Saturday, April 12, 2008

Weekend Potpourri: Need A Job In Finance? Go East, Young Man

Needs Financial Job? Go East, Young Man
China Daily reported that China is facing a shortage of experienced financial staffers. What is ironic is that it is the foreign banks, who have expanded rapidly into China, are feeling the brunt of the shortage. As each foreign bank tries to capture a bigger piece of the market, or just trying to keep their toehold, they have resorted to poaching talent from each other. According to the article:

“In a survey by PricewaterhouseCoopers last year, 40 overseas banks polled said that finding and retaining good personnel was the second-most difficult job in the Chinese banking industry. Of the 40 banks that polled, 35 percent recorded annual staff turnover rates between 15 and 20 percent. Only a small group of large international banks have been able to keep that rate below 5 percent.”

So, if you are an experienced bankers, China is beckoning for you, since the survey indicates that: “Today [May 2007] the banks together employ some 16,752 staff but this number is expected to grow to 35,685 by 2010, a whopping 113% increase.”

Here are the latest survey results from for Hong Kong and Shanghai (click here for Yahoo currency converter):

Hong Kong Salary (in HK Dollars)

Shanghai, China Salary (in Chinese Yuan Renminbi)


Taiwan EPA: Eat Less Meat To Save Earth
Prompted by Kuomintang Legislator Lin Hung-chih’s question, Taiwan Environmental Protection Administration Minister Winston Dang urged consumers to eat less meat as a way to help reduce global warming:

“If a person eats no meat for one day, it can help to reduce carbon dioxide emissions by 7 kilograms, Lin pointed out. The opposition legislator therefore asked Dang to openly pledge to promote effective measures to save the world. In response, Dang said his administration will move in that direction by adding the measure to the EPA's list to protect the planet from global warming in the future as requested by the KMT lawmaker.”

So, if this goes into Taiwan’s EPA list, then there are going to be millions of Taiwanese who are going to be upset at their government for going to far with their regulations.

However, there is a problem with Legislator Lin’s figure of 7 kilograms of carbon dioxide reduced per person a day. According to the United Nations Food and Agriculture Organization report, 1,000 kg of animal biomass produces 4,522 kg of CO2 (see chart, below), or 4.5 kg of CO2 per 1 kg of biomass. So, in order to reduce CO2 emission by 7 kg per day, Legislator Lin Hung-chih is stating that an average Taiwanese consumes 1.55 kg (3.4 lbs) of meat a day. Now, according to the USDA Economic Research Service March 2008 report, a typical American ate 6.5 ounces of biomass equivalent (meat, eggs, and nuts) a day. So, if Legislator Lin’s figure is to be believed, then Taiwanese people must be the world’s biggest consumers of meat. And, they say we Americans eat too much.

China Unveils New 350 KPH Bullet Train
China Daily reported Friday that China has built their first bullet train, which can seat 557 passengers and is able to run at 350 kilometers per hour (218 MPH). This train will begin service on the newly built 120 kilometer (75 mile) Beijing-Tianjin route by August. Now, according to Railway Technology website, the Beijing-Tianjin route is only the first portion of the 17,000 kilometer (10,500 miles) of new railway. Once trains begin running on the Beijing-Tianjin route, it will cut the travel time to 30 minutes. This means that the trains will be running at an average of 240 kilometers per hour (150 MPH). Not top speed but much faster than what we have in the U.S.

So, what do we have in the U.S.? The fastest train that we have is the Acela train that runs along the Northeast corridor from Boston to Washington D.C. According to the Amtrak website, One can “Enjoy superior comfort, upscale amenities, and polished professional service — at speeds up to 150 mph — aboard Acela Express.” However, when I checked, the Amtrak schedule for Monday, April 14, for an Acela Express service from Boston to Washington, DC is estimated to take 6.5 hours. The distance is approximately 440 miles (704 km), so the average speed of the Acela on its route is 67.7 MPH (108 km). For a country that prides itself in innovation, when it comes to rail, the U.S. seems to be still talking about turn-of-the-century type of innovation.

Oh, by the way, the Chinese were able to build the 120-kilometer (75 mile) Beijing-Tianjin route in just two years. Just for comparison purposes, the AirTrain system, consisting of 8.3 miles (13.3 km) rail connection to JFK Airport took five years. Either we are very slow or the Chinese are super fast. (I think the smart money is on the Chinese.)

Have a Great Weekend!

Ed Kim
Practical Risk Management
P.S. I wasn’t intending on writing solely about the Far East, it just happened that way. EK

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Friday, April 11, 2008

Risk Analysis Of Global Grain Shortage

Major media around the world have increased their reporting on the shortage and increase prices of feed grains’ deleterious effect on developing countries. BBC News has an excellent, detailed coverage on this subject but let me present a small sampling of the local press, which reveals that the rising grain prices are not regional but truly global:

China Daily: “In a bid to curb inflation, which has been driven by high food prices, the government has been trying to contain the price of edible oil by releasing stocks from the State reserve and putting price restrictions on some oil products. The government has also been working to increase supply by giving more subsidies to producers.”

Chosun Ilbo (South Korea): “…some food and consumer products prices have gone up by a whopping 60 percent. The main reason for the increases is soaring prices of raw materials including wheat, corn, soybeans and oranges as well as oil.”

Philippine Star: “Analysts in Asia have warned that the Philippines, together with Bangladesh, where the poor currently spend around 70 percent of their income simply on food, will be among the first to be hit by rising global food prices.”

RIA Novosti: “Kazakhstan may introduce grain export duties or ban grain exports completely to protect the domestic market…Any grain export restrictions would be aimed at protecting the Kazakh market from grain shortages. Kazakhstan, which is one of the world's top five grain exporters and the world's largest flour exporter, last considered introducing grain export duties in March.”

RIA Novosti: “Russia banned on Monday grain exports to Belarus and Kazakhstan until April 30 in an apparent effort to stabilize domestic bread and flour prices.”

AP News (Egypt): “The bread crisis here in recent days has largely been fueled by the worldwide increase in food prices, which has pushed more people to rely on subsidized bread in an impoverished country where 20 percent of the 76 million population live on less than $1 a day. The result has been bread shortages and riots by customers waiting in long lines at subsidized bakeries.”

BBC News: “UN World Food Program (WFP) and other agencies may be forced to ration food aid due to shortages. Last week, the head of the WFP, Josette Sheeran, warned that global food reserves are at their lowest level in 30 years and that the rise in basic food costs could continue until 2010.”

Reuters: “Across the globe foods from bread to milk have become more expensive and in some countries helped fuel inflation. High prices for rice, beans and other food staples provoked food riots in Haiti this week.”

What Are The Culprits For The Global Food Price Inflation?
According to Reuters report, Jose Graziano, the UN food and farm organization's regional representative for Latin America and the Caribbean is blaming the “Global investment funds and the weak dollar”.[i]

However, The World Bank has a different theory: “Increased bio-fuel production has contributed to the rise in food prices. This has led to increased demand for bio-fuel raw materials, such as wheat, soy, maize and palm oil, and increased competition for cropland.”

“Numerous countries have set standards or targets for use of bio-fuels. The E.U. has set a goal of 5.75 percent of motor fuel use from bio-fuels by 2010. The U.S. has mandated the use of 28.4 billion liters of bio-fuels for transportation by 2012. Brazil will require that all diesel oil contain 2 percent bio-diesel by 2008 and 5 percent by 2013, and Thailand will require 10 percent ethanol in all gasoline starting in 2007. India mandates a 5 percent ethanol blend in nine states, and China is requiring a 10 percent ethanol blend in five provinces.”

BBC News, focusing on rice (but still relevant to other grains) theorizes that there are “Factors contributing to the price rise…”

  1. Poor harvests resulting from extreme weather
  2. A rise in demand in some rice-importing countries, where populations and incomes are growing
  3. The expectation of further price increases - resulting in hoarding
  4. Low stockpiles and a long term lack of agricultural investment
We may not fully know how the competing theories weigh in as being the “main culprit” causing the current food crisis until a few years later. Rather than one main culprit, it appears to be a combination of cause and effect started by traders seeking alpha from weak crop reports. However, all of the analyses agree that this is a global crisis that threatens each sovereign’s national food security. So the focus of this assessment will be on “What are the risks faced by exporting countries, importing countries, and the overall global community?”

Risk Assessment Of The Global Food Crisis
For Net Exporters Of Grain, the biggest question that they face is to whether to add to their stockpile or sell into the rising prices. Russia and China, two major exporters of grain, have already placed restrictions on exports and are stockpiling. Thailand and India, two major exporters of rice, may announce some restrictions in the near future. The U.S. may decrease its exports of grain to meet internal demands, especially that of biofuel.

If more grain exporting countries begin to limit exports, and/or more grain is diverted to biofuel production, then I think that the following risk events will increase in their probability of occurrence:
  1. Grain prices will continue to reach new price highs due to limited world supply (traders will be able to skew the market prices even further with their speculative trading)
  2. People will begin hoarding grain, leading to more shortage and still higher prices (self-fulfilling action)
  3. More countries will begin to experience bread lines (less developed and developing countries) or place a limit on the quantity that one may purchase at one time (developed countries)
  4. There will be sporadic shortages of grain based products, leading to localized panic, vandalism, and protests
  5. There will be reports of grain carrying ships being hijacked (especially in the South China Sea)
  6. Border tension and skirmishes between non-friendly nations will increase in frequency, scope, and duration
  7. Companies will begin substituting other vegetables for grain in their products (potato flakes for breakfast anyone?)
  8. Mass deforestation of vital rain forests and old growth forests to make room for more farmland (very bad move as it will cause more global climate imbalance)
  9. Global stagflation brought on by rising food and fuel prices coupled with businesses failures, mass layoffs and devaluation of the local currency (Nations will print more money (fiat currency) to pay for imports, which will cause rampant price inflation)
  10. Precious metal prices will set new highs
  11. More catalytic converters will be stolen for their content of platinum, palladium, or rhodium
  12. Global pollution levels will increase due to reduction in forest cover and production of more fertilizers
  13. Carbon credits will rapidly rise in value as more nations realize that they will not meet their limits set in the Kyoto Treaty
  14. Potential for a major outbreak of disease brought on by over farming, malnutrition, and increased pollution
Please note that the above risk events are my opinions based on the facts presented. I developed these opinions by asking “What would be the likely outcomes of current events, should they continue linearly in their present vector?”

The World Bank’s April 2008 report Rising Food Prices: Policy Options and World Bank Response does not paint a rosy picture of the global food shortage and rapid rise in food prices. The World Bank report’s conclusion is that “Food crop prices are expected to remain high in 2008 and 2009 and then begin to decline, but they are likely to remain well above the 2004 levels through 2015 for most food crops.”

While we in the developed countries bemoan the impact on our wallets, there are people around the world who bemoan the impact on their survival. As more families are forced to cut back on food, malnutrition will increase. This in turn will lead to increased incidents of major illnesses around the world. The overall effect of this will be series of grass root riots that will increasingly grow in size and turn more violent. With more frequent and violent protests, the probability is great that malevolent ideologists will use this opportunity to take control of some of the affected countries.

After all, history shows that the oppressive economic condition – first hyper-inflation, then stagflation, and finally a major depression, all kick-started by the Treaty of Versailles – lead to public discontent in Germany, which made it possible for Hitler and the Nazi party to come into power. This theme reoccurs throughout modern history. John Foran, Professor of Sociology at the UC-Santa Barbara, notes in his research on approximately 36 revolutions in the 20th century that economic change combined with stagnation or deterioration in basic quality of life are two major components of revolutions.

We’ve heard the adage that history repeats itself, albeit in a slightly different form. If we persist on staying the course on the current food shortage and its rapidly rising prices, then we are setting the stage for more revolutions to come. I hope that we do not come to that point.

Enjoy Your Weekend!

Ed Kim

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Thursday, April 10, 2008

Risk Update – Airline Safety

***4-10-08 UPDATE: MIDWEST AIRLINES ALSO FLIES MD80. As of October 2007, they had 15MD-80s (13 MD80s at the beginning of 2007 with two additional MD80s purchased in June and July 2007, according to the 10Q page 26).***

Avoid Booking Flights On MD80
Following up on my previous article on this topic, the FAA is now (finally) auditing the airline carriers to ensure that they have carried out the necessary inspection and maintenance called for in the FAA Airworthiness Directive (AD) for MD-80, effective September 5, 2006. All airline carriers flying the MD80 series planes had 18 months to comply with the directive. However, it seems that American Airline had not been fully compliant with the directive as they are canceling more flights on MD80 planes. It is a sad and disturbing testament that airline companies will only comply with FAA safety directives only with the threat of FAA audit and enforcement.

Those customers who have had flights cancelled should be outraged for two reasons:

  1. Their travel plans have been severely disrupted by American pulling MD80s out of service for inspection that should have been already done.
  2. Had they flown, their lives may have been in jeopardy since the FAA AD for the MD80s is a very serious one; one that can potentially cause the plane to explode.
How can you avoid flying MD80s? Before you book the flight, look for the plane that the particular airline carrier is flying for the flight. Most online travel service will identify the plane type. If you have already booked your flight, look at your flight confirmation / ticket for the information. If it not available, then you can go to a site like Travelocity’s Flight Status to check on the plane type assigned for your flight and also to check to see if your flight is on time or delayed.

Or, better yet, avoid booking flights on carriers flying MD80s until all MD80s have passed their mandatory inspections. U.S. carriers flying MD80s are: American, Delta, Northwest, and Allegiant airlines. Two major international carriers flying MD80s are Alitalia and SAS. (There are other international carriers flying MD80s, so check with your carrier for further information.)

The FAA audit of MD80 wiring inspection appears to be taking longer. USAToday is reporting that American Airline has yet to inspect 121 MD80s, which means that their flight disruptions can go into the summer months.

At this point, American Airline is losing more than money. It is losing money and customer loyalty; and rightly so. It is reprehensible for a company that is charged with ensuring safety of its passengers to willfully disobey a FAA AD that specifically called for proper inspections of wire bundles to prevent sparking a fuel explosion. They had 18 months to conduct the inspections and make the necessary maintenance from September 2006. By canceling flights now, well after the 18-month period, is an admission of guilt. As such, FAA should penalize American Airline for their greed and willful disregard for the safety of their passengers.

May your travels be safe and timely

Ed Kim

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Wednesday, April 9, 2008

Risk Analysis Update – What’s In Store For Real Estate

More Pains Ahead
Investors, like children in the back seat of a long car trip, keep asking “Are we there yet”. In the case of the investors, the ‘there’ is the bottom of the current down cycle. Unfortunately, the response to the investors is still the same as given to the children: “No, we are not there yet.” With IMF now weighing in on the overall size of the downturn, which it claims will last well into 2009, it would seem that we are still in the middle of the economic maelstrom.

So what are investors to do? In this article, the Practical Risk Manager will outline additional signs of the things to come, which astute investors can use in conjunction with their own due diligence to make their way through the current market. For my list of previous signs of things to come, click here.

More Signs Of Things To Come
Residential Real Estate

  • With the arrival of Spring, hopes of home sellers of being able to finally sell their homes springs eternal. However, their hopes will be dashed. As more mortgages reset off their initial teaser rates, more homeowners, who were already treading water, are going get more desperate. Their desperation will manifest itself in the following ways:
    • Offers of incentives will increase: more home sellers will offer free add-ons, including vacations and willingness to picking up all of the broker and closing costs.
    • Some homeowners will sweeten the incentives further with rent-to-own options. However, this is not the bottom. Once you start seeing more of “take over my mortgage and the house is yours” type of advertisement, then we have hit bottom.

  • Real estate advertisement will dry up substantially to a point of being nearly nonexistent. Number of pages of advertisement will go down to a page or even half a page. Not bottom yet. Shortly thereafter, there will be a flood of advertisement all offering one incentive or another, some even begging you to take over their mortgage and house. I would call this a ‘tsunami’ effect. (In a tsunami, the water will first go out to sea, leaving the beach high and dry and then the water will surge back in a torrent of water, sweeping everything it its path.)
Commercial Real Estate
In any economic down cycle, there is a trend of cause and effect. Commercial real estate is no exception. Here are the causes and effects of the economic slowdown on commercial real estate:
  • For smaller commercial properties: news of economic slow down affects consumers’ sentiment. Their reaction is to slow down on their purchases. This causes retailers and small businesses to suffer and go out of business, due to lack of sufficient business. As these small businesses go out of business, they will vacate their commercial spaces in strip shopping centers, class-B or class-C office spaces, and industrial/flex spaces. This will cause a reduction in the net operation income (NOI) to the commercial property owners. The overall effects of this cycle are increased delinquency and foreclosure of commercial properties, especially the ones that cater to marginal businesses, ‘mom-and-pop’ businesses, and small operations.

  • For large office properties: businesses will trim their workforce in response to lower profit forecasts. Large corporations will begin to reduce their middle management and operation support staffers, the layers that are typically targeted in any downsizing. The effect of the downsizing is the excess space.

    A good rule of thumb for an office space is 200 square feet of space per cubicle dweller and 400 square feet of space for an office dweller. (This accounts for the space needed for aisles, cabinets, pantry, etc.) So, in the case of Citigroup, with their layoff of 25,000 people, one can assume 50% office and 50% cubicle for an average of 300 square feet of space. Multiple this by 25,000 staffers will result in 750,000 square feet of space that Citigroup will no longer require, about the space in a major class-A building, as a result of its downsizing. Do the math. Large companies will consolidate their spaces, resulting in higher vacancy rates; leaving some buildings with large blocks of vacant space.

  • For shopping centers: in response to economic slowdown, retailers will curtail their expansion plans. As the economic slowdown worsens, retailers will start to close their less profitable stores, leading to increased vacancies at shopping centers, including major malls.
Overall, expect commercial real estate to lose their luster as increasing vacancies lead to falling rents. The above lists are just my views of where I think the real estate markets are headed. Therefore, I strongly encourage you to do your own due diligence.

May your investing be profitable!

Ed Kim

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Tuesday, April 8, 2008

Operational Risk Of HSBC Data Security Breach

The London newspapers were all abuzz yesterday with the news that HSBC had lost 370,000 customers’ data via the post (mail for the U.S. folks). According to BBC News:

"The HSBC banking group has admitted losing a computer disc with the details of 370,000 customers. The disc was lost four weeks ago after being sent by courier from the bank's life insurance offices in Southampton. The customers' details included their names, dates of birth, and their levels of insurance cover. However, there were no addresses or bank account details and HSBC said the customers' exposure to potential fraud was limited.

"We are looking into it and basically it has got lost from A to B," said an HSBC spokesman. "The reinsurer we sent it to is doing a thorough search for the disc. We will do anything we can to find it." "There are no financial details there in terms of banking details. There are no address details or anything like that," he added. As well as name, date of birth and value of the cover, the documents revealed only the customer's policy number and whether or nor the customer was a smoker.”
HSBC is claiming that customers’ exposure to potential fraud will be limited. I think that that ‘limit’ will be determined once the investigation has been completed. However, if the disc fell into the hands of professional identify thieves, the potential for fraud will not be limited.

Operational Risk Analysis
  • Fact 1: HSBC’s wire service was ‘down’ on the day of the delivery, according to Financial Times
    “HSBC usually employs an electronic wire service to transmit details to its reinsurers but it had to use the postal service because the wire service was not working that day.”

  • Fact 2: Customers’ data, while password protected, was not encrypted.

  • Fact 3: Disc containing customers’ data was sent by Post
    “The bank said a computer disc had gone missing after it was sent via Royal Mail Services…"

  • Fact 4: The disc was lost about four weeks ago, according to the Guardian:
    “The disc went missing around four weeks ago after being sent with an external courier from the group's offices in Southampton to a reinsurer [Swiss Re in Folkestone].”
Basel Levels 1 And 2 Loss Event Categories And Violations Identified
Potential operational risks, based on the above facts, would fall into the following Basel loss events:

Level 1 - Business Disruption & Systems Failures
  • Level 2 - Systems – (Utility outage / disruptions) By having the electronic delivery system go down on the day of the delivery, HSBC is in violation of its own Business Continuity Plan (BCP), which stipulates that the business should have redundant backup systems at ready, in case of primary system failure. BCP also stipulates that the continuity plan be tested regularly to ensure implementation at a moments notice. This initial failure set in motion for the loss of customers’ data.
Level 1 - Clients, Products & Business Practice
  • Level 2 - Suitability, Disclosure & Fiduciary – (Fiduciary breaches / guideline violations) By failing to encrypt the disc data, HSBC violated its own data security policy as well as guidance issued by the Information Commissioner's Office (ICO), which recommended that all information must be encrypted before being physically moved by disk or memory stick.” This subsequent failure contributed to increasing the potential for data being exploited by identity thief.

  • Level 2 - Suitability, Disclosure & Fiduciary – (Breach of privacy) By losing unencrypted customers’ data, HSBC may be in violation of The Data Protection Act of 1998, which stipulates that organization have appropriate measures against accidental lost of personal information.”

  • Level 2 - Monitoring & Reporting – (Failed mandatory reporting obligation) By waiting four weeks before notifying the authorities of the data loss, HSBC may be in violation of other data security regulations and their own internal policy for prompt notification of serious operational breach.

  • Level 2 - Customer / Client Account Management – (Negligent loss of client assets) Regardless of how the data was lost, the simple fact of loss is an operational risk.

  • Level 2 - Vendors & Suppliers – (Outsourcing) By using an outside delivery method, HSBC lost control of the data and method for tracking its transportation to the proper counterparty.
Loss From Identified Risk Events
Why HSBC would send a disc full of customers’ data unencrypted by post is anyone’s guess. What is certain is that HSBC will be fined for their negligence. In similar data loss cases, the Financial Services Authority (FSA) fined Norwich Union £1.26 million in December 2007 for “not having effective controls in place, enabling fraudsters to get hold of customers' details and cash in £3.3 million of policies.” FSA also fined Nationwide £980,000 in 2007, after a “laptop containing confidential customer details was stolen from an employee's home in a domestic burglary” in August. Based on these precedents, it is possible that HSBC will face a hefty fine in the range of Nationwide.

While HSBC is cooperating with the investigation into the loss of data, the fact that it took them nearly a month before disclosing the loss is suspect. However, without additional details on how the data was lost in transit, it is suffice to state that the facts so far disclosed to the public is sufficient to indicate that HSBC had serious breach of the Data Protection Act and internal data security policies. Most likely the person who authorized the sending of the data via post will lose his/her position. Right now, HSBC internal Operational Risk and Compliance departments are performing “deep dive” exercises to ascertain the “root cause” of the cascading operational risk events, and drafting “corrective actions” to mitigate a repeat of a similar incident. Having been there and done that, I wish them well.

For more information on Information Security, look into Inforsecurity Europe 2008 event to be held in London.

Ed Kim
DISCLOSURE: The author holds no positions in HSBC at this time nor is affiliated with Infosecurity Europe or The SANS (SysAdmin, Audit, Network, Security) Institute that is sponsoring the event

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Monday, April 7, 2008

Risk Analysis Of The F.D.A.

Again the media is all a buzz about the many shortcomings of the FDA (Food & Drug Administration) and its inability to prevent faulty drugs from being sold to the public or even withholding viable drugs from the market, due to politics. This has been an on-going problem as Dr. Henry I. Miller, a former FDA official (1974 to 1994) and a fellow at the Hoover Institution, wrote in his February 2008 letter to the NY Times’ Editor:

“Although it’s true that the Food and Drug Administration lacks “enough money or enough skilled scientists to do its job,” more resources alone are not the answer. The agency’s most significant problems are mismanagement and a culture that is excessively risk-averse. According to a 2006 survey of biopharmaceutical companies’ views of F.D.A. oversight…more than half said that the F.D.A. “needs the most improvement” in “risk-based decision-making,” which is supposed to be regulators’ essential stock in trade.
Dr. Miller’s view is only the latest in a series of complaints and concerns about FDA. In 2004, NY Times reported on FDA preventing Dr. Andrew D. Mosholder, a FDA epidemiologist and top expert, from presenting at a public hearing his study’s findings that “antidepressants cause children to become suicidal.”

The most damning testimony came from Dr. David Graham, the Associate Director of Drug Safety for the FDA. In 2004, Dr. Graham went before Senate Committee and blew the whistle on the FDA. Dr. Graham blamed the FDA for allowing dangerous drugs to stay on the market, which contributed to the deaths of thousands of Americans. In his testimony, Dr. Graham recommended major changes, including “competent management, discipline in the ranks, more effective risk-benefit balancing, a commitment to permitting patients to assume more responsibility for the risk of medicines, and the banishment of politics from regulatory decisions and policy.”

Drs. Graham, Mosholder, and Miller have confirmed what the media had been reporting all along: FDA, a regulatory body that is supposed to be an expert at assessing the risk versus benefit of new drugs, could not perform its fundamental task and allowed dangerous drugs into the market. This is very troubling. So what is being done about this?

Not much, unfortunately. Dr. Graham testified in November 2004 and Dr. Miller wrote about the same issue in February 2008. Nearly four years and three FDA Commissioners later, we have the same problem. One would think that after story after story of FDA woes, the Congress would have shaken up the FDA management.

Instead, we are still reading like lawsuit against J&J for hiding safety risk data on birth-control device and FDA approved drug being revealed as being ineffective (Vytorin and Zetia). (These are only a small sample of issues, as there are many more, including the pet food poisoning in early 2007.)

Are we not outraged at reading about another failure on the part of the FDA to protect the public? We should be. Rather than reading about how the FDA is failing to protect the public from dangerous drugs, we should be reading about how the FDA was able to prevent dangerous drugs from being sold in the U.S. Harmful drugs should be so rare as to cause major public outrage and immediate corrective action, as it was in the case of the 1982 Tylenol scare. Where is the accountability?

Because of this lack of accountability, J&J will probably win the lawsuit by using the “pre-empted” motion that is based on the theory that the FDA is the only agency with enough expertise to regulate drug makers and, therefore, the courts should not second-guess its decisions. (Here are the precedents, and here, that pave the way for J&J having a good chance of winning.)

Corrective Actions
Dr. Graham’s recommendations are still relevant today as it was when he gave them in his testimony before the Senate Committee in 2004:
  • Install competent senior management
  • Have the senior management install discipline in the ranks
  • Institute a more effective risk-benefit balancing
  • Banish politics from regulatory decisions and policy
To Dr. Graham’s list, I will add the following additional corrective actions:
  • Instead of relying on drug maker’s data for drugs’ safety, efficacies, and quality, as it is currently done, have the FDA conduct the clinical tests directly. FDA can outsource the clinical tests to a respected medical research facility that is not affiliated with any drug manufacturer. Also, have the drug companies pay for the clinical tests. This way FDA will receive the drug data immediately and without any delay or redaction of negative data, as is being done now.
  • Make the FDA strictly a medical regulatory body. Hand over the Food regulatory portion to the U.S. Department of Agriculture, which already monitors and regulates food and food products.
  • Combine the FDA, stripped of its responsibility for food, with AHRQ - Agency for Healthcare Research & Quality, ATSDR - Agency for Toxic Substances & Disease Registry, CDC - Centers for Disease Control & Prevention, and NIH - National Institutes of Health to create a new FDA (let’s call it Federal Drug Administration).
The resulting agency will be streamlined and focused on health, medicine, and disease. The cost savings should be realized (especially by leaving the acronym as FDA) as it will remove multiple layers of bureaucracy and cut through red tapes created by competing agencies’ agenda.

I doubt that the Federal Government will make any substantive changes to the FDA. After all, I am not the first one to highlight the multitude of issues with the FDA or make recommendations for its improvement. And I won’t be the last one either. The workings of the government, like major corporations, are driven by life-timer (bureaucrats, in the government), who have been with the organization for decades and are very resistant to change.

Perhaps, if we had a similar law as China, which can be very harsh, things might change that much faster.

Ed Kim
Disclosure: Author holds no positions in Pharmaceuticals

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Risk Analysis Update – A Forward Looking View Of The U.S. Economy

U.S. Dollar Still Treading Bottom
Bloomberg reported today that currency futures traders have increased their bets against the dollar. Three major banks that control 40% of the global FX market, Citigroup Inc., Deutsche Bank AG and Royal Bank of Scotland Group Plc, are now projecting that the dollar may fall as low as $1.65 per Euro by October, from $1.57 on April 4.

“The dollar will continue to move lower in the next couple of months until the U.S. economy improves markedly,'' said Adam Boyton, senior currency strategist in New York at Deutsche Bank.”

As I have noted in my previous article, Now The Dollar Is The Carry Trade Vehicle, this may seem bad but there may be a silver lining in that the U.S. firms may be able to use the low dollar to increase their profit from exports. This may already be happening as the U.S. Import / Export Price Indexes for February 2008 noted that agricultural prices rose 4.4% in February, capping a 30.8% rise over a 12-month period ended in February, largest rise since September 1988. Nonagricultural prices increased 4.6% in 2007[i].

Risks To Consumers

  • With the weak dollar, price of imports, including imports from China, will go up. This will result in higher consumer prices. According to the U.S. Import / Export Price Indexes for February 2008, prices for foods, feeds, and beverages rose 11% in 2007[ii].
  • As the prices of exportable goods increase, businesses will raise prices across the board, resulting in even higher consumers prices, as they (U.S. consumers)will have to compete with demands from other nations.
  • As foreign demands for certain commodities increase, U.S. consumers may be facing sporadic shortage of certain goods as businesses begin chasing profit and ship more goods overseas.
  • Electricity price will rise as the prices of coal and natural gas used to generate electricity increase
Risks To Businesses
  • Increased potential for consumer backlash against rising prices
  • Risk of increased frequency and duration of truckers’ strikes affecting their supply and product chains
  • Increased risk of rising utility price affecting profit
  • Increased risk of brownouts from insufficient supply of electricity
Signs Of Above Stated Risks
  • There will be less discounts and coupons offered in grocery stores (clothing retailers, on the other hand will continue to invent new discount events to draw customers)
  • Bifurcation of retail – sale of extreme upscale products (ones one would typically see in Robb Report magazine) will still do well while sale of ‘upscale’ products geared to middle-class families will see sales declining
  • Some companies will reduce the portion on their products and offer it the consumers as being ‘new and improved’
  • Prices of generic and store brand products will also go up, reducing the discount spread between it and the brand name products
  • Increased frequency of advertisement aimed at informing consumers on energy shortage and the need to conserve
  • Increased frequency of protest against rising food and energy prices, worldwide
Areas That May Benefit
  • Carbon traders – Carbon trading market will increases as well as the price of metric ton of CO2 equivalents
  • Energy trading – With increased demand and periodic reduction in supply, it is only natural for speculating in this area
  • Alternative energy – It is only logical that as price of fuel increases, people will look for alternatives. Solar energy seems to be one area that will benefit
  • Energy storage – Again, as fuel price increases, the companies that make energy storage facilities, such as batteries or inertia storage (think large spinning cylinder), should do well
  • Oil Refineries – Demand for gas and oil is not decreasing as much as people would like. Higher prices will make for another record profit year
  • Water desalination – Demand of clean water from arid areas will increase, making desalination more feasible
  • Rail transport – Warren Buffett may be on to something. If there is a prolonged trucker strike or truck transportation disruption, companies will have to resort to using rails to transport more of their products and supplies (while trucks will still have to handle most of the final mile delivery, the bulk of longer transportation will go to rail if truckers strike)
  • Motorcycles & Scooters – Low fuel consumption and low cost will be the draw
  • Movie Theaters & rentals – As people cut back on vacations and long-distance travels, they will still want to be entertained. The logical choices will be local form of entertainment, such as movies and rentals
  • Family style restaurants – people will have to eat and will still want to go out from time to time, in lieu of going on vacation. Low cost family style restaurants will do well as people will step down from more expensive restaurants
  • Dry good shipping – U.S. will increase exports of dry goods, especially grain, to the rest of the world. This will keep those dry good shipping companies afloat. Also, as more companies switch from airfreight to ships, ships will see a solid year
  • Executive & timeshare Jets – As airlines cut back on services and routes, more businesses will find it attractive and affordable to fly timeshare corporate jets, especially when several people are flying together
  • Auto repair shops – as more people opt to keep their existing cars instead of purchasing a new one, demand for repairs will increase
Areas That May Be Adversely Affected
  • Airlines – rising fuel costs will force more of them into history
  • Automobile manufacturers – with people opting to stay with their car for a few more years, car sales will suffer. Big cars and SUVs will be hit the most, even if they are touted as being a hybrid. The bottom line is the rising fuel price
  • Auto leasing – The combined effect of more cars come off their leases and less customers seeking to lease, auto leasing companies will be stuck with rising inventory. Expect to see ridiculous lease options on certain vehicles as these companies try to minimize their losses. Their loss is your gain
  • FedEx and UPS – Trucker strikes, rising fuel costs, and reduction in delivery, all contributes to lower revenue and challenging times
  • USPS – Consistent reduction in ‘snail mail’ with higher fuel costs, and disruption in long distance services (they rely on UPS, FedEx and major airline carriers to help in delivering the mail)
  • Internet shopping – again, rising cost of shipping and disruption in delivery will decrease sales as people opt to go back to their local stores for most items
  • Major department stores – why shop retail when you can buy outlet prices? Retailers will offer more and more discounts but they will never be able to compete with discount stores like Target that is closing the gap on quality and affordability
  • Specialty retail – stores that offer upscale version (not the ultra upscale of the wealthy but those geared toward the middle- an upper-middle class) of regular products that is widely available, such as bottled water, coffee, soap, lotion, shoes, etc., will see lower sales as people replace these with lower cost items
  • Recreational boats and wave riders – the yachts will weather this downturn but those selling smaller recreational boats will not. The combination of high fuel cost (marine fuel is far more expensive than regular fuel) and general cost of upkeep will reduce the demand for these items
  • Travel & Leisure industry – people will cut back on their dream vacations to Hawaii or other long distance locales; instead they will opt to go to local spots. Flow of Foreign visitors coming to the U.S. will also dry up as their economies also begin to slow down
  • Restaurants – people will be eating out less frequently and opting to go to a lower-cost ‘family style’ restaurants to cut costs
  • Winery – Wealthy will always buy expensive wines but those wines targeting the middle-class consumers may feel the pinch
  • Housing & RE Brokers – people who want to buy a house will still wait on the sideline, knowing that the housing prices will continue to fall
  • Lumber & Building Materials – Slowing housing and remodeling markets and reduced demand for cardboard and packaging papers will hurt
  • Home Material & Supplies – Home Depot, Lowe’s, and the likes will see slowdown in demand coupled with higher delivery cost and sporadic disruption in delivery from truckers' strikes
  • Lower quality commercial properties – commercial properties that were marginal or had small local tenants will see increased vacancies. Loans secured by these properties will experience haircuts
  • Timeshare Condos and hotels – less vacationing and traveling mean less need for timeshare condos and hotels. Expect to see some really great deals from these companies that have overbuilt. Caveat: expect reduced level of services, if you should go
  • Car rental companies – As travel slows down, so will the demand for rental cars. Also, due to rising fuel prices, expect vacationers to economize to smaller (read less profitable) cars
The above lists are just my views of where I think the various markets are headed. I didn’t list them all, as the list will be very long. However, I listed the major ones and ones that most readers are familiar with. Naturally, I strongly encourage you to do your own due diligence.

Given this, note that there are going to be common themes in 2008, revolving around limited resources, such as oil, grain, and water, uncertainty in the financial market, and U.S. Presidential race. These themes will be further modulated with sub-themes like Middle East, Summer Olympic, global climate changes, and regional unrest. All of these will make 2008 a very interesting year for businesses and investors alike. Commonsense approach with focus on fundamentals will work best. Those chasing fortune in commodities will need to have titanium stomachs, as the volatility in the commodities market will be nauseating.

May your Investing be profitable!

Ed Kim
Disclosure: Author holds long position in Berkshire Hathaway and Oil Refineries

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Sunday, April 6, 2008

Risk of Mr. Bush Trying To Restart The Cold War

Mr. Bush suggested and NATO accepted a U.S. missile defense system in Europe. By doing so, Mr. Bush has pushed us back to a start of another Cold War. BBC News has an excellent Q&A on this, so I will not go into the details here. However, it is suffice to state Bush’s claims that the U.S. led missile defense system will prevent Iran and North Korea from sending missiles to Europe seems preposterous. Well, if this is true, then why not simply sell the Patriot system to European countries that want a missile defense? After all, they are sovereign nations. That is what U.S. did with Egypt, Germany, Greece, Israel, Japan, Kuwait, the Netherlands, Saudi Arabia and Taiwan.[i]

According to a Federation of American Scientist, Iran currently has only short-range missiles that are incapable of hitting Western Europe. Nuclear Threat Initiative notes that Iran is on track to be able to extend its ballistic missile capabilities to reach Southern Europe sometime in 2005-2010 and the U.S. by 2015."[ii]

OK, let’s look at these facts: Iran currently has no missile to reach Western Europe. Moreover, they may have missile technology sometime by 2010 to reach Southern Europe. Then, why is Mr. Bush pushing for a missile defense system in Poland and Czech Republic?[iii] I don’t know about some folks, but if the Southern Europe was an immediate target, then the missile defense systems should be installed in a better intercept location like Turkey, Greece, or Italy. Or does Mr. Bush thinks that the missile defense system in Poland and Czech Republic is close enough to Southern Europe to effectively take out Iranian missiles? Someone please give Bush geography lessons because his logic doesn’t make sense. (But then again, it will not be the first time.)

Both Poland and Czech Republic have not agreed yet to put missile defense system in their country since, rightly so, they are concerned about Russia. They are no dummies. So, Mr. Bush has to resort to arm-twisting and piling on incentives (read as billion of dollars in aid).

By pushing for this system, all Mr. Bush is doing is antagonizing Russia and spreading our military resources even thinner. Who do you think is going to be manning the missile defense systems in Poland and Czech Republic, once they are built? It is highly likely that it will be a contingent of U.S. soldiers acting as ‘advisors’ who will be manning the missile defense systems. Sounds like Vietnam redux.

By his attempt at trying to salvage his legacy, Bush is digging a bigger hole for the U.S. to climb out of. Instead of trying to strengthen international relations with Russia and China through diplomatic and trade ties, he is pushing them away by berating them (in the case of China with their currency) and threatening them (in the case of Russia). Throughout history, Russia had been concerned about invasion from the West (Swedes in1240, Poland in 1604-1613, Napoleon (France) in 1812, and Germany in World War I and II[iv]).

Lucky for us that Mr. Bush is leaving office soon. The projected implementation date for the European missile defense is estimated to be sometime in 2010 to 2013. Hopefully, the next President will have enough sense to realize that this is not the way to ensure peace and to spread democracy and quash the missile defense system. But then again, what do we expect from Mr. Bush. After all, didn’t he say “I just want you to know that, when we talk about war, we're really talking about peace.”[v]

Now, I can sleep peacefully at night knowing that our Commander in Chief is busy trying to secure global peace in his last few days in office by trying to restart a cold war.

Ed Kim
DISCLOSURE: The author makes frequent pokes at stupidity, especially in the guise of leadership

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