Tuesday, July 22, 2008

A Quick “Q&A” styled Risk Assessment Of Select Current Events

Q: What will happen to the gasoline prices once a hurricane hits anywhere near the oil refineries?
A: It will go up. Even if the hurricane misses the oil refineries, any close call will result in a decrease production of oil distillates. This is a normal precautionary measure taken by the refiners as they move employees out of danger and reduce the pressure within the pipes. If the hurricane hits the refineries directly, do expect to see a repeat of another immediate $0.30 to $0.40 per gallon spike. In case of a near miss, a rise of $0.05 to $0.10 could occur.

Q: Will the new President put his emphasis first on the economy or the war?
A: As it was in 1992, when a the incoming President had to focus attention on the economy (remember the slogan: “It’s the Economy, Stupid”?), the newly elected President will, once again, have to clean up after a Bush and focus most of his attention on reviving the economy.

Side note: Isn’t it interesting to note that after the Presidency of both George Bushs, we are left with a stagnant economy, large deficit ($290 billion in 1992 and $268 billion as at July 11), and having to pay to rebuild the armed forces after a Gulf War (1992 estimate, here). Like father like son.

Q: Will Ford or GM survive to see 2010?
A: Their respective cash burn rate is alarming. According to BusinessWeek, “GM burned through $6 billion in cash from the end of October [2007] to the end of March [2008].” This is a burn rate of approximately $1 billion per month. With about $24 billion as of March 2008, GM may be able to just squeak into 2010 with just enough pocket change. However, along the way, look for GM to jettison various units and cut payroll continually. This is analogous to the occupants of a falling hot air balloon trying to lighten the ballasts to stay afloat.

As for Ford, analysts think that they are in a better shape. According to JPMorgan analyst, “…Ford's 2008 cash, marketable securities and loaned securities will decline by $10.9 billion year over year to $23.7 billion." By the end of 2010, this is expected "to decline to $9.5 billion by the end of 2010." However, given their overweight and dependence on trucks and SUVs, Ford may be a bigger disappointment.

Q: Will Citigroup stay as a financial supermarket or be broken apart and realize its value?
A: The 10-year Sandy Weill’s experiment of trying to run a vertically integrated financial supermarket has been proven to be a failure. The market realizes this. I hope Pandit realizes this as well. Its parts are indeed more valuable than the whole. Having been a part of the Citi culture, I can attest to the difficulty management faces in trying to make all of its pieces fit together. The future of Citi lies with separating itself into four separate businesses: SmithBarney Asset Management, which can easily fit with Merrill Lynch or Charles Schwab; Consumer Banking and Cards (the true retail bank unit); Citi should revive the Salomon name and make it a stand-along Investment Bank unit; and the Global Wealth Management unit, which holds the core of the private bank businesses. However, I am only thinking out loud, just like the Union (American Federation of State, County and Municipal Employees Union, that is).

Q: Will the Federal Reserve fight to tame inflation or will it fight for growth?
A: They should try to fight to tame inflation. The operative word here is “try” as they have a long way to go if they really want to lower the price shock to the American consumer. Unfortunately, the “sticker shock” is only beginning. Companies have been holding back raising their prices for a while and they can’t hold it back any further. As more and more companies begin passing the higher costs of raw materials, expect to see the core CPI numbers to shoot up.

What will the Fed do? They will try to something that would be a good imitation of the Keystone Cops.

Q: Will the real estate market recover?
A: Yes.

Q: Will the new bankruptcy law help to keep people from filing for BK chapter 7?
A: No. The new bankruptcy law is not so new and, while it is not friendly to consumers, it has not prevented people from filing for bankruptcy. In fact, according to the U.S. Courts’ bankruptcy filing statistics, BK filing increased 29.7% for the 12-month period ended March 2008 from 12-month period ended March 2007. While the total number of filings of 901,927 as of March 2008 is below the high water mark of 1.6 million filing set in 2004, the trend is very disturbing. (Click here for a historic trend of BK filings from 1986 to 2003.)

Ed Kim
Practical Risk Manager

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