Saturday, May 24, 2008

SocGen Is Still Lying

Societe General (SocGen) is back in the headlines again, this time with a little more (just a nanometer more) truthful then what was reported back in January. Back in January, the blame was firmly and solely on Jerome Kerviel, the rogue trader who was somehow able to hack the banks middle-office and back-office trade reconciliation and audit systems single-handily.

Now, SocGen, in its internal report released Friday, May 23, is stating that there were some management oversight failures. According to MarketWatch, SocGen is stating “Multiple mistakes along most of the chain of command allowed a rogue trader to amass billions of euros of fraudulent positions that eventually led to a loss of $7.7 billion.”

Yes, managers up the chain of command made multiple mistakes. However, having worked in an Investment Bank front- and middle-offices and in risk management, I find it laughable that SocGen is still in denial and is willing to publish this type of rubbish. I think other people who have worked at an investment bank middle-office will also find SocGen’s latest report to be incredulous.

The truth will come out, no matter how slowly; it will come out. And the truth is that someone at the senior management level knew of Jerome Kerviel’s activities and signed off on it. Other layers of management, knowing that a senior manager signed off on Kerviel’s activities, allowed the trading marks to continue.

The real mystery that I cannot fathom is what SocGen’s internal audit and compliance departments were doing all those years that Kerviel was trading and why they didn’t raise any red flags to the board of directors. Perhaps, the board of directors was the one who signed off on Kerviel’s activities.

I look forward to another official report from SocGen toward the end of 2008 stating that there were additional mistakes made along the way, including managers in charge of checking trading marks and positions. Even if that report comes out, it will still be mostly fiction.

Have A Great Weekend!

Ed Kim
Practical Risk Manager

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Can The Big Three Auto Makers Make It To 2010?

In March, I seriously questioned the viability of GM and Ford given their overly optimistic projections and declining economic conditions. Now, after months of denial, Ford has finally come clean and admitted that they would not be able to meet their profitability projection for 2009. GM had already stated in their FY 2007 financial results that they are looking to 2010, having written off 2008 and 2009.

“Ford said Thursday that it would drastically scale back production and step up cost-cutting efforts in response to a sharp drop in sales of pickups and sport utility vehicles. Ford executives also retreated from their pledge of delivering a full-year profit for 2009.” - NY Times

A surprising turn of events after Ford announced a first quarter profit? Not at all. Rather, the first quarter profit is the surprise. With the Big Three U.S. automakers (GM-Ford-Chrysler, a.k.a. the “Big-3”) still producing larger SUVs and trucks instead of fuel-efficient cars that consumers are demanding, it will be a very difficult future for the Big-3.

Simply put, the high fuel prices changed the rules of the game and the Japanese automakers making further changes with their hybrid cars. Honda has its hybrid Civic and Toyota has its Prius – the tope selling hybrid cars in the U.S. For the Big-3, only GM and Ford have hybrids in their current lineup. GM has hybrid SUVs, GMC Yukon and Tahoe, that get 20 city / 22 hwy MPG. GM has hybrid Chevy Malibu and Saturn, a part of GM, has two hybrid cars, Aura and Vue. However, their MPG is no better than a small block 4-cylinder engine’s at 25 city / 32 hwy MPG. Ford has only the hybrid Escape that is rated at 30/34 MPG. (Source: Yahoo Auto)

How Much Worst Can It Get?
“Ford is now forecasting that industry demand for cars and light trucks will be 14.7 million to 15.1 million vehicles — the lowest point in more than a decade.” - NY Times

According to BTS, the total figure for new vehicles sales and leases for 2007 was 17,129,000. So Ford is forecasting 2008 sales to decrease by approximately 11.8% to 14.2% from 2007. According to Motor Intelligence’s New Car Sales report as of May 5, 2008, the total light truck sales dropped by 17.6%, year over year, from 715,730 in April 2007 to 589,989 in April 2008. On a year-to-date basis, the total light truck sales dropped by 13.5%, year over year, from 2,817,280 for January-April 2007 period to 2,436,375 for January-April 2008 period. For cars the total year-to-date sales dropped by – 0.8%, year over year, from 2,409,394 for January-April 2007 period to 2,389,234 for January-April 2008 period.

With the fuel prices well over $4 in many cities, the potential for regular mid-size to large cars, SUVs, wagons, and light truck sales to drop even further than 11.8% to 14.2% in 2008 is quite high. With GM, Ford, and Chrysler not having much to offer to panicked buyers seeking high MPG cars, it will be the Japanese auto makers, once again, taking more market shares away from the Big Three. The shift of market shares to the Japanese auto makers have been very sharp in the first few months of 2008 with buyers scooping up hybrid electric-gas cars made by Toyota and Honda.

Further adding sting to the pain, is the news that Honda is on a mission to bring a hybrid Honda Fit to the U.S. market in 2009 and plan on adding new models to the hybrid lineup in the next three years. The Honda Fit is already a very fuel-efficient car at 28 city / 34 hwy MPG. Imagine what the hybrid engine will do. I am guessing at least 50 MPG. Oh, the new hybrid Fit will be only about $1,900 more than the standard gas model. The Big-3 is in big trouble.

Toyota is not standing pat. They announced plans to expand their battery producing capacity and plan on selling 1 million hybrids by 2010. With Toyota and Honda eating Big-3’s lunch, what are the Big-3 doing? It is not like they didn’t know that this was happening or lack the technology. GM and Ford have their international divisions that are experienced in building small cars such as the popular Ford Ka and GM Matiz / Spark. Why didn’t they look to building them in the U.S.? Even the Japanese, Korean, and German automakers are building cars in the U.S. and exporting them out.

Are the Big-3 officers so dense as to not realize that the oil prices will go up and quite soon? Have they not learned their lessons in 1970’s with the OPEC oil embargo and Japanese car invasion? How is it that the international automakers are able to build vehicles that consumers want on a timely basis while the Big-3 cannot seem to make substantial changes even when given a head start with the Freedom Car Project that launched in 2002?

For those naysayers that think that we cannot bring the extreme subcompact cars such as the Ford Ka and the GM Matiz / Spark to the U.S., please look at other extremely small cars that have passed the necessary federal standards and are selling in the U.S.: Smart Car and the Cooper Mini.

Finally, if any of the readers think that I am bashing U.S. automakers, dissuade yourself of that thought. All automakers are international, including the Big-3. While their headquarters are in Detroit, the Big-3 have less footprint in the U.S. than the Japanese automakers. In my book, the U.S. automakers are the ones that create jobs in the U.S. by building plants in the U.S. Using this measuring stick, the Big-3 are ‘foreign’ automakers.

So, God bless the automakers, with U.S. assembly plants[i], who are turning out quality cars that rank high in safety, quality, reliability, and customer satisfaction. Maybe you have heard of them. They are Honda, Toyota, Nissan, BMW, and Hyundai.

Risk Assessment
The potential for the Big-3 to lose more market shares to other international automakers are increasing every year. As more fuel-efficient cars enter the market, such as the VW Up! and the Fiat 500, the Big-3 will be forced to close more of their existing assembly plants to retool to build smaller, fuel-efficient cars. Additionally, they will be financially strapped as they sit on growing inventory of SUVs and light trucks that just won’t sell. Making matters worst are the SUVs and light trucks coming off leases. They will add to the bulging inventory of large vehicles that consumers will shun. So, between market loss, closure of plants, retooling, and ever-growing inventory of un-sellable vehicles, expect to see more news of Big-3 taking billion dollars more in losses.

Ed Kim
Practical Risk Manager

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Wednesday, May 21, 2008

Is It Time To Say Goodbye To American Airlines?

Based on today’s news from Reuters, it appears that American Airlines (AA) has its back against the wall and is trying to survive in this ever-increasing-fuel-cost environment. American Airlines, taking the old adage of “desperate times require desperate measures” to heart, is now charging $15 for the first bag, planning on slashing service domestically by about 11% to 12% by 4Q 2008, and removing 75 aircrafts, including old MD-80s, from service. It would appear that AA is desperately trying to stay alive by jettisoning highest cost routes and planes while trying to squeeze as much revenue from its passengers.

Now, back in April, I noted in Issues With The Delta-Northwest Merger - Part 1 that the MD-80s typically burn about 22% to 26% more fuel per seat miles flown than a more efficient airplane, on an apples-to-apples comparison. Additionally, 94% of American Airlines’ fleet is MD-80s (source: Wikipedia and respective airline’s website):

So, on a daily basis, America Airlines is using approximately 20.7% to 24.5% more fuel than other airlines that do not fly MD-80s. With jet fuel prices now averaging $2.58 per gallon, it is only a matter of time before the higher fuel cost completely erode American Airlines’ income and make it economically difficult to remain in business. Stay tuned for further analysis.

Ed Kim
Practical Risk Manager

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Tuesday, May 20, 2008

Risks Of Congressional Bill To Sue OPEC

And the scene gets stranger still in Washington as the House Of Representatives pass a bill to sue OPEC. Here is the lead in from Reuters:

“The House of Representatives overwhelmingly approved legislation on Tuesday allowing the Justice Department to sue OPEC members for limiting oil supplies and working together to set crude prices, but the White House threatened to veto the measure.”

The House passed the Bill H.R.6074 by a vote of 324-84. The Senate is looking at a similar bill, S. 2976 – The OPEC Accountability Act. For the House Bill to go to the President, the Senate will have to reconcile the two bills and have the entire Congress approve it. If the President follows through on his threat of a veto, it would be one of the few and rare cognizant moments from him.

The problem with bills like these is that we are trying to lay blame for our own avarice. Americans have over-consumed and wasted limited resources and still continue to do so in face of rising prices and further decrease in global supply. Instead of using Congressional powers to enact bills that would lead to better CONSERVATION and reduction in consumption, Congress is engrossed in blatant finger pointing to other parties as being the ones responsible for the current condition.

This act is similar to the fat people who sued McDonald’s for their weight problem. What is happening to their common sense? Does serving in Washington atrophy their brains? I don’t know but if this bill is any indication of their mental capacity, then there is something definitely wrong.

Here are the risks of the bill

  • U.S. becomes the fodder for more late night jokes; you just can’t make these things up
  • World community will join the late night hosts in mocking the U.S.
  • If the bill becomes law, then expect to see OPEC and other resource-rich nations to retaliate against the U.S., which will drive up prices of limited resources even further upwards
  • If the bill becomes law, then expect to see OPEC members counter suing the U.S., especially Venezuela
  • If the bill becomes law, then expect to see other nations suing the U.S. for squandering limited resources
Here is the roll call summary of the votes for this inane bill (click here for the full list):

Ed Kim
Practical Risk Manager

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Monday, May 19, 2008

Risks Of Steps Taken By China And Japan To Hedge Against Raw Material Price Shocks

Nippon Steel Corp. is seeking to invest in Cia. Vale do Rio Doce's $1.4 billion planned coalmine, according to Bloomberg. This is a natural progression for companies being hit with continually increasing price of its basic raw and intermediate materials. Taking a script from the major oil refiners, Nippon Steel, the world's second-biggest steel maker is looking for ways to lessen the risks of price shock from rapid costs increases.

Nippon Steel’s move closely follows the China model, which is trying to secure sufficient raw materials for steel manufacturing by buying into BHP Billiton. The rationale is simply to ensure steady supply of material at a reasonable rate, something that China has not been able to with Rio Tinto. As BHP Billiton pursues merger with Rio Tinto, the need for Asian industrial companies to buy into suppliers of raw material becomes more pressing.

However, as China and Japan continue to buy stakes in leading mining companies, there is a growing risk that other nations may experience raw material shortage or be forced to pay a higher price on the spot market. Since Vale, Rio, and BHP control more than 50% of world’s iron ores, the investments by Japan and China bear watching.

Of the two, China will be more aggressive as they are still in the development stage of the country’s lifecycle. As such, their economy will require more and more raw materials in the years to come. This will put China in direct collision course with its SE Asian neighbors, especially India. This will fuel increase in national protectionism and may lead to increased international friction between developed and developing nations. The friction will come from developing nations crying foul as more raw materials are diverted to developed nations while developing nations are forced to may ever increasing prices in the spot market.

Ed Kim
Practical Risk Manager

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