Cameron Izadi

Personal Financial and Informational Blog

Category Archives: Finance

Why Basel III Could Do More Harm Than Good

In an effort to prevent banks from becoming over-leveraged and insolvent (as has been seen over the last few years), the new Basel III regulatory regime calls for substantially raised equity requirements, among other changes. However, these changes do not include much needed modification to the mechanisms through which risk is measured. This is cause for concern, given that, in search of higher returns under more stringent regulation, banks will be encouraged to invest available capital in more risky (or toxic) assets.

"Basel III is continuing to enable (and even encourage) banks to take on potentially toxic assets..."

Pablo Triana illustrates this scenario in a recent article of his in the Financial Times. Imagine you have $20bn in equity capital and would like to invest in high-yielding assets. Triana states that before the recent changes, capital charges for “adventurous” (or risky) assets were as low as 1%  of notional value (the total value of a leveraged position’s assets). So, the $20bn of “funky stuff” could cost you just $200m in up-front capital cushion. Those charges will rise with new regulation. However, the increase would remain modest in comparison with trading assets, whose costs could triple in the future. Returning to the scenario, you would only need about $400m to back your risky (and potentially toxic) bet of $20bn. Basel III is, thus, continuing to enable (and even encourage) banks to take on potentially toxic assets by failing to increase the costs associated with taking on risky positions.

Here’s an easy way to think of this effect: one figure banks measure their performance on is return on equity (ROE). The formula for ROE is simply net income divided by shareholder’s equity. When regulations require banks to maintain higher levels of equity, shareholder’s equity (the denominator in the ROE formula) is increased, which decreases ROE. Naturally, banks will seek to maximize ROE in any way possible. With a larger denominator, the numerator must by equally increased to maintain the same ROE. In order to increase net income, banks will seek more high-return, riskier investments.

Essentially, Basel III cracks down on equity requirements without adjusting for the riskiness of a financial institution’s investments, or for the amount of leverage the institution takes on. While the new framework is a much needed attempt to prevent similar scenarios to the crises of 2007 and 2008, it’s failure to account for these essential factors may prove detrimental down the road.


How the ‘Smart Money’ is Influencing Tax Law

It has been the subject of much debate, and even reason for Senators to return to Capitol Hill for a brief work session before continuing campaigning for the midterm elections. I am, of course, referring to the end of the Bush-era tax cuts. With their seats on the line, Democrats are eager to take advantage of this opportunity to win back some favor among constituents.

Wall Street Political Contributions (Dem v Rep)

However, with the legislation that the Democratic majority has pushed through this year, especially the Dodd-Frank Wall Street Reform and Consumer Protection Act, large financial institutions and hedge funds have been sharply shifting financial support from Democrats to Republicans. Dave Levinthal, spokesman for the Center for Responsive Politics commented, “We noticed a very dramatic shift right around the beginning of this year, which coincided with financial reform.” Levinthal sees this as a “major shift in the opposite direction and one that has persisted ever since.”

Here are just a few examples of large banks and investment firms that have participated in political contributions this year:

Citigroup is still partially government-owned, thus it has given equal contributions to Republicans and Democrats this year.

  • Bank of America (NYSE:BAC) is strongly supporting Republicans, with 61% of total contributions made this year. This is a large change from the 2008 elections, where 56% of the bank’s contributions went to Democrats.
  • Morgan Stanley (NYSE:MS) is also favoring Republicans, with 55% of the company’s contributions going to Republicans. Morgan Stanley also favored Democrats in 2008.
  • Citigroup (NYSE:C) appears to be playing it safe by giving equally to Democrats and Republicans (as the federal government still owns a sizable portion of the company). However, in 2008, Citigroup favored Democrats as well, contributing 63% of funds to Democrats.
  • Even Goldman Sachs (NYSE:GS), which has favored Democrats for 20 years, is channeling the majority of its political contributions to Republicans this election cycle.

The question is whether or not the new tax-cut program endorsed by President Obama will help Democrats fare well in the elections this fall. The cuts are, however, namely different from the Bush-era cuts in that they exclude cuts previously available to individuals with over $250,000 in annual taxable income (which really only affects about 3% of Americans). Despite this revision, House Republican Leader John Boehner said Sunday that he’d support an extension of tax cuts for the middle class, even if he couldn’t do the same for wealthier Americans.

President Obama's $50 billion infrastructure improvement plan's aim is to create jobs, something this halted economy needs desperately.

Other forms of economic aid, including a new $30 billion small-business lending fund (details available here), President Obama’s $50 billion infrastructure improvement plan (details available here), and other small-business tax incentives, are all aimed at creating jobs. However, it is clear that, in the end, they do not benefit the “big boys” (or the “smart money”). This is why we continue to see large institutional support for republicans whose political philosophies are more closely aligned with corporate bottom lines.

Whether or not these programs will help Democrats during the elections is yet to be seen. All that is certain is the large role that financial institutions are playing in legislation. Whether this involvement is constructive or detrimental is up for discussion.

Why I’m Excited about Oracle

Computer software giant Oracle Corporation (NASDAQ:ORCL) made a smart move by hiring ex-CEO of Hewlett-Packard Company (NYSE:HPQ) Mark Hurd as co-president.

Oracle Corporation's Headquarters in Redwood Shores, CA

Oracle acquired Sun Microsystems (a computer software and hardware company, made famous by it’s development of Java) earlier this year for $7.4 billion. This acquisition is Oracle’s first foray into the computer hardware and components business, which can be a reason for concern given operations on such a large scale. However, this is where Mark Hurd comes in. Hardware is what Hurd knows. Having served as HP’s CEO for nearly four years, Hurd’s knowledge of the hardware industry will prove pivotal in Oracle’s success in this new venture. In a statement he made Monday, Hurd stated how he believes that “Oracle’s strategy of combining software with hardware will enable [it] to beat IBM (NYSE:IBM) in both enterprise servers and storage.”

Mark Hurd, ex-CEO of Hewlett-Packard

While we’re on the topic of Hurd’s depart from HP, let’s look a little deeper. What does Mark Hurd’s resumé look like? After working his way up through the ranks at NCR Corporation (NYSE:NCR) for twenty-three years, he served as CEO for two years. His time at NCR gave him a tremendous amount of experience and knowledge of the IT industry.

After leaving NCR, Hurd served as an excellent CEO at HP, drastically increasing it’s market share in computers, laptops and printers, while implementing tough cost-cutting tactics, resulting in a very lean and profitable operation. Recent sexual-harrasment allegations and scandal surrounding misleading expense reports are the reported reasons for HP letting Hurd go, although it is also probable that his reputation as a “cost-cutter” left distaste in the mouths of both rank-and-file employees, and board members. While making these cuts (which included jobs and remaining workers’ annual compensation), Hurd himself took home total compensation in excess of $24 million for 2009 alone. It is believed that the expense report and sexual-harassment issues were just pretexts the board used to fire Hurd.

Meanwhile, Oralce, which, as I said earlier, recently acquired Sun Microsystems, was ready to begin shifting its focus from only software, to manufacturing the hardware that would run its already popular and widely-used software. To date, Oracle and HP have been a pair, Oralce providing the software that runs on HP’s hardware. Now, looking to enter the hardware arena for itself, Oracle needs to gain market share in a market dominated by two other companies: IBM and HP. From Oracle’s perspective, were Hurd to join the team, it would be much better-equipped to fight HP in the years to come.

Larry Ellison, co-founder and CEO of Oracle

Oracle CEO, and world-renouned gazillionare, Larry Ellison commented on HP’s decision to let Hurd go: “The HP board just made the worst personnel decision since the idiots on the Apple board fired Steve Jobs many years ago. That decision nearly destroyed Apple and would have if Steve hadn’t come back and saved them.” Ellison really made it a point to publicly criticize HP’s actions, raising suspicion that there may be a job offering for Hurd at Oracle. This speculation turned out to be true. “Mark did a brilliant job at HP and I expect he’ll do even better at Oracle,” Ellison said. “There is no executive in the IT world with more relevant experience than Mark. Oracle’s future is engineering complete and integrated hardware and software systems for the enterprise. Mark pioneered the integration of hardware with software when Teradata was a part of NCR.”

It’s painfully obvious that HP’s decision will cost them. Oracle will continue to become a larger force in the IT industry, taking on HP and IBM. As Raymond James analyst Michael Turits put it, “HP’s loss is Oracle’s gain in our view, and in particular a gain that should help dent the bear case that Oracle will have trouble becoming a hardware company following the Sun acquisition.”

Analysts’ opinions on Oracle suggest that the stock is not currently over-valued, prompting a buy to strong buy recommendation from nearly all analysts following the company. I am eagerly anticipating future news from Redwood Shores regarding new developments in pulling together the acquisition and new operational modifications/expansions. I will be keeping an eye on Oracle in the coming months.

UPDATE: Among the reasons I listed for HP’s vote to force Hurd to resign is the popular (even cited by Larry Ellison) notion that HP didn’t want to have to deal with a “bogus” sexual-harrasment suit, and it would create bad publicity for HP.

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