We've Only Seen One-Third of Writedowns?

According to John Paulson, founder of the hedge fund company Paulson & Co., global writedowns stemming from the credit crisis may top $1.3 trillion, surpassing the International Monetary Fund's estimate of $945 billion. Who is Paulson, you ask? He's the guy who placed a bet on the speculative bubble in the sub-prime lending market, which has netted his fund a gain of a whopping 591% in the past year. This is the guy who saw the storm coming so you could say that he's got a fairly good insight into the breadth and depth of the sub-prime market.

$1.3 trillion in writedowns is three-times higher than the writedowns already reported. That's both a staggering total figure and worrying prediction for what the future holds for the global economy and financial markets. The U.S. economy has certainly taken the brunt of the immediate downturn, but as economic speculators are working diligently to maintain a positive attitude in the business press, the reality is that the downturn we've seen thus far is only the tip of the proverbial iceberg.

In a survey of hedge fund managers conducted at a meeting in Monaco last week, more than 80% said that the see the current credit crisis persisting for some time yet so Mr. Paulson is certainly in good company. Moreover, as much as 23% of those surveyed see the current situation worsening further before it gets better. What's interesting, is that it appears that these same hedge fund managers are watching the financial stocks like vultures circling; they waiting for the best time to buy the stocks that have been beaten-down by as much as half. If you're anything like me, then you will be watching the actions of these firms to insights into when, exactly, will be the right time to jump back into the banking waters where the opportunity appears to be astronomical.

Citigroup to shed $500 Billion; that 'B' for Billion!

In today's financial climate it's not particularly news to hear that a bank is writing down some assets. When its this scale, however, it tends to grab your attention.

Don't mistake my comments for criticism. I agree with other opinions on the matter that this is the right move for Citi's new chief, Vikram Pandit. A good rule of thumb for any investor is to limit their focus to only a handful of securities; you really can't properly monitor more than that and adequate portfolio management is key to long-term success. I see Mr. Pandit's actions as no different. He's consolidating. Here's a good summary of their reasoning for the move form this article:

...Citigroup executives did point out several shortcomings at the bank that need to be fixed, including organizational redundancies, a fractured corporate culture and waning market share in U.S. retail banking. And the company introduced a new slogan as part of its revamping efforts: "Citi never sleeps."

It's funny that people are actually concerned about Citi's resulting loss of its top-spot as the nation's bank; who cares! I'm not a shareholder, but if I was I wouldn't care about its ranking nationally or otherwise; I care about the bottom line. I care about what management's decisions mean for its earnings and how that will affect equity value. Period.

US Economic Woes & the Wealth Effect

The U.S. economy is suffering. The reasons for an economic slowdown are never singular, but a lot of what is happening in the U.S. today has to do with the credit crunch: the lack of liquidity in the financial system that results in less investment dollars available for the activities that usually grow the economy.  On a personal level, this has mean fewer dollar available for home buyers, which in turn has led in lower demand for home buying. The consequence... home prices are have been falling and continue to fall. The strange thing this, for folks like me over the border in Canada, we have thus far been insulated from much of it. How long can that possibly last?

The answer has a lot to do with what is known as the Wealth Effect in economic theory. The theory is about how people make decisions in spending (consumption) and saving (and investment). As home equity represents the bulk of people's savings, a decrease in the value of their homes represents a decrease in their net worth ...or wealth. Moreover, because the vast majority of homes are mortgaged financed, there is a leverage effect that further enhances this reduction in equity and wealth. In other words, the more home prices fall, the faster is the reduction in individuals' net worth and wealth. So, how does affect the economy?

As anyone's net worth (wealth) is reduced, there is a growing need to save rather than consume. Lower consumption means lower spending at stores, which in-turn results in the falling sales and layoffs that we've all be hearing about in the news. The increased savings, however, instead of making investment dollars more available, are flowing into highly risk-averse alternatives and avoiding more risky (read mortgage-backed securities) because of the many mistakes made by the folks on Wall Street. The result is that we have lower spending, falling sales and investment dollars available only to the safest possible opportunities ...not for those new home buyers with short credit histories and budding careers.

So, what about us Canucks over the border?

Well, if you go back to the concept of the wealth effect, then you can begin to appreciate how there will necessarily be an impact on the Canadian economy, but also understand that there will be a delay. The delay is the result of the time it takes for companies to recognize the slowing demand for their products and services and to react by cutting staff. This rising unemployment combined with falling wealth will drive even further reductions in consumption ...on both sides of the border. The U.S. is our #1 trading partner. The question is not whether it will affect us here, but when.