Monday, October 27, 2008


Sick Corny Joke of the Day:
1. Avoid “Fortified Milk”, because melamine maybe used to “fortify” the milk.

One of the biggest news that is hogging the headlines lately is the Chinese Melamine Tainted Milk Scandal. Actually, it is one of the biggest news globally because of the far – ranging reach of the Chinese export machinery. A lot of milk and milk – derived products, confectionery, and milk – based beverages of both big name companies and little known producers are affected by this scandal causing panic among buyers and inducing an aversion to milk based products among consumers. And they are rightly to be afraid, for the melamine tainted milk has so far claimed the lives of 4 babies and sickened some 53,000 more in China. It has become a nightmare for parents with babies and toddlers, for these parents do not know what “safe” brand of milk to buy for their babies, i.e., safe as in a milk formula with no trace of melamine. Melamine based on my research is a nitrogen based macro – molecule with a formula of (NH2)n. It is a highly toxic substance in large dosage and is used as raw materials in the production of melamine resins plastic, which in turn is used in the manufacture of melamine wares (plates, cups, saucers). It is used in building construction as a super – plasticizer. And in the 1950s, melamine was also used as fertilizer due to its nitrogen based chemical structure as well as a non – protein nitrogen source for feed to cattle. However, melamine use in fertilizer and in feeds was largely discontinued (not totally, I surmised) by the 60s basically due to the fact that melamine doesn’t easily break down into its useful nitrogen form during the digestive process in cattle and during photosynthesis in plants. There is however no indication of toxicity being the reason for its discontinued used. It is very probable that the fact that melamine is used in cattle feeds may have prompted it’s use in “watering down” the milk. I mean melamine is readily available to dairy farmers who are using melamine as cattle feeds and because of its nitrogen structure, addition of melamine in milk would produce a high nitrogen yield during laboratory test suggesting that the milk is “rich” in protein, which is in fact the opposite since the “fortified” milk has already been watered down in the first place. Milk is watered down to artificially increase the output from the same inputs and therefore fatten the profitability of whoever is the culprit behind this despicable scheme. Anyway, aside from melamine, another compound used as non – protein nitrogen for cattle feeds is cyanuric acid. Now, when melamine and cyanuric acid enters the bloodstream, it reacts to form melamine cyanurate which is a crystalline compound and once these crystals entered the kidney, it damages the cells resulting into kidney malfunction, which ultimately led to the deaths of those poor babies. As previously mentioned, melamine is added solely to increase the profitability of the milk producers. And this illustrate a very disturbing point, that some people can be highly ingenious and would go great lengths and at the same time, being unscrupulous enough to do something such as lacing milk with melamine just to earn more. And this is the crux of the problem, the greed for more profit. Taken in this light, it’s not only the producers of melamine tainted milk that are “blinded” by this greed for more profit. There are others like them and melamine tainted milk is just simply the tip of the ice berg and one of the latest case in the long lists of tainted product cases (although not all of them are as toxic as the melamine laced milk, some may even be considered “safe”). Furthermore, this is not limited to food products only. As a businessman and an MBA graduate, I’m all for profit, the more, the merrier however, I and many business people like me draw the line between what’s honorable and what’s not. Being honorable means you don’t “cheat” your customer just to earn a few quick bucks, you earn it the hard way, which is providing what the customer paid for even if that means ultra thin profit. Unfortunately, there are a few of these unscrupulous business people who are not bound by this code of honor. A case in point would be adding extenders to food products. Adding extenders is a common practice among food processors. It is not only a fact but a way of life as this could reduce cost in a price competitive environment and help shore up profit. Even so, there is a limit for adding extenders and in most cases; it is likely in the vicinity of 5 – 20%. It is not surprising however to see that the most unscrupulous ones would use extenders up to say 60% or more to the extent that they practically substituted the product with something entirely different (adding melamine to milk actually started out as simply adding extenders to milk). Adding extenders is just but one of the tricks. Another trick usually resorted to by unscrupulous business people of whom they are in the minority, is size reduction. So instead of 1/8” thickness, these unscrupulous ones would offer products that are thinner say maybe 1/16” and still sell it as 1/8” thick but with huge discount from the regular price. As I mentioned before, a majority of businesses are honorable and we don’t cheat. We even balked at cheating because we care much for the welfare of our customers and that our ethical beliefs prevented us from committing such a grave act. As such, we couldn’t really imagine that somebody could actually do that or gone to that great length but apparently, we are wrong in our assumption. As a result, we are usually caught off guard by the actions of these unscrupulous business people especially since these very same people are engaged in predatory selling, which drive some of the honorable ones out of business. In short, honorable business people are also victims, not just the buyers. I remember this lesson I had in business school. It’s about a firm’s competitive advantage. According to my professor, competitive advantage is that firm’s capability, or organizational ability, or assets that help provide an edge to a company versus other competing firms in attracting customers in the market. So if a company could produce their goods more efficiently than others and maintain superior quality as well and they are able to parlay such efficiency into a reduced price for the consumer, it is only but natural for such a company to attract a great deal of buyers from the market and with the expanding revenues as a result, such company would not only stay afloat but would grow substantially as well. Conversely, a firm who fails to deliver what the consumer want because it lacks the skills, the abilities, the capabilities, and the material resources to do so, it would eventually fail because it wouldn’t be able to attract any would – be buyers from the market. That is what the theory says. Reality however has a different take and this is what they didn’t teach us at business school; that unethical practices and unscrupulous attitudes can be and has proven to be a source of competitive advantage as well. If one doesn’t play fair, one always have an advantage no matter what. Well, one could always argue that customers are not stupid and that sooner or later, they would have discovered the hoax and drive these unscrupulous businesses out of business. Though that is true but the problem is that by the time, these unscrupulous businesses went bankrupt, the damage is already done for some of the “honorable” businesses would not be around by then as the latter were “priced out of the market” by these unscrupulous firms in the first place. So what then? What are we going to do? Well, the most effective solution to punish these unscrupulous businesses is for the buyer to exercise vigilance. Remember, the ultimate decider in the marketplace is not the competing firms nor the government regulators but the consumers and only you, the consumers. If the consumers demanded only the best quality before price, I don’t see how these unscrupulous businesses would succeed in the first place. Remember, the customer is always right.

1. Wikipedia

Tuesday, October 21, 2008


It is one of those usual rainy afternoons in Manila; heavy downpour causing flash floods during rush hour followed by traffic mayhem afterwards as people tried to get a ride after the rain and cars barely get moving at all due to both the floods and as well as due to public transports blocking the road. At any rate, in the worst of this kind of situations, monstrous traffic could extend for kilometers and a normally 30 minute travel could take as long as two to three hours. Traffic was so slow that one felt that it would be faster just to leave your car in the middle of the road and just walk home. Just when you think that you’re in a traffic nightmare already, you suddenly noticed vehicles usually jeepneys and tricycles but also other vehicles as well breaking from the “established traffic column”, overtaking virtually everybody else by travelling at the opposite lane and before you know it, what was once a 4 – lane 2 – way traffic (with no concrete barrier in the middle) has now in effect become a 4 – lane one – way traffic, which completely blocked the flow of the opposing traffic. As a result, somewhere down that lane, the same thing happened with the opposing traffic and whala! We have a gridlock! And what was expected to be a 2 – 3 hour traffic nightmare has now morphed into a traffic hell wherein cars barely crawl from their place. It take some time before a traffic cop came along and untangle the mess and guess what he did to solve the “crisis”? He lets the overtaking vehicles occupying the opposite lane to go first so as to “create an opening” for the opposing traffic to “flow” and eventually, traffic “normalizes” (as in reverting back to the “old” 4 – lane 2 – way traffic) and the flow “smoothens”. The traffic cop never even bothered about confiscating the licenses of these “rule breakers” and yet alone punishing them for creating the mess in the first place. What this story illustrate to us is that once a “rule breaker” or a “trouble maker” acting upon their self – serving interest and trying to grab a “fleeting” opportunity manages to “clog” the system to such an extent that the system breaks down entirely and that these “clog” of a rule breakers are so vital and strategic that they became the “key” to the solution to the mess that they created in the first place. As such, it became practical to reward these “clog” of a rule breakers by giving to them the gain they so desired (which in this case, getting to go first ahead of everybody else who diligently lined up in traffic) just in order to get the system back up running again. Of course, such scenario aren’t exclusively seen in Manila’s traffic during the rainy season, for the recent financial crisis plaguing the world is also an exemplary case in point. Here, we have a handful of financial institutions whose unbridled greed has managed to bring the entire global financial system to it’s knees and yet, instead of going the way of dinosaurs for being similarly “stupid”, we have to bail them out from the mess that they single handedly created because failure to do so would spell “the end of the world” as we know it (by “the end of the world”, think of it as the 21st century version of the Great Depression of the 1930s). Under “normal” market conditions, a company that makes a big mistake has to pay for it’s mistake big time; a company that commits a costly error has to pay dearly for that error and a company that happens to make a huge, momentous, and critically mortal “bubu” has to pay for it with every cents it had to the extent of going belly up. That’s, the law of the market. Well, at least that is true for “small” companies that don’t cause critical “strain” to the well – being of the economy. For companies that are too large, too vital, too strategic, too “important” to fail, the laws of the market are simply inapplicable. Being too large however, doesn’t necessarily exempt them from the laws of the market, a company must also be a “vital clog” as well as in the case in point. If AIG were allowed to fail, then, we would see the unwinding of derivative positions worldwide precipitating a catastrophe of incalculable proportions as funds from bank deposits, from retirement savings, from governments would just disappear. Or if the US government failed to bailout Wall Street, the credit market would be utterly destroyed forcing us to pay everything in cash (including global trade) and thus, drastically reduce the scale of economies worldwide (one reason why economy grows is because of credit as one can purchase and eventually sell more from what little capital they have). Yet, it is these very same companies that are the very reason why we’re in such a mess in the first place. And therefore, we “reward” these companies by bailing them out without “punishing” them in the way we punish lesser companies with little clout. Rewarding rule breakers are not really fair nor right but in scenarios wherein they are the “vital clog” to the smooth functioning of the system, “rewarding” these rule breakers are the most pragmatic thing to do if not the best solution to the problem. Even so, it is still hard to swallow and is still distasteful.

Thursday, October 16, 2008


Quote for the day:
1. Cash is King – anonymous.

The biggest news hogging the headlines for the past 10 months or so is the total unraveling of the global financial system that till now has wiped out trillions of dollars (one new stories gave a figure of $12 trillion) and requires trillions more in bailout money. What started out as an American sub – prime mortgage crisis has now officially become a global financial crisis engulfing every nation on earth. And why has this happened? It is because of 3 things: (1) The creation of the derivatives market, (2) over – leverage of the typical working middle class, and (3) the globalization of finance. Derivatives are securities on a security (a security is a financial instrument indicating ownership or claim on a property or asset, be it an equity like common stock or debt such as bonds that has financial value and is tradable). To illustrate, imagine a 5 year tenor bond that pays 5% per annum quarterly that is bought by a financial entity. The financial entity in turn issues 5 – one year tenor bonds based on the 5 year tenor bond (obviously the two should have the same maturity). The interest to be paid for the 5 – one year bonds is derived from the interest income coming from the original 5 year bond. The financial entity makes money by pocketing the difference between the interest payout to the one year bonds and the income derived from the 5 year bond. Using the illustration, supposed that the interest rate of those one year bonds is set at 4% per annum, then by calculation, the financial entity makes a profit of 1% every year from the difference between the interest payout and income. The original 5 year bond is the security, while the 5 – one year bonds created from the original bond is the derivative. Based on the illustration, one might say that derivatives are not that complicated and it is a simple thing but in reality, the truth is much farther. Derivatives are way, way more complex. There are many derivatives in the market such as options, warrants, bond derivatives, Collateralized Debt Obligation (CDO), futures, etc. Now, if betting in a security is a tough call because nobody can really predict the future and the behavior of a security whether it would go up value or collapse the next day is highly volatile, imagine then betting on a derivative that hinges on these volatile and unpredictable securities. It’s a lot tougher. If buying on security is like playing a dinner table poker, playing derivatives is like gambling in a high stake casino. Now, the present financial crisis started out as a sub – prime mortgage crisis. Sub – prime mortgages by it’s term refers to real estate mortgages (loans for purchase of real estate and using the real estate in question as collateral) made to people with poor creditworthiness and/or to people with good credit standing but due to certain circumstances, the loans to be made do not conform to certain standard requirements and hence rendering these people with good credit standing ineligible to apply for the loan. In short, sub – prime mortgages are pretty risky loans with high default risk that normally, a prudent investor would shriek at putting their money into. However, due to their high risk nature, the commensurate pay – off is also high, i.e., the interest charged on this type of loans are quite high, very much higher than the prevailing interest rate. As such, it becomes “enticing” to some investors looking for means to “maximize” the return on their investments but their numbers are however, few. To broaden the appeal of the sub – mortgages to the greater number of investors looking for high return and relatively “acceptable” risks, investment banks began to package them as Collateralized Debt Obligations (CDO), a type of bonds whose cash payments to the bond holders came from the payments made on mortgages by the mortgagor (the borrower). In this set – up, the investment bankers are the ones who technically assume the risk of credit default by the mortgagor. Usually, investment bankers in order to assure bond investors of the steady stream of cash flows payout in spite of the erratic cash flow payment behavior of these high risk loans, would pool together numerous mortgages and creates a “basket” from these mortgages with more or less a predictable cash flows. The investment banker makes money from the whole scheme of things through charging commission on the sale of the bonds and the fees from obtaining the loan, management fees and etc. Investment banks don’t make money from the loans. This is entirely different from the traditional commercial mortgage loans obtained from a commercial bank. In the commercial bank mortgage loans, the banks obtained their loanable funds from depositors and in return pay, the depositors a fixed interest for the deposits which are usually low. The commercial bank would then in turn lend out these amassed funds to borrowers in return for interest payment. A commercial bank makes money from the spread between the interest paid to the depositors and the interest earned from the loans. In addition to that, the commercial banks assume the risk of credit default of borrowers. In this traditional set – up, due to the fact that the profit of commercial banks came from the interest spread between loans and deposits, return of investments on the part of the depositors are hideously low. Furthermore, banks are fiduciary financial institutions i.e., they are institution of trusts and as such are highly regulated by the government. Henceforth, commercial banks cannot just simply give out loans freely to anyone and this in turn forced them to apply stringent credit evaluation guidelines. As a result, poor credit quality borrowers were often unable to obtain loans from a commercial bank and sub – prime mortgages wouldn’t have existed at all. In contrast, the CDO deal would technically create a win – win solution for all the parties involved. The investor (the equivalent to the depositor of a commercial bank) would earn higher rate of return from his funds, the investment bank makes money through commissions and fees, and because the whole set – up is not regulated like that of commercial banks, poor credit quality borrowers can actually get a loan. It is precisely because of this supposed “win – win” scenario that makes CDOs the more preferred form of mortgage lending than the traditional set – up except for one caveat, the risk assumed by the banks. For investment banks, the credit default risk is very high, higher than the risks assumed by commercial banks because of the credit quality of the borrowers. To circumvent this problem, investment banks created another derivative product called credit derivatives and the types usually employed in this deals are the credit default swaps (CDS). This is where AIG comes in. Credit default swaps are very much like insurances. The investment banks basically buys a cover against credit defaults from the sub – prime borrowers and pays a certain sum for that cover with the basket of mortgage loans as reference not as collateral. In the event of a credit event be it a default on payment or a declaration of bankruptcy or pre – payment of loans, etc, the seller of the credit default swaps (in this case, AIG) pays the buyer of the swaps (the investment bankers) an amount equivalent to the difference between the actual market value of the defaulted security and the agreed value. So if the security is initially valued at let say, $1 million and after the credit event, the market value of the security is say $800k, then, the seller of CDS would pay the buyer the difference, which in this case is $200k. CDS may seem simple enough but it is actually not. CDS differs from a regular insurance in one aspect, namely, the collateral or the property or asset to be insured. In an insurance, there is a property or an asset to be insured and serve as collateral (in the case of insurance, the collateral is usually irretrievable in the event that triggers a payout). In CDS, the property or asset in question which in this case refers to the basket of mortgage loans serve only as reference for the calculation of the premium payments and eventual payout. There is no collateral at all. In short, investment banks or any financial entity doesn’t have to hold the reference securities in question but they still could buy for the cover and receive payout in case of credit defaults. In addition to that, there is no regulation to supervise the creation and sale of CDS. So what the whole set – up suggest is that CDS like any other derivatives are tradable instruments for profit gain and not simply just for cover of risks. So in the event that an entity felt that likelihood of default increases due to some macroeconomic changes and therefore increase the likelihood of a payout from the seller of the CDS, the holder of the CDS could sell it to a third party for a certain amount of profit. Or, the seller of the CDS could “sell” the swap to a third party in return for cash up front while the third party receives the premium payment from the buyer of CDS granting the likelihood of default is minimal at that juncture. Now, with the understanding of the underlying financial basis of the sub – prime mortgage loans, one would get a feeling that the entire complex and supposedly, “win – win” dealings hang by a very thin hairline, which is the paying capacity of the mortgagor or the borrower. If the borrowers pay their mortgages diligently and timely, the wheel of this dizzying meshwork of a clock would keep on going. On the other hand, if a few borrowers were unable to pay and defaulted on their mortgages, the “clock” would suffer a jolt but it will still tick but if there is a massive bankruptcy of the borrowers, the clocks utterly breakdown and the result is catastrophic and chaotic as we’re in right now. This led us to the second of cause of the global meltdown, which is the over leverage positions of the middle class Americans. Since the 1990s, with the launch of the dotcom boom, the ensuing prosperity has greatly increased the “paper wealth” of the average American thus laying the foundation for increase in spending. Couple this with a healthy economic growth for almost 2 decades, American spending increases dramatically to the extent that during the aftermath of the 1997 Asian financial crisis, American consumers became “the consumer of the world”. Two recessions, the Mexican Peso Crisis, the Russian financial crisis, the 1997 Asian Financial Crisis, the dotcom bubble burst, and the 2001 terrorist attacks had temporarily tempered the American economy but failed to completely dampen it. This is due in large part to the aggressive rate – cutting authored by the Federal Reserve under the guidance of Alan Greenspan. As a result, American spending continued to roar on. This time, it is abetted by cheap credit. It became common at that time for a typical American to possess multiple credit cards with credit transfer features. It was also at this time when American began to translate their paper wealth into hard assets via investments in real estate and automobiles. So what all this translate to is that the claims on the future cash flows, i.e., the money that had yet to earn of the average American grew significantly such that not much could be saved from what remains of those future earnings. Given this scenario, in prosperous times where opportunities for economic gains abound, future incomes are assured and were enough to cover all these claims. However, in bad economic situation, future cash flows becomes unstable and claims has caused an added burden to consumer struggling to make ends meet. This is what happened two years ago when inflation sky rocketed mainly due to a surge in oil prices and the spiraling increase in the cost of food. Added this to the aggressive rate increases to curtail inflation by the Federal Reserves, the claims on future earnings grew and ate whatever little surplus those future earnings had if not totally outstripped it. As an immediate consequence, Americans first reacted by withholding payments for big ticket items like mortgages or selling their fixed asset holdings like real estate. However, in a struggling economy wherein a few can afford to buy, the influx of so many real estate for sale resulted in precipitous dropped of real estate prices. This is in turn exacerbated the worsening mortgage crisis as paying mortgagor suddenly find themselves saddled with expensive debts with soaring interest rate backed by real estate whose value is declining rapidly. And so, it came to a point that defaulting on expensive mortgages packs more financial logic than holding onto it. This in turn creates a snowballing effect that produced the sub – prime mortgage crisis late last year. On the financial side of the sub – prime mortgage crisis, the patchwork of derivative deals has broken down completely as the cash flows from mortgage payments dried up forcing investment bankers to pay up the bondholders (the buyers of CDOs) from their own pockets and since investment banks normally don’t take in deposits, they’re hard pressed for cash. This in turn force some bondholders to call in the CDOs whenever possible which further aggravate the already perilous state of investment banks. Now, the CDS should in theory cover for the mounting losses from sub – prime mortgages but since the value of tradable CDS are way, way bigger than the actual mortgage default and the fact that the seller of CDS didn’t set aside a contingency fund in the event of default and that the default is no longer a distinct possibility but a reality, the fund required for payout of the cover is simply too much for a insurer of credit default and this is what led AIG to sought for government bailout. Now, with CDS being somewhat “useless”, investment banks are left alone to fend for themselves. With no revenue income (due to defaulting mortgages and restricted payouts from CDS), pricy debts (due to high interest rate CDO’s), and virtually no funds on its own (since investment banks don’t take in deposits like a regular commercial banks), investment banks are left with no choice but to find ways to raise funds and payout the bondholders. They do this by either selling their shares in return for cash infusion or borrowing heavily to finance short term debts. But as we all know, one cannot survive by raising debts at least, not that long. Because of the deteriorating financial conditions, financial institutions with excess funds became apprehensive about lending out precious cash to firms with doubtful survivality. And this triggers among other things, the fall of investment banks led by Bear Sterns and (hopefully) ended with Lehman Brothers, thus, precipitating, the Wall Street Financial Meltdown. Even so, the Wall Street Meltdown was actually an American crisis and limited to the USA only. It morphed into something greater because of a third factor and that is the globalization of finance. Since the end of the cold war in the beginning of the 1990’s, nations around the world began to realize the “superiority” of the capitalist system and quickly adopted it by opening up their markets to foreign trade and investment through the removal of tariffs and the removal of restriction on the flow of capital in and out of the country. The result is the alignment and integration of the national financial systems to the world financial markets dominated by Western Europe and Japan and led by the United States and this in the process gave birth to the global financial system that we see today. Financial markets of every nation around the world became more closely linked and highly dependent on each other. It is therefore no surprise to see American companies having financial interest across the globe and that the rest of the world has financial interests in America. One of the greatest American exports aside from Capitalism, Democracy, automobiles, computers, the internet, and McDonald’s is the derivative instruments (and the financial crisis if one is to be sarcastic about it). Companies around the world including their government’s central banks usually invested in American debt, a major part of which are in treasury notes but with sizeable investments in bonds issued by venerable Wall Street institutions with superb credit rating like Bear Stern and Lehman Brothers. So when Wall Street is crumbling, the rest of the world became apprehensive about buying into American debt and this in turn created a credit squeeze on these once high flying investment banks. As the value of American debts kept falling, the finances of some of these companies outside America are also gravely affected resulting into their shaky financial situation and expose their vulnerability to sudden adverse changes in the macro environment. And that adverse change was triggered with the fall of Lehman Brothers (a venerable financial institution with long history and previously good credit standing) and it’s eventually bankruptcy. Soon, companies with poor financial foundation and huge exposure to the toxic American debt followed suit and this in turn forced companies especially commercial banks to become even more apprehensive if not outright fearful about lending precious funds to other banks who maybe in intensive care. The net effect was the frozen the credit market. You see some companies for one reason or the other cannot turn their paper profits into cash easily that could fund their daily activities and they therefore turn to the short term debt market like the commercial papers market for their financing needs. However, with the credit market frozen, cash suddenly becomes scarce and companies are fraught with to panic on how to “sustain” their operations even if they are profitable and the old adage about “Cash is King” became the cardinal rule in the market. With little cash and nowhere else to borrow money from, the next logical step among companies was to sell whatever asset they could sell in order to raise cash and the most liquid of all assets available to them for the moment are their marketable securities that they’re holding, i.e., stocks (other assets like fixed assets are harder to sell and could materially affect their operational sustainability). After all, a dollar in cash is much better than a dollar in stocks whose value may become next to nothing overnight. This caused the global sell – off in stocks that we bear witness to the past few weeks. The global stock selling frenzy cause the companies to sustain loses which makes finances of these companies all the more precarious and this in turn feed more fear and panic contributing to the ceaseless downward spiral into total chaos necessitating unprecedented bailouts and intervention by governments around the world last week. And that folks, is in a nutshell (and 6 pages long), the 2008 global financial crisis, which is unraveling as we speak.

1. Bond Markets, Analysis, and Strategies, 5th edition, international edition. Frank J. Fabozzi, Pearson Prentice Hall, 2004.

Monday, October 13, 2008


Nessun Dorma, the Latin phrase for “None Shall Sleep Tonight” is a highly popular classical opera song and is considered by many to be Puccini’s magnum opus. I first heard the song a long time ago at near the ending of the movie, “The Mirror has Two Faces” and then again during the climax – resolution phase of the movie “The Sum of All Fears”. I was since then smitten by the song and was mesmerized by the elegance and the grandeur of the music. However, there was a problem. I never knew the title of the song and for the longest time possible, I was searching for that mesmerizing music with not much of a success until recently when I “discovered” the music’s title rather accidentally. I was watching TV sometime ago and I came across Paul Potts and to my excitement, he was singing Nessun Dorma then as his award winning song. From there, I scoured the net, looking up for the name Paul Potts and finally discovered the music that captivated me for so long and last Sunday, I finally bought a copy for myself. Nessun Dorma based on my research over the internet (well, mostly at Wikipedia) is the one of the climatic song written by Puccini for his last play, Turandot. Turandot is a play about the story of a cold hearted “Chinese” princess who finally discovered love. Princess Turandot (the name is actually Persian in origin rather than Chinese but the play cast Turandot as a Chinese princess) is a strong willed and a cold hearted woman who vowed to never submit to any man however, her father, the emperor Altun wanted Turandot to get married at the soonest possible time. Eventually, Turandot relented to her father’s wishes on one condition, that the suitor should answer her 3 riddles. Turandot agreed to marry the suitor who will able to answer all the three riddles however, if the suitor failed to answer the riddles, he would be beheaded. And so, many young men came forth and tried to win the hand of Turandot but only to lose their heads. The last of these was a prince of Persia, he too failed at his task and was sent to meet his fate and it is here where the play begins. In midst of the commotion of the impending execution, a young wanderer came forth to see for himself what the commotion is all about and he chanced upon a blind old man with a slave girl who was shoved to the ground by the unruly crowd. The blind old man happened to be his father, himself a former prince and the slave girl was named Liu. Quickly, the young prince came to help up his father and father and son were rejoiced to have met up again. During the reunion, the young prince however, forbade his father to call out his name in public for fear of political persecution because of his past political ties. It is during this time when the gathered crowd witnessing the execution begged loudly for mercy for the unlucky Persian prince. In the middle of the clamor, Princess Turandot appeared in the balcony of her palace and ordered the execution to proceed showing neither mercy nor remorse (and witnessing for herself the execution). It is at this moment when our young prince caught a glimpse of this terrifying beauty of a princess and he immediately fell in love (call it love at first sight). And in his dazzled state, the young prince rushed to the palace door and strike at the gong, 3 times announcing to the world that he has taken up the challenge and at the same time, declaring his love for the cold – hearted princess. The crowd was shocked to hear the sound of the gong and equally shocked by the audacious stupidity of the young prince. At any rate, the palace door opened and three ministers, Ping, Pang, and Pong came to dissuade the young prince to give up his quest but to no avail and therefore, the three ministers led the young romantic to the court chamber to meet either his destiny or his doom. At the court, the young prince met both the emperor and the princess and proceeded to answer the 3 deadly riddles. The first riddle asked by the princess was, “What is born each night and dies each dawn?” To this riddle, the young prince easily answered, “Hope”. Unnerved, the princess presented her second riddle, “What flickers red and warm like flame but is not fire?” Now, the second riddle was rather difficult but nevertheless, the young prince prevailed after giving some thought for he gave the correct answer, Blood. Now, the princess was badly shaken and was rather angry when the crowd cheered for the young prince for now she presented her third and final and perhaps the most difficult riddle. “What is like ice but burns like fire?” It may seemed though that the princess has finally claimed another poor victim and our young prince has failed like those before him for he was unable to answer the question for a long time and then, just then the prince finally figured it out. He shouted his answer, “Turandot”! Shocked by the turn of events, Turandot fell on hers knees and pleaded with her father not to allow the marriage to take place but the emperor has spoken before and his word is the law of the land and he is bound to honor it. Seeing this, the young prince put forth a proposal to the princess. If the princess could answer by tomorrow morning the one riddle that the young prince would ask, the young prince would be willing to die but if the princess failed to provide the correct answer to the riddle, then she is bound to marry the young prince. Seeing her chance, Turandot agrees to the proposal and asked for the riddle, to which the young prince asked “What is my name?” In an instant, everyone was dumbfounded for nobody knew who the young stranger is. That night as the stranger was ushered to his quarters, the Princess Turandot sent out her guards with this explicit instruction, “None Shall Tonight until they find out what the stranger’s name is, if they fail by tomorrow morning, they shall all be killed.” It is in this context that our hero witnessing the frantic acts of desperation, that he sang “Nessun Dorma”. Soon afterwards, Ping, Pang, and Pong came to the chamber of our hero and offered him a bribe and asked him to leave during the night and so as to avoid the inevitable come morning but our hero flatly refuses the offer. It is not long afterwards that the guards brought in the blind old man and his slave for questioning since somebody have pointed out that the old man was seen conversing with the young prince. Running out of time and patience, Turandot have both of them tortured to reveal the identity of the stranger but none of them spilled the beans until Liu the slave girl in order to save her master and as well as repay the young prince for having smiled at her once (Liu is madly in love with the young prince) confessed to know the true name of the stranger. Liu told the princess that his name is “Love” and drove a dagger into her heart and killed herself. By this selfless act, Liu, now forever silent took the secret to her grave. The young prince on hearing the death of Liu was so enrage by the cruelty and the cold heartedness of the princess rebuked Turandot. However, he was also madly in love with the heartless princess that he gave her a kiss and tried to convince her of his true love for her. And in an act of love, he revealed to her, “My name is Calaf, son of Timur”. In this stroke of either ingenuity or stupidity, the young prince Calaf has placed himself in the hands of the princess for her to destroy or save. The next morning, the emperor Altun summoned the princess and asked her if she knew the answer to the stranger’s riddle and to which the princess replied, “yes”! “And what is his name?” The emperor demanded. Guess what the princess answered? “His name is Love”, that was the princess’ answer. Both Turandot and Calaf kissed and they eventually got married and lived happily ever after (as always the case in story – telling). Well, personally I think the storyline is quite bizarre (but I don’t know if the 19th century audience would find it bizarre as well or simply find it to their liking; I think it’s more to their liking). Then again, that’s the beauty of classical music. I mean, unlike modern pop music, which no one could barely “get” the message of the songs, classical music has an entire back story to rest on, which makes the song more enjoyable and entertaining. Enough said and speaking of Paul Potts, the guy is really one lucky Brit. Paul Potts used to be a phone salesman and rode a bike to work (based on what I heard) but he took his chance, his one shot at his dream and made it. He joined the reality show, “Britain Got Talent” (similar to American Idol and Simon sits as one of the judges there as well) and won with his rendition of Nessun Dorma. He became an overnight sensation and a darling in the internet circuit with his performances being shown in YouTube. Since then, he had begun his recording career and his album has become a certified platinum hit (if I remembered correctly). Furthermore, he also went on a world tour and last October 8, he came to town to perform his piece. I was never a music guy and I never dig going to concerts but in this case, I really liked to watch him sing. I really liked his rendition of Nessun Dorma. Unfortunately though, I wasn’t able to watch Paul Pott’s performance last Wednesday for no particular reason at all except for that I don’t have a date…….. (At least, Calaf has Turandot to listen to him sing).

Nessun Dorma
By Giacomo Puccini
Nessun dorma! Nessun dorma!
Tu pure, o, Principessa,
nella tua fredda stanza,
guardi le stelleche tremano d'amoree di speranza.
Ma il mio mistero è chiuso in me,
il nome mio nessun saprà!
No, no, sulla tua bocca lo diròquando la luce splenderà!
Ed il mio bacio scioglierà il silenzioche ti fa mia!
(Il nome suo nessun saprà!...e noi dovrem, ahime, morir!)
Dilegua, o notte!
Tramontate, stelle!
Tramontate, stelle!
All'alba vincerò!
vincerò, vincerò!

Nobody shall sleep!... Nobody shall sleep!
Even you, o Princess, in your cold room,
watch the stars, that tremble with love and with hope.
But my secret is hidden within me,my name no one shall know...
No!...No!... On your mouth I will tell it when the light shines.
And my kiss will dissolve the silence that makes you mine!...
(No one will know his name and we must, alas, die.)
Vanish, o night! Set, stars! Set, stars!
At dawn, I will win!
I will win! I will win!

Wednesday, October 08, 2008


1. To be greedy when everybody is fearful and to be fearful when everybody is greedy. – Warren Buffet.
2. In business, it pays to be a cynic and a skeptic.
I remember this quiz I had in my Controllership class during my years in business school. The quiz was actually the first one in the said class. It was basically a sort of a review of our basic accounting knowledge, i.e., return on equity, leverage ratios, current ratios etc and our professor at that time gave us the previous year’s published financial data of the top 5 corporation in the Philippines as our test case. However, that particular quiz had a very interesting twist. I remembered that the last question asked in the quiz was which of the top 5 corporations we want to lend money to. I also remembered that the number 1 corporation at that time was Petron Corp which at that time is hemorrhaging badly and is deep in the red. The number 2 company at that time if my memory serve me right was Texas Instrument and MERALCO was like number 3. Anyway, all our financial analysis indicated that the number 2 company, Texas Instrument was the best choice to loan money to but guess what did I picked? I picked Petron! At the following session, the professor brought out the topic of our quiz and she frankly admitted that she was in a bind as to how to grade two particular answer sheets, mine and another guy’s paper. According to her, the correct answer was Texas Instrument (TI) which was quite obvious from our financial analysis but why in the whole wide world would 2 guys answer differently from the obvious? The other guy picked MERALCO and he reasoned that although MERALCO’s number were less than stellar compared to TI but her financial statement was by all means strong and furthermore, MERALCO has the stronger cash flow than TI, i.e., it is cash rich. So instead of crowding up at TI, a loan to MERALCO could prove to be more of a bane. Nice answer indeed! On my turn to defend my choice of Petron when I was asked the same question, my answer was relatively simple. Petron was and is still is partly owned by the government and it carries an express guarantee of the state on its debt obligation. Therefore, who cares if Petron was in the red, the government would simply pay the debtor regardless and from the state coffers. Although my answer was by and large practical, my professor rejected it and I scored the lowest at that quiz though I didn’t fail (at any rate, it was a minor setback; I eventually passed the subject with flying colors, 3.5/4.0; not bad for a non – accountant in an accounting subject). What was missing in the question at that time however was how much would we charge for the loan to our respective choice of company? For all practical purpose, Petron would probably be charged more for their weak balance sheet and if that were part of the question, I’m pretty sure that my answer would be the best one. Looking at hindsight, I can say that most of my classmates (99% of them are accountants by profession) at the controllership class are good accountants and auditors and nothing more. The other guy who answered differently is an example of a good value investor while I am the archetypal maverick Wall Street trader that everybody loathes nowadays. And this is my point, why would a guy like me (back then) and rest of the many who got “burned” in the latest subprime crisis would skirt the “obvious” safe choice and invest in high risk securities and end up in the mess that we are seeing right now? By the way, I didn’t get “burned” at all, I simply end up with the lowest score in that quiz taken years back but the great many lost their hard earn savings in this recent financial debacle. So what really is the cause? The answer is because of the need to maximize the return on investment. Put it simply, it is the “how much more could I get from the dollar or peso that I had invested be it in a financial instrument or in a business or in an asset?” It is human nature to want more “profit” for the little that we own. Nobody can blame anyone for wanting to maximize their return on investment. However, one had to remember that though almost everybody handles finance, very few do actually understand what finance is. Finance is not simply about managing returns. It is as much of managing risk as well (and allocating funds and managing cash flow). Finance is not just getting more bucks from what we have or maximizing return. It is also making sure that that buck is safe or in short, minimizing risk. Taken in this light, it puts the very idea of maximizing return in jeopardy. How we could maximize return if we are constrained by risk? For how could we be sure of getting that much money given the risk? And this is where the “magic” of Wall Street comes in. That “magic” is called pricing models, the pricing of human behavior and the human behavior in this particular case is Greed. Most people have a “healthy” appetite for risk, i.e., for a certain limited range of risk, people are willing to take their chances (if that didn’t happen, you won’t see people getting married). And for every risk, there is a commensurate return. The bolder ones getting rewarded with better pay offs. However, for huge risks, 99.99% of the people are avoiding it even if the return “commensurate” with the risk involved and one doesn’t need financial analysis to come to that decision. However, Wall Street has managed to skewer the risk appetite curve towards risk taking bordering on gambling and they do this by simply offering “bigger” return on investment, much bigger than the “commensurate risk” which in essence is stoking greed. Such is the case of the current sub – prime mortgage financial crisis wherein investment banks package mortgages with poor credit quality into a high yield debt instrument and resell it to investors looking to maximize their return. And as these sub – prime mortgages fumble under the weight of a falling economy, the debt papers backed by these mortgages became essentially a worthless piece of paper. This has in turn, triggered the massive selling of these debt instruments or calling in of these debts issued by some of the most venerable Wall Street institutions resulting into their bankruptcies and eventual demise. Alas, Wall Street has done what behavioral scientists had failed to do, that is to quantify or more specifically, to put a price on a human behavior – greed. Essentially, this is the same mechanism employed in pyramiding schemes. Greed however is not the only human behavior that is explicitly witnessed in these turn of events. Panic is one. Panic is the extreme fear that defies logical reasoning. By logical reasoning, it refers to logical financial reasoning and this is quite funny because how does one expect people to be logical and reasonable along the established rationale of a financial analysis when the rationale of their decision has turned from one of maximizing return to that of preservation? Interestingly, unlike greed, no one has priced panic yet. Perhaps somebody already did if one considers the bailout package as the ultimate price of panic. But then again factoring panic into the price decision could very well prove to be useful. I mean in regular appraisals of assets to be mortgage, most lender would only lend out a portion of the total value of the asset in question. The difference between the actual value of the mortgaged asset and the loan amount is the buffer that lenders seek in order to protect them against a devaluation of the mortgaged asset in case of a default and the ensuing fire sale. However, in times of panic wherein the price of the assets in a defaulted mortgage would precipitously dropped below its reasonable fair market value, lenders stand to lose because they wouldn’t be able to recover their money through the sale of the asset in a defaulted mortgage. Henceforth, pricing “panic” is essential if one is to stay afloat in times of market hysteria. However, there is an inherent difficulty in pricing panic since the rationale is no longer that of obtaining a return on investment but on securing the investment. Would somebody buy a $1000 asset for just $100 in a panic market especially when that person has been “burned”? Most likely not. After all, a dollar in cash is better than a dollar in a risky security. But what if the same $1000 asset is sold for say $10, would somebody buy? What about if it were sold for a dollar? If one can determine the discount from the fair market price of an asset that would entice a jittery investor to purchase the said asset, we would have our price on panic. Opposite panic, we have euphoria which in a not so long ago time, is the prevailing mood of the market. I remember before during my early days in business school, the fair valuation of a corporation’s common stock trading in the market was 15 times the projected future earnings of the said company. By the time, I’m halfway through MBA, that multiple has jacked up to 22x average with some valuation going as high as 30 to 50 times (that is during the internet bubble era). Furthermore, the valuation then is no longer based on projected earnings, which is properly defined as net income from operations after tax and interest and after deduction of one time charges. Instead, the market back then was talking about pro – forma income, which was accordingly defined as income from operations before tax before interest charges and before deducting other charges which was a very “creative” way to define profit. At any rate, how do we valuate euphoria or in the former Fed Chairman Alan Greenspan’s word, irrational exuberance? But before we could price euphoria, we have to define what a fair valuation is. Is 15x, 22x fair? This is aside from the fact that each analyst employing different methodology has their own forecasts and projections, which then should be used for valuation? So many questions, so little answers and this is basically why market swing and swoon. This is also why some people make money and some people lose money. All because of the volatility of human behavior and our inability to accurately price them for our own sake.