Saturday, March 8, 2008

Note To My Readers Regarding The Random Musing

Just to change the pace a bit, I am introducing a short article from time to time – either in conjunction with an article on risk analysis of current events, economic trends, or as a stand-alone – particularly on the weekend when most people’s attention shift from making money, or attempt at making money, to more recreational thoughts. On Sunday evening, EST, I will write the first risk analysis piece of the week so that my readers on the other side of the world, who starts their Monday earlier, will be able to enjoy a new article of weighty proportion.

I thank all my readers; and if you like my topics and/or analysis, then do tell your friends and share the knowledge. Have a great weekend and enjoy the first of the series of short articles.


The Random Musing is meant to amuse, pique curiosity, and add a bit of controversy by looking at issue from a completely different perspective. If you emote after reading the Random Musing, then it is working.

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Random Musing Of The Day

Is the Kyoto Protocol another attempt by men to mess with nature under the guise of being environmentally correct?

Here are the facts:
§ The Kyoto Protocol ends in 2012. After that there is no specified targets for greenhouse gases. Does that mean that all countries are able to go all out burning fossil fuel, particularly coal?

§ The objective of the Kyoto Protocol to the international Framework Convention on Climate Change is to reduce Greenhouse gases that cause climate change.

Is that a good thing? After all, nature, all on its own, has been changing the global climate, oscillating between periods of ice age and periods of tropical forest for billions of years. Heck, nature even reversed the magnetic poles all by itself.

If we want to reduce carbon emission, should we limit human population?
Here are the facts:
§ A person's exhaled breath is approximately 4.5% carbon dioxide by volume.

§ An adult respires 500 ml of air per breath and normally takes 12 to 20 breaths a minute.

§ Estimated world population as of February 2008 is 6.7 billion. Of this approximately 27% are children below the age of 15.

§ 29.57 ml = 1 ounce

§ 2,204.6 pounds = 1 metric ton

Few Guesstimations:
§ Child’s breath is 50% of an adult, or 250 ml per breath

§ Women’s breath is 80% of men, or 400 ml per breath

§ Adult population is evenly divided 50%/50% between man and woman

§ Average breathing rate of 16 breaths per minute, based on the respiration range of 12 to 20

Based on the facts and a few assumptions, here is the annual output of CO2 by the world’s population:
962.6 billion metric tons
The total CO2 output by World energy related emission: 26.9 billion metric ton

Since the world population’s respiration generates more than 3,579% of CO2 emitted by all fossil fuels, to truly limit CO2 emission in to the air and reduce the greenhouse effect, we should start limiting the World’s population. This will also help to reduce global demand for fossil fuel and other resources, and thereby further reducing CO2 emission.

I think the members of OEDC know this as their population growth is slowing. Good job guys; keep it up. The world is depending on you.

Cheeky Regards,
Ed Kim

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Friday, March 7, 2008

At $105 Per Barrel, Is Oil Overpriced? It All Depends.

The price of crude oil closed at $105 yesterday, a record new high. As the price of oil continue to climb, people are questioning if the price of oil will continue to rise. Already traders are betting on the price of oil reaching $125 by December 2008, as evidenced by the recent options market activity.

While there are groups of economist and financial managers publicly stating that the price of oil is already too high, that may not be the situation.

Risk of Thinking Inside The Box (i.e., only considering the price of oil in U.S. $)
Since February 2002, the U.S. dollar has declined 76% against the Euro. The dollars to Euro exchange rate on February 1, 2002 was $0.859 to 1 Euro. As of Wednesday, this exchange rate was $1.512 to 1 Euro. Given that oil is priced in dollars, the falling dollar is also a major factor to consider when determining if the price of oil is too high.

Source: LA Times

When one considers the price of oil in Euros, the price of oil has risen much less than when considered in dollars. In February 2002, the price of oil was $18.88 per barrel (or € 21.69, based on €1.149, 28-day average exchange rate). Converting the closing price of $105 to Euros, equates to € 69.44, based on conversion of $1.512 per €1. So the increase in U.S. dollars from $18.88 to $105 is a whopping 456% price increase in five years. However, when calculated in Euro, the price of oil rose by 220% during the same period. While this too is a large increase, it is much less than currently reported in the media.

So, it is only logical for the Saudi Oil Minister and other members of OPEC to consider moving away from the dollar peg and adding Euro pricing.

The Risk of Pricing of Oil in Euros
If the dollar continues to fall in value versus major currencies such as Euro, Yen, and Pound, it will have dire consequences for the U.S. economy. if OPEC begins pricing oil in Euro, we will see spikes in gas, oil distillate, and manufacturing prices in the U.S. Given that the U.S. economy is in a recession and may face slipping into a depression, this is a possibility that we should take into account. Should the U.S. slip into a depression, the Fed would have to continue lowering the Fed rate, perhaps down to 1% or even match Japan’s 0.5%. If that occurs, the falling value of the dollar against other currencies would accelerate.

The Risk of Assuming that Dollar is Still Global Standard
Not too long ago, the global currency was the British Pound. This Pound Sterling standard began to lose its luster shortly after World War II, beginning with the Bretton Woods system of monetary management. In the 1970’s the global currency began to drift toward the U.S. dollar. While we in the U.S. still believe that the U.S. dollar is the global standard, a recent study on the Euro versus the Dollar by David Cobham of Heriot-Watt University, Edinburgh seems to indicate otherwise. In his draft report dated May 2007, Professor Cobham concludes

“…more countries anchor consistently to the euro than to the dollar; this is not because more countries than expected anchor to the euro, but because less countries than expected anchor consistently to the dollar.”

If Professor Cobham’s study is correct, then it is not too long before OPEC begins pricing oil in Euros.

The Long Term Risk of Rising Oil Price and Pricing of Oil in Euro
If the geo-political instability in oil producing regions and the War in Iraq continue, the potentiality of the price of oil will continue to increase. Additionally, this will have a direct affect on the prices of gasoline and oil distillate. It would not be long before the price of gas will reach and perhaps go above $4 per gallon by 4Q 2008 and even begin approaching $5 per gallon by early 2009. As trucks move majority of raw and finished materials in the U.S., this will also cause inflationary pressures on price of all products. In a word: stagflation. The repercussion of price inflation coupled with weakening economy will lead to a vicious downward spiral culminating in a severe depression not seen since the Great Depression of 1930’s.

May your trading be profitable.

Ed Kim

DISCLOSURE: The author holds long positions in Oil Refining Companies at this time

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Thursday, March 6, 2008

Which Way Will The Price Of Oil Go From Here?

As the price of a barrel of oil reaches new record high, there are two distinct groups of thought: one group asserting that the price of a barrel of oil will go to $125 by the end of 2008 and the other asserting that the price of a barrel of oil is too high and will go back down to $60 to $80 range.

Given that each groups’ assertions have support among well-respected economists, how can you monetize these disparate data sets?

Risk Manager’s Analysis of Crude Oil Price
All the articles I have read on the price of a barrel of crude oil contains speculative opinions on where the price of a barrel of crude oil will be in the near future. Now, there may have been analysis performed but that data is missing from the articles, leading an investor to either pony up tens or hundreds of dollars to buy their analysis report. Well, to save you a few bucks and to give you something to think about, here is my analysis on the price of a barrel of crude.

Historic Data Analysis
BP (BP p.l.c. and BP America Inc.) has a wealth of information on their website on oil prices, from which the data and charts for this analysis were obtained. Using the data obtained from BP’s website, here is the analysis of the historic oil price relative to production and refinery through-put, cross-index with major economic event timeline:

From the chart of crude oil prices up to 2006, indexed to major economic events, the biggest spike in the price of crude oil occurred in the late 1970’s with the Iranian revolution. The thought of Iran, a major source of oil to the U.S. and with 11.4% of the proven oil reserves, at the time, being controlled by a hostile government shot the crude prices to $65.14 per barrel in 1980 ($90.46 in 2006 dollars).

The price of crude oil collapsed in 1986 when Saudi government introduced the "Netback price" as a way to stop other OPEC members from selling their crude below officially posted price. (The netback pricing effectively is where the seller charge the market rate for crude oil instead at the officially posted price.) This drove the price of crude down to a low of $14.43 in 1986 ($26.45 in 2006 dollars).

The price of crude went up in 1990 to $23.73 per barrel ($36.76 in 2006 dollars) when Iraq invaded Kuwait, which holds 8.5% of proven oil reserve. However, this changed with the U.S. invasion of Iraq in 2003. Since then the price of a barrel of crude steadily climbed to our record levels.

Chart Source: BP Global - Reports and Publications - Oil Prices; Chart URL

Recent Price Drivers (Factors)
1. Cost of the Iraq War: According to the National Priority Project’s calculations, the monetary cost of the Iraq war is approximately $245 million per day with over $500.2 billion spent so far. This cost has strained the U.S. national budget, leading to other domino effect.

2. Increased National Debt: From the combination of funding the war in Iraq, additional spending in military build-up, and pumping the economy through tax cuts and rebates, the national debt went up from $5.67 trillion in 2000 to $9 trillion as of 2007.

3. Diminishing Value of the Dollar: As a consequence of the War in Iraq, increasing national debt, and lowering of U.S. interest rates, the overall sentiment in the international community toward the U.S. has increasingly grown negative. Since the dollar, like other currencies, is fiat money, the value of the U.S. dollar has been dropping against other major currencies such as the British pound and the Euro as foreign investors seek to diversify out of the dollar in search of better returns. Since OPEC pegs the price of crude in dollars, this has a direct effect on price.

4. Increased Demand for Oil worldwide: As countries around the globe, particularly China and India, continue their economic growth, their appetite for commodities, including oil, have increased, driving up the price. The import of oil by countries outside of the U.S, Europe, and Japan, has grown from 28% of the world’s total import in 1990 to 38.6% in 2006, a 37.7% overall increase in oil imported by the rest of the world since 1990. (Source: BP Global - Reports and Publications - Oil Prices)

5. Speculation by Traders: Traders seeking a source of positive return in a sea of red numbers have latched on to commodities as a way to profit from the slowing U.S. economy and uncertainty in the Middle East. It is Economic 101: simple demand and supply of oil. Supply of oil is relatively inelastic and finite (the caveat: new reserves of oil may be identified in the future, increasing the supply.). Moreover, its price is highly volatile, making it a great vehicle for traders to speculate in. Since OPEC produces more than 43% of the world’s crude oil, any bad news out of the Middle East will drive up the price of crude. This is now true for Venezuela, with its proven reserve of 6.6% of world’s total oil reserve and 3.5% of world’s total oil production threatening Columbia.

So, Where Does it Go From Here?
Price Floor: Saudi Oil Minister Ali al-Naimi stated that oil price will not fall below $60 to $70 range since the production cost of alternative fuels has a threshold of $60 to $70.

Assuming the price floor of $65, a midpoint of Minister Naimi’s range, then the difference of it and the current oil price of $104, or $39 per barrel, may be largely due to a combination of speculation and increased global demand.

If the current world geo-political situation does not change, then the price of crude oil will rise due to the increasing demand worldwide for oil. Traders are now betting that oil will reach $125 per barrel by the end of 2008.

If OPEC reverses itself and increases production, the current geo-political trend in the Middle East continue, the current tension in Latin America settles down, and/or U.S. begin larger pull-out of troops from Iraq, then the price of oil could come down to more realistic levels.

Ed Kim

DISCLOSURE: The author holds long positions in Oil Refining Companies at this time.
Legal Note On BP data and charts used in the article: All rights in the content used herein, provided by BP p.l.c. and/or BP America Inc. (collectively, “BP”) is the property of BP or its third party suppliers and contributors.

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Wednesday, March 5, 2008

TSA – Security Is An Illusion But The Costs Are Real

Since Mr. Bush federalized the airport security guards and made it a part of the Department of Homeland Security (DHS), the airport security system has evolved into a large governmental organization consisting of 43,000 employees of the Transportation Security Administration (TSA)[i].

According to the TSA, they are to “…protect the nation's transportation systems so you and your family can travel safely. We look for bombs at checkpoints in airports, we inspect rail cars, we patrol subways with our law enforcement partners, and we work to make all modes of transportation safe.”

Unfortunately, TSA has not been living up to their ‘mission’ of protecting the nation’s transportation systems. The latest study released by GAO titled AVIATION SECURITY, Vulnerabilities Exposed Through Covert Testing of TSA’s Passenger Screening Process in November 2007 (hat tip to Bruce Schneier of Schneier on Security), revealed that TSS had failed to detect bomb components in series of tests conducted at 19 airports in March, May, and June 2007 (page 8). Or as LA Times reported in its report, Airport screening tests reveal major security flaws,[ii] that there were allegation of cheating on the test where TSA agents in some airports were tipped off to the test. Even then, they failed.

This series of tests only confirms what the general public had known for a while that the TSA is totally INEFFECTIVE at identifying potential threats. In fact, TSA has been failing the security tests since 2002. USA Today reported back in September 2002 of TSA failing to detect threats at 32 airports[iii].

So How Much Are We, the taxpayers, paying for this “Security?”
According to the OMB FY2008 budget[iv], the budget for TSA is $6.4 billion for FY2008, a 6.5% increase from FY2007 of $6 billion. So, we are spending $6.4 billion for a security system that has continually failed inspections. WHY?

What Are Our Alternatives?
The risk of future terrorist attack on the transportation system is very high and quite real. I do not discount the need to provide the highest level of security possible. However, there are smarter and better ways of securing our transportation systems. Without belaboring the point, Airport Council International (ACI), an association of airport operators worldwide, has published a very good overview of the current security shortfalls and their recommendation for improving airport security in their Three-Part Improvement Strategy[v]:

1. Introducing an element of uncertainty or surprise to the pre-boarding screening process

2. Use profiling techniques to focus the screening efforts on the passengers that may present the higher risk

3. Increasing the use of explosive detection equipment (some of these explosive detection equipments are already in place in select airports around the world.)

Risk Analysis of Our Airport Security Features
We know from the ACI paper that the current airport screening system has not changed much since 1970’s and there are a lot of great technology out there that can be implemented right away at all major U.S. airports. So what are the risk and rewards of status quo versus quickly adapting new and better technologies?

Risks of current system: Continued failure to detect and prevent introduction of improved explosive devices and their components on to airplanes.

High Cost of a Single Risk Event:
1. Current TSA infrastructure cost of $6.4 billion per year

2. $2.7 billion in compensation (based on Pan Am Flight 103 compensation from Libya[vi])

3. $141 million for a Boeing 767-300ER[vii]

For a total risk event cost of approximately $9.2 billion, based on a single airplane incident.

Relatively Low Cost of Implementing New and Better Screening Technologies:
A. $180,000[viii]: Smith IONSCAN SENTINEL II, a non-contact, walk-through screening device for explosives or narcotics[ix]

B. $60,000 "millimeter wave" device[x] from Brijot Imaging Systems, which can senses and analyzes the density of energy radiated by humans and concealed weapons. The device can capture images from as far away as 45 ft, with maximum detection time of 0.3 sec

C. $300,000 COBRA system[xi] from Analogic, which can check carry-on bags for explosive and weapons, using CT scanning technology

While there are a total of 19,960 airports in the U.S.[xii] – 5,233 public and 14,757 private – only 567 are qualified under Part 139 Certification as of January 2008. This means only 567 airports serve typical commercial flights[xiii].

I. Upgraded screening package consisting of a Smith IONSCAN SENTINEL II, "millimeter wave" device, COBRA system, a single entry screening package is $540,000.

II. 2,000 packages for each of the 47 largest U.S. airports[xiv], 200 packages to the remaining 325 Class I airports[xv], and 20 packages for the remaining 195 Class II-IV airports.

Based on the assumptions and the data, the total estimated cost of upgrading all 567 commercial airports to the latest passenger and carry-on screening is approximately $1.2 billion. Double this amount to account for installation and integration into the existing x-ray machine and metal detectors, and we get a grand total of $2.4 billion.

Risk Recommendation
Based on this analysis, we could install the newest passenger and carry-on screening system in all 567 commercial airports and revert majority of the TSA security functions back to the airport operators and airlines. This will result in continued annual cost savings of the $4 billion (TSA budget of $6.4 billion less the upgrade estimate of $2.4 billion)

1. All airports will have the latest screening systems

2. For added protection, the DHS can work with the airport authorities and local police to monitor the airports

3. The latest screening systems will reduce the long wait time at pre-boarding check-in

4. The latest screening systems will also allow DHS to focus on other surveillance functions, including enhancing their Screening Passengers by Observation Techniques (SPOT) program

Will The Government Make any substantive changes?
Don’t hold your breath. It has been more than six years since the 9/11 incident and only a handful of airports have some form of the latest screening systems[xvi]. So in the meanwhile, if you need a job, stop complaining and find out if you are qualified to be a TSA security officer.

Hey Who Wants To Be A TSA security Officer?
You can get started with this NBC interactive test: MSNBC Airport Security Screener. And if you like to join the force, you can look for jobs on the government job site[xvii]. The salary of a TSA security officer is ranges from $24,400 to $36,600[xviii] and supervisor’s pay ranges from $68,300 and goes to $105,900. So for a government job, this is pretty good.

Ed Kim

DISCLOSURE: The author is Long on “Common Sense” and heavily Short on Collective Idiocy.
[viii], page 6
[xvi] and

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Tuesday, March 4, 2008

The Real Deal On The Real ID Act

The following is a dramatic monologue set as a Q&A between John Q. Public and the Risk Manager on the Real ID Act:

Q: What is this about the Real ID?
A: The REAL ID Act of 2005 set federal standards for state-issued driver licenses and non-driver identification cards to board a federally regulated airplane, access a federal facility or nuclear power plant.

Q: OK, I can understand that but why is this an issue?
A: The federal minimum standards for state-issued driver's licenses or personal identification cards requires states to substantially modify their operations for issuing driver licenses and non-diver identification cards, thereby increasing costs.

Q: The cost of printing and issuing new driver's licenses or personal identification cards seems to be peanuts, so what’s the problem?
A: While the cost of the physical card may be about $1 to $2 per card[i], there is the cost of upgrading the existing computer systems and operations as well as re-training the employees. A September 2006 report presented jointly by the National Governors Association, National Conference of State Legislatures, and American Association of Motor Vehicle Administrators estimated that the cost to the states to meet the Real ID requirements was $11 billion[ii].

Q: OK, $11 billion is a large figure but can’t the states suck it up and take the hits?
A: According to the study, there are an estimated 245 driver's licenses or personal identification cards, nationwide. This comes to $45 per license or ID card. Some states have issued more licenses and ID cards. The cost to the states is not proportional.

Q: Well, how about passing the cost to the license and ID holders? I would.
A: In addition to the cost to the states, there are costs to the license and ID holders. All license and ID holders will need to bring additional proofs of identification and go through the whole ID verification process. Since the verification process will be more involved, you may have to wait on an extra long line, and may have to take a day off to do it.

Q: Boy, I can’t afford to take a day off from work. My pay is just barely making ends meet as is. Isn’t there a way to do this by mail or through the Internet?
A: No can do. The Real ID Act is specific on the need for the states to physically re-verify your address, identification, re-take your picture, and obtain new signatures.

Q: This sounds like it is going to cost a lot and cause major SNAFU. Why is it necessary?
A: Ah, now you are asking the RIGHT QUESTION. The real deal with the Real ID is motivated by the need to improve our overall homeland security, especially the ports of entry to the U.S., transportation, and government facilities.

Q: I don’t get it. How is my getting a new driver’s license card and my daughter getting a non-driver personal identification card going to help homeland security?
A: Here are the official lines from the Department of Homeland Security (DHS) FAQ pages[iii]:

“State-issued driver’s licenses serve many purposes in today’s society, including being the primary identifier for individuals attempting to access a Federal facility, board Federally-regulated commercial aircraft and enter nuclear power plants. Terrorists know this, and actively seek this form of identification. For example, eighteen of the nineteen 9/11 hijackers used driver’s licenses or similar identification to board planes which they used to kill thousands of innocent civilians. Many of these credentials were obtained through fraudulent means.

Additionally, these documents provided the terrorists with cover to operate freely within the United States by allowing them to open bank accounts to draw down funding, rent places to live, rent cars and board planes. Having secure identification is an important step toward enhancing national security.

REAL ID will help cut down on identity theft. The program accomplishes this by establishing layers of security to ensure that identity documents only go to the people they actually belong to. This is achieved through increased security, including: physical security features on the credential itself; tightening DMV practices and procedures for the production and issuance of the documents (security plans and background checks for employees, for example); and verifying the information presented on source documents presented at the time of application through enhanced verification systems. REAL ID also mandates that a State cannot issue a REAL ID license to a person who holds a license issued by another State or to an individual who already holds a REAL ID card. REAL ID will make it more difficult to steal other people’s identities and use them to obtain driver’s licenses.”

Q: How is that going to stop a terrorist? I mean, wasn’t some of the terrorist homegrown? Look at the Oklahoma City bombing, David Koresh and the Branch Davidians in Waco, TX. Theodore Kaczynski a.k.a. The Unabomber, ; It was done by Americans[iv].
A: True, however, the real intent of the Real ID is to prevent illegally entered individuals from obtaining U.S. driver licenses and identification cards.

Q: Getting past all of this politics, what’s going to stop those individuals who present fake IDs at the time of getting their license. Like the Social Security Administration issuing approximately 8% of 100,000 social security cards in 2000 to people who presented illegally obtained documents or invalid immigration papers[v].
A: This is a concern not addressed by the Real ID Act. There are individuals who deal in fake social security cards, and fake birth certificates etc. If an individual can obtain a valid social security card by using fake documents, then the Real ID process is compromised.

Q: Alrighty, I am getting a bit smarter on this issue. So, let me get right down to it. Tell me if ‘m wrong. The reason DHS wants a Real ID qualified identification card is to prevent foreign terrorist who come into our country illegally with the intent of obtaining a valid driver’s license or identification card so they can board a plane or enter a Federal facility for nefarious reasons?
A: Yes

Q: So, tell me what is going to prevent these foreign terrorists from using their legal passports, once they are in the U.S.? How about these foreign terrorists obtaining legal passports from countries that have very lax security features and using these passports to board planes and enter Federal facilities?
A: Nothing.

Q: I thought as much. This is a multi-billion dollar boondoggle of trying to secure a bathroom window while the front door is wide open.
A: OK, I don’t know that that means. But in risk terms, the cost of requiring the implementation of Real ID Act will cost the states more than $11 billion and more than $9.8 billion in lost income by the 245 million driver license and ID holders (calculated at $8 per hour based on an estimated 5 hour long process).

Therefore, in risk terms, the upfront cost will be approximately $21 billion and large loopholes existing in other areas will largely compromise the intent, rendering the risk management value to be $0.

Or in layman’s terms, shell out $21 billion and get squat, nada, or a big donut hole.

No actors or animals were harmed in this dramatic dialogue. Any similarity to real or imaged persons is purely coincidental and should not viewed in any other way. If you should feel that the use of the name John Q. Public, in any way, caused you offense, then “Hey, get a life!”

Ed Kim

DISCLOSURE: The author is Long on Common Sense, which appears to be in short supply in Washington D.C.

[ii]}, pg 3.




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Risks From The Current Recession

The Guru of Omaha, Warren Buffet, stated yesterday that the economy is in a Recession[i]. Even Chairman Bernanke stated this in his February 27 Semiannual Monetary Policy Report to the Congress[ii] [bold and italics added for emphasis]:

“The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.

The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or a little above its longer-term trend and the unemployment rate edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish economic activity in the near term.”

There you have it. We are in a recession and we will not see any major improvements until 2010. As if there were any doubts, FDIC adds more gloom to the news, as noted by the Wall Street Journal report, FDIC to Add Staff as Bank Failures Loom[iii]:

“The Federal Deposit Insurance Corp. is taking steps to brace for an increase in failed financial institutions as the nation's housing and credit markets continue to worsen.

The FDIC is looking to bring back 25 retirees from its division of resolutions and receiverships. Many of these agency veterans likely worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed amid the savings-and-loan crisis.

"Regulators are bracing for well over 100 bank failures in the next 12 to 24 months, with concentrations in Rust Belt states like Michigan and Ohio, and the states that are suffering severe housing-market problems like California, Florida, and Georgia," said Jaret Seiberg, Washington policy analyst for financial-services firm Stanford Group.”

OK, we are now in a recession that will last a while and may see over 100 bank failures. But wait; there’s more:
1. Consumers are cutting back on conspicuous consumptions[iv].
2. Restaurants are also facing hard times with same-store sales declining and cost of material increasing[v].
3. With oil closing over $102 per barrel, the news that sales at the automakers are declining is no surprise[vi].
4. Companies are battening down for a long haul; the job market is drying up[vii].
5. Those who are still working are working longer hours to fill the gaps, resulting in sleep deprivation[viii].
6. U.S. manufacturing activity fell to a five year low[ix].
7. Independent truckers cannot make ends meet as fuel prices soar while demand for their services dry up[x].
8. Increasing prison population – 2.3 million as at end of 2007 – is increasing[xi]

Given These Data Points, Here Are The Risk Issues To Think About:
Adverse Impact On GDP:
As consumers begin to cut back on consumption, many businesses will experience lowered revenue stream, leading to cutbacks in service, reduced service hours, wage freeze, and, for some, eventual closures. Additionally, increased fuel price combined with higher raw material prices[xii] are leading to lowered profit for manufactures.

§ High risk of $422.5 billion reduction in GDP, based on 3% reduction of 2007 GDP of $14,084.1 billion[xiii]

§ Increase Stress On State and Local Governments: The combination of lower wages and reduced business revenues will result in lowered tax receipts for state and local governments. In rust belt states, increased unemployment and increasing foreclosure rates combined with house abandonment will lead to increase in vandalism, crime, and illicit businesses. This will increase the state and local governments’ outlay for public safety and correction.

§ High risk of $4.9 billion in additional correction cost, estimated at 10% of $49 billion expended in 2007[xiv]

§ High risk of $3.6 billion increase in unemployment insurance (UI), estimated at 5% of UI claim of 2.8 million as at February 16, 2008[xv] calculated at $1,000/person (my guessitimate) for 26 weeks (typical UI limit).

§ High risk of $38 billion in reduced tax receipts, estimated at 3% reduction on 9% of 2007 GDP, noted to be state and local governments allocation[xvi]

§ High risk of $21 billion in reduced sale tax receipts, estimated at 5% tax rate on 3% reduction of 2007 GDP (the estimated reduction in consumer spending, above)

§ High Risk of $23 billion in losses resulting from state and local governments modifying their bond obligations or even defaulting – estimated at 20% default rate with 5% loss from default on $2.3 trillion in outstanding muni bonds[xvii]

Lowered Federal Revenue:

§ With slowing economy and more people out of work, tax revenue is expected to decrease. Based on the above estimated decrease on GDP figures, there is a High risk of reduced tax revenue.

§ High risk of $63.4 billion in reduced tax receipts, estimated at 15% tax rate (blended estimate of personal and corporate tax rates) on $422.5 billion reduction in GDP.

The signs are out there and I have simply laid out some of the major risk issues and their potentials for losses. While the possibility of the above estimated losses is increasing, proactive efforts, jointly by private and public sectors, to mitigate these risk factors may help to reduce the severity of losses.

In the spirit of Damon Runyon’s quote – “The race is not always to the swift, nor the battle to the strong, but that's the way to bet.” – high risk of losses doesn’t always mean there will be one, but that’s the way to plan and act.

Ed Kim
DISCLOSURE: The author is Long Berkshire.
[iii] Wall Street journal, FDIC to Add Staff as Bank Failures Loom, February 26, 2008, by Damian Paletta
[xi] and

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Monday, March 3, 2008

Risk Assessment of the 2008 Presidential Race – Part 1

NOTE: This series on the Risk Assessment of the 2008 Presidential Race is a non-partisan assessment based on information gathered from the candidates' official websites, newspaper articles, and other reputable sources. All sourced materials are referenced within the article or as endnotes.

With the 2008 Presidential election about nine months away, I find myself entertaining the thought similar to an expectant parent: is it a boy or a girl? To help me understand the professional sentiment, I naturally turned to the odds makers. According to, the current favorite is Barack Obama at 4 to 7, meaning if Obama is elected President, a $7 bet on him will to win receive $4, or 57% return on a placed bet. John McCain is far behind at 3 to 2 (150% return):

Source: (as of March 1, 2008)

Naturally, everyone is interested in who will become the next President of the United States, since the fate of a $13.8 trillion economy hangs in the balance. As a risk manager, I am interested as well since the risks – Sovereign, Enterprise, and Business – facing the nation and the businesses, large and small, will be vastly different, depending on the eventual winner.

The Risk Categories Used for The Analysis: This analysis will limit itself to looking at the following top six (6) issues to reduce the complexity:

(1) Domestic Program Spending
(2) Economy
(3) Energy
(4) Foreign Policy
(5) Military Spending
(6) Taxes

Also, the analysis will look only at the three leading candidates – Hillary Clinton, John McCain, and Barack Obama – and their current positions on the selected issues. The candidates’ positions on the issues were obtained from their respective websites, NY Times, and

Risk Factors of the Top 6 Issues[i]

What Does All These Colors And Numbers Mean?

To read the above chart, first look at the issue and then read down the issue column to understand the levels of the risk factors that I have assessed for that particular issue. For example, for Domestic Program Spending issue, the following risk factors are important to the issue and require careful considerations: Domestic Tranquility, Economic Development, Legal & Legislative, National Revenue, Ongoing Operation, Resource Management, Science & Technology, and Strategic Planning. Security risk is germane but has a moderate negative impact to the Domestic Program Spending issue. Reputational, Foreign Investment and Industrial Competitiveness risk factors have low relevance to the Domestic Program Spending issue.

Each “High” risk levels have been given 15% weighting, “Medium” risk levels is 5% weighting, and “Low” risk levels is 0%. The total of each issue column equals to 100% weighting. The purpose of this forced weighting is to focus attention on the risk components that are deemed to be the ones that will cause the largest damages, if the issues are not properly addressed.

Translation, Please!
Again, using Domestic Program Spending, we look at the 2008 estimated U.S. Budget from the Office of Management and Budget[ii] Table 5-1. For 2008, the U.S. Budget is estimated at $3,013 billion. From this, I have deducted National Defense ($693.2 billion), International Affairs ($39.4 billion), and Energy ($2.8 billion) to arrive at an estimated total Domestic Program Spending of $2,278 billion. Applying the risk weighting, we arrive at the following breakdown of the $2,278 billion earmarked for Domestic Program Spending in 2008:

Now, we can look at each Presidential candidate’s position on Domestic Program spending and see if they had addressed it in any meaningful way to mitigate or manage the risk factors.

Next Time: Part 2 – Assessing the Risks of The Presidential Candidates

Ed Kim

DISCLOSURE: The author has not yet decided for whom to vote.

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Sunday, March 2, 2008

Charge: A Redux of the Past (1990 and 2001) Credit Card Loss Scenes?

Newspapers are reporting on the credit card problems faced by consumers with increased frequency. This issue was noted several months back by respected financial blogs, such as Mish’s Global Economic Trend. In his December 25, 2007 blog entitled Credit Card Defaults move to Forefront of Deflation Debate, Michael “Mish” Shedlock concluded that:

“It took a while, but now credit cards can be added to the growing list of problems. Rather than a single domino triggering a collapse, perhaps there is simply a sudden out of the blue implosion caused by too much debt with no possible way to service it.”

His conclusion, being echoed by the major media, correctly assesses the increasingly difficult financial landscape that consumers are facing. However, they are looking at this mounting problem from a consumer’s perspective. In looking at this issue from a business risk perspective, the picture is not any prettier.

Historical Background:
National Bureau of Economic Research[i] notes two recessions, each taking eight months from peak to trough, since 1990:

(1) July 1990 to March 1991
(2) March 2001 to November 2001.

Using the Federal Reserve Statistical Release statistics for credit card charge-off rates and total revolving charged amounts for the two recessions, one gain a sense of the size of the losses incurred by the financial institutions:

Sources: Total Revolving ( and;)
Credit Card Default % (

A Quick Assessment Of The Current Credit Card Issue:
Based on the most recent financial reports of the four major credit card issuing companies – American Express[ii], Discover Card[iii], Master Card[iv], and Visa[v] – and the latest the Federal Reserve Statistical Release statistics for credit card charge-off rates, even if the current charge-off rate remains constant at around 4.15%, the estimated losses by financial institutions using these four card brands may experience approximately $91.7 billion:

Notes:1. % of total receivable of $40.1 billion
2. FRB seasonally adjusted delinquency % (
3. FRB seasonally adjusted charge-off % (

How Badly Can It Get?
Former Fed Chairman Alan Greenspan noted the increased credit card uses in his speech, Understanding household debt obligations, at the Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C., on February 23, 2004[vi] [bold and italic, added for emphasis]:

Although it does not show the relationship conclusively, the Federal Reserve's Survey of Consumer Finances suggests that these newer homeowners who make smaller down payments tend to bring with them higher levels of nonmortgage debt and, in particular, credit card debt.”

Chairman Greenspan concludes by stating [bold and italic, added for emphasis]:

Another possible reason for rising credit card debt ratios is the use of credit cards for a variety of new purposes. The rise in credit card debt in the latter half of the 1990s is mirrored by a fall in unsecured personal loans. Reflecting this general trend, the proportion of personal loans in credit union portfolios has been declining as well. The wider availability of credit cards and their ease of use have encouraged this substitution. The convenience of credit cards also has caused homeowners to shift the payment for a variety of expenditures to credit cards. In sum, credit card debt service ratios have risen to some extent because households prefer credit cards as a method of payment.”

Recently, the USA Today article[vii] echoed this sentiment, More Americans using credit cards to stay afloat:

“Credit bureau analyses of consumer payment data show that financially squeezed borrowers have begun paying their credit card and car bills before their mortgages. That's a striking reversal from the norm, one that reflects rising desperation. It suggests that some people essentially have given up trying to stay current with their mortgages and instead are focused on using credit cards to squeak by.”

This trend of using credit card for daily expenses is going to increase as more companies including utilities and even mortgage servicers accept credit card payments. The current view is grim. According to Mark Zandi, chief economist and co-founder of Moody's Inc.: "Credit card quality will continue to erode throughout next year." [viii]

Additionally, if history is any indication, we may see further losses in our current environment:


Business Risk Analysis
Financial: Applying 6.83% default rate as our stressed maximum, calculated at 130% of 5.25% default rate as at 3Q 2001, to the current credit card use of $2,207 billion, the approximate total expected loss, industry wide, from credit card default is $150.6 billion. This will substantially impact earnings.

Reputational: As financial institutions continue to mitigate losses from credit card defaults, the use of more aggressive credit collection methods will increase, resulting in continued negative news reports on credit card lending practices and debt collection methods. This reputational harm will have repercussion on the financial, by manifesting itself in lower stock prices, and to internal stakeholders, by lowered employee morale.

External Stakeholder: Along with internal stakeholder risk, there will be increased risk of external stakeholders’ dissatisfaction, as expressed in either lower stock prices or higher P/E ration, or both.

Compliance: Pressured by their constituents, more politicians will try to enact or further enforce legislations, aimed at protecting the consumers, or hold hearings with financial institutions’ CEOs. This will increase the legal and compliance cost to the financial institutions, resulting from preparing and responding to legislative and media inquires.

It will be tough for financial companies for the next few quarters as they try to manage their credit card delinquency and charge-off rates. However, this too shall pass. Hopefully, financial companies are currently enhancing their brand strategy, readying themselves for the better times ahead.

Ed Kim

DISCLOSURE: The author holds no long or short positions in Amex, Discover, or MasterCard at this time.







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