Thursday, March 26, 2009

A Joke called the Indian Accounting Standards

There is a old saying that goes as "You can fool some people all the time, and all people some of the time, but you cannot fool all the people all the time".  Corporate India and Accountants, however, disagree with this truism.  

As FASB goes about suspending mark-to-market for illiquid securities, the Indian NACAS has come up with something even better - suspending mark-to-market for forex gains and losses, when one can argue that of all the markets, the currency markets are the one which are the most liquid and the most efficient. 

The vast majority of Indian companies do not report quarterly balance sheets or cash flow statements, so one can't look at the "Other comprehensive income" item on the balance sheet to figure out what exactly has happened. There is no way for anyone now to figure out what uneconomic transactions all these companies have done. 

This is from ET: "The demand to suspend this rule, known in accounting circles as AS-11 , was made by the Confederation of Indian Industry (CII) on grounds that it could severely distort the earnings of many companies. It was contended that this accounting standard, designed to address normal conditions, should be suspended for the time being, as the present market conditions were not normal"

Are they telling me that the currency markets are distorted in some way, and they are in normal order only when Rupee is at Rs 40 against the dollar. This is a joke. 

One day in the next 3 years, all these transactions will mature, and the companies will make cash payments, or receive less cash than projected. Suddenly, the net debt on the companies balance sheet will zoom up much beyond what analysts are projecting. And suddenly, the companies leverage ratio will go out of whack.  And just as suddenly, retail investors, who wouldn't have focussed on this issue, will find that their company has gone insolvent.

It makes sense to stick with only the highest quality names in this environment like Infosys. Third tier managements like Crompton Greaves are out to screw shareholders now. 

Tuesday, March 24, 2009

The Game Changing Proposal

Finally, the US treasury has decided to pursue what has always been the least bad of all options - purchasing assets. Nobody knows what the unintended consequences of this is going to be. But nobody also knows what the impact of a $800 bn stimulus package is going to be.

Plunging asset prices were what started the crises, and stabilization of asset prices is what is going to cause the end. Once asset prices have stabilized, earnings will follow after a year or so. 

What is absolutely essential is that the plan gets implemented as proposed - otherwise Geithner will come across as extremely undecisive. There might be political opposition, but this is Obama's treasury first real proposal. So there is enough political capital to get it started. 

There are three tricky parts in this entire proposal:

a) Can the Treasury get private capital involved?  This is a heads I win, tails you lose situation. What will get investors really excited is if the first few deals are really sweet and the investors end up making boatload of money. I think people are going to be surprised by how much private capital will eventually get involved. And if Treasury were to give tax-breaks to retail investors investing in these PPIF's - that will cause a stampede. That way, the Treasury can also counter any cries of "the rich guys benefitting at the expense of the taxpayer". Get the taxpayer involved. 

b) Pricing of assets. Treasury is allowing the PPIFs to lever themselves up at extremely cheap leverage. This is crucial, as it automatically pushes up the pricing of assets in credit markets - many of which might be priced now an almost unlevered basis. Haven't we all heard of people talking of equity like returns in credit markets?

PPIF's don't really need to "overpay". A very important aspect of pricing of assets is - what is the leverage and the cost of funds of the investor buying those assets. The discount rate to calculate the "fundamental" value of any security is different for different investors. Even if PPIF's and I have the same outlook on the cashflows and default probabilities etc etc, they can pay more than me and still make more money than me because their ability to leverage is higher and cost of leverage is much lower than me.  An appropriately levered investor can always pay more than an unlevered investor.

Nobody is subsidizing anyone - if one assumes the prices in credit markets are fair value prices today for a relatively unlevered investor. Taxpayers lose if credit markets are overpricing securities for a relatively unlevered investor.  If the economy goes down substantially from here and indeed credit markets turn out to be optimistic, then Obama won't get re-elected for sure. The lynch mob will forget about AIG and focus on Geithner.  

If anyone is subsidizing, it is the investors in the bonds issued by the PPIF's and the Treasury to lever up the PPIF's - i.e the Chinese and the Japanese. But havent they been subsidizing the US for a long time now? 

c)  Exit plan: A successful PPIF will create its own exit plan, for e.g. list the fund on the exchanges, and Treasury sells its equity portion to other investors etc. An unsuccessful PPIF doesn't have an exit plan by the very fact of its failure. 

I think this is the game changer for banks. For any asset that has been written down to market value, selling into a PPIF will generate a higher price  (GS and MS have probably written down the most to market prices). This will free up the asset side and also create valuable equity capital. And as bank share prices go up, banks can also raise less expensive equity (compared to today) from the markets. 

This is not to say we are back to the races like 2007. That is unlikely to happen in our lifetime again, and there are too many problems in the world. But I think the time has come to become more aggressive than I have been in the last 18 months. Krugman is right when he says that Obama is risking his entire political capital on this - there are no second chances here. 

Friday, March 20, 2009

What drives inflation?

This is the most important question facing us now. The correct answer to this question is going to determine whether one makes money or not in the next three years. Can there be inflation when there is a recession? The 1970's certainly suggest so. Is it necessary that printing money leads to inflation? Japan of 1990's will suggest that need not be the case. Is it really possible to have sustained inflation without wage inflation? 

So, I thought it would be useful to read the history of the Weimar Republic as well as 1990s Japan. I ordered this book recently: Lords of Finance by Liaquat Ahamed, to figure out what happened in Germany in the 1920's. I have yet to figure out a good book on Japan. 

When both longs and shorts book profit on a trade:

Very interesting dynamic at Abitibi Bowater.

Tuesday, March 17, 2009

AIG FP employees work in Insurance

They hedged their compensation perfectly. It is not correlated to anything else in this world. 

Sunday, March 08, 2009


From Barrons: S&P's low of this bear market came on Friday - at 666. GE's low of the day was also 6.66. 

Now that is an interesting observation. 

Thursday, March 05, 2009

Michael Lewis on Iceland

Great article in Vanity Fair: It is 7 pages long. 

And some great lines to conclude the article:

When you borrow a lot of money to create a false prosperity, you import the future into the present. It isn’t the actual future so much as some grotesque silicon version of it. Leverage buys you a glimpse of a prosperity you haven’t really earned.

Sunday, March 01, 2009

Does Warren Buffett try to time or not?

Certainly he is unhappy about his timing of ConcoPhillips. From the latest annual report:

I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.