Greed

Imagine a bank (we will name it “A” subsequently), has total asset value amounting to USD25 million in their balance sheet, and operate at “high leverage” level to gain huge profit for it’s shareholders. With leverage of 30 times it gives you a leveraged amount of USD750 million. It means A is pledging its USD25 million to borrow USD750 million from investors for its investment purposes. With expected rate of return of 5%, the profit will be USD37.5 million, a return on asset (ROA) of 150% which is extremely high!!!

What A intends to do next is lending out this sum of USD750 million to certain borrowers for mortgage loan purpose.

In order to get around the default risk, A approaches B to insure against these sum of loans. A agrees to pay USD3 million in the next 5 years to B for such insurance, it amounts to USD15 million in total. For A, it is good cause it has B to insure against its loans and after paying USD15 million, A still has a profit of USD22.5 million (USD37.5 million – USD15 million) while B is profitable as he makes another business which will get them USD3 million annually provided that the actuarial calculation indicated that the risk is within an acceptable range. This is the so called Credit Default Swaps (the notorious CDS).

Now C is getting jealous with the abovementioned deal and want to become part of this game so that he can benefited from this scheme as well. So C approached B and asks B to sell 1000 CDS contract to C for USD10 million. B can happily do so because it takes 5 years for B to earn the USD15 million but now B can bag in USD10 million immediately if B agrees to sell 1000 CDS to C.

And then C repackaged the CDS and securitizes it and sell to D in the market, so on and so on and so on until it reaches trillion of dollars in the market.

Now, with some spices the story goes like this. Assuming that the borrowers that A provided loans to are of sub-prime credit rating and the loose regulations enable A to lend to these group of borrowers with lower credibility. The property market is booming and the increasing price of the houses represents just the good collaterals for these loans. So people borrow money to buy house with the intention to resell later on.

However, the price can never go up forever, it will drop when the bubble burst. What happen after the burst of the property bubble the borrowers may not be able to sell the house to repay the loans, hence default begins. A loses hence turn to CDS for its insurance claims.

Holders of the CDS contract suffer since they are liable to pay out the insurance sums at the point of time when the borrowers default. It is a huge amount; hence the CDS holders collapse and declare bankruptcy.

This is properly one of the problems with AIG, financial risk is very different from the normal insurance risk that they encounter. One’s car was crashed in an accident does not mean your neighbor car’s is about to be crashed too. But financial risk is different, it is contagious, insurmountable and unstoppable, when the market crashes many parties will take the brunt of it.

As a result, if the holders of CDS can not take out the insurance money, they only left with the choice to declare bankrupt or ask uncle SAM to bail them out.

What am I talking about here? I think you know.

p/s: greed is good, take action now in here.

somemore..............

Something to add on to the landsliding tragedy, what about those pylon built on hillslope and near residential area, are all these pylons safe? What if the hillslope where the pylon was built has erosion which lead to the toppling of the pylon? Woow, better dun think further.

p/s: picture googled from the Internet, this is clearly not pylon in here. Dun know where it is so ask me no more. Hehe.

p/s: visit http://oneyearplan.net/Andrew

Again and again it happens

What is hot in past one week? It is the landslides that struck Bukit Antarabangsa one week ago that we are talking about, this tragedy has taken it’s toll of 4 persons and one is still missing now.

This incident sounds so familiar; it happens quite a couple of times. One can not help asking why serious actions from Government were only taken now. Is it due to the mounting public outcry over last week tragedy? Or they are trying to make amends to something wrong they have done?

Our Government has, at the very least, frozen a few projects currently under construction at certain landslide-prone area to deter likely landslide or land erosion tragedy and evaluations / proper studies is now undertaken on these temporary frozen projects. On the other hand, our Government also plans to adopt certain Hill Slope Property building policies and guidelines effectively executed and duely implemented in Hong Kong so that we can get around further casualty in future.

But why all these only come now, that it is so “Just in Time”? Isn’t mandatory for the Government and the developers to carry out proper study before any construction works was kicked off? If this situation continues, we really need to enquire the possibility of achieving the “Wawasan 2020”. How can we get there if the people running the system lack that level of quality to ensure that things are on track? If our country can not assure its people of their shelter, we really wonder on what earth we are going to ask our people to achieve the much ambitious “Wawasan 2020”. It is same as the water issue, many know that the quality of the water here is horrendous and one knows the importance of water to one’s health. If the water is not clean, how do you expect our people to stay healthy to be competitive?

I think I have to repeat what American Presidents like to say but with slight changes : God Bless Malaysia.


p/s: the picture was googled out somewhere from the Internet. Not taken by me.