Cash, cash and more cash. Bank’s have been battling this enemy since the beginning of the credit crunch last year. Stress tests carried out by the US government reveal that ten of the nineteen top banks in the US will need to raise an additional $74.6bn in capital. The news was well received by the market as the shortfall was not as high as expected.

However, let’s take a closer look at how most of the bank’s are going to come up with this additional money. Bank of America, which needs the largest capital infusion of almost $34 billion will exchange government-owned preferred shares for common stock.  Most other banks are also using the same strategy.

How does this account for “additional” capital? Granted that this will enable banks to avoid paying costly dividends, which reduce earnings but the “conversion” will not inject the much needed cash these banks are looking for. Furthermore, US taxpayers should be worried as the government will now become a major shareholder in most of these banks, but at the bottom of the ladder.

What do I mean by this? Well, common stock holders are the last to get paid if the banks become insolvent. Therefore, some might say that the money paid to bail out the banks is now completely free for them as it does not even carry the cost of dividends. In addition, the government is now well and truly a major decision maker in the day to day running of these banks and I have said this before and I will say it again, “Leave the business of banking to the bankers.”

Banks must be pressured to improve their business models and get rid of unprofitable businesses. This is the only way depositors will begin depositing more money with banks and banks will start lending responsibly (under strict regulation and KYC compliance), thereby kickstarting the economy again.

The banking arena must become one in which only the fittest survive.  Allowing the weaker banks to fail might worsen the situation in the short term but in the long term, it will seperate the weak from the strong and create a more robust environment for investment.

The once dominant players in the financial markets, hedge funds, are facing tough re-negotiation demands from pension funds and other large institutions who control eighty percent of the money invested in these funds. The movement was triggered two weeks ago when the $175 billion California Public Employee Retirement System pension fund, or Calpers said they wanted a restructuing of hedge fund terms.

Investors are now insisting on more lenient restrictions on withdrawals during redemption periods. The restrictions, also known as gates, limit the amount of money that can be taken out during the redemption period, thereby protecting funds from massive losses of cash at any one time. Large institutions are also demanding better management fees based on performance (rather than a fixed percentage), more information on investments and increased access to cash.

Hedge funds, once kings of the financial world, lost their power and credibility, when customers withdrew a record $185 billion in capital in 2008. Their power has been further weakened by changes in regulations regarding a ban on short selling. Previously, hedge funds could sell shares of companies they did not own and then buy these back at a lower price. This hedging strategy was one of the main ways in which hedge funds could protect long positions in stocks through short positions. However, short selling was banned in September last year by financial authorities in many countries including the US and UK.

The success of hedge funds, brought about mainly through fewer regulations is no more. These giants are going to have to work harder to retain their clients and maintain the level of confidence they enjoyed before the financial crisis.

The British government stopped short of nationalising Lloyds Banking Group after increasing its stake to 65% from 43%. Business Secretary Peter Mandelson has clearly said that the government has no intention of completely taking over banks in the country, calling for nationalisation as neither “necessary or desirable”.

Is nationalisation the answer to Britain’s banking woes? Although bankers have given in to greed and are responsible for the situation today, what makes one think that politicians can do what greedy, but nonetheless experienced bankers failed to do. Let politicians do what they do best and leave the running of difficult financial institutions to bankers.

In the case of Royal Bank of Scotland, more than half its lending portfolio comprises loans to corporations outside the UK. Is it fair to ask the British taxpayer to fund loans that do not even belong to British companies? It seems not.

Why put the country’s financial institutions on a pedestal when industries all around are collapsing under the weight of the financial crisis? Industries from media to construction and retail are all reeling from dried-up lending. Why not rescue them as well?

These are some of the questions that need to be answered. What then is the solution?

From where I sit (in a small room at the Tremough Campus in Falmouth), the best solution seems to be a mix between partial government ownership and rigorous regulation. There is no doubt that banks must pay for their actions. Governments can control monetary payouts to top executives and set targets for banks to achieve but leave the day to day running of these complex institutions to those that know how to do it.

Abu Dhabi’s investment arm, Abu Dhabi Investment Authority (ADIA) is sitting on $7.5 billion in Citigroup convertible bonds. According to the contract, the bonds must be converted into common stock at a price range of $31.83 to $37.24 between March 2010 and September 2011. However, the troubled bank has lost most of its market value with lending woes and its shares are trading at $1.50.

Convertible bonds are seen as a strategic investment in bad times since the investor enjoys the advantages of security of the bond (in terms of interest payments) during poor performance, but can also convert the bonds to common stock if the share price rises in the future.

However, chances of Citi’s share price rising  from $1.50 to anywhere in the mentioned range in the next 18 months is laughable. ADIA is then, effectively, holding a busted convertible security or one where there is very little or no chance of conversion. Therefore, this convertible bond is now to be treated as regular debt. This would actually work in ADIA’s favor if the bank was otherwise healthy and sitting on large cash reserves. But we all know this is not the case. Three government bailouts and possible nationalization tell another story.

What can ADIA do? The investor can hold the shares through to conversion and hope that the share price recovers. It can also sell the bonds but will find it very difficult to get a buyer, mainly hedge funds who are themselves strapped for cash. A third option is to convert early before the government possibly nationalises the bank. All options present a bleak picture to the oil rich emirate. Of course, if instead of nationalising the bank, Citi was acquired, that might drive the stock price closer to the conversion price, thus making the bond more valuable.

The dire situation of most US banks and banks worldwide just goes to show that investors need to be extra cautious when investing in instruments which in normal circumstances would have been winners.

I was talking to my friend in the US about how much I miss watching Desperate Housewives. She has just had a baby but still manages to keep up with all her favorite shows. How does she do that?

The American Broadcasting Corporation (ABC) now allows its viewers to watch prime-time shows on its website. The way it can afford to do this is by allowing companies to advertise on its site and thus earn revenue. This works for both ABC and the advertisers as companies hit by the financial crisis can’t afford to pay for expensive ads between prime-time shows on TV.

The economic downturn is forcing broadcasters, especially traditional TV channels to explore new avenues of revenue. Recent ratings show that more viewers watched the Obama inauguration online then on TV for the first time in US history. What’s more, broadcasters like CNN wooed viewers by enabling them to talk live to each other during this historic event. This was not casual viewing, audiences all over the country were participating in the event like never before.

Traditional broadcasters are also looking to foreign markets and tie-ups with cable service companies to diversify revenue sources. The future is wide open and thinking out of the box may just be the requirement of the time in this ‘survival of the fittest’ environment.

P.S. For more about the revolution in the UK media industry, visit my other blog

The Obama administration has wasted no time in angering Chinese officials. Relations between the two countries got off to a bad start when US Treasury Secretary Timothy Geithner accused Beijing of keeping the yuan undervalued to boost exports. Su Ning, Vice Governor of the People’s Bank of China (Central Bank) for the first time, publicly criticised the comments as being misleading.

Although China has been accused, in the past of manipulating its currency, the US has sufficient domestic problems to deal with and should concentrate on its local economy. China and other large emerging market economies such as India are also expected to play a key role in lifting world economies out of recession. Alienating China is not going to help matters.

It will be difficult in this economic climate to persuade any country to artificially strengthen its currency as this will make exports of that country more expensive. With weak domestic economies and high unemployment, no government will create a situation that will cause further job losses.

Citi is close to selling its 135-year old lucrative brokerage business, Smith Barney, to Morgan Stanley, with a deal expected to be announced by mid-week. Morgan Stanley will merge its retail business with Smith Barney to create the world’s largest brokerage overtaking Merrill Lynch/ Banc of America.

What then are the taxpayers, who have already shelled out $45 billion under the government’s Troubled Asset Relief Program getting? Citi needs the cash to boost its balance sheet, one of the conditions put on the bank for receiving the bailout but is it making the right decision? It will be selling one of its most profitable businesses and for what? A measly $2 billion.

The deal itself is risky. The greatest assets of a brokerage businesses are its brokers and Morgan Stanley may have to incur greater costs to retain Smith Barney brokers who will most likely be reporting to Morgan Stanley bosses. Getting the two adversaries on Wall Street to work together will be a challenge.

And who is providing the funding for the deal? Not Morgan Stanley who has not been unscathed by the credit crunch. Yet again, the government and effectively the taxpayers come to the rescue. The money for the acquisition will come from the US government who invested $10 billion for a stake in Morgan and from Japanese Bank, Mitsubishi UFJ who took a 21% stake for $9 billion.

Happy New Year or is it?

If 2008 was a nightmare for banks and financial institutions, 2009 may just rub more salt into deep wounds. Most US banks who earned a substantial portion their fee-based revenue from capital market activities such as IPOs and M&A will have to look at alternative sources of such revenue. According to Robert W. Baird & Co., a private equity firm, global M&A in 2008 (until November end) declined by about 36% in value last year compared to the prior year. Subsequently less and less US private companies are looking to raise capital via public offerings (IPO) due to depressed market conditions. Bloomberg predicts it will take another three years till 2011 for IPOs to return to their 2007 highs.

Barack Obama’s potential $310mn tax cuts for the US economy have been overshadowed by lower than expected corporate profits.

Both the demand and supply side need to be stimulated. On the demand side, investors are keeping their money liquid, mostly in cash. Prolonged market depression despite several government bail out plans for the banks and the auto industries continues to undermine investor confidence and reduce demand for goods and services. Repressed corporate profits also play a major part in keeping the economydown.

On the supply side, bank lending is nowhere near 2006 levels with the mortgage market particularly feeling the effects.

Things might get worse before they get better and 2009 may just be another year of pain for the financial markets and global economies.

Canada’s commercial paper market is in trouble. Commercial paper is issued by banks and other companies in order to get cash quickly, cash which is then invested in long term products such as mortgage-backed bonds and collateralised debt obligations. It is a cheap method of raising funds compared to inter-bank lending and long term borrowing. Issuers in the past have made a profit by borrowing money at low rates through commercial paper and profiting from higher returns of the long term instruments.

However, money market funds, the buyers of these instruments refuse to finance issuers any longer. Why? A lot of the commercial paper is backed by subprime mortgage loans, also called asset backed commercial paper and with the uncertainty and current economic conditions, these mortgages have lost value.

Almost C$ 32 billion in commerical paper is now going to be restructured into long term debt. However, this means that the buyers of the commercial paper need to be paid back before the restructuring can happen. Large banks such as Deutsche Bank, HSBC and Citigroup say they will provide cash to these issuers. The restructuring is overseen by the court , however the banks providing the backstop have warned they will abandon the deal if the restructuring plan is not agreed to by tommorow.

If this happens, commercial paper issuers will have large amounts of untraded paper sitting on their books, which will severly restrict their lending capacity and possibly cause them to look for expensive ways of raising money to redeem these papers.

What was effectively a done deal for an intial bailout package for the three US automakers has failed as Republicans wanted the United Auto Workers union to accept wage reductions in line with their Japanese counterparts.  A proposed $14bn bailout plan fell through last night.

There is pressure now on the Bush administration to use the some of the $700bn reserved for banks and financial institutions to rescue General Motors and Chrysler. However, Henry Paulson stands firm that that money is for the financial sector.

If the three fail to get cash, it could mean even more job losses for millions employed directly by the companies and those servicing the big three.

November saw job losses at a 34-year high and unemployment figures at a 15-year high.