Did Obama Plagiarize Glass And Stegall?

Did Obama’s Volcker’s Rule announcement contribute to the drop of DJ?  Did Obama plagiarize Glass and Stegall?  Pundits all over the place say that is the result of the Volcker’s Rule.  One, Volcker’s Rule alone did not necessitate the fall.  Two, who among these pundits actually read what the White House press release, and not the Bloomberg announcement, is about?  Three, Volcker’s Rule is not “new”.  Volcker’s Rule is actually a re-tro.  Four and finally, what is the implication/impact (theoretical or academic) of Volcker’s Rule?  What can we learn from Geithner’s opposition to this Volcker’s Rule?

Yahoo (of all places) actually hit it right: there are plenty of reasons for DJ to fall.  Realizing the profits from Massachusetts Senator election is quite a good reason already.  In fact, the rise of DJ on Tuesday contradicts the fall of DJ on Thursday: DJ rose because the market expected that having 1 more Republican in the Senate would derail the agenda of Obama.  If investors believed in that, then the investors could not have believed Obama’s Volcker’s Rule would become law.  So, Volcker’s Rule alone did not create the fall.

The White House press release regarding Volcker’s Rule actually gives very little information.  And luck would have it that everything covered by Obama’s 01.21 announcement is already covered by H.R.4173 – Wall Street Reform and Consumer Protection Act of 2009.  Quite possibly, nothing is new. 

Worse, nothing is new: Glass-Steagall Act probably covered everything Volcker’s Rule is about.  Since Volcker’s Rule is not in the legislation form, no comparison can be done.  In fact even Volcker calls it “in the spirit” of Glass-Steagall Act.  It further proves that Obama named it Volcker’s Rule for political purposes: to show he is doing something to punish the bad guys (banks) for the rest of us. 

Preventing banks from having private equity funds, hedge funds et etc do decrease profits of the banks.  However, these funds make up 5% of revenues of Bank of America (NYSE: BAC), Citi (NYSE: C) and the like.  Yes, it does strengthen the point that this rule is for show, especially after the Massachusetts’ loss.  However, Volcker’s insistence on this issue has a point: it takes 5% of their revenue.  However, these banks are using depositors’ money to play these large bets, using FDIC’s insurance to back themselves up, and twisting their risk adjusted return on capital (RAROC).  Here is an example:  How much can $1000 bet if you were to trade on currencies?  Answer: with $1k, you can trade the equivalent of $100k of Japanese yen, British pound, Euro and so on.  If the currency fluctates 1%, the $1k is already gone.  If the market swings more than 1%, the bank has to lose all of its money (the $1k depositors’ money) and more.  So, these banks are misappropriating depositors’ money (which would be illegal in insurance laws), making taxpayers pay for their risk, and presenting themselves before the eyes of investors. 

What it really does is to draw out a lot of hot money from the market: less money will change hands on a daily basis.  That affects all industries.  Investors (institutional espeically) will have to play with real money, if this works.  Retail investors will make up a greater proportion of money in the market than before.  Market will be more difficult to be manipulated than before by a few players.  Will that shrink the whole market? Probably.  However (or hopefully), it will mean everyone will be trading with a saner head since no one will be playing with free money.

How Long Can You Wait For A GM Bailout?

GM (NYSE: GM), Chrsyler and Ford (NYSE: F) are asking for a nagging for an auto industry bailout.  This is what should have been expected once the $700B bailout flood gate is open.  After the auto industry will be the steel industry, the building industry.  If you bailed one, you need to bail all. 

 

Obama said the auto industry is important.  That may be an electoral language.  It may be too early to tell if he will deliver or break the promise.  However, one thing is certain: he should focus more on transition than governing.  For that reason, he is likely to remain mute on this issue.  

 

What about Bush?  Bush already said he will not bail out.  Some think Bush is using that to bait Senate to rectify trade treaties.  It is more likely Bush is being a prudent and a responsible out going president – do nothing.  This is best described by Treasury Secretary Paulson’s article on NYTimes.  During a transition period, the stunt show could have been to advocate for McCain (“who else can steer us through this mess?” Not that it worked).  Once the election is (or was) out of the equation, the job (Paulson’s job) is make sure the ammunition is available for Obama and hope that Paulson does (did) not have to use the ammunition or use all the ammunition.  Here is why: Paulson’s reputation will be the first for crucifixion under the Obama administration when Obama is up for a recovery failure.   The best Paulson can offer is to recommend the best talent he can find.  

 

The starting point to any bailout is the House.  Will House give the money?  Even if Pelosi wants it, she is unlikely to get the ammunition to push it through, given the controversy of the $700B and the margin that vote had.  Suppose it passes, it does not have enough votes to override Bush.  

 

Will Obama ask for it?  Who will take credit for the bailout?  Or the blame?  Who will have to be accountable to the execution of the bailout, if the money actually goes through?  Obama administration or Bush administration?  Obama wants no ambiguity.  Bush is unlikely to want to create another potential mess for a Democrat to manipulate against him.  The $700B stunt show is already enough for both Bush and Obama.  

 

So, the story is then: forget about trading auto stocks based on political news or even the hearing.  No matter how appeal the hearing will turn out to be, the earliest possible actionable news is after Obama’s cabinet becomes clear, if not after inauguration.  

The Danger Of The Merrill Purchase To You

“Thank God, they bailed out AIG”?  Can we say “Thank God, Bank of America bought Merrill”?

Do you think the Merrill (NYSE:MER) take-over by Bank of America (NYSE:BAC) is better than the bankruptcy of Lehman (NYSE:LEH)?  Because at least the company is saved?  Not really, unless you are an employee of Lehman.  In fact, the Merrill take-over by Bank of America is worse to all tax payers and to anyone who is a depositor of Bank of America (Bank of America has overseas operations).  

 

Investment banks take high leverages.  Investment banks have a different nature in their business from retail or commercial banks (or wholesale banks).  That is why investment banks have a much more volatile nature than other banks.  For instance, take the year 2000 instead of 2008.  The market capitalization variation of Citi (NYSE:C) is only 29% while Goldman (NYSE: GS) is 62%.

 

The danger of this merger is that since investment banks are a lot more volatile, having a deposit bank and an investment in the same balance sheet puts the retail depositors’ money in danger.  It comes down to one question: what if the hole of investment bank is big enough to suck out all the depositors’ money?  Exactly for this reason, America got a thing called Glass-Steagall: separating investment banks and deposit banks.  This requirement is removed by another law Gramm-Leach-Bliley during Clinton Administration.

 

Glass-Steagall was created to contain the risks from the investment banking industry, preventing their risks to spread out to all over the place.  Investment banks make loads of money during the good time, i.e. high M&A seasons.  During the bad times, like we have now, investment banks sink harder than Titanic. 

 

This merger means more of FDIC’s money is now exposed to a greater risk, the hole of Merrill.  Bank of America’s Tier 1 capital is now at best 7.4%.  Once we see formal filing, we will probably see that the Tier 1 will be even lower than 7.4%.  What is the cost to the depositors?  What can be done about it?  The fed can actually give Bank of America a greater pressure on the Tier 1 capital requirement.  It cannot fix everything, but something. 

 

Bank of America already swallowed LaSalle and Countrywide.  However, Countrywide is more about swallowing client list.  LaSalle is more about geographic expansion.  Merrill is about a new business line and new clientele.  This will be a great test of Bank of America’s management.  It’s just that Bank of America is not known for management integration.

 

Certainly Bank of America got the biggest brand in the investment bank.  What is the price in addition to the stock swap?  What is the management cost of this merger?  This will take years or even a decade to work out the integration.  How long will it take to get a divorce out of this one?

 

Where Do Mccain And Obama Want To Go With This?

Lehman was still crying about loss of the Korean (KDC, sold at SEO, not in any of the US exchanges) sale last Friday.  And now, poof, gone!  Merrill is now a subsidiary of Bank of America!  Certainly buying Merrill is a smarter buy when one compares the balance sheets.  However, what about the management cost to make the transition?  What kind of clienteles do they have in common?  Of course, Bank of America may just want to buy the asset portfolio and client list and start cost elimination (layoffs).  However, this event is more than Merrill, more than Merrill and Lehman, more than the whole today’s S&P.  Lehman and Merrill have become a political issue in this election year.  It has been given its own life and it will take to all sorts to directions.  Its political impact will probably exceed Katrina or Ike and Katrina combined.  

 

The non political impacts are obvious: oldest brands in the investment banking world are gone (who will do my next merger deal?); financial consequences are global (where to park my money?); confidence in the America investment banking is immediate; confidence in the financial industry is also weaken (Countrywide, Freddie and Fannie, Merrill, Lehman, AIG.  Anyone left?). 

 

The political impacts are very unpredictable:  Republicans are calling regulation overhaul; Democrats are taking shots at the McCain’s subscribed philosophy.  

 

Are the Republicans are talking about a reform in mortgage underwriting?  Or retail banking? Investment banking? Hedge fund?  Speculative commodity trading?  Or accounting practices so that nothing is off the balance sheet?  Or are the Republicans talking about payday loans?

 

Are the Democrats talking about getting rid of exchanges?  McCain’s POW philosophy (if there is such a thing)?  

 

The candidates are so vague not only because they need to have the flexibility, but also they are clueless of what is going on.  You may laugh.  But that is the dangerous part.  Any piece of the finance industry is now part of a tighter regulation cycle.  This situation is no different than FDR’s power grab. 

 

Mortgage companies were in trouble.  Now, investment banks.  The connection is not “Wall Street” industry.  The connection here is the work flow.  The problem started out from the mortgages, the product.  Next, the buyers of these mortgage investment products.  Bond underwriters and the like are obviously the first one in line to take a hit.  However, the next ones are insurance companies, especially re-insurance companies.  AIG is the best exchange.  UK’s Lloyd is another one.  These companies are no different than multi-line banks: making money out of interest rate spread.  These insurance companies employ similar financial products to make their money.  

 

We may want to think about what kind of creative regulations politicians can think of.  However, the more myopic question is: where does it end?

Whose Money Get Hurt In The Middle Of This Cold War 2?

 

Russia invaded Georgia to show Russia is still a superpower.  Certainly, Russia caught the US off guard.  And of course Russia is dragging its own feet to leave.  Is the objective of “being a superpower” achievable for Russia?  What are the impacts?  What companies will get hurt the most?

 

Russia is no longer financially strapped like they were in the 90’s, thanks to the oil.  Military is a very costly adventure to archive national interests.  To assess if the objective is achievable is equivalent to ask if the economy can support such an activity.  Since exchange rate is different daily and purchasing power is different in each country.  A good way to measure the GDP is GDP by purchasing power parity (PPP).  This is a link to 2008 GDP PPP. 

 

Russia is about the scale of France, both are less than $2.1T.  The US is $13.9T while China is half of the US ($7T) and India is $3T.  Russia’s scale of economy is about 1/7 of the US and less than 1/3 of China.  Russia’s export is mainly natural resources (or defense sales).  Its exporting countries are mainly EU countries, i.e. NATO countries.  

 

Its economic structure is heavily dependent on 1 type of product to 1 geography (or even 1 buyer).  Anyone could have given a warning to a company that is so heavily dependent on 1 product to 1 buyer.  It is then very obvious that this strategy cannot last long.  

 

Since Russia’s size of economy is so small (1/7 of US), a new Cold War cannot get started.  The scale of this Cold War 2 is either small or short.  Russia’s fuel will get burnt out very fast, when compared to THE Cold War.  With the energy price keeps falling, this strategy will fail even faster.  Russia’s only hope with this strategy is to have more support from China and India to build a multi-polar world.  

 

The impact will be felt most heavily on companies where Russia constitutes a major part of their operation similar to their operation from NATO countries.  It need not be revenue, operation such as production or material input would be enough.  BP is an obvious example.  Energy is an industry where everyone will have to look for.  Heavy industry is another.  Anyone who has production sites in Russia can get stuck.  Russia’s militarism will increase friction with the NATO countries.  Pressures will not only come from international sanctions (if any), but also Russia’s suspicion against these companies’ operation in Russia and other CIS countries.  

Obama vs McCain Platform (Part 3): Your Taxes

Obama made his tax announcement on 2008.08.12.  This probably the most valuable plank in any election.  Yet so little attention is paid by the mainstream media.  Is the Olympics Game drowning out all the media space?  This post summarizes the most important points out of the 2 candidates studied by TaxPolicyCenter.org’s research based on IRS data.

Under Obama’s tax plan, 99% of tax units will generate more tax refund (by cash income, see Table 1 of the link).  Only the top 1% of tax units will have to pay more taxes.  

 

How much do these top 1% earn?

Well, $2,871,682. 

 

Let’s look at McCain’s tax proposal.  This is the Table 6 of the same link.  Great news!  Everyone gets to pay less taxes!  Even the top 1% pay less.  The lowest 20% of tax units pay $21 less in taxes while the top 0.1% pay $290,708 less!  One may argue that since the lowest 20% have a smaller taxable income, their smaller tax refund increase is justifiable.  That is a very sound argument.  So, let’s see if the tax refund were proportional across income groups.  

 

The lowest 20% of tax units will see an increase in after-tax income of 0.2% while the top 0.1% see an increase in after tax-income of 4.7%.  This is also McCain’s.  Even Arizona’s newspaper cries fool.

 

For Obama, the lowest 20% tax units see a 5.5% after-tax income increase while 1.9% for the highest 5% tax units, 0% for the highest 1% tax units.  The top 1% see 8.7% decrease in after- tax income and the top 0.1% see -11.4% decrease in after-tax income. 

 

People have been wondering about capital gain.  Obama’s announcement also clarified some clouds as well.  TaxPolicyCenter.org checked the numbers on this capital gain issue as well.  

 

Although 80% of the tax returns claim capital gains in 2006, they take up only 6.2% of capital gains.  These filers are all below $75k in Adjusted Gross Income.  However, 0.3% of all returns take up 60% of capital gains and they are all >$1M Adjust Gross Income filers. 

 

Obama’s tax plan was absolutely unclear prior to this announcement.  But then it is the voters who can force the candidates to be clear and accountable to their promises.  

Pricing The Risk of Georgia-Russia Conflict

Russia and Georgia are engaged in a military conflict over the South Ossetia.  Georgia is not an oil producing country.  Therefore, the oil price is not affected, yet.  The US dollar is appreciating against all currencies (GBP, CNY, INR, EUR, AUD, CAD, JPY, CHF).  This USD appreciation actually contributed to the price fall in all base commodities: gold, oil, copper, everything.  There is no indication that the political risk posed by this military conflict has been priced in the oil market yet.  The political risk may be being priced into the currency market alone, for now.

 

First of all, why didn’t the bad unemployment news sink the USD further?  Well, the world is gloomy right now.  The US happens to be not as bad, that’s all.  

 

The appreciation of USD, using CNN’s figure, is 0.59% while the price drop of oil is 3.47%.  This price drop is more than adjusting the currency fluctuation.  The market has priced in something else, but definitely not Georgia conflict.  Hot money still has to go somewhere.  It has been slowly moving back to the stock market for weeks.  Thus, growth stock got a better boast than the rest of the market.   Therefore, how much of the stock price is supported by fundamental versus by parking availability is very questionable.  

 

Georgia is not oil producing country.  However, the tradition is when there is a major conflict, oil goes up and USD goes up since every economic fundamental is questioned.  However, this is not yet the case.  Maybe the market needs to first work out the oil price.  After all, oil has been high for so long. 

 

Another reason why this has not been priced is there is no reaction against Russia, the oil producing party of the conflict, yet.  Recall Russia jumped its gas price over Ukrain?  Maybe the Georgian conflict will be a forgotten item.  The only caution is this area is close to Turkey and Caspian Sea.  So, depends on where the pipes actually are, the political risk can get factored into the oil price as the conflict enlarges its theater.  Some of price drop can be attributed to demand destruction since aggregate demand, especially commodities, takes a long time to change.  The duration of high oil prices may actually have shifted demand for oil.

 

The interesting part is actually the currency exchange rate.  If we look at the change in exchange rates, then we see that the closer the country is to the conflict zone, the more USD appreciates.  Go check google finance.  This is ranked order of USD appreciation against other currency: EUR, CHF, GBP, CAD, JPY (at least at the time it is written).  Looking at the price differential at day end may give a hint where this risk is going.  Of course, Euroland’s fundementals are priced in as well.

 

Obama And Stock Expectation

Economy is the top concern for voters.  In theory, Democrat contender should have an easy win.  However, poll shows Obama has only a small margin.  Is race really the open question?  Since this race is about Obama vs. anti-Obama, let’s check if Obama’s fiscal policy is giving any hint about his performance.

 

Considering seniors constitute the biggest voting block, attention should be placed around this block’s interests. 

 

The flagship item of Obama’s fiscal policy toward seniors is the elimination of income tax among seniors of income less than $50,000.  However, a good portion of seniors’ income, in addition to Social Security, originates from pension funds, individual investment or through downsizing their real estate since most of them generate very little income tax. 

 

Obama, at the same time, wants to increase capital gain tax from 15% to 28%.  This impacts seniors’ income.  How will this off set Obama’s first $50,000 tax free income for seniors?  No one has the figures yet.  However, let’s see how much hard that will make for the seniors’ stocks (pension plan, IRA, 401k…). 

 

If the stock is expected to generate 10% after tax growth with 15% capital gain, the stock value has to grow 11.76%.  This is computed by 10% / (1 – 15%).  If the capital gain tax rate is raised to 28%, then the stocks have to grow at 13.89%.  Don’t think the difference is only 2.23%.  Think how much harder the companies have to work in order to generate this 2.23% extra growth:  (13.89% – 11.76%) / 11.76% = 18.06%!  Companies have to work 18% harder to find the growth investors (in this case, seniors) are expecting / dependent on. 

 

If the seniors are not checking these numbers, fund managers certainly are.  This bit of information probably does not change every voter’s mind.  It certain would help prioritize which stock sits in the parking lot for a while and which queues in the drop list.

Senate Banking Cmt: Mortgage Bill on Thursday

Senate Banking Committee Chairman Chris Dodd (D-Conn.) yesterday said that his panel on Thursday will consider a draft housing bill that would allow the Federal Housing Administration to insure up to $300 billion in refinanced mortgages, and create a new regulator for Fannie Mae, Freddie Mac and the Federal Home Loan Banks. Under the legislation, lenders would, among other things, volunteer to substantially reduce the amount of the original mortgage note. In exchange, the FHA would insure a new loan at a 30-year fixed rate that the borrower could afford. The House last week passed a housing package with some similar measures.

This is not the version of Treasury Secretary Henry Paulson. 

This plan is more consumer-centric than that of Henry Paulson, although improvements can still be made.  For instance, the mortgage write-down has to be initiated by the lender in this version.  For that reason, the lenders have the strongest incentive to unload the riskiest mortgages first.  However, the riskiest mortgages may not be the neediest. 

This riskiness may be perceived as loan by asset.  The lender may also see that as mortgage payment by burrower’s income.  However, the most desperate burrowers usually would see the need as payment by income.

Burrower’s consent is not needed.  The house has to be owner occupied.  The gov’t will also own part of the house’s equity (proceed upon sale).

Bush has threatened veto this legislation.

 

The text can be found in the Banking panel of the Senate website.

The common interests of Microsoft, Pharmaceuticals and Rumsfeld

Forbes published a few articles related to patent laws that are English friendly in the last 10 weeks.  The patent universe is likely to change very soon.  And Rumsfeld probably would not like this idea. 

 

The legislature has been considering patent laws reforms for the past few years.  The pressure of this reform comes from major corporations, which hold a lot of patents, have been getting sued by patent trolls, or patent speculators, for royalty fees.  Additional royalty fees of course cuts into the profit margin.  However, intellectual property suits are costly to fight simply they are so difficult to understand (and thus higher legal fees).  

 

For some industries, intellectual property (IP) lawsuits affect the legal fees and royalty fees.  However, for some industries, these lawsuits affect their capitalization the suit hits the news.  These are the IP-centric industries, such as IT and medical industries.  

 

When RIM, the maker of blackberry, got sued for patent infringement, its stock price dropped to its knees.  After all, RIM has nothing but blackberry.  And even if RIM’s patent is not void, a heavy royalty fees will seriously affect its profit.  

 

A key element of the reform is revolved around unique concept of American patent system: first to invent versus first to file.  The congress will remove the first to invent rule and make US to be in sync with the rest of world: first to file.  In the first to file rule, one needs not be an inventor, but just to be the first to walk into the patent office to own all rights of the invention.  

 

The first one to be disadvantaged is obviously the legal industry.  However, not many people will feel sorry for that.  And we will skip.

 

A loss to one may be a gain to another.  Here are some of those:

 

The second to be affected (not necessarily disadvantaged) are the medical and IT industries.  A lot of drug patents are expiring, just like the copy rights of a lot of Disney characters.  For these US giant pharmaceuticals to stay afloat, they need new patents.  They either have to invent or find other people’s invention to file before the inventor does.  So, the firms that are better industrial espionage will do better.  

 

Some items are affecting directly the rights of the inventor: 1) Damages will be restricted as well, a classic republican cause; 2) Challenges will be for the entire life span of the patent rather than a probation period; 3) Disclosure of invention will be required prior to granting the patent. 

 

Who gets the benefit out of this?  Infringers.  Infringers will be able to have a cap on the compensation to the patent owners, able to challenge the patent until the patent runs out (yes, they can), able to learn the invention before it is patented and therefore free from paying royalties fees, and no injections from the inventor to stop the infringements. 

 

Alright, how does it relate to Rumsfeld? 

 

As a defense hawk, Rumesfeld is interested at slowing the China’s economic growth.  Making it cheaper for patent violation is a big favour for the medium enterprises in China.  Inventors lobby groups probably would want to get more funding from pharmaceuticals and hire Rumsfeld to be the lobbyist for a cause that its core constituents probably does not have the funding nor the votes for.