"Please Accept Our Cash"

Another economic panic - Three-month U.S. Treasury rates reaching negative territory. With the stock market crashed, commodities sinking, housing underwater and banks starved of liquidity, it seems that investors are searching safe heaven at the US Treasury. In other words investors are ready to “pay” the US Treasury for “borrowing” their capital where they think that they can protect the values of their capital.  But that also means that borrowing becomes even more difficult with widening spreads. The only silver lining is that bailouts would look much cheaper! 

Three Month T-Bill Rate [12/9/2008] 

[The three-month T-bills rate is lowest rate since the US Treasury started auctioning the securities in great depression era according to Bloomberg.com]

© Rohit Deshpande

Citi never sleeps (?)

“Every time you sleep but your dreams are wide awake.  Because ambitions never sleep, aspirations neversleep, goals never sleep, hopes never sleep; opportunities never sleep; the world never sleeps. That’s why we work around the world. That’s why we work around the clock to turn dreams into realities. That’s why Citi never sleeps.”

 That’s the TV commercial CitiGroups has been airing for last many months. Citi, itself suffering financial crisis, last Monday announced buying commercial banking division of Wachovia, another mortgage security hit bank for $ 2.1 billion. The deal was backed by FDIC - Citi would have assumed $53 billion worth of debt and agreed to absorb up to $42 billion of losses from Wachovia's $312 billion loan portfolio. The FDIC agreed to cover any remaining losses in exchange for $12 billion in Citigroup preferred stock and warrants. The deal, referred as a forced acquisition, was almost done. But the dynamics changed since that – 

1. Liquidity crisis becomes severe even after central banks over the world poured liquidity. (LIBOR peaks to 5.3%). On the contrary, bank deposits provide easy stream of liquid cash.
2. On Tuesday, the Internal Revenue Service issued new guidance that would allow banks to take larger tax write-offs from the losses from loans and other bad debts held by other banks they acquire.
3. Hopes rise as the Congress come closer to the financial rescue plan

 And deposit rich banks like Wachovia become valuable assets. On Friday, in a surprise announcement Wachovia Corp. agreed to be acquired by San Francisco-based Wells Fargo & Co. in the all-stock deal for about $15 billion. The deal would not need assistance from government.

 These are not the everyday deals. JP Morgan Chase gets Bear Stearns and WAMU; Bank of America gets Countrywide and Merrill Lynch; Barclays gets Lehman Capital; Well Fargo would get Wachovia. As Warren Buffet says – “You buy a farm during drought”.

 

It is not the end of the world for Citi.  It has announced a legal action. It will try to get something from the deal. Or will buy a regional bank. But for now it looks like Citi did sleep for 48 hours. 

© Rohit Deshpande

Too big to let fail ; Too big to save - It's WAMU WAY

There is an interesting relationship between a bank's financial state and its deposit rates: IndyMac was offering 4.85 % just before it was put into conservatorship. WaMu is still offering 5% on 12 month CD when national average is 3.69% ! Here are some facts about WaMu:

• WAMU has lost 90% of its market value in last 12 months.

• Standard and Poor lowered credit ratings on WaMu to BBB- on long-term, just shy of the "junk bond" status.

• The bank has already lost over $ 6 billions in write-offs mainly in risky mortgages; many billions to come in near future.

• Despite of the its reduced market cap to $ 9.1 billion, the huge assets over $ 300 billions make it difficult to be acquired.

Would WaMu become 12^th bank to fail in 2008 ? I don't think so. The real question is WHO will save the bank ?

(By the way, small depositors are safe; FDIC has them covered. But the outlook doesn't look too promising” Berkshire Hathaway subsidiary's plan to stop insuring bank deposits above federal limits may reflects Warren Buffett's worries about future bank failures?)

Nature of the Beast

I was in the middle of a very important ‘financial decision’ last few days. I was recently assigned on a project in a small town in Tennessee countryside, 50 miles north of Memphis. My earlier plan was to rent an apartment in the farthest suburb of Memphis and drive everyday. But as gas prices marched towards $ 4 / gallon, my plan began faltering. My other option was to rent an apartment in this small town, just across the street from my workplace. This plan would have definitely saved 10-15 bucks everyday, but my preference was to stay in Memphis. Also there is such a little visibility about the validity of gas prices; commodity market is so volatile right now.

In order to facilitate the decision process, I set-up a spreadsheet and developed a ‘complex’ financial model involving all the factors such as miles saved in daily commute, miles driven for leisure trips, incremental travel to airport and also other factors such incremental cost of auto insurance, tax difference, depreciated car value which would otherwise incur due to daily commute and so on. I ran this model for different scenarios of gas prices varying from $ 2.5 through $ 5 per gallon to account the volatility in the oil prices.

The financial model showed that renting apartment in this small town would be beneficial as long as the gas prices stay above $ 3.12 per gallon. If the gas prices start falling below this benchmark price, the benefits would also start diminishing. Based on the these results I decided to rent an apartment in the small town for 6 months, assuming that there will be major correction in the commodity market by the year end. Please note that this decision was purely based on the quantifiable benefits and I did not consider any intangible benefit on either side such as cutting daily commute or benefits of small town, city life etc.



My financial analysis would appear rather stupid, since there is low risk involved in either of two alternatives for a very short term. But if you amplify the scale of this project over million times, the risk will also amplify substantially. What I am trying to simulate is the decision process of investment in an alternative energy venture.

There are so many energy alternatives: some renewable such as solar, wind, bio-fuel, and some traditional such as offshore drilling. But viability of every alternative would depend on the same analysis I have just demonstrated. If the price of crude oil, which is the major source of energy today, stays elevated, these investments look particularly lucrative. On the other hand if the prices fall, these investments would go red. For example a major energy company recently started investigating viability of using oil-shale (mud-rock) for oil production, but only when crude oil crossed $100 mark. It would be difficult to justify the same investment when the crude oil is below $60.

Traditional energy companies are not necessarily evil as they have been portrayed whenever there is hike in energy prices. But they certainly have their first accountability towards their investors for every dollar invested in such projects. It is true that these decisions can not be based merely on the investment returns. These traditional energy sources will come to depletion at some point of time in the future. Such issues as greenhouse gas emissions and global warming must be addressed on highest priority. Thus it is the responsibility of the energy policymakers to create environment for attracting the investors towards renewable energy sources. Wind energy was once considered one of the ‘text-book energy sources’. Today it is one of the most profitable businesses worldwide. That became possible only when government subsidies and tax-breaks created a very conducive investment environment.

Well, soon after relocating to this small town, I was eating dinner with some of my friends. The topic of discussion directed towards gas prices. Everyone was complaining about the gas prices and started talking about green technologies. When it was my term, I said – “Today we are talking about all these green technologies because of the hurting gas prices. Tomorrow if the FED increases interest rate even by 25 basis points, the gas prices will start falling down and I bet you, we will stop talking about ‘green technologies’ at very same moment …” Apparently no one liked my statement !!

I don’t know what the energy future is. As far as I am concerned, I have tried to minimize my own ‘carbon footprint’ by relocating to this small town. But I am sure that this happened only when gas prices reached beyond the reach and unfortunately that’s the nature of the beast!