Lessons learnt from Wall Street

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  • Publication: Jamaica Observer; Date: Sep 28, 2008; Section: Sunday Finance; Page: 10F

    Lessons learnt from Wall Street

    THERE are many lessons to be learnt from the present crisis in the US financial market, mainly that good ole Uncle Sam has a serious

    weakness. Americans lack of propensity to save is a dire cause for concern. The current Wall Street crisis is very similar to our own FINSAC

    catastrophe that required an urgent bailout and the impact was severe for some, but presented cheap gifts for many. Individual lifestyle

    decisions affect us collectively and it is evident throughout this crisis that it is countries such as Japan, South Korea and China, which have

    higher Marginal Propensities to Save (MPS), that are able to capitalise on some cheap stock prices now, because they have the cash saved.

    The average American is saddled with US$16,635 in debt, excluding mortgages. Americans have approximately US$1 Trillion of credit card

    debt excluding mortgages, and if mortgage debt is included it stands at US$12 Trillion. This stems from an American attitude towards debt

    overall, which needs to be moderated. Mortgage debt, as we all know, is the bane of Wall Street's existence. It is not prudent to purchase a

    US$300,000 home with just a salary of US$50,000. Neither is it sensible for a corporation to invest more than 20 per cent in one asset class,

    particularly bad debt securities. Most on Wall Street overlooked this rule.

    The Securities Exchange Commission (SEC) had not put the necessary framework in place to prevent this among other catastrophes from

    happening. Now that the mortgage bubble has burst Credit Default Swaps (CDS) that once had no regulation and were able to act

    independently and free from all scrutiny are being placed under the microscope. CDS in addition to ratings agencies are now forced to

    conform to tighter regulations under the suspicion of misleading investors about their true exposure to the credit crisis. It's about time these

    credit- laden Special Vehicle Securities (SVS) and ratings agencies allow for better transparency.

    All is not lost though, because the FED is trying to come to the rescue and after the downside we ought to see life back to normal. If we are

    not at the bottom, let's just say we are very near. It's time for Jamaican investors to focus on protecting our portfolios and purchasing the

    cheap instruments up for grabs. Currently, worldwide investors are still uncertain about how much exposure these institutions have suffered

    and are very wary of US stocks and corporate bonds. Gold is where the money is safest and for local purposes Real Estate is the Jamaican

    gold. Look out for some more Real Estate Investments offered here in the near future.

    Although investors may be scared, there are many cheap high-value companies for sale at this time which will be profitable in the long term.

    Citigroup (C), for instance, is the largest public company worldwide and also the world's largest bank by revenues, so we can have faith that

    there is no way the Government will allow it to fold. This would be an excellent time to SHORT Citigroup (C) over the medium term (if it were

    permissible). However, due to current SEC restrictions, we recommend a BUY on Citi if the price pulls back to US$10-12 in the short term

    based on the Fed's bailout package. The rebound is in sight for sure as Citigroup has many oil owners at its helm and the Dubai wealth fund

    may look to go in as soon as oil prices increase. In addition, there are talks about Citigroup acquiring Wachovia and there are possibilities of

    other mergers in the financial sector which ought to build investor confidence and help the stock price surge. Expect a 30 per cent increase

    above book value (US$20.08) by

    next year assuming that this is indeed the bottom of the barrel for financials. Just last October Citigroup was at US$48.77. So indeed, we can

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  • manage to seize this opportunity.

    Let's get back to the whole credit concept again. The effect of putting your hat where you can't reach it also applied to the corporations.

    These banks overleveraged their balance sheets and became dead broke as a result of overextending themselves and having too much

    exposure in the midst of the economic crisis. Take a look at the approximate leveraging ratios for some US financials; Bear Stearns 25:1,

    Lehman Brothers 25:1, Morgan Stanley 30:1 and Goldman Sachs 25:1. The benchmark by the way based on risk analysis is at most 5:1. This

    needs to be curbed. The regulatory bodies are called upon to provide better enforcement with regard to this issue. The Bear Stearns collapse

    is a testament to the dangers of overleveraging.

    The extent of regulation in a free market has always been a topic of constant evaluation. Where consumers lack the will power to curtail bad

    habits, the Government needs to offer mechanisms to deter them. AIG's failing threatens not just the US but the world economy and

    evidently more regulation is required to prevent world stagnation. Here in Jamaica, credit is becoming more accessible, the small and

    medium businessmen need to look at the US situation and realise the importance of borrowing what can be afforded. We must adapt a

    culture of saving for the rainy days to come, after which I recommend checking with Stocks and Securities Limited because just like with

    FINSAC the auction is out and there are some very great deals to be had provided one has the liquidity.

    Raul Haynes is a research analyst at Stocks & Securities Limted.

    By Raul Haynes

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