Farm loan waivers and Investment bank bailouts

John Ruskin said “the highest reward for man's toil is not what he gets for it, but what he becomes by it.” I wonder what will he make of the global financial system that never seem to learn from its mistakes.

Have governments and central banks finally aligned? Or have they all run out of ideas? I certainly see character here. Very charitable one at that. I see across the board farm loan waiver in India (a massive $15 billion bill on the tax payer) and a massive bailout of failing investment banks in the US. The fed backed it up by cutting interest rates – sixth cut in a row since September,2007.

I see parallels that feed systemic excesses –

In the US, the financial services industry has defied gravity by using debt, securitization and proprietary trading to boost fee income and profits. Why care for capital adequacy if the tax payer is obligated to bail them out? In India, farmers have been pampered for long – tax exemptions, loan write-offs and yet keep them clustered under priority sector. Why repay a debt if it’s likely to be written off?

The value of outstanding credit-default swaps in the US financial system, for instance, has climbed to a staggering $45 trillion. In 1980 financial-sector debt was only a tenth of the size of non-financial debt. Now it is half as big. In India, outstanding agricultural credit is currently less than 10% its net NPA. A couple of waivers like this, and it will get there.

Leverage process practised by Wall Street has turned investment banks into debt machines that trade heavily on their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out, as it did with Bear Stearns and many others.

Globally, salaried tax payers can't escape tax cuts because they get checks after deduction of tax. That comfort is making governments smugger and they're emboldened to write more loans off, bailout wrongdoers in one swoop. It is not within our power to not let them cut taxes before they cut our checks. But with a bit of initiative and aided by a stroke of luck, we can certainly turn farmers or investment bankers and benefit from the largess that won’t stop any sooner :-)

.

Controlled bleeding or cauterization...?

Agreed, not so upbeat title for an Economist story with no hemal touch. But as an opener, it isn’t entirely out of place either. The metaphor fits in water tight. Excerpts -

"That was the unappealing choice facing UBS, a Swiss bank which has been badly hurt by the carnage in America’s mortgage market. Today, the bank opted for the latter. First it opened the wound, by announcing a hefty $10 billion write-down on its exposure to subprime infected debt. UBS now expects a loss for the fourth quarter, which ends this month. It may end up in the red for the entire year. Then came the hot iron: news of a series of measures to shore up the bank’s capital base, among them investments from sovereign-wealth funds in Singapore and the Middle East."

[It started with Merryl Lynch, then Morgan Stanley and Citi Group bringing up the rear.] "Why then did this new batch of red ink still come as a shock? The answer lies not in the scale of the overall loss, more in UBS’s decision to take the hit in one go. The bank’s mark-to-model approach to valuing its subprime-related holdings had been based on payments data from the underlying mortgage loans. Although these data show a worsening in credit quality, the deterioration is slower than mark-to-market valuations, which have the effect of instantly crystallising all expected future losses."

Will this bloodbath end, ever…? Loss of reputation for a conservative bank like UBS is deep enough cut. What is worse is the impact that has exposed the fluidity of its capital adequacy ratios at the tier 1 level. Of course, it has rich friends ready to pitch in. The white knights include sovereign-wealth funds (GIC, Singapore) and rich middle east investors that have pledged support to shore up its bottomline by infusing SFr 19.4 billion. Marrying bigger-than-expected write-downs with bigger-than-expected boosts to capital looks like the right treatment in this environment. But UBS still cannot be sure that its problems are over.

.

When a Private Equity deal goes bust

Buyout firms like to present themselves as a can't-fail combination of operational genius and financial support that can heal sick businesses and create thriving companies. But sometimes, as in the case of Aegis Mortgage, genius fails and bankruptcy is declared. The private investment firm Cerberus bought a controlling stake in the Houston-based mortgage lender in 1998, but despite an infusion of cash and talent, Aegis ceased operations on Monday, August 6. Now hundreds of employees have been laid off - all without health insurance. It's a reminder that risky turnarounds can mean real pain for more than just investors raising questions about how Cerberus will treat other ailing companies it has purchased, notably Chrysler.

In India, PE deals are on the rise. Over leveraged transactions be put on watch.