net profit with least maintenance cost. The stock price goes up, his stock options become more valuable asset and he also earns fat bonus at year-end running into millions of dollars. That is his performance. His colleagues and neighbors consider him as “Smart Ass”

Now, what happens when the interest rates rise? Well, until the rates rise by 2% to 3%, his profit margin merely narrows down. Instead of earning arbitrage interest differential of 3.75%, he would earn 1.5 to 2% or $ 1500 to $ 2000 per $100,000 per borrower per year.

However, when the short term interest rate rises to 3.5%, and above, he will have to visit Wash Room often. He is losing in every case. Being a fixed rate mortgage, he cannot pass on extra cost to his borrower. If he tries to under other Alt-mortgages, the borrower will come to him, hand over the key and say, sir, enjoy your property. He becomes “lender in possession” with no recourse to the borrower. In short, the banker is now in duress.

If interest goes to say 8%, he will have shell out 4% from his own pocket or $ 4000 per $ 100K mortgage per borrower per year. If he has granted $ 300 billions of such loans, he would lose 4% or about $ 12 billions from his bottom line. NOW, his bottom line becomes bottom less pit.

There are about $5.5 trillions of mortgage loans in United States. In the event of massive rise in interest rates, the banks would be losing $ 220 billions for rise in interest cost by 4%. In other words, the lenders would lose @ 55 billions for every rise in interest rate by 1%. If the rates rise to say 24% as it happened in early 80s, the bankers and mortgage lenders will lose over $ 2 trillions ($ 2000 billions) per year.

We are not counting derivatives that run nearly 6 to 20 times the above amount.

There will be catastrophe. The borrowers will not be affected because they have fixed rate mortgage. But when his lender gets bankrupt and gets sold to some third party, what happens if the said third party annuls the agreement on the ground of equity (it is possible legally) and fair play?

At the moment, thanks to four musketeers – Hank Paulson, former Treasury Secretary from Goldman Sachs, Timothy Geithner, incumbent Treasury Secretary, Ben Bernanke, incumbent Fed Chief and Alan Greenspan, former Fed chief for over 18 years. They are the “Destroyers of America”

The rates are about to rise. China has already expressed intention not to buy any more T-Bills that has infuriated the United States. A vicious propaganda is launched to the effect that China bubble is about to burst. They are trying to squeeze Chinese nose so that their mouth and purse open up.

But then, they do not know the Chinese.

When the rates begin to rise, all the banks and mortgage lenders will come under severe squeeze. The double “dhol” (an Indian musical drum) with Bernanke on one side and Geithner on the other, will make such noise that the markets would be rattled to the extreme.

Several banks will fail, in thousands. Several trillions will be lost again. The Fed will find difficult to print more and more $ notes. FDIC will be busy taking over banks day in day out with no funds in the kitty.

President Obama with no cash in the kitty, printing press closed, no majority in Senate to pass mischievous Health Care bills, will be pushed to the wall. His popularity will go down below 30 from 46 at the moment.
Hell will break lose again in the financial market. Will it happen and so early. It all depends at what speed the rates rises. It is not the question of “whether” but “when”

Ride the rally in the stocks and bonds for the time being. A financial earthquake, more severe than Haiti, is in the waiting. I could hear the simmering sound, I could smell the faint smokes, what I do not know is the precise time when this volcano and earthquake will burst and with what intensity.

Kalidas (Anil Selarka)
Hong Kong, 19th January, 2010 Ref: 10-003

Personal Blog: http://anilselarka.com
Book Web : http://www.subprimeresolved.com

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