Last week I had a guest post at Cash Money Life discussing the factors that you should keep in mind when selecting a brokerage. You can check it out here.
Here are some carnivals that OneMint participated in last week:
Bankruptcy and Debt Carnival
Month: May 2009
Interesting Reads: 23 May 2009
A friend told me that he had a colleague who likes to respond to Nigerian scammers from work. Every day after lunch, he opens up his Gmail spam folder and replies to each and every scammer who wants to mail him a million dollars.
He thanks them profusely, assures them that they reaffirm his faith in humanity and tells them that because they have been so kind, they can keep the money themselves or donate it to charity.
He thinks that replying to Nigerian scammers is the most unproductive thing he can do with his time (he loves his employer) and it gives him the pleasure of getting even.
I found this little story really hilarious and that was pretty much the most interesting thing I came across this week.
On to our usual great stuff from the blogosphere:
- How to Travel with Money at The Digerati Life
- How to be a Millionare: Secrets to Success at The Smarter Wallet
- The Economics of CAFE at The Baseline Scenario
- Review: Hot Flat and Crowded at Weakonomics
- How Should a Budget Planner Handle Windfalls at Vilkri
- Credit Card Act of 2009 — Good or Bad at Cash Money Life
- Rise of the Silver Surfer at The Reformed Broker
- How To Find Best Mortgage Rates at Five Cent Nickel
- Why academics make better bloggers than journalists
- Introducing the Expensive Loan Option by Bad Money Advice
A Bet On GM Bankruptcy
Image by Marcandrelariviere
Last Tuesday, FT ran a story about the chances of GM’s bankruptcy looking very high and Bloomberg said that a GM bankruptcy was inevitable.
Bankruptcy inevitably means that the shareholders will be wiped out and the stock price should go down to zero.
The stock that day traded at about $1.15 and I heard three main reasons for the stock being higher than zero:
- People were covering their shorts.
- There was an outside chance that the government or the creditors will change their mind and GM will not have to declare bankruptcy.
- People were being stupid.
I don’t trade in Options very frequently, but, that day, for some reason, as I was checking my brokerage account – I looked at the Put Options for GM.
This is the most interesting contract that I saw:
Symbol: .GMQV
- Base Commission: $9.95
- Contract Charge: $1.50 per contract
- Quote: $0.13
- Strike Price: $1.00
- Market Price: $1.15
- Expiry Date: 05/16/2009
- Today: 05/12/2009
Now, since the Option expired in four days – the stock could hover at a buck for four days and then go down to 50 cents or something on the fifth day and I would have still made a loss. But, somehow I just got into this contract.
Normally, I don’t get into any trades that depend on the misfortune of someone else (like tobacco stocks) or other things. And the problem with making pennies on such speculative bets is that you could get ten rights and make a few dollars and then one wrong bet will blow up in your face and wipe out all your profits.
I felt the strong urge to get in the trade and I thought I’d just bet a small amount so I just bought some 7 contracts, so the amount that I could lose would not exceed a 100 dollars. As usual, I lost money on this bet because the stock just hovered around that price and I sold the contract at six cents. I lost a little money, but, this should keep my gambling instincts at bay for some time now.
Who Rates the Rating Agencies
The big story today was S&P’s warning to UK about their high debt levels and how the UK could lose its AAA rating, if their debt continues to rise.
From the FT:
Standard and Poor’s, the credit ratings agency, warned that the medium-term outlook on the UK’s triple A rating on its debt was now “negative” rather than “stable” for the first time since it started analysing British public finances in 1978.
Though the agency lowered its outlook to negative, it affirmed its “AAA” long-term and “A-1+” short-term sovereign credit ratings.
S&P based its warning on a forecast that UK net government debt risked approaching 100 per cent of national income and staying at that level. “A government debt burden of that level, if sustained, would in Standard & Poor’s view be incompatible with a ‘AAA’ rating,” the agency said.
What surprises me about this story is how big it became. That shows that people are still interested in what the rating agencies say. I am not sure if they have ever predicted anything that has proven right. They rated all that junk – AAA, and almost always act on events after the fact.
And yet they have some semblance of credibility. I am not sure if this can be attributed to people having short term memories or just that there is really nothing else to go by. You can’t expect everyone to do their own research before investing and you have to rely on someone. And they are the only one we have right now.
I think as part of their annual statements they should present a summary of the major decisions they took during the year and how they turned out. It should be like a hit and miss summary that gives investors an idea how wrong or right these agencies have been.
There is no one rating the rating agencies and that looks like a big hole in the current system.
Annualized GDP Decline
From the WSJ:
Steep declines in the economies of three of the U.S.’s biggest trading partners — Mexico, Japan and Germany — underscored the severity of the global recession and put pressure on major industrialized nations to revive moribund global trade talks.
I took annualized numbers because they look more sensational (same reason I chose red), but there is a good chance that these countries might see better Q2, Q3 and Q4 numbers, so the actual GDP figures may not turn out as bad as these.
CAFE Emission Standards
Image by Chris Campbell
On Tuesday, President Obama announced rules that would require a car company to have a fleet with an average of 35.5 miles per gallon (mpg) by 2016. Right now, this number stands at 27.5 mpg, as required by the Corporate Average Fuel Economy (CAFE) standards.
Let’s take a look at some interesting things about CAFE.
CAFE Facts
CAFE is the fuel economy of a manufacturer’s fleet of cars and trucks. It has two different categories – one for passenger cars and one for light trucks. The current standard for passenger cars is 27.5 mpg and 22.2 mpg for light trucks.
Trucks and other vehicles that weigh over 8,500 lbs don’t have to comply with CAFE rules. (Just for reference — the Toyota Tundra weighs 6,200 lbs).
Imported cars are treated as a different fleet and the car manufacturer has to calculate the CAFE differently for domestic and imported cars.
The different car types are taken and then a harmonic mean is calculated to arrive at a single number for a car manufacturer. This number determines whether the car manufacturer is in compliance or not.
If manufacturers exceed CAFE standards, they get credits, which they can then use in a subsequent year (up to 3), if they fail to meet the standards at that time.
If they fail to meet with the standard then they are charged a penalty based on how far below they are and how many cars or trucks they have sold.
These emission standards are expected to get the car manufacturers go green and help reduce pollution levels over the long run.
This is just one way of doing it though; the Japanese have taken another route to tackle this situation and have come up with tax cuts that have greatly benefited their car sales last month.
The Japanese Alternative
Japanese automakers had good news on Tuesday, when they saw car sales rising; spurred by tax cuts by the Japanese government for fuel efficient cars.
The Japanese government has announced tax cuts for different categories of vehicles – ranging from fuel efficient to hybrids and Japanese companies like Honda, Toyota and Nissan have seen their sales take – off because of these tax cuts.
From Bloomberg:
Nissan Motor Co., Japan’s third- largest automaker, said domestic sales this month have risen about 30 percent so far, helped by government measures to spur car sales.
Nissan is benefiting from a tax break on purchases of fuel- efficient cars that applies to 14 of its models, Chief Operating Officer Toshiyuki Shiga told reporters today in Tokyo.
Which One Is Better?
The Japanese alternative works much better for the Japanese who are looking at the worst ever quarterly GDP decline and desperately need something to kick start their economy. Not only do the tax cuts nudge car makers to go green, but also give their sales a boost by incentivizing sales of greener cars.
The American situation is quite different. With major car manufacturers facing the prospects of bankruptcy – the American administration can’t give tax cuts to greener vehicles. That would just give foreign cars an edge and further deteriorate the position of domestic car companies and push them to a position from which they may never recover. So, in that sense the Japanese solution was never really meant to be implemented here.
In the longer run, I prefer tax cuts because they are much more direct, easy to administer, understand and give more flexibility to people and car makers in what they do.
If car makers want to make trucks with a low MPG and people are willing to buy them; despite the higher emissions price – it will happen (under both regimes). With tax cuts; at least it is much more direct. Under CAFE – the car makers will pay a penalty for not meeting the standards and then pass on the cost to the consumers.
Just that, in tax cuts, you would be able to see the difference directly in the price of the vehicles and put your finger on the tax rebate and make the decision.
Allen Stanford, Bernie Madoff and Wally
Is this art reflecting life or life reflecting art?
Dilbert; from a few days ago.
From the Times, a few weeks ago:
Allen Stanford, the billionaire cricket sponsor, lost money with the alleged $50 billion swindler Bernard Madoff but lied to his investors that he had not, say regulators.
The US Securities and Exchange Commission (SEC) lodged 25 pages of allegations with a court in Detroit yesterday, detailing a $9.2 billion fraud allegedly perpetrated by Mr Stanford and three companies he controls.
“Perhaps the most alarming is that Stanford Investment Bank has exposure to losses from the Madoff fraud scheme despite the bank’s public assurance to the contrary,” said the SEC.
iShares S&P GSCI Commodity Indexed ETF: GSG
iShares S&P GSCI (GSG) ETF is a fund that aims to track returns of a particular S&P index (S&P GSCI Index) that represents a diversified set of commodities.
The iShares GSG ETF holds future contracts, which track the value of the commodities held in the S&P GSCI Index.
Underlying Index: S&P GSCI Index
In order to understand how the iShares GSG ETF will move, you need to know the underlying assets of the index it tracks.
So, here is the breakup of the futures contract currently included in the S&P GSCI with their percentage dollar weights on February 27th 2009:
WTI Crude Oil: 33.74%
Brent Crude Oil: 12.38%
Natural Gas: 5.91%
RBOB Gas: 4.82%
Wheat: 4.66%
Corn: 4.57%
GasOil: 4.33%
Heating Oil: 4.16%
Gold: 3.72%
Live Cattle: 3.69%
Soybeans: 3.04%
Copper: 2.66%
Aluminum: 2.35%
Sugar: 2.19%
Lean Hogs: 1.89%
Red Wheat: 1.00%
Cotton: 0.99%
Coffee: 0.90%
Feeder Cattle: 0.68%
Primary Nickel: 0.61%
Zinc: 0.55%
Cocoa: 0.42%
Silver: 0.40%
Standard Lead: 0.36%
As you can see, this index is heavily weighted towards oil and gas, which form about 65% of the total assets.
The prospectus explains that the index is calculated in the following manner:
The quantity of each of the contracts included in the S&P GSCITM is determined on the basis of a five-year
average, referred to as the “world production average”, of the production quantity of the underlying commodity as published by the United Nations Statistical Yearbook, the Industrial Commodity Statistics Yearbook and other official sources.
This means that unless there is a substantial change in the output of any of these commodities – there won’t be a substantial change in the composition of this index.
Operating History and Performance
iShares GSG ETF has an operating history from June of 2006 and its investing pool has grown from $7.35 million in June 2006 to $466.23 million at 31st December 2008.
The iShares GSG ETF has a management fee of 0.75% and has a beta of 0.98 with the S&P 500. The trust has returned -21.80% since inception.
The iShares GSG ETF tracks the return of its underlying index by investing its funds in the long positions future contracts on the S&P GSCI Excess Return Index, called CERFs.
Here is a look at its price movement since inception.
Conclusion
Most investors stumble upon the iShares GSG ETF, when they are looking for a fund that will help them invest in commodities.
Different people have different things in mind when they think of commodities, some think of precious metals like gold and silver and others think of copper and zinc. But, the underlying index of GSG weighs heavily towards Oil and Gas.
So invest in this fund, only if you were looking for an investment vehicle that tracks the price of oil and gas for the most part.
If you had a specific commodity in mind (other than oil), then you may want to pass this ETF and look for something that invests in the specific commodity (or commodity class) you had in mind.
The Lure of Ponzi Schemes
Image by Timothy Valentine
I came across this IMF working paper on Ponzi schemes via the Baselinescenario and it has got some pretty interesting facts about them.
What caught my eye was that most investors get sucked into Ponzi schemes, even when there are plenty of signs that the scheme is too good to be true, and it reminded me of the way things were during the dot com boom.
Too Good To Be True
Most of the bigger scams mentioned in the paper promised monthly returns that should raise your eyebrows, even if someone was offering them annually. Most investors know that such numbers are impossible to attain over a long period, but, somehow they manage to convince themselves that everything is just fine.
The opacity of the schemes should be the second indicator that something is wrong, but, investors are generally happy to leave the boring details to their fund managers and so aren’t surprised that the fund doesn’t even have a prospectus.
Great PR
A lot of people get conned in Ponzi schemes and they are not necessarily foolish or greedy. There is a lot of public relations (PR) work that goes on to make a Ponzi scheme tick. It is not easy to ignore such great PR; not to mention the wealth your neighbor is amassing in the same scheme. That’s just human nature.
Ponzi PR
Often, Ponzi Schemes are carried out by very influential people who are politically well connected and on top of that donate to charity quite liberally. This gives them the soft power and the aura to attract investors and create a sort of halo, which says — they could do no wrong.
Donating millions to charities, political parties and churches help them win friends who can pass on their credibility to the Ponzi scheme and help it run a little longer. So even when officials warn that there is something wrong with the scheme, there is a backlash from prominent figures and that acts as a powerful shield for the Ponzi Scheme.
The other factor that lures people is that someone they know is making money out of the scheme. This is a very significant factor and I think ultimately this is what tips the scales in favor of the Ponzi scheme.
Parallels with the Dot Com Boom
During the dot com boom, there were many Indian cement, retail and even fertilizer companies that changed their names to make them sound like an IT Company. Suddenly — Acme Cements turned into Acme Infosystems. Soon thereafter these companies went for an IPO which got heavily oversubscribed and popular.
At that time I was quite surprised to see that the people who invested in such IPOs knew that they were not buying an IT company, but were not bothered by the fact that a cement company is trying to fool people into thinking that it exports software.
There were several reasons people did that and I think it has some strong parallels with people investing in Ponzi Schemes.
1. Others were making money: At that time almost every IPO made money and over a period of a couple of years, it became a sure shot way of making money in the market. A ponzi scheme will give handsome returns to investors till the time it is discovered. In that sense people are lured to it by seeing that someone they know has already made quite a bit of money on them.
2. Analyst Support: Equity analysts who were supposed to know better came on television and recommended the IPOs. So, analysts with brokerages that had offices all over the world lend credibility to these companies.
3. Any Publicity is Good Publicity: A lot of these companies got negative publicity from the press about changing names, but at the same time there was no action from the regulators because they were not doing anything illegal. This made people think that if the government is not taking any action despite all the negative press, everything must be alright. The same is true for Ponzi schemes too; regulators need data and evidence to take any action, but this is usually a long drawn process. In the meantime people tend to get attracted towards the Ponzi schemes precisely because — no action is being taken.
Conclusion
People are wired in a way that makes them susceptible to following the herd in booms, falling for Ponzi schemes and the like. It’s good to recognize the things that make us fallible and watch out for them. There is really no better way to protect your money than by using common sense and looking for honest people to do business with.
FT: Brazil and China eye plan to axe dollar
China takes another step to reduce its dependence on the US dollar, and wants to trade in local currencies with Brazil.
FT Reports:
Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz Inácio Lula da Silva, Brazil’s president.
The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency…..“Currency swaps are not necessarily trade related,†the official said. “The funds can be drawn down for any use. What we are talking about now is Brazil paying for Chinese goods with reals and China paying for Brazilian goods with renminbi.â€
Japan had made a similar move a few weeks ago.