BofA reacts to an article that says things remarkably similar to what I wrote 13 days back!

On August 10, I wrote about Bank of America, and headlined my blog entry with the words, The Death Spiral beckons ... . I then wrote a follow-through piece, on  August 16, highlighting the gathering storm clouds around BofA. Then, I attempted to put what I wrote about BofA into perspective for Indian readers of my blog, by explaining how serious the situation of BoA was, really, for itself and for the US economy, and indeed, for the rest of the world. 

On August 23, Henry Blodget, a former Wall Street analyst and currently CEO of Business Insider, an online financial news and views publication wrote about Bank of America. Blodget has cited many more figures - and exaggerated at least two, according to Bank of America's official Press Release. But Blodget exulted, 'Oh My Goodness: Now Bank of America is blaming its Collapsing Stock on Me!' He admitted that BofA was right about one of the two points of rebuttal, and updated the article to reflect the correct figure.

Why do I write about Blodget and BofA? I think I may have just influenced what Blodget wrote. Of course, it is entirely likely (and probably true) that Blodget arrived at the same conclusions as I did on his own. But that cannot obfuscate the fact that the substance of what he wrote on August 23 is remarkably similar to what I wrote in the three pieces referred to above. He even uses the same phrase - the death spiral - in his piece. Now, that is a coincidence, indeed!

Imitation, it is said, is the sincerest form of flattery. I should feel flattered indeed, except that

(a) Writing about BofA pained me, but when elephants flail around, ants get trampled. So I thought a warning was in order, to point out something the bank was hiding behind accounting opacity. Now, I have no illusion about being so well-regarded that BofA or the US economy or Wall Street would take note. But then, through Henry Blodget, exactly that seems to have happened!

(b) When what (in my view) is almost inevitable happens, those who took evasive action to the extent they could (after understanding what I, or for that matter, Blodget, had to say) will have me to thank in a small measure. That is the only moral justification for predictions of financial doom (which have a disconcerting habit of being self-fulfilling these days) in writing. What makes me puke is that Blodget is enjoying the discomfiture he is causing BofA.

Of course, Blodget has not cared to acknowledge that he has read my blog and been influenced by what he wrote. But then, how will he know that my blog had more readers in the United States than in India in the week upto August 16? (you need to be logged into Facebook to see that link).

Blodget probably thought he was the only guy in the US who read it. But then, even after being in the online news business, I am sorry that he has not fathomed the power of the Internet.

Now to Bank of America again - their Press Release  reproduced here defends itself weakly by talking of its tangible book value per share as of June 30. This is a non-GAAP measure by BofA's own admission in its Balance Sheet (read the footnote to my death spiral writeup). GAAP means Generally Accepted Accounting Principles. Non-GAAP measure thus means, by definition, not a generally accepted accounting measure. If you read what BofA wrote about Goodwill, the only figure I concentrated on in the death spiral blog entry, you will realize that BofA knew it was on tricky ground there.

Libya - Another instance of western countries going beyond UN resolution

The UN Resolution in March 2011 only authorised the implementation of a no-fly zone over Libya. That objective was achieved almost immediately thereafter, but all along, the intent of the US and European leaders was to effect regime change. They are now closer to that objective - though the only thing they were authorized to do by the UN was to implement a no-fly zone. By openly supporting and arming the rebels, they have thrown caution to the winds, and are on the threshold of regime change, but no one knows what the new Government of Libya will be like, who will head it, and so on. A typical case like Iraq and Afghanistan - they have a plan for the war, but not for the peace that follows. 
Update:
Worse, there are now reports that the supposed scent-of-victory situation in Tripoli is mere war propaganda, and that Gadhafi' son and heir apparent has not really been captured. He appeared in person before international reporters in a hotel in downtown Tripoli. This is egg on the face of not just the rebels but all who are supporting them. 

Vultures rapidly heading towards extinction - and how that will affect us

The population of vultures in India is down in only 15 years from 50 million to 60,000. Imagine, our children and future generations yet to be born may never see a vulture!  
The cause?  
Feeding Diclofenac as a pain-killer (like Ibuprofen) to livestock for cracked hooves and swollen udders. Diclofenac ingested from carcasses causes untreatable fatal kidney failure in vultures. In spite of its being banned, this is still being used and prescribed by several vets and quacks.
The effects? 

• Cows cannot be killed in India; now their carcasses will have to be handled and disposed by humans. This will become a public health problem.
• Parsis will have to worry about how to manage disposal of their dead in absence of vultures, when there is no alternative solution in their scriptures.  
• Vultures can ingest without any problem foot-and-mouth, brucellosis, tuberculosis and anthrax-ridden carcasses. Now these will have to be handled by humans. This too could become a public health problem. 
• Population of aggressive scavenging dogs has gone up in several cities, among them Bangalore. That is nature's way of filling up the vacuum left by vultures. Whether we humans like it or not. So now we have to control the dog menace. This has already become a public menace.
• Here, nature is helping us, by the spreading incidence of dermatitis (shows up as loss of fur on the skin) in almost 40% of these stray dogs, that eventually kills them. 
• But dogs aren't interested in dead Parsis. Besides, now that Diclofenac is present in several human formulations as well, who knows which Parsi's remains will end up killing a few more of the remaining venerated vultures?     

This is an eco-catastrophe in the making (indeed one that has reached an advanced stage before effective diagnosis or action). Should we shed a tear for these descendants of Jatayu who once valiantly at the cost of his own life,  tried to prevent Sita's abduction by Ravana?


Read this article for more detailed exposition.
  

Ratings are rotten - proof from an insider

Earlier, I had written about the fact that rating agencies' methodologies were suspect - "Rating agencies will have to revisit their sovereign rating norms. Currently, it is unthinkable in their models to question the rating of AAA to the US".
Now, there is proof from an insider that the rating agency Moody's was utterly compromised and conflicted.  This 78-page Comment on SEC Proposed Rules for Nationally Recognized Statistical Rating Organizations makes for shocking reading, though it confirms what we had always suspected - that conflict of interest permeated all levels of this "Nationally Recognized" rating organization. It is a must-read for those trying to understand how the crisis of 2008 could have happened, and the role of rating organizations in this crisis.

Putting the Bank of America situation in perspective

What would you think of the state of the Indian economy, if what I said of BofA and Citibank was said of State Bank of India and ICICI Bank in India by some economist of repute? 

The situation is that serious for the US and for many countries in Europe, where the nation's top banks have dug themselves into deep holes that not even the EU or their respective Governments can afford. All these economies have their underbellies exposed.

On both continents, banks are hiding behind accounting gobbledygook called Impairment and Fair Value Accounting. But the understanding is filtering through. Tonight (in India) brought news of a blood bath on bourses in the US and Europe. So tomorrow (19th August) will almost certainly see a bloodbath on Indian stock exchanges - as FII Fund Managers make a beeline to the nearest exit. Expect a fall of at least 400 points in the Sensex on 19th August, 2011 before short covering enables a partial recovery.

I believe that this is the beginning of the unravelling of several economies in Europe and of the US economy as well, with them slipping into R-2, needing QE-3 and possibly QE-4.

I shall write again tomorrow to report whether what I said about the bloodbath on Indian stock markets was accurate. I feel comfortable making these gloomy predictions because I currently am sitting on cash, having (fortunately) believed in my own predictions and taken my own advice!

The Gold Standard: In Memoriam

On August 15, 1971, 40 years and 3 days ago, President Nixon, remembered today for another of his “achievements” - the Watergate scandal, announced that the United States will go off the gold standard. Till then, the gold standard meant that the money supply in any country would be limited to a specified proportion of the gold reserves owned by the Government. The gold standard was abandoned when the consumption-hungry Americans found the fiscal discipline it imposed on all Governments too inconvenient, and substituted it with a promise of the United States Government, then the most powerful and richest country on Earth.

After this epochal action, demand for Gold fell worldwide. To such an extent that India (its citizens, not the Government) was the only net importing country in the world, importing what the rest of the world exported, for well over two decades. Till India reached its economic nadir in 1991, when the Government was forced to sell or pledge tonnes of gold to save the country from financial bankruptcy. After that, India has slowly picked up its gold buying again, and Indians are still the world's leading buyers of gold. The RBI has bought back all the gold it pledged, and more. I am also sure that the RBI has recently bought more gold – it announces the value of its foreign currency reserves in US Dollars, but the actual composition is India's best-kept secret. I suspect that the RBI has fallen back on the age-old wisdom of buying gold when all currencies' future looks uncertain.

For aeons, gold has been considered in India as a refuge against uncertainty, as well as a status symbol – something no family would sell unless they were in dire straits, and then too, with the internal understanding that they would buy it back at the earliest. So while India's Government is the 10^th richest in terms of gold holdings officially declared, Indian citizens' private hoard of gold, if added to the RBI's holding, would probably make India the richest nation with the most liquid reserves in the whole world.

In the meanwhile, the freedom from the peg to gold allowed the United States to spend like there was no tomorrow. Whenever it looked like tomorrow would dawn, the United States would instigate a competitive devaluation game among other countries, which enhanced the external value of the dollar, which ensured that tomorrow was deferred yet again. Dollar prices of gold went up briefly following the 1974 oil price shock; and then again after the 1979 oil shock. Then, it continually fell till 2001. So, if one compared gold prices against inflation or any other currency value, gold always suffered, till end of 2001 when it was $272.22 in the NY market. After 9/11, some Middle Eastern countries and their residents, sharing the Eastern love for gold with India, began hoarding up on gold. So dollar prices of gold started looking up. But then, in 2007-8, tomorrow arrived.

By 2009, gold had crossed the hitherto unthinkable barrier of $1,000 an ounce. To put this in context, in August, 1971, when the gold exchange window closed, the price of gold per ounce (1 troy ounce=about 31.1 grams) was $37.60 (according to Niall Ferguson in his excellent book, The Ascent of Money). Going to $1,000 in 38 years means a CAGR of around 9% per annum. A handsome rate, but absolutely mind-boggling, if one allows for the fact that for almost 32 of these 38 years, gold prices hardly rose at a CAGR of 3% in dollar terms, when it rose at all. Do you know what the price of gold now is? It is $1,794 an ounce as I write this, in August 2011. Which means a growth of 79% over the 2000 value of gold.

Let us look at this from another perspective. If an American had turned in $1,000 before the US went off the gold standard, he would have got almost 26.6 ounces of gold. The same quantity of gold today would be worth $47,720. This is an index of how much the value of the dollar has slipped and that of gold has gone up. This means that gold worth $1,000 is now worth almost 48 times as much in 40 years – a CAGR of about 10.1%. Not bad, for something considered as a bad investment by the whole world, for almost 30 years! When the world realizes that gold has proved to be a safer haven than any other currency, there could be a renewed weakening in the belief in the US Dollar as a store of value and as a reserve currency.

Way back in June, 2008 I had written that it was time to buy Gold.  Elsewhere, I have written that gold prices could touch $4,000 an ounce in 3-5 years. At the rate the price of gold has been shooting up in the last few months, this price point should be reached much sooner than 3 years, if only because of the expected continuing weakness of the dollar. So will we see a return to the Gold Standard, or some variant of that? That has to be counted as a distinct possibility after the S&P downgrade of the AAA+ rating of the US.

Till that happens, we Indians should thank our womenfolk for consistently ignoring advice that investing in Gold was a poor bet. Thanks to that, India is possibly the most liquid and financially secure economy in the world today. What's more, it is a hidden strength - it is the reason why Indian families will survive in a world without Medicare/ MedicAid/ Social Security.

(Historical gold dollar price data sourced from www.measuringworth.com and current price from http://goldprice.org)

 

BofA: The vultures are gathering ...

Barely 3 days after I blogged on the death spiral Bank of America seems to be sliding into, the signs of death throes have become clearer. Already, its share price represents only 32% of its book value, showing that the market agrees with my assessment that its assets are massively overstated. I had pointed out only one asset, Goodwill, that called for significant impairment.  
Wall Street Journal now reports that Bank of America has entered into deals to sell the following:

• its Canadian Credit Card portfolio to TD Bank
• its Spanish Credit Card unit 
• its small-business cards in the UK to Barclays

WSJ also reports that BofA intends to sell other card units in Europe. It further speculates that BofA may also sell its stake in China Construction Bank Corp. Another report states that Bank of America has also sold off portions of its credit card business within the United States to Sovereign Bank and to Regions Financial Corporation. In April this year, BofA sold its stake in Black Rock Inc.. 
All these sales are obviously intended to shrink its way into a viable situation by raising money without a share issue, and also thus raising "tangible net worth per share" of Bank of America.
If you think BofA was the only bank in trouble, look at this list of 64 FDIC-insured banks that have failed and closed down in the first 7 months of 2011. This is in addition to 157 banks that failed in 2010, and 138 in 2009. It is obvious that things aren't getting better. But that they have company is cold comfort for BofA, around whom vultures are gathering. 

• In early 2011, it settled charges of mortgage-backed securities fraud charges with BlackRock, PIMCO, Freddie Mac, Fannie Mae, insurer Assured Guaranty and a few others, agreeing to pay $8.5 Bn. These settlements have run into some trouble, and are now facing opposition.
• Already, AIG has claimed $10 Bn damages for securities fraud in sale of mortgage-backed securities by BofA, Merrill and Countrywide. 
• In addition, over 90 similar suits have been filed demanding damages of $197Bn, says the above article, quoting LawyerLinks, a legal consulting firm.
• Now, it  is being reported that the National Credit Union Administration has declared that it is suing several banks for damages of up to $50Bn for misrepresenting safety of securities it sold to several credit unions that collapsed as a result of the investments. Among those likely to be sued is Merrill, now part of BofA. 
• Credit Default Swaps on BofA have risen to their highest level since May 2009, showing nervousness of investors.
• BofA has begun writing down principal on Californian "underwater" home loan mortgages of troubled borrowers. BofA is reported to be seeking immunity from prosecution in return for paying fines and writing down principal outstandings of underwater mortgages.
• Elsewhere, BofA is facing energetic protests from locals fed up of the number of foreclosed properties that are ill-maintained, sending property values in entire localities tumbling. 
• The richest Hedge Fund Manager in the world according to Forbes' 2011 List of Billionaires, John Paulson, and who is known for sticking to his bets for longer than most fund managers, has sold half his stake in BofA and Citigroup.

There is speculation that it could spin off Merrill Lynch Wealth Management and Investment Banking operations. There is also some speculation that BofA could put Countrywide, acquisition of which is by consensus considered as a big corporate blunder, into bankruptcy. However, moves taken to consolidate Countrywide and BofA have clouded BofA's ability to ringfence Countrywide-related liabilities. 
Watch this space! 

The Death Spiral beckons ...

Bloomberg reported that as of August 10, 2011, 186 US-based financial services companies traded for less than 60 percent of their book value, or common shareholder equity, including Bank of America, Citigroup Inc., Morgan Stanley, AIG and SunTrust Banks Inc. Together, they had a market capitalization of $300.5 billion, compared with $686.4 billion of book value. This means that a fall in their share prices to this extent (40%) is well nigh inevitable. 

How likely? These banks are very, very vulnerable. For example, earlier this week, AIG filed a suit accusing Bank of America of securities fraud; demanding damages of $10Bn. This sent the BofA stock down 20%, in addition to the bloodbath that the Dow Jones has experienced in the week after August 2, and the S&P downgrade. Its market cap stood reduced to $68.6Bn. Compare this with just one year-end intangible item on its 2010 Balance Sheet: Goodwill is shown at $73.8Bn (see p.130, Table XIII. See also Footnote 1 below)  – forget the rest of its balance sheet, BofA would have the world believe that this intangible item alone, built up from excess over book value paid for its past acquisitions, is worth more than the entire BofA is worth on Wall Street. How many will believe this, and for how long? There will always be the small boy who shouts, “The Emperor is not wearing any clothes!”. After reading Page 114-115 of its 2010 Annual Report, any accountant will understand that BofA will have to write down goodwill significantly (it wrote down $12.4Bn in 2010) - and to keep the shareholders' equity intact after this write-down, it would need to raise more equity. The dilution this would almost certainly drag the share price lower. Which will require them to raise more equity at even lower prices ... leading to a death spiral.

What about the demand for financial sector shares? All but non-existent. Retail interest was never very visible in the US in equities; now it has disappeared. Institutional investors are worried about what write-down of such intangibles would do to the Balance Sheet – and will stay away from any further issues in sufficient number as to make a public issue a very big gamble that could very easily fail. So the only solution – a government bailout wherein the financial institutions that still bear the TBTF tag (Too Big To Fail) are partly nationalized. Expect this to happen in the not too distant future, when the pressure of reporting numbers that have no relation to stock market prices forces them to look for ways of raising their net worth to blunt the edge of the writedowns that are inevitable already. 
What if the US Government finds it politically unpalatable or impossible to rescue these firms with a QE3? Refer to the title of this post! 




Footnote 1 referred to above: 
Table XIII on p.130, and Table XII and Table XIV before and after it, were the result of BofA's attempt to dress up their Income Statement and Balance Sheet, and the justifications for using these were on page 40. If they had followed GAAP alone, the Tables and the explanation on p.40 would be unnecessary. They used "non-GAAP measures" - euphemism for accounting legerdemain to make accounts smell sweeter, euphemism for which is "additional clarity". The footnote to Table XIII reads: Presents reconciliations of non-GAAP measures to GAAP financial measures. We believe the use of these non-GAAP measures provides additional clarity in assessing the results of the Corporation. Other companies may define or calculate non-GAAP measures differently.

What goes around, comes around ....

The US, IMF, and the World Bank have lectured India on the need for fiscal discipline, how to allow market forces full rein, and allow businesses and companies to close down rather than support them in difficult times, which is what the Government was wont to do. The US have not taken their own advice, on the specious plea of "Too Big to Fail", and bailed out top investment banks, commercial banks and insurance companies.  The IMF and the World Bank conveniently forgot to lecture the US for the same folly - of letting deficits go haywire.
What goes around, comes around ....
The UK Press had a great time, roundly criticising the organising gaffes of the Organising Committee for the Commonwealth Games. They preened over the fact that with one year to go, their preparations for the Olympics were ahead of schedule. In less than a week after this, the London riots have exposed the seamier side of the recession-hit economy - about how thin the veneer of civilisation is, even in what is considered one of the more civilised countries in the world. All it requires is a little financial discomfort in enough people to spark riots, arson and looting. And now, there are worries about how secure London really is, with a few sports ties being called off due to the riots. Who knows if the 3rd test between India and England will happen now? If you think such rioting is uncommon, see this from November 2010 and this protest in March 2011 pushing for greater profligacy from a Government that already has racked up a cumulative deficit of 4 times the country's GDP. 

What goes around, comes around ....
The BBC calls the London arsonists and looters as "protesters" - a cute euphemism - but coyly refrain from saying what they are protesting against. A far cry from what they call helpless victims in unmanned drone attacks and in cross-fire between the "Coalition" forces seen as interlopers and those protesting their continued meddling in Iraq and Afghanistan  - "insurgents". See synonyms of insurgents here and judge for yourself how many of these terms apply to those perpetrating violence in London more accurately than "protesters".  And then Google this phrase: "Insurgents Iraq Afghanistan BBC". Orwell's 1984 is well and truly upon us. Long live Doublespeak!