Month: March 2009

Indian elections are normally a very colorful affair so I wasn’t surprised one bit when I saw the launch of the “Recession Party” to fight the forthcoming Indian parliamentary elections. Jaspal Bhatti is a very popular comedian in India, who launched the Recession Party last Monday and is banking on the votes of fools.

He says that he will not divide voters along the lines of religion, caste, color or race, but, rather along the lines of foolish and intelligent voters. He doesn’t want the votes of the intelligent voters, who vote corrupt politician to power, pay the price for it, and then do the same thing all over again. He wants the votes of only foolish voters; he has mine.

On to the other interesting stuff around the blogosphere this week:

1. The Year of Living Dutch by Investoralist

2. The Tyranny of Investing Fees by The Dividend Guy

3. Get The Best Home Loan Rates With These Tips by The Digerati Life

4. Meet My New Credit Card by M is For Money

5. Psychological Benefits of Index Funds by The Oblivious Investor

The House has passed the Bonus Tax Bill after the AIG bonus furor.

WSJ reports:

“The House measure was approved on a 328-93 vote and would impose a 90% surtax on employees who earn more than $250,000 at companies that have received at least $5 billion from the government’s financial rescue program. The bonus tax, if approved by the Senate and signed into law, would be retroactive to Dec. 31, 2008.”

I am glad that the bill is passed and the real reason for that is — now the people at AIG Financial Product Division will surely quit.

I was watching Mr. Edward Liddy’s testimony and there is one piece that has been on my mind ever since. But before that, some interesting facts that I gathered from his testimony:

Last Friday, AIG awarded millions of dollars of bonuses to employees of the AIG Financial Products Division. This is the same unit that made massive losses and brought AIG to its knees. These bonuses were not “performance bonuses” but rather “retention bonuses”

In the beginning of 2008, AIG had made contracts with these employees, that promised them bonuses, if they stayed throughout 2008 and wound down the derivative contracts they wrote earlier.

The Financial Products unit itself is about 450 to 500 people, but the people who caused the real damage form a much smaller sub – unit of around 20 people or so.

Each financial contract is unique in itself and the person who wrote that contract is in a much better position to wind it down, rather than another person with similar ability but no knowledge of the contract.

In fact that is the main reason of paying the bonus. They didn’t want to lose the person who wrote the contract.

The second most important reason is that they had a contract which had to be respected.

Mr. Edward Liddy joined as CEO about six months back at the behest of the government and is just drawing a $1 per annum salary.

Obviously, any man who takes up this kind of job has nothing but the greatest good of the country in his mind (and maybe a little glory after wards). The main reason that Mr. Liddy has allowed the bonuses is because he felt the people getting the bonuses were irreplaceable.

In fact, all other banks and financial institutions have made the same case — that if they don’t give out the bonuses; they will not be able to retain their top talent, which implies that they can’t buy cheaper talent from the market.

And this is what has been on my mind ever since: Are these people really that talented?

Unfortunately, there is no way to find that out without firing these people. Fortunately, something quite close to that has happened.

These taxes mean that all these people have no incentive to work in the same company or even the same industry any longer and a lot of them will leave. If that happens, then according to the people who were in favor of the bonuses — the results will be catastrophic.

I think there won’t be any catastrophic results and these talents are largely mythical. Why do I feel that way? Because there are hundreds of people doing the same job. Some may be more familiar with a derivative contract than another, but, that doesn’t mean that they are irreplaceable.

And, when we find out that these people were replaceable that will hold a good lesson for future generations on:

How Not To Award Bonuses To People Who Screwed You In The First Place.

In hindsight, it is easy to understand the mistake that most home-owners made when they tapped into their Home Equity to renovate their bathrooms. I think a point that most people don’t address is how the financial markets advanced, without any advancement in the financial literacy of people. To me, this is one of the causes of all this trouble that is not talked about frequently.

Let’s take a look at the whole situation from the start to see where it goes.

Capital Expenses and Current Expenses

You can broadly think of all the money you spend as “current expenses” or “capital expenses”.

Current expenses are the things that you need to buy every month – month after month, in order to maintain a certain standard of living and go through life. So, stuff like groceries, power bill, internet bill, shopping for shoes and clothes form part of current expenses.

Your capital expenses are big ticket expenses like buying a new car, new house, jewelery or even a holiday.

Most people earn a salary and meet their current expenses out of their salaries. So the salary is like a “current income”. After spending a part of their salary on their current expenses, whatever is left, goes to – Savings. This is most people’s – Capital.

This capital is then used for big ticket expenses like houses and cars. The capital will usually not be in cash or a checking account, but will be split into different type of assets.

So a typical salary earner will have his capital split into – stocks, bonds, gold, houses etc.

Now, selling your stocks or tapping into your savings to go to a restaurant or re-decorate your bathroom is a bad practice. This is easily understood by most people and normally people are prudent enough not to do this.

Securitization of assets throws in an angle that entices home-owners to spend their capital on their current expenses.

Basically, the availability of credit on your home or on your stocks mean – that instead of having to sell off your stocks or homes to raise the money – now you can keep your home, and still raise money out of it.

This is where a really big illusion is created and the line between credit and capital is blurred.

Your savings that are invested in your home or stocks is your capital. If you spend your capital on a fancy vacuum cleaner you will be in trouble. But if you take credit and spend it on a vacation in Hawaii – you will go broke.

A house used to be a really illiquid asset and therefore the chances that someone sold off their house to go for a vacation used to be negligible.

However the advancements in the capital and credit markets made it possible to not sell your house, but still take a loan out of it, and this led to the kind of spending bubble that we saw.

Now securitization is just a tool and in itself is an inert thing that is neither good nor bad. The way you use it makes it good or bad. The way most humans are wired – this thing turned out to be disastrous.

There is not enough emphasis on financial literacy in formal education and the best chance any one has got — is to learn good spending habits from their family.

But, if that doesn’t happen – then you are pretty much on your own. When advancements in the capital and credit markets brought forth new tools for people to explore and get “rich” the lack of financial literacy was magnified and the chances that people made financial mistakes were greatly increased.

There is slightly more emphasis on financial literacy today, than it was before, however it is still up to each individual to learn good financial practices and stay out of trouble. The tools are there and the internet has made those tools accessible to a lot of people. The next step to  remain out of trouble is for people to explore those tools and use them for their benefit.

On Wednesday morning, I was surprised to see that someone landed on OneMint using the keyword — “probability of getting laid”.

For the rest of the day — I searched the whole website for interesting stuff on the website that may have been hidden from me all this time.

Turns out there isn’t any hidden fun stuff on this site that I am unaware of (which is a mixed feeling by the way). One of my posts about probabilities and risk uses the phrase – “probability of getting laid-off”.

Which brings me to the most interesting thing that I read this week. This forum board discussion which started when someone asked – “Is it easier to get laid in Europe?”

A couple of amusing things that I saw there:

“Europeans hate Americans. I think you will have an easier time finding Freedom Fries in France than getting laid. My friends, who were visiting Germany, said that if anyone overheard them speaking in English, they would hear shit yelled at them like “Go Home, Fuck You” or “Fuck Bush”. By the end of the trip, they were telling people they were from Canada just to avoid the long speeches about why America sucks.”

Most other people refuted this.

“I got laid a lot in Europe, but I was on vacation with my wife. 🙂 And we never had a problem with the locals. They don’t like our government, but everyone was really nice to us.”

On to the usual interesting finance and economy stuff, top picks from the blogosphere this week:

1. First Time To Home Buyer Credit, Cheap Property Market: Time To Buy a House: TDL discusses the benefits of buying a house in this economy.

2. Do Precious Metals belong in My Portfolio by The Dividend Guy: The Dividend Guy talks about his evaluation of precious metals and final decision on whether to include them in his portfolio or not.

3. Demographics Matter  For An Investor by Investoralist: Investoralist discusses why an investor can’t ignore demographics while making an investment decision.

4. Planning for Retirement? 5 Financial Tips for the Boomer Generation by The Smarter Wallet: Planning for a retirement? here are some tips to get you started.

5. Why Index Funds are Rarely at the Top and Why I like them Anyway by The Oblivious Investor: Mike discusses Index Funds in depth. This is a good post for those of you who invest in Index Funds or ETFs or are planning to do so.

6. Jon Stewart vs Jim Cramer by Cash Money Life: Patrick has created a good post which contains all the videos from the recent Stewart and Cramer episode.

7. Nationalization and Capitalism by The Baseline Scenario: James Kwak  presents great insights on the nationalization debate.

8. What are Treasury Securities by The Investing School: A crisp definition of Treasury Securities.

9. Steve Waldman believes Banking Industry Sick Since At Least the S&L Crisis by NakedCapitalism: Yves has this very insightful post about the banking industry and has a nice historical perspective on it.

10. Have You Been Offered an Amex Bribe by Master Your Card: Amex is offerring a lot of its card holders money to actually close down their accounts!

Finance Carnivals

Millionaire Mind and Making Money

Cavalcade of Risk

In the past I have written a bit about – how to invest in gold, but looking at the recent run up in gold prices, it looks like – gold is where the next bubble is going to form.

There is nothing in the world that can rise indefinitely. Everything that goes up must come down. That was what happened with Japanese Real Estate, Dot Com and then the Real Estate bubble.

It is too early to call a gold bubble yet, but the way in which gold has run up means that there is immense risk of a sharp fall. There is no way of telling when this will happen, but it is inevitable.

Gold Bubble

A friend of mine told me that on some days, there is a queue of people lined up outside Mumbai’s prominent gold shops to sell their old jewelery and take advantage of the peaking gold prices. Selling gold jewelery is really unusual for Indians, and I was quite surprised to hear this.

Does this indicate a bubble in gold?

I know that it is still quite early to call a gold bubble because there are a large number of people who still haven’t advised me to buy gold.

And gold is not the topic of conversation during lunches or dinners. When gold becomes the topic of dinner discussions – you can be assured that the bubble is going to bust.  Till then you can watch with wonder at how high this precious metal goes.

Source of Gold Chart: http://www.kitco.com/