Vacation in Puri

It has been a long time since I have written and, to some extent, the demand of my coursework is to blame :). I won’t complain because this term has been quite interesting from the practical perspective and I always found myself immersed in some course text rather than penning down my thoughts. But my account of the winter break has long been pending and I would want to put in words what’s left in my memory.

During the winter break of Dec 2011 – Jan 2012 I took a month long trip back home and I must say that it has been the most engaging and diverse vacations I’ve had. I obviously stayed in Delhi and then had some fun in Bangalore after which I went with my family to Bhubaneshwar, Orissa and then to Puri, a beach in Orissa. Puri is quite a popular religious destination that hosts the yearly padh yatra, a ritual in which priests travel a long stretch of road bare foot with lord’d idols to seek divine blessings. But apart

from being one of the four most sacred pilgrimage sites in India it is very strategically located so that both the sunrise and the sunset are visible from the beach – and was that amazing! Puri is a small city and as you travel along the beach the swarm of people, with all of them engaged in their own activities would instantly overwhelm you. In the clamorous hustle and bustle you’d find young children trying to sell you everything from t-shirts, shorts, sea shell accessories to road-side food which, for sea food lovers, is hard to look away from.

As we went further the density of the crowd diminished and so did the shops that sold such merchandise. Now we could only see small shacks along the beach selling God idols and others providing fried shrimps, fish, crabs, etc. with which passerbys gorged themselves during their evening walks. Our first reaction of living in a guest house amidst such noise quickly dispelled as we entered an area where all we could here was the sound of the waves lashing against the shore. As we arrived in our guest house, we were simply stunned by its interior design and here is when a picture is worth a 1000 words.

The location, the ambience, the weather, the stay arrangements and the mindset – all the attributes that can make or break a vacation were perfectly aligned. The personal touch of the staff was unmatched and it really felt like being at home, imagine when home is as grandiose. The structure was designed with an open heart. It had glass doors and huge windows that opened out to a big and well maintained lawn which further overlooked the beach. Sitting right outside on the couch in the morning, sipping an amazing ginger masala tea, staring at the infinite horizon with cool breeze striking the face and some nice songs playing in the background – nothing can take away the stress better. It was the start of a perfect leisure vacation. The rooms also contained the same style with wooden floors and off white walls and again with large glass doors and windows with an attached balcony that opened out to the sea. The tranquility of the nights was further enhanced in such a setting. After a sumptuously prepared meal spanning daal, rice, aloo gobi and an amazing masala prawns and fish curry, we used to sit outside and chat over tea. It was an extremely relaxing environment and unarguably the best way to take a moment away from the fast paced lives that we all live and blend with the breeze that took all thoughts away.

I could go on about the calmness of those moments and it was ironic how it was right in front of the fiery of the sea, which is also something we enjoyed immensely. Puri is known for its beaches, especially the beach art where hand craftsmen gather from the surrounding places and model the sand into different 3D structures. We were fortunate to be in Puri at a time when the festival was going on and we could get a glimpse of some pretty skilled art work. At the beach the waves were not too quiet and were rough enough to have a wild time. It was the first time that I went into the waters as much as I did, way ahead of the point where the waves start breaking. At this depth it felt like being in an infinite wave pool, only much stronger. There were two ways in which we could play with the waves – either jump with them or stay rigid and face their full force. Both had their own kind of fun but what I particularly liked about smashing a wave was it created sort of a halo if you stood with your back towards a strong one. Another “game” was to jump and let the wave strike your legs. The sheer force would topple you and it would be a challenge to stand back before another one arrives.

It may sound routine and just like another day on a beach but I would say that I have been to many beaches but Puri was a complete package. I would certainly recommend this place to anyone looking for some time to relax but do look for a place away from the cacophony of the central part.

How CDS pulled AIG down

I have been wanting to talk about things relevant to my course but have just not been able to find any time to devote to writing. On the other hand, I have studied, researched and learnt quite a bit about the mechanics of financial instruments and I would like to share two such topics.
Note that I obtained the facts mentioned in the following lines from different credible sources and all I that have done is paraphrased the content and broken it into categories. I guess the jargon will be too much for some of you so shoot any questions that you have.

The following post is about investigating the reasons behind AIG's fallout:

Why did CDS contracts almost provoke the bankruptcy of AIG?

AIG had been a successful insurance provider until, seemingly, it started to venture out in the business of writing Credit Default Swaps. It began insuring debt obligations of lenders against a risk of counterparty default, thereby taking the credit risk of the counterparty on itself. At one stage, of the $60 trillion CDS market, AIG owned about $440 billion of notional, an enormous amount compared to its peak market value of about $240 billion, with the portfolio contributing over a quarter of AIG’s profits.

The problem was that CDS was designed in such a way that it didn’t require any capital requirements and hence it attracted pension funds, insurers, hedge funds and banks for they could reap on the credit risk without any capital to lend. Furthermore, the demand for such instruments rose as they added on to the profits on the income statements without a mention of the risk involved.

Most of these CDS were on asset backed securities pools, primarily mortgages, and when the housing market collapsed these mortgages that AIG had “indirectly” insured started falling in value. The losses began accruing in 2006 and by 2008 AIG had less equity than it needed to fulfill its obligations. This trapped it into a vicious cycle as its credit rating was downgraded and hence it was required to post an additional margin that further put strain on its financial resources.

Hence we see that AIG, due to its good credit rating and the nature of CDS, was able to stack up large quantities of such insurance on its books with being questioned about the risk involved. Since the notional value of these contracts exceeded the market value of AIG, the possibility of the underlying assets going sour raised a possibility of bankruptcy for AIG.

http://www.economist.com/node/12274070

http://www.economist.com/node/12552204

What saved AIG from bankruptcy?

AIG is one of the biggest insurance companies in US and during the crisis it held a huge amount of credit risk on its books. It started getting calls on that risk when the underlying assets began degrading in value but its capital stash was not enough to meet all the requirements. To avoid a contagion across those who had insured their risks as well as to avoid the mess that AIG’s default would create in its other space such as life insurance and annuities, the government decided to bail it out with taxpayer’s money.

When AIG reported the biggest quarterly loss of any company in American history, of $61.7 billion, the government proposed a bailout package of $85 billion and took a 79.9% stake in the company in return. It further provided up to $37.8 billion in capital and removed the coupon on a $40 billion equity that was injected by the government in Nov 2008. Although AIG quickly used up about $90 billion of the ~$120 billion credit line awarded, it was able to stabilize its margin requirements on its contracts and was able to fulfill its obligations

http://www.economist.com/blogs/freeexchange/2009/03/government_and_aig_together_fo

http://www.economist.com/blogs/freeexchange/2009/04/did_we_need_to_bail_out_aig

http://www.economist.com/node/13213322

What could be done, in terms of reorganizing the CDS market in order to diminish the impact of situations like the one that almost doomed AIG?

There seem to be quite a few fundamental flaws with the way a CDS contract is designed:

• With the exception of capital requirements, a CDS contract allowed smaller firms, such as hedge funds, which did not have huge capital to lend, to be able to take on the credit risk of a counterparty’s portfolio in exchange of insurance premium.
• The accounting policies did not require such companies to reflect such transactions on their financial statements and hence the risk of such instruments went unnoticed and what appeared on the balance sheets were the profits.
• Depending on their credit rating, the companies had to put aside minimal margin, relative to the loan, to cushion against possible defaults.
• The CDS contracts allowed speculative positions to be held in the market. Hence the CDS market was over inflated and peaked at about $62 trillion when the value of the underlying debt was just about $5 trillion. This in turn had an effect on the ability of a company to take on debt as its CDS spread in the market would determine its credit strength.
• The voting power that comes with a debt stays with the debt holder even when the risk has been passed on. This can result in a clash between the intentions of the lender and the insurer regarding the default of the borrower as the lender might not agree to a debt restructuring.

It seems that with a proper understanding of CDS and its implications its abuse, and hence what followed, could have been avoided.

• The regulations around CDS can be more stringent to provide evidence of “credit risk” against which the insurance is sought. This will avoid speculative positions that can overburden the market with possibility of a multiple losses over a single debt.
• The accounting regulations also need to be strengthened so that such risks are portrayed on the balance sheet and hence are accounted for in assessing the financial health of a firm.
• The firm selling such contracts should be required to reserve certain capital in the event it needs to meet its obligations under the contract. This would help restrict the amount of CDS a company can write based on its capital cushion and credit rating.
• The voting power that comes with taking on debt should be somehow shared with the CDS seller so they have a say in the debt restructuring of the defaulting firm.

http://moneymorning.com/2009/04/23/ban-credit-default-swaps/

http://moneymorning.com/2008/09/22/credit-default-swaps-2/