Sen. Warren Calls for New ‘Glass-Steagall’

Sandy Weill

Sandy Weill looking jolly (or smug?)

Sen. Elizabeth Warren (D-Mass.) and Sen. John McCain (R-Ariz.) are calling for the revival of certain parts of the Glass-Steagall Act to reform the banking industry. The Glass-Steagall were famously and controversially repealed by the Gramm-Leach-Bliley Act of 1999.

The original Glass-Steagall Act (okay, let’s call it GSA for short because I am tired of typing out Glass-Steagall, which I just did again… D’oh!) was instituted in 1933 and created general guidelines between commercial banks (taking deposits and giving loans) and investment banks (which deal primarily in securities), and segregating the two as a way to protect consumers from the risk-taking of securities firms.

The Gramm-Leach-Bliley Act overturned two main clauses of GSA. Section 20, which stated that federal reserve member banks are banned from being affiliated with firms engaging principally in securities or speculation, and Section 32, which stated that such firms cannot share a common board, were overturned specifically.

Let’s think back to 1999 for a moment. Those were the heady days of Wall Street and the Clinton-Greenspan administration was notoriously lax with its regulations. So much so, in fact, that financier Sanford Weill famously (or brazenly?) orchestrated the merger of CitiCorp (a commercial bank) and Travelers (parent of its namesake insurance company and Salomon Brothers investment bank) in 1998. Now, that merger would have violated the GSA, but Weill (amongst others) were so confident that it would be repealed that he went ahead with it anyways.

A lot has happened since then. We’ve been through a bubble and burst, the wheelin’ and dealin’ mid-aughts, and finally the 2007-2009 financial crisis and stock market crash. The financial crisis led to consolidation in the banking sector, and propelled Bank of America and Merrill Lynch to merge (wouldn’t have been possible under the GSA), and investment banks like Goldman Sachs and Morgan Stanley to convert into bank holding companies (also not possible under the GSA).

The goal of bringing back provisions of the GSA is to get rid of the concept of “Too Big to Fail”. Which brings us to the main question, would bringing back GSA help?

From purely a size perspective, the GSA repeal helped to speed up the process by which banks got too big (and by virtue of that, too big to fail). But we were probably heading to to this direction anyways, it was just a matter of “when” the banks got too big.

But in terms of protecting consumer deposits from risk-taking, there’s some bite. Commercial banks would be barred from engaging in securities trading, issuance, and derivatives, and the chance of them needing a bailout would decrease. Standalone investment banks, on the other hand, would continue as they are.

So yes, I agree with Sen. Warren (despite her past asinine demands for $22 minimum wage) on this one.


Read This Before Investing in Emerging Markets

(This article originally appeared in the Epoch Times)

By Warren Song & Frank Yu

While the phrase “diversify your portfolio” has become a cliché, it holds true in most cases. However, investors should exercise caution when investing in stocks of publicly listed companies based in emerging markets, especially the so-called BRIC nations of Brazil, Russia, India, and China.

In theory, diversification means holding investments from several sectors, types of securities, and geographical locations. But stocks from emerging markets, for the most part, should have lower valuations than those from developed countries, especially compared to U.S. equities. Generally speaking, returns on investments in emerging markets have been largely disappointing.

A few factors should be considered when valuing stock from any emerging market company:

  1. Its home country’s government and legal systems are just, stable, and free of corruption.
  2. The public company’s priority is to work on behalf of the shareholders.
  3. The company is competitive—has value—relative to those in developed markets.

Companies from India and China (including companies listed in Hong Kong) are at a severe disadvantage when measured with rule No. 1 mentioned above. And when factoring in rule No. 2 and 3, most companies from developing countries fall short when measured against competitors from developed nations (of course, there are exceptions).

To illustrate this, we will use China as an extreme example.

In China, corruption is so widespread that among management levels of public companies, there are hundreds of thousands of employees who are the children and relatives of Communist Party and government officials.

Let’s use the U.S.-listed China Petroleum and Chemical Corp., or Sinopec, as an example (NYSE: SNP).

Management typically is appointed by China’s State Council, and this creates a conflict of interest because as a publicly listed company, it should serve the interest of shareholders, not cater to the ruling elite.

In Sinopec’s case, it has a negative reputation within China due to its poor environmental record. Also, because many employees cannot be terminated, productivity is low—far lower than at U.S. competitor Valero Energy (NYSE: VLO). Despite Sinopec’s underinvestment in exploration and research, it still lacks meaningful free cash flow. If China introduces real market-based financial markets, Sinopec would have trouble competing.

While Sinopec was used to illustrate the above points, most other Chinese-based public companies are either state-owned or controlled by local governments in one way or another. As such, the objective is often to increase revenues so the related officials can use such figures (similar to aggregating China’s GDP growth rate) to climb the political ladder to higher-level positions in the government. In addition, they borrow heavily. The end result is industrywide overcapacity, heavy price discounting, vanishing margins, ballooning accounts receivable, and finally stock value destruction and investor disappointment.

Let’s take a look at the price-earnings (P/E) ratios of emerging market firms. Some investors argue that there are quality companies in emerging markets with low P/E ratios, which is an indication of value.

But the P/E ratio alone doesn’t tell the entire story. One thing to remember while investing is that valuations are relative. If you compare the stocks to yields of 10-year government bonds of those countries, the stocks will immediately seem overvalued.

Take Russia for example. Its 10-year government bond yield is almost 8 percent. Move a typical Russian company with a P/E ratio of around 10 to the United States, and its valuation will immediately halve given the fact that the U.S. 10-year Treasury (risk-free) yield is 2.7 percent. This is due to the huge risk difference between the Russian equity and U.S. Treasuries. Conversely, if U.S. Treasury yields suddenly jumped to 8 percent, the U.S. stock market would see a major movement from current levels.

Emerging market firms also typically have lower free cash flow amounts compared to their U.S. counterparts. In China, for example, many public companies have minimal or no free cash flow when applying U.S. accounting standards.

We’ve used China and Russia as general examples. Similarly, Brazilian 10-year government bonds yield more than 11 percent, and for India, the figure stands at more than 10 percent.

Investment of one’s own money is a serious matter. Imagine your portfolio holdings are like your children. You’d want each and every one of them to receive the best education possible, instead of sending three of them to China, Russia, and Brazil just for the sake of diversification.

Warren Song and Frank Yu are contributors to the Epoch Times.

Bernanke Eases Up, Markets Exhale

The Dow Jones Industrial Average and S&P 500 Index rallied to exceed record highs (nominal) on Thursday, July 11.

The Dow’s previous all-time high of 15,409 was reached on May 28, and S&P’s 1,669 was reached on May 21. Today, investors sent stocks higher on remarks by Chairman Ben (Bernanke) that he’s not in a hurry to ease his stimulus measures, or at least not as fast as the market had predicted.

So what led up to this? A recovering housing market and last Friday’s better-than-expected June employment helped. This week so far, stocks have been buoyed by solid corporate earnings.

All of this enthusiasm has some analysts crying foul and predicting a pullback. While others say that the transition from bonds to equities has barely begun.

Right now is probably a time to hold and see. There are still some signs of economic weakness that could thrash U.S. markets–China, Egypt (driving up oil to their highest since May 2012), unemployment, and Greece/Europe. And in addition, avoid emerging markets.

Another China Growth Worry

Every time we think we are in the clear, China comes along and rains on our parade.

On Wednesday, China announced that official exports declined by 3.1% in June, to $174bn. It’s the first decline since Jan. 2012, and was far below analysts’ expectations of 4%.

Chinese officials began a series of tightening around issuing fake invoicing by exporters to boost figures. But even then, the results need to be taken with a huge grain (no, make that a fistful) of salt.

June trade figures raises the specter that China wouldn’t meet its GDP growth of 7.5% in its next announcement.

Chinese economic figures on the decline? STOP THE PRESSES! The really disappointing news out of this is that I’m surprised the market hasn’t already priced in the fact that the Chinese economic growth is a house of cards ready to collapse at any minute (if it hasn’t already). “Official” GDP and trade figures are artificially boosted to attract inflows of foreign capital (from Western and Chinese ex-pat origins), and are basically lipstick on a pig.

And this comes after last month’s interbank rate squeeze. The picture doesn’t look good.

S&P’s Ratings ‘Puffery’

I’m not sure if this is court room desperation or fact (ok, it’s fact), but credit rating agency Standard & Poor’s (S&P’s) launched an interesting defense in court, against the government’s civil lawsuit seeking $5bn on grounds that S&P defrauded investors during the financial crisis by slapping on “AAA” ratings on piles of dung (a.k.a. mortgage-backed securities).

S&P, in its defense, stated that any reasonable investor would not have relied that much on S&P’s ratings, which were mere “puffery” (in there own words).

“They’re seeking to blame the entire financial crisis on Standard & Poor’s,” S&P lawyer John Keker said in court. “Those generic statements don’t make a scheme to defraud. For a scheme to defraud, there has to be a specific intent to harm the victim, in this case the investor.”

Well, Keker does have a point. And the entire financial crisis probably shouldn’t be laid on S&P alone. There are other ratings agencies (Moody’s, Fitch Ratings), and of course the banks, mortgage finance companies, shady mortgage brokers, and not to mention the U.S. government itself, should all share the blame.

But I digress. Getting back to S&P–the fact that S&P ripped its own work (which is its own bread and butter business) in public is pretty eye-opening (and funny). But believe it or not, S&P is absolutely correct.

Professional investors don’t trust the credit ratings. And most Wall Street banks, institutional investors, and funds know that the ratings are hogwash. Sure, a “CC+” rated security might be worst off than a “AAA” rated security, relatively speaking, but no investor would rely solely on those ratings without doing their own homework first.

So in the end, I don’t think S&P intended to deceive investors. What it did intend to do was get as much money as possible from their clients (the issuers who hired them to rate their securities), by slapping on the “AAA” stickers as quickly as possible.

Stocks – No History Repeating

Today (July 8), in 1932, the Dow Jones Industrial Average hit its rock bottom during the Great Depression.

There’s no repeat of that happening this time. The stock market is in the green, with the S&P up for the third-straight day.

“The market is getting comfortable that the economy is strong enough to withstand reduced Fed support. The market is inching toward normalcy. We’re not in an abnormal environment where the Fed and Fed actions are dictating market movements,” said Gary Flam from Bel Air Investment Advisors LLC.

Those are some rosy predictions. And we’ll see how it plays out on Wednesday, when the Federal Reserve publishes its minutes and Ben Bernanke takes the mic. ‘Stoic Ben’ might repeat his comments from last month, or offer no additional news, in fear of rattling the market similar to what happened on June 19.

Stocks Calm as Earnings Season Nears

Major market indices closed higher on Friday–with the S&P and Nasdaq both gaining 1%–as Wall Street headed home for the 4th of July weekend.

Stocks jumped after the US Government reported 195,000 new jobs for June, a sign that the economic recovery is here to stay. Perhaps a bit more unnerving is that bond investors took the report as a precursor that the Fed may taper its quantitative easing, and raise interest rates. As such, Treasury yields on 10-year bonds creeped up past 2.7%.

With another earnings season to kick off on Monday (aluminum producer Alcoa will report after market close), it’s hard to predict which direction stocks will go from here. On one hand, analysts have already priced in effects of the sequester, so companies may exceed their earnings consensus. But considering that more positive news usually equates to the Federal Reserve edging closer to ending QE, stocks may yet disappoint.

But since there already seems to be a bond sell off underway, perhaps it’s time to get into the corporate bond market. Especially since yields have increased–while official interest rates haven’t budged–short maturity bonds may be a better deal than stocking away cash at the bank.