Portfolio Paranoia

Intel’s Andy Grove penned a great book back in 1996 about Intel, business and being paranoid about the competition. People have been asking me what’s happening worldwide, what’s up with India, etc…I see two stories being told depending on the audience.

The positive spin is “in the long term everything will be okay and you might actually want to invest now” and the other is “dude, watch the expenses, be liquid and don’t trust anyone.”   When it comes to my money, I’m absolutely paranoid and the competition is anyone out there trying to reduce my capital. In the last 6 weeks I have seen legitimate deals vanish, what was a viable business plan back in September is now apparently crap. The VC studs at Sequoia Capital had a meeting this week with a slide deck titled “RIP: The Good Time” and in short – get your house in order, things might get real crazy real fast. (Here is summary from Om Malik of the meeting).  

Someone asked me what is the silver lining to all this. I would take this time to vet out money managers, if they can survive this period they can rock in any market. If big companies can be paranoid about the future, I’m not sure why you shouldn’t be. It’s not me being a permabear, it’s just me protecting my capital at all costs.

Here are some great quotes from today’s newspaper:

The property rates in Mumbai will not see a correction above 10-15%, given the land rates are very high in Mumbai…

Gopal Sharma of Gundecha Builders 

Gopal has to be positive or his cashflow won’t be positive

Indians buy a home for long term use, unlike people in western countries

Pravin Doshi, Pres of Maharashtra Chamber of Housing

Seriously, Pravin have you even visited the West or just talking smack?  I know several of my cousins in India that have bought property for a quick flip. And several of my cousins in the US, that only have one house – the one they live in.

Be absolutely paranoid about your portfolio and don’t let anyone sway you.  People talk about risk metrics, the best risk metric is if you can sleep peacefully at night.

Boom to Bust

Over the past several years the great Indian real estate story has been front and center. From a Bombay point of view it’s been fun to hear about how prices will never come down and the time to buy is now.  Even in the last 3 months, people have been saying the real estate market will not crater like in the US.  I’m sorta leaning towards bulls@#$ when I hear that.  

I’m expecting every country that had a real estate bubble will have at least one bank and one developer go bust. Every time I rattle off a list of developers people have a reason why they will never implode:

Indiabulls – politically connected, it’s just a front for converting black to white money
DLF – lots of land, good rental income, political money
Unitech – backers with deep pockets
HDIL – politically connected, focused on slum rehab projects

On the bank front, the last 48 hours have generated more headlines and rumors about a bank going under. The one name that consistently seems to come up is ICICI, hence they have been appearing on TV the last 2 weeks telling everyone everything is okay. I’m sure the only reason it comes up because it was the most aggressive of the Indian banks. I have pulled all my money out of ICICI because if they fail, I’m not sure the Indian gov’t can create magic like Paulson and Company.

Credit Crisis 101

If you are watching your portfolio plummet and wondering what is happening, this post might help you understand with better clarity why it seems your money is being flushed down the toilet.  The 3 combined podcasts run about 100 minutes, I’ve summarized the key points and some choice quotes. However, I highly recommend you downloading them yourself to listen to. (If you have a Zune or don’t use iTunes, please close your browser and jump off a cliff)

60 Minutes (iTunes link, 42 minutes)
– What went wrong with the risk models

“You can’t model human behavior with math”

– What is a credit default swap (CDS) 

“It is an insurance contract, but they’ve been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a ‘swap,’ which by virtue of federal law is deregulated,” 

– The CDS market is around USD 50-60 trillion dollars

Radioeconomics.com (iTunes link, 34 minutes) – The guest is Barry Ritholtz (from The Big Picture blog which is one of the best blogs covering the financial crisis)

– The Commodity Futures Trading Act of 2000 exempted any derivatives instrument (such as CDS) from being regulated
– The CDS market went from USD 2 trillion to USD 50-60 trillion in just several years
– Ratings agencies (Moody’s, S&P and Fitch) were rating most mortgage backed commerical paper as “triple A” investment grade
– Housing sales peaked in 2005 and housing prices peaked in 2006
– Why in 2004, were 5 investments banks exempted from the Net Capitalization rule?
– The ban on short sales in financial stocks is stupid

This American Life (iTunes link, 1 hour)

Part 1 – Commericial Paper Market
– The commerical paper market (one of the largest markets) locked up after “breaking the buck” occured with the Reserve Fund

Part 2 – CDS’s
– Satyajit Das talks about the market originally being used for insurance and soon turned into gambling. (He has a great book, that I reviewed a while back)
– Great analogy of using CDS’s for fire home protection
– CDS’s are traded via over-the-counter (OTC) between two private parties in an unregulated market
– USD 5 trillion in Bonds and USD 60 trillion in CDS  – a 12x leverage

Part 3 – CDS’s traded in an unregulated market

After listening to all 3 podcasts it’s clear, there is no quick fix to the problem.  The Fed stepped in on Tuesday and announced a Commercial Paper Funding Facility and the DJIA still got slammed over 500 points down. 

The two largest financial markets: commercial paper and CDS are unregulated and I’m sure the market participants like it that way. With regulation and transparency, you have to fight for business and lower your prices, look at the US brokerage model.  Once the US brokerage model was littered with companies offering rock bottom services, the industry looked towards new markets – CDS.

The size of the world stock market is estimated at about USD 60.9 trillion  at the end of 2007.  The size of the CDS market is between USD 50-60 trillion. Shouldn’t both be regulated the same way based on their size and importance?

The ONLY thing that is going to continue to rise is the US National Debt…USD 10 trillion and counting…

1 conflict, 2 outcomes

The subprime crisis has caused havoc to anyone with a pulse.  Most people are affected in a negative way and a select few are actually doing well because of it.  

First the bad news, I’m not 100% sure but I believe Karthik Rajaram is the first person to commit suicide due to the crisis. He lived in a suburb of Los Angeles and not only killed himself but 5 others – mother in law, wife and 3 sons. His 19 year old son was a Fulbright Scholar, no small feat, at UCLA.  Really, there is not much else to say…[LA Times story]

Now the good news, the USD 700 billion dollar man is Neel Kashkari, he used to work in Redondo Beach, California a stones throw from where I used to live.  According to his biography Neel “developed technology for NASA space science missions.” Paulson is brilliant for selecting Neel, maybe he can re-package all this toxic paper and shoot it into outer space…problem solved.

The Harvard Plan has Passed

On Friday, the US House approved the revised USD 700 billion bailout to stabilize the financial markets. Henry Paulson has finally gotten his way and now the question remains…will it work? Based on what the equity markets did the last couple days, there is not much confidence. The credit markets are still locked up and LIBOR rates have hit recent highs.

I personally feel Paulson is the wrong guy to be leading the clean up, since it seems he was partly to blame in the creation of this mess.

…we and other global firms have, for many years, urged the SEC to reform its net capital rule to allow for more efficient use of capital. This is the single most important factor in driving significant parts of our business offshore, so that our firms can remain competitive with our foreign competitors risk-based capital standards must become the norm. The SEC has made it clear that risk-based capital rules can be implemented only when the Commission is confident that firms employing value-at-risk models have robust credit and risk management policies in place. (full testimony)

That was Paulson’s statement back in 2000 to allow banks to take on more leverage.  So in 2000 he asks for more leverage, then 8 years later it blows up and now is asking to clean it up.

That would be similar to an executive of a large alcoholic beverage maker asking to lower the drinking age, allows advertising on college campuses, sponsor parties, etc…Then realizing kids are getting drunk and doing things they shouldn’t be…Then hiring that executive to clean up it via legislation. Only in America.

So why do I call it the Harvard Plan because the 4 most powerful men right now in this economic blow-up all attended Harvard:
George Bush – MBA ‘ 75 
Henry Paulson, Treasury Secretary – MBA ’70
Ben Bernanke, Chairman of the Federal Reserve – BA ’75
Christopher Cox, Chairman of the SEC – MBA ’77

A little humor, check out this website for Strategery Capital Management

Real Estate Update

Several of my friends were in town this week for a real estate conference and I got a chance to catch-up with them and get the real deal on the Indian real estate market. They said most of the conversations at the conference went like this:

Developer A – We are okay, we didn’t grow too fast but Developer B is screwed
Developer B – We are okay, we started early but Developer A is screwed

The build out for the retail segment is a complete disaster, malls are empty and the ones operating have occupancy rates from 25% to 80%. In many instances the malls cannot be reconfigured, case in point the Crossroads Mall in South Bombay was converted to an office building after an extended and expensive renovation.

Residential is set for a large fall since many of the new projects were bought by investors looking for a quick flip. With rates going up, people will end up bailing on these units and add to the overall supply.

This past week the equity markets were not kind to the Indian real estate sector including some of the companies I track. HDIL (down 87% from peak, click the above image for a chart), Orbit (-83%), Parsvnath (-84%) and Sobha (-82%) are all near their all-time lows, of course most have only recently listed on the exchanges. HDIL is the Bombay based property kingpins run by the Wadhwan family. This research report from ENAM covers HDIL, the report is good if you want a macro view on the Bombay real estate market.  ENAM had a price target of Rs. 712 when it published the report on Aug 18, 2008, on Sept 26, HDIL closed at Rs 190.35. I might be a bit jealous of HDIL as they have one of the largest collection of sweet rides in Bombay, most notably the Rolls Royce Drop Head Coupe.

Fool Me Once…

Shame on you
Fool me twice
Shame on me.

Ben and Henry (Benry???) as I blog are pleading their case to the Senate Banking Committee. It’s almost like a repeat of the justification for the Iraq War – If we don’t do something about weapons of mass destruction (WMD) the US is toast.  This time the WMD’s are derivatives as Warren Buffet so accurately predicted back in 2003.  

This is a complete sham, they should be focusing on the homeowner – cut them a check and hope they don’t default.  Instead, their theory is to help the banks and people holding these toxic instruments and make them whole and in turn that will trickle down to the homeowners.  Awesome theory, I believe the theory about the Iraq war was that it would pay for itself once we start pumping the oil…we all know how that is going. Iraq is costing taxpayers close to USD 10-12 billion a month with no end in sight.  They want USD 700 billion for this bailout, I’m sure that figure will easily exceed USD 2 Trillion if they get this passed in Congress.

I’m not sure what will be more valuable – Monopoly money or the US dollar?