Posts Tagged ‘Leverage’

George Soros on European Fiscal & Banking Crisis and EU Summit on June 28-29, 2012

Monday, June 25th, 2012

Here I present key take-aways from George Soros’ in depth Bloomberg interview on the current European fiscal and banking crisis, Angela Merkel, the Spanish bailout, and Greece leaving the Eurozone.

The video is also below:

Banking & Fiscal Issues

  • “There is an interrelated problem of the banking system and the excessive risk premium on sovereign debt – they are Siamese twins, tied together and you have to tackle both.”
  • Soros summarizes the forthcoming Eurozone Summit ‘fiasco’ as fatal if the fiscal disagreements are not resolved in 3 days.
  • There is no union without a transfer.
  • Europe needs banking union.
    • Germany will only succumb if Italy and Spain really push it to the edge (Germany can live in the present situation; the others cannot)
    • Europe needs a fiscal means of strengthening growth through Treasury type entity
      • What is needed is a European fiscal authority that will be composed of the finance ministers, but would be in charge of the various rescue mechanisms, the European Stability Mechanism, and would combine issuing treasury bills.
        • Those treasury bills would yield 1% or less and that would be the relief that those countries need in order to finance their debt.
        • Bill would be sold on a competitive basis.
        • Right now there are something like over €700bn euros are kept on deposit at the European Central Bank earning a 0.25% because the interbank market has broken down, so then you have €700bn of capital that would be very happy to earn 0.75% instead of 0.25%, and the treasury bills by being truly riskless and guaranteed by the entire community, would yield in current conditions less than 1%.
        • Governments should start a European unemployment scheme, paid on a European level instead of national level.
        • Soros’ solutions, however, are unlikely to prove tenable in the short-term as he notes “Merkel has emerged as a strong leader”, but “unfortunately, she has been leading Europe in the wrong direction”.
          • “Euro bonds are not possible because Germany would not consider euro bonds until there is a political union, and it should come at the end of the process not at the beginning.
          • This would be a temporary measure, limited both in time and in size, and thereby it could be authorized according to the German constitution as long as the Bundestag approves it, so it could be legal under the German constitution and under the existing treaties.
          • The political will by Germany to put it into effect and that would create a level playing field so that Italy and Spain could actually refinance debt on reasonable terms.

Scenario Discussion

  • LTRO would be less effective now
  • At 6%, 7% of Italy’s GDP goes towards paying interest, which is completely unsustainable
  • Spain may need a full bailout if summit is not successful
    • Financial markets have the ability to push countries into default
    • Because Spain cannot print money itself
    • Even if we manage to avoid, let’s say an ‘accident’ similar to what you had in 2008 with the bankruptcy of Lehman Brothers, the euro system that would emerge would actually perpetuate the divergence between creditors and debtors and would create a Europe which is very different from open society.
    • It would transform it into a hierarchical system where the division between creditors and debtors would become permanent…It would lead to Germany being in permanent domination.
      • It would become like a German empire, and the periphery would become permanently depressed areas.

On Greece

  • Greece will leave the Eurozone
    • It’s very hard to see how Greece can actually meet the conditions that have been set for Greece, and the Germans are determined not to modify those conditions seriously, so medium term risk
    • Greece leaving the euro zone is now a real expectation, and this is what is necessary to strengthen the rest of the euro zone, since Greece can’t print money
    • By printing money, a country can devalue the currency and people can lose money by buying devalued debt, but there is no danger of default.
      • The fact that the individual members don’t now control the right to print money has created this situation.
      • A European country that could actually default. and that is the risk that the financial markets price into the market and that is why say Italian ten-year bonds yield 6% whereas British 10-year bonds yield only 1.25%.
  • That difference is due to the fact that these countries have surrendered their right to print their own money and they can be pushed into default by speculation in the financial markets.

On Angela Merkel

  • Angela Merkel has been leading Europe in the wrong direction. I think she is acting in good faith and that is what makes the whole situation so tragic and that is a big problem that we have in financial markets generally – she is supporting a false idea, a false ideology, a false interpretation which is reinforced by reality.
  • In other words, Merkel’s method works for a while until it stops working, and that is what is called a financial bubble
    • Financial bubbles look very good while they are being formed and everyone believes in it and then it turns out to be unsustainable…
    • The European Union could turn out to have been a bubble of this kind unless we realize there is this problem and we solve it and the solution is there.
    • I think everybody can see it, all we need to do is act on it, and put on a united front, and I think that if the rest of  Europe is united, I think that Germany will actually recognize it and adjust to it.

On Investing

  • Stay in cash
  • German yields are too low
  • If summit turns out well, purchase industrial shares, but avoid everything else (consumer, banks)

Conclusion: We are facing conditions reminiscent to the 1930s because of policy mistakes, forgetting what we should have learned from John Maynard Keynes.

Understanding Bankruptcy as the World Collapses Around You (1)

Saturday, June 9th, 2012

We have seen the dire economic consequences of excessive consumer, corporate, financial, and sovereign leverage of the past 5 years. Our global economy has been a punching bag for corporate greed, political incompetency, and poor central bank planning. From shadow banking and derivatives (“weapons of mass destruction” according to Mr. Buffet) in the United States to Greece’s fraudulent attempt to the enter the Eurozone, world markets have been whipsawed every year since 2007. I cannot help but feel deep remorse after witnessing multiple occasions of the VIX above 40, sovereign CDS making multi-year highs, and political uprising. Five years later, we have yet to learn that leverage is the primary cause of our pain.

Despite an Icelandic bankruptcy, 2 Greek bailouts, a Portuguese bailout, and Irish bailout, and a U.S. bank bailout, 35% of U.S. homes underwater, and 20%+ unemployment rates in certain Western nations, student loans have emerged as yet another bubble, the U.S. consumer savings rate remains below 4%, European banks are levered 26x on average, and countries continue to borrow at astronomical rates. Are we doomed to repeat our mistakes? Sadly, the answer seems to be yes.

Every 2 generations (70-80 years), individuals tend to forget the pain that their forefathers felt in a deep economic contraction. The Great Depression certainly did its job. Maybe we need a constant painful reminder to reign in our tendency to express “irrational exuberance?” Luckily, for learning purposes, a global debt deleveraging cycle is the most painful type of contraction. Hopefully, our children and grandchildren can learn from our mistakes.


Until then, I have started this series to explain the BANKRUPTCY process, specifically the U.S. Ch. 11 process, as I continue to do my part to clean up the riff-raff, the banksters, the incompetent politicians, and the corrupt corporate bureaucrats holding back true capitalism.

  • Bankruptcy is governed by federal statute (11 U.S.C., Section 101):
    • For the equitable distribution among creditors and shareholders of a debtor’s estate in accordance with either the principle of absolute priorities or the vote of bankruptcy majorities of holders of claims
    • To provide a reasonable opportunity, under Chapter 11, to effect a reorganization of business
    • For the opportunity to make a “fresh start” through, among other things, the discharge of debts

  • The goals of bankruptcy are:
    • To afford the greatest possibility of resolution for the estate as a whole, while maintaining the balance of power as between all creditors and the debtor as of the petition date
  • Debtor’s rights and protections include:
    • Automatic stay: an automatic injunction to halt action by creditors
    • Exclusivity to formulate/propose plan of reorganization
    • Continued control and management of the Company
    • Assumption/rejection of executor contracts and unexpired leases
    • Asset sale decisions
    • Avoidance actions
    • Discharge of claims
  • Secured creditor’s rights and protections:
    • Secured to extent of value of collateral
    • Limitations on debtor’s ability to use proceeds/profits of collateral (“cash collateral”)
    • Entitled to “adequate protection” for use of collateral or diminution thereof
    • Entitled to relief from automatic stay for cause shown
    • Entitled to interest and reasonable legal fees when collateral value exceeds debt
    • Entitled to be paid in full in cash or to retain lien to the extent of its allowed claim and receive deferred cash payments totaling at least the allowed amount of such claim

  • Unsecured creditors’ rights and protections include:
    • Majority voting controls
    • Improved and mandated disclosure by debtor
    • Committee representation at debtor’s expense
    • Ability to challenge business judgment of debtor
    • Absolute priority rule generally ensures payment before distribution to existing equity security holders
    • Ability to examine/challenge validity and enforceability of liens and, if debtor refuses, to obtain authority to bring fraudulent conveyance, preference and other actions
    • May continue to exercise corporate governance subject to limitations
    • Valuation as the fulcrum and equalizer of debt and creditor powers
  • Equity may also seek committee representation under certain circumstances and thereby obtain leverage similar to that of creditors’ committee

~Xavier, Leverage Academy Instructor

(All similar entries are in LA’s “Bankruptcy” folder on the right of the blog.)

Bank Stocks Beware: Bernanke & Fed Support Increasing Capital Requirements

Tuesday, June 7th, 2011

U.S. bank indices fell 2% yesterday after fears that capital requirements would increase as much as 7%.  Bank of America (NYSE: BAC), fell below $11.00, the lowest since last year.  The discussion came about after the Basel Committee on Banking revealed how levered large financial institutions still were, and tried to reconcile levels with future recession risks.  A 7% equity capital raise for most banks would be catastrophic and dilute equity by 50%+, but a 3% raise seems manageable in a functioning economy.  The problem is that the U.S. economy is on life support, and that life support is called Quantitative Easing 2.  Once this support fades on June 30th, how will U.S. banks (at their already low valuations due to real estate risk and put backs) raise new equity capital?  A replay of 2009?  You be the judge.

According to Bloomberg, “The Fed supports a proposal at the Basel Committee on Banking Supervision that calls for a maximum capital surcharge of three percentage points on the largest global banks, according to a person familiar with the discussions.

International central bankers and supervisors meeting in Basel, Switzerland, have decided that banks need to hold more capital to avoid future taxpayer-funded bailouts. Financial stock indexes fell in Europe and the U.S. yesterday as traders interpreted June 3 remarks by Fed Governor Daniel Tarullo as leaving the door open to surcharges of as much as seven percentage points.

“A seven percentage-point surcharge for the largest banks would be a disaster,” said a senior analyst at Barclays Capital Inc. in NY. “It will certainly restrict lending and curb economic growth if true.”

Basel regulators agreed last year to raise the minimum common equity requirement for banks to 4.5 percent from 2 percent, with an added buffer of 2.5 percent for a total of 7 percent of assets weighted for risk.

Basel members are also proposing that so-called global systemically important financial institutions, or global SIFIs, hold an additional capital buffer equivalent to as much as three percentage points, a stance Fed officials haven’t opposed, the person said.

Bank Indexes Fall

The Bloomberg Europe Banks and Financial Services Index fell 1.45 percent yesterday, while the Standard & Poor’s 500 Index declined 1.1 percent. The KBW Bank Index, which tracks shares of Citigroup Inc., Bank of America Corp., Wells Fargo. and 21 other companies, fell 2.1 percent.

In a June 3 speech, Tarullo presented a theoretical calculation with the global SIFI buffer as high as seven percentage points.

“The enhanced capital requirement implied by this methodology can range between about 20% to more than 100% over the Basel III requirements, depending on choices made among plausible assumptions,” he said in the text of his remarks at the Peter G. Peterson Institute for International Economics in Washington.

In a question-and-answer period with C. Fred Bergsten, the Peterson Institute’s director, Tarullo agreed that the capital requirement, with the global SIFI buffer, could be 8.5 percent to 14 percent under this scenario. A common equity requirement of 10 percent is closer to what investors are assuming.

‘Across the Board’

“I think 3 percent is where everyone expected it to come out,” Simon Gleeson a financial services lawyer at Clifford Chance LLP, said in a telephone interview. “If it is 3 percent across the board then it will be interesting to see what happens to the smallest SIFI and the largest non-SIFI” on a competitive basis, he said.

U.S. Treasury Secretary Geithner, in remarks yesterday before the International Monetary Conference in Atlanta, said there is a “strong case” for a surcharge on the largest banks. Fed Chairman Bernanke is scheduled to discuss the U.S. economic outlook at the conference today.

“In the US, we will require the largest U.S. firms to hold an additional surcharge of common equity,” Geithner said. “We believe that a simple common equity surcharge should be applied internationally.”

Distort Markets

Financial industry executives are concerned that rising capital requirements will hurt the economy, which is already struggling with an unemployment rate stuck at around 9 percent.

Higher capital charges “will have ramifications on what people pay for credit, what banks hold on balance sheets,” JPMorgan Chase & Co. chairman and chief executive officer Jamie Dimon told investors at a June 2 Sanford C. Bernstein & Co. conference in New York.

The Global Financial Markets Association, a trade group whose board includes executives from GS and Morgan Stanley, said the surcharge may apply to 15 to 26 global banks, according to a May 25 memo sent to board members by chief executive officer Tim Ryan.

Dino Kos, managing director at New York research firm Hamiltonian Associates, said the discussion about new capital requirements comes at a time when banks face stiff headwinds. Credit demand is weak, and non-interest income from fees and trading is also under pressure.

Best Result

U.S. banks reported net income of $29 billion in the first quarter, the best result since the second quarter of 2007, before subprime mortgage defaults began to spread through the global financial system, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile.

Still, the higher profits resulted from lower loan-loss provisions, the FDIC said. Net operating revenue fell 3.2 percent from a year earlier, only the second time in 27 years of data the industry reported a year-over-year decline in quarterly net operating revenue, the FDIC said.

“You can see why banks are howling,” said Kos, former executive vice president at the New York Fed. Higher capital charges come on top of proposals to tighten liquidity rules and limit interchange fees, while the “Volcker Rule” restricts trading activities. Taken together these imply lower returns on equity, he said.

“How can you justify current compensation levels if returns on equity are much lower than in the past?” Kos said.

Understanding The Basic Elements of Forex Trading

Thursday, March 10th, 2011

Understanding The Basic Elements of Forex Trading

The foreign exchange market is finally beginning to garner mainstream attention.  The Bank of International Settlements estimates that the average daily volume in the fx market is around $4 trillion, which makes it by far the largest financial marketplace in the world.  Surprisingly, however, many novice investors and traders have never even heard of this market.

Until the late 1990’s, the only players allowed to execute trades in the foreign exchange market were investment banks, hedge funds, and very wealthy private investors.  Since the minimum contract size was generally $1,000,000, smaller traders were effectively denied entrance into the market.

In the late 90’s, however, this all changed.  The advance of the internet and technology led several online forex brokers to open shop and begin catering to smaller investors and traders.  This led to the birth of the retail foreign exchange market.  In this article, we are going to discuss three key elements to forex trading:  Leverage, Margin, and Equity.

Leverage

The idea of leverage in the fx market has been under intense debate over the last several years.  Since the market is decentralized and worldwide, regulation was largely absent from the fx market until recently.  In 2010, the National Futures Association instituted some major changes, one of them being a cap on leverage at 50:1.  This means that an fx trader in the United States can trade on leverage at a ratio of 50:1.  Thus, if a trader has $1,000 in his account, then he is able to leverage that $1,000 into $50,000 and trade much larger positions in EUR USD.  Until the National Futures Association passed this regulation, some brokers were offering traders up to 400:1 leverage, which means that with a $1,000 account, traders were able to control a $400,000 position in the market. Note that leverage is a two-edged sword. It will increase both losses and profits.

Margin

Margin is the life of a trader.  If a trader does not have enough margin, then he cannot open a trade.  Furthermore, if a trader has an open position moving against him, he may eventually not have enough money to act as margin, which means his account would suffer a “margin call.”

Margin is the amount of money required to open a leveraged position.  For example, if Broker ABC offers 50:1 leverage, and Bob the Forex Trader wants to open a position of $100,000, then Bob has to put up $2,000 of margin.  If Bob’s trade begins to move against him to the point where his account equity becomes less than $2,000, Bob will suffer a “margin call,” which basically means that his broker will call for more margin if Bob wants to keep the position open.

Equity

Everyone knows that one of the leading causes of business failure is a lack of initial capital, and trading is no different.  If a trader opens an account with a few thousand bucks and trades heavily leveraged positions, his chances of success are nominal.

Equity is essential to trading success.  The question many new traders have is, how much money do I need to open an account?  Well, the answer to that question is different for everyone, and it largely depends on what your goals are.  If you simply want to get some trading experience, but still have a full-time job, then a person can open an account with a few thousand bucks.  However, if you are trying to generate enough capital gains to sustain a living, then the initial account balance should be much, much higher.

Leverage, Margin, and Account Equity are three essential aspects of fx trading that every trader must be familiar with.

Check out our intensive investment banking, private equity, and sales & trading courses!  The discount code Merger34299 will be activated until April 15, 2011. Feel free to e-mail thomas.r[at]leverageacademy.com with questions.


KKR Tries to Fool Investors with Toys R’ Us IPO

Wednesday, March 2nd, 2011

Toys R Us was an Opco-Propco deal done by KKR, Bain, and Vornado in 2005 for $6.5+ billion.  The company was one of the largest owners of real estate in the United States, other than McDonalds.  Since the toy business was not performing well and Babies R Us could not yet produce enough EBITDA to drive the company’s public valuation, these three players found an opportunity to take advantage of its real estate holdings (good call, right?).  Unfortunately, the company now has $5.5 billion in debt on its balance sheet and only has 2.3% growth in sales, a $35mm loss in earnings, down from $95mm in profit last year, and a 25% increase in expenses year over year (SA).  Cash used in operations also increased from $800mm to $1.2 billion over that time period.  Sounds like a great time to IPO, right?  Well, the sponsors in this deal seem to think so.  With equity markets topping, they are trying their hardest to take advantage of foolish retail investors.  Invest at your own risk:

“(Reuters) – Toys R Us Inc TOY.UL is looking to raise around $800 million in an initial public offering in April, though a final decision has not been reached, the New York Post said on Saturday.

The New Jersey-based retailer, which operates stores under its namesake brand and the Babies R Us and FAO Schwarz labels, had put off plans for an IPO in 2010.

“Toys R Us took more market share from competitors last year than they have in the past 20 years,” said one source the Post described as close to the company. “But I don’t think they were satisfied with how they did on the profit level.”

Toys R Us spokeswoman Kathleen Waugh said the company could not comment on the matter.

For December 2010, Toys R Us reported a 5.4 percent total sales rise at its U.S. unit as it lured holiday shoppers away from No. 1 toy retailer Wal-Mart with more temporary stores and exclusive toys. But same-store sales fell 5 percent at its international segment.

Overall, a tough 2010 holiday season had margins hit across the toy industry by bargain-seeking, recession-hit consumers.

So the economic environment has stoked continued debate between management and owners at Toys R Us about whether this is the best time to re-launch an IPO, according to a source briefed on the situation, the Post reported.

Toys R Us was taken private in 2005 by Kohlberg Kravis Roberts KKR.AS, Bain Capital and Vornado Realty Trust in a $6.6 billion deal.

In May 2010, the company filed to raise as much as $800 million in an IPO. But that was not launched.

Toys R Us’s net loss widened to $93 million in the third quarter ended on October 30, 2010, from $67 million a year earlier. While sales were up 1.9 percent in the period, total operating expenses rose about 9.4 percent.

Last fall, the retailer opened 600 smaller “pop-up” stores that added to the more than 850 larger year-round stores it operates in the United States, the Post said.”

Borrowing Money Demystified

Wednesday, March 10th, 2010

Video covering lending and credit card, mortgage lending.

[youtube]http://www.youtube.com/watch?v=P7ARTJqUJCc[/youtube]

~Saving & Investing

Principles of Leverage

Wednesday, March 10th, 2010

Video going over the common principles of leverage.

[youtube]http://www.youtube.com/watch?v=T-X8LpzCTkM[/youtube]

~Saving & Investing

What is Leverage?

Wednesday, March 10th, 2010

Video explaining leverage concepts for the investor.

[youtube]http://www.youtube.com/watch?v=GBsyA0JGFLA[/youtube]

~Saving & Investing

General Growth Properties Splitting in Two

Wednesday, February 24th, 2010

Many currently think that the offers General Growth Properties has received are very steep, especially since the country’s largest mall owner went through a debt restructuring last year….As a result, the company is splitting itself in two and will raise capital to ease its transition as the economy recovers.

You can refer to our first General Growth Article HERE…

According to Bloomberg, “General Growth Properties Inc. plans to split in two to exit bankrupty and will receive $2.63 billion in capital from Brookfield Asset Management Inc., according to a person with knowledge of the company’s plans.

The plan would value the shopping-mall owner at a minimum of $15 a share, said the person, who asked not to be named because the negotiations are private.

Simon Property Group Inc., the largest U.S. mall owner, offered to buy General Growth for more than $10 billion in a bid that would give equity investors about $9 a share.”

~I.S.

Credit Suisse Junk Bonuses Turn Into $5B

Wednesday, February 24th, 2010

All of you probably remember last year how Credit Suisse did something “unthinkable” by giving bonuses in the form of CDOs and ABS.  Now it seems that CS bankers were some of the most highly compensated during the recession!

Credit Suisse sign

Bankers’ ‘junk’ bonuses turn into $5bn

By Alex Ritson
Business reporter, BBC World Service

Bonuses made up of so-called toxic debt and given to bankers at Credit Suisse as a punishment for poor investments, have soared in value.

Their bonus pool, made up financial products originally thought to be worthless, is now worth $5bn (£3.2bn).

The bank lost $7bn last year, in part due to the investment decisions of some of its best-paid staff.

The toxic debt bonuses had been described as a way of giving the bankers to taste of their own medicine.

But it has now emerged the value of the toxic bonus pool has climbed by 72% – far outperforming many safer investments.

Well-deserved?

The money had been put into complicated financial products linked to the risky commercial debt secured on among other things, a Japanese shopping centre, an American supermarket chain and other commercial property that had plunged in value.

At the height of the financial crisis, many people thought these investments were worthless. To Credit Suisse, it seemed right to share them out as annual bonuses among the people who had apparently got things so wrong.

But as confidence has returned to the market – it has become clear that the toxic asset pool wasn’t nearly as toxic it had been thought.

The toxic bonus fund has soared in value by 72%. That compares with a 60% rise in the value of Credit Suisse shares over the same period – or a mere 19% rise in the main US share index the Dow Jones.

The bankers may well feel they have earned the money though.

Credit Suisse is safely back in profit – and unlike its rivals at UBS, Credit Suisse did not take a bail-out from the Swiss Government.

~Sourced by I.S.