Month: February 2009

When I started out investing I used to keep a check on daily stock market movements. At the end of each day – I listened to CNBC experts, and read newspapers to find out why the market moved the way it did?

It was great to know why the market moved in a certain way, and I felt like I was in complete control.

This typically went on for a few years (in which I lost money), and after which – I still kept track of the way the market moved, but ignored why it moved the way it did.

After listening to reasons for a few years – they started sounding more like “rationalizations”. Of course, the fact that I lost money in that time also helped.

Eventually I came across – Mr. Market – Ben Graham’s imaginary character. According to – Ben Graham – Mr. Market was my servant. He came to me every day, as a collective representative of the entire stock market, and offered to buy and sell stocks from me at a certain price.

It took a few months for me to digest this concept.

For years, I had been looking at Mr. Market, as someone who moved the market every day, and at the end of the day told me why he moved it that way. And what’s more – he was always right. I never knew I had the option of disagreeing with Mr. Market.

After this; my whole outlook on stocks changed. It was a gradual shift, not a sudden one, but it was a shift nonetheless. I started buying stocks that went down. Earlier, whenever I used to see stocks go down – I used to rationalize that downfall, and never bought those stocks. I always thought that the entire market must know more than me, and if they thought that the stock was not worth it – it surely wasn’t worth it.

But all that changed when I thought of Mr. Market as my servant. Now, at least for some stocks, I felt that Mr. Market was making a mistake in selling them so cheap, and he is wrong.

That was truly when – I started buying stocks – cheap.

After doing this for a few years – I internalized the concept to such an extent that at some occasions I used to think – Mr. Market has gone nuts. One such occasion was last Friday, when the unemployment figures that came out – were worse than expected, and the market went up substantially. It went up, because it thought that the numbers were so bad that they would help the stimulus bill to be passed. So Mr. Market thinks a worse economy is good if it can get the stimulus bill passed.

Mr. Market has gone nuts – but that’s just me.

Citigroup made a loss of 18.71 billion dollars in 2008. In 2007, it had turned a profit of 3.6 billion dollars.

They made these losses because of three reasons:

1. Total revenues went down from 78.45 billion dollars to 52.79 billion dollars.
2. The Provision for Losses had to be increased from 17.91 billion dollars to 34.71 billion dollars.
3. The Operating expense went up from 59.8 billion dollars to 61.19 billion dollars.

To put this in context, lets see how these three factors would look like if Citigroup was a regular guy, and not a bank.

The first point is akin to taking a pay cut for a regular person.

The second point is like saying you had a house which you thought was worth 250,000 dollars (and spent accordingly), but when you tried to sell it, it fetched only 50,000 dollars. So you have to provide for a loss of 200,000 dollars.

The third point is like saying your grocery bill rose from 10,000 dollars to 10,400 dollars.

As you can see from the graph – the main problem lies with the – pay cuts and loss provisions; the grocery bill is not too much to worry about.

Citigroup’s Revenue Decline

Citi actually earned more interest income in 2008 than it did in 2007. But that’s the only revenue item that increased in 2008. All the other things that Citi made money on – declined in 2008.

The chart below shows the break up of Citi’s revenues in 2007 and 2008.

The key point is that Citi’s 2008 revenue of 52.79 billion dollars can’t even cover its 61.19 billion dollars Operating Expense, let alone the Provision for Reserves.

But the gap is not even 10 billion dollars and if somehow Citi could get rid of those toxic assets on its Balance Sheets, for which it has to carry out these Provisions and incur losses – it could return to profitability.

They Don’t Call it TARP for Nothing

One of the objectives of the Troubled Asset Relief Program (TARP) is to take toxic assets away from the Balance Sheets of Banks, and stop them from bleeding to death.

Citi has a balance sheet worth 1.945 trillion dollars! That means the total value of their assets is 1.945 trillion dollars, but in reality some of these assets are worth much less than that (toxic assets).

The liabilities are worth 1.794 trillion dollars and the remaining 150 billion dollars is the Equity (what belongs to the shareholders).

To make it easier to relate – Think of a person named – Citi – who owns a house worth 500,000 dollars on which he owes 400,000 dollars. The remaining 100,000 dollars is his equity.

Now if the house was worth only 300,000  dollars – Citi would be insolvent. The amount he owed would be more than his asset’s worth. But, and this is a significant But – if he can continue to make mortgage payments till the situation improves (he starts making more money) – he can be solvent again.

Similarly out of the 1.945 trillion dollars, if there are more than 150 billion dollars worth of toxic assets on Citi’s balance sheets – Citi would be insolvent.

But, and this is a significant – But – a lot of big banks (especially Japanese banks) were able to return to back to solvency after facing a similar situation. This is primarily because banks make more money on their assets than they pay on their liabilities.

So, Citi could bounce back to solvency too. That is certainly what most people are hoping for.

Conclusion

Citi is just an example and a look at any other major bank’s balance sheet and income statement is likely to reveal the same kind of numbers. If that were not so – there would be no need for TARP.

The problem right now is dual in nature and sometimes that is not emphasized enough. There is a recession going on and then there is a financial / credit / banking crisis.

Stimulus packages are being used by the administration to fight the recession. For the banking and financial crisis – bank bailouts, TARP etc. is being used.

I think the bottomline is that all this is part of the economic cycle, so in the time to come – we will come out of this and see better times.

Valentine’s Day has made some of us think about things other than the current recession and other sad things that go with it.

I was especially touched, when I read about Kim and her Grandmother this week. Very lovely story.

Some other stuff from around the web:

1. Consumer Confidence Index: Any Signs of Economic Recovery by The Smarter Wallet: A hidden silver lining in the plethora of bad news.

2. Valentine’s Day Gift Ideas by The Digerati Life: A great article about Valentine’s Day Gift Ideas.

3. How The Economic Stimulus Check Affects your 2008 Tax Return by Cash Money Life: This is a very detailed article related to tax returns and stimulus checks.

4. Poor 10 – year Stock Returns is Not Unprecedented by Canadian Capitalist: A fresh look at the current stock market downfall.

5. Using Tax Loss Harvesting to Find Dividend Bargains by Dividend Growth Investor: This is a useful concept and people who are reeling from the stock market downturn and make use of this.

6. Top 50 Investing Blogs by The Dividend Guy: I added a lot of blogs from this list.

7. Definition and Examples of Arbitrage Trading from the Investing School: This post tells you about arbitrage trading with real examples and how you can make money out of it.

8. Positive Influence of Saving Money by MoneyNing: MoneyNing talks about the positive influences of thrift.

9. What is the best Porfolio Rebalancing Strategy by Moolanomy: This article discusses asset allocation with respect to the other factors that determine it.

10. Education is a Lifetime Endeavor by My Wealth Builder: I always like it when someone gives education the due it deserves.

A newspaper’s job is to report – news. Tell facts as they are, and provide unbiased information about events happening around us. Granted; newspapers are always – left-leaning, right-leaning, liberalists etc. and this really does impact the way they report their news.

However, everywhere in the news section – newspapers are expected to report unbiased news. But in the – Editorial and Columnist sections – newspapers do not report news. They take a  stand on the news. Editorials are essentially the opinion of newspapers.

When the New York Times reports about – Mr. Obama’s campaign success – theoretically it is devoid of any bias; and is based on purely on the returns of the campaign.

However, when the New York Times posts an editorial backing Mr. Obama – that is its opinion.

There is a big difference between – News and Opinion, and it is so implicit that most of us don’t think about it at all.

Blogs and News

There was a time; not long ago – that I read only newspapers or magazines, and no blogs at all. I depended on them for all my news and opinions.

Today I read a lot more blogs, and very few newspapers.

The reason for that is – there are really good bloggers out there; who post news – real-time, and provide commentary on that news; that I really enjoy.

The flip side is that most blogs are – Opinions, and not News. Every writer has a certain leaning, and even in discussing News, that slant comes into play. Of course, that is the very purpose of blogs. I wouldn’t read a blog if it just reported News. I would go and read a newspaper for News.

I think most people are gradually moving towards blogs and editorials, switching from CNN, Reuters etc., and the general direction is – News loaded with opinions for all.

As long as we are consciously aware of this cultural shift – it will not hamper our decision making and thought process.

For example – on my blog reader – I have a lot of blogs that I don’t agree with. I disagree with their assumptions, reasoning and conclusions (the whole package). But if I don’t have them on my reader – I switch myself off from the – other side.

As long as I depended on TV and Newspapers for News, I was forced to hear and read whatever I was presented with. WIth a Feed Reader – I can decide who I want to listen to.

As humans we like people who are like us, and enjoy their company. That is true for blogs too. When it comes to taking advice from people – I believe that is a sound strategy.

But absorbing news and forming opinions about stuff relies on listening to both sides of the argument. If your reader is full of stuff that you like, and agree with: you may want to re-think the composition of your reader.

You want to rely on Facts to form your Opinions, and not Opinions to form your Opinions.

The general public is outraged at Wall Street bonuses, and everyone feels passionately about them. Let’s take a look at some arguments in favor of the bonuses, and their counter arguments as well.

1. Not Everyone on Wall Street is Guilty: There are certain departments within a bank or insurance company that made money for the company. If you don’t pay them bonuses – they will be punished for others’ mistakes.

• The other side of this argument is that the taxpayers didn’t commit any mistakes, so why are they being punished by bailing out banks and financial institutions with their money?

• Yet another argument is that – if a car company fails, then the people who fixed headlights or seat-belts would also lose their job (even if they did their job well). That is how the system works, employees share the fate of their company, in good times and in bad.

• If Wall Street employees whose department made money could function as a stand alone business – they would certainly function that way. But, they need the assets of the whole bank or insurance company to work with, and to that extent they are not isolated from the fate of company

2. Bonuses are Needed to Retain Star Employees: If companies like AIG do not hand out bonuses to its star employees, they will move out to other firms, and the company will not be able to come out of the crisis.

• If I have a reputation in the industry, wouldn’t my company’s competitors try to poach me? If I have a job-offer from a  stronger company with better prospects, wouldn’t I jump to that company, rather than hold on to a sinking ship? Or, would I rather take my year-end bonus, and then jump ships?
• By giving bonuses to people with – bailout money – you are being unfair to stronger companies with better balance sheets. They should be the ones who emerge out stronger from this crisis, and capitalize on mistakes made by competitors.
• This one is from Jon Stewart – “You don’t have any best employees”

3. Companies are Legally Bound to Pay Bonuses: Wall Street firms are contractually bound to pay bonuses.

• There are laws in the United States to deal with insolvent banks. Those laws are not being invoked, and new rules are being laid down in the form of TARP etc.  If the existing legal framework was to be used, there wouldn’t be any banks in the first place.

4. In Wall Street; Bonuses are Part of Salaries: In Wall Street, your bonus can be twice the size of your annual salary. So cutting down bonuses on Wall Street is like reducing salaries of other people.

• The counter – argument is that – on average Wall Streeters make thrice as much, as the average employee, and a comparison with other employees is not fair. Of course, the average Wall Streeter is much more qualified than other average employees, but this comparison is between apples and oranges.

5. Bonuses are already down 44%: When compared with 2007, the bonuses paid in 2008 are already down by 44% and this shows that the industry has already taken a hit.

• This argument would have been valid, if the profits were down by about 44%. When companies are making billions of dollars in losses, how are any bonuses justified?

I hope I have been able to cover all the major arguments, I’d be really interested to hear arguments that I may have missed out.

There are several things that I read this week, and a lot of interesting stuff from around the blogosphere. Here are some good reads:

1. FreeCreditReport.com is Not Free by Moolanomy: Free Credit Report automatically enrolls you  in their credit monitoring service, for which they charge a monthly fee, unless you opt out of it.  AnnualCreditReport.com is a good resource to check your credit report but it doesn’t give you your credit score for free.

2. My Issue with Risk by The Oblivious Investor: Any time anyone talks about risk – I get interested, and this is an interesting article.

3. Help, I’m Unemployed by The Smarter Wallet: This is a very informative article and can really help someone who has hit the rough patch.

4. How Much Debt Do You Have by The Digerati Life: My favorite blog talks about calculating your debt to income ratio.

5.  Is it Time to Get Back in the Stock Market by The Penny Daily: I guess everyone is looking for an answer to this one.

6. Reduce Taxable Income by Contributing to IRAs by The Wealth Builder: This is a very good and informative article.

7. Secrets of Dealing with a Financial Crisis by MoneyNing: MoneyNing offers some data and asks – is it really so bad?

8. The Hidden Benefit of a Depressed Real Estate Market by Cash Money Life: An article that talks about property prices and taxes.

9. Using Tax Loss Harvesting to Find Dividend Bargains by Dividend Growth Investor: This is certainly a different way of thinking.

10. 3 Free Sources of Dividend Data by The Dividend Guy: Anyone interested in number crunching with raw stock data will find this post very useful.