Basel III - Tier I and Core Capital

For those of you who have recently been reading the consultive document, published by BIS for analysis, probably have stumbled upon the new rules concerning the inclusion of capital in the Tier I and Core Capital Ratios:

1 - The quality of capital that will be eligible for the Tier I ratio should increase significantly. Hybrid securities that were once eligible for this ratio and widely issued by most banks will transit out from Tier I to Tier II capital.

2 - A new capital ratio is to be introduced, the Core Capital Ratio, adding to the two existing ones: Tier I and Total Capital ratios. Although no specific minimum has yet been proposed for this ratio (unlike the existing minimum of 8% for the Tier I ratio which will probably remain at the same level in the new proposal) specific criteria has been put forward on the type of capital that is eligible. Core Capital shall be composed primarily of Equity like capital, with no fixed coupon, no maturity and absolute subordination to all other capital. In other words this should be that type of capital that takes the first hit in an event of insolvency.

3 - Most of the deductions that were priorly made to the Tier I capital will now be made directly from the Core Capital.

4 - Additional deductions are to be made to Core Capital (most of which have stirred controversy among the principles of the banking industry) namely the exclusion of Minority Interest, exclusion of Deferred Tax Assets, all type of Goodwill and full and immediate deduction of unfunded fixed benefit pension fund liabilities.

Other general thoughts:

Mutual banks on average have weathered the crisis quite better than for-profit commercial and investments banks mostly due to being more conservative (apparently there is some benefit to moving slowly) and concentrating on their core lending businesses, while others have been chasing short-term objectives.

An interesting fact about the mutuals is that apparently they might be better prepared for rasining capital. With a large member base, banks such as Rabobank, Raiffeisen and a few traditional French and Italian mutuals might be able to raise eligible capital for their Core Capital base directly from their customers. Actually this is being done already. Rabobank in particular has about 20% of its Tier I capital in the form of member certificates. Maybe standard commercial banks can learn on their experience and become more "mutual oriented themselves".

And what about Kosovo?

It is no news that politicians and the population in general subject to the propaganda of mass-media have short memory, but the following few quotes from an article on bloomberg is just ridiculous:

«U.S., Europe Condemn Russian Recognition of Georgia Breakaways»
And what happened when Russia, Spain, Serbia and the rest majority condemned the recognition of Kosovo by US?

«...President George W. Bush urged Russia to ``reconsider this irresponsible decision,'' which he said was ``inconsistent'' with United Nations Security Council resolutions on Georgia's borders that Russia had supported...»
Wasn't the recognition of Kosovo "inconsistent" with United Nation Security Council just a few month ago, but the interested parties decided to step over this minor detail?

«...In international relations, you cannot have one rule for some and another rule for others...»
And that has been said over and over again, but no one seemed to listen, not even now.

So maybe someone could answer to a straight and simple question:
What is so different between Kosovo and South Ossetia?

Quoted source: bloomberg.com (http://bloomberg.com/apps/news?pid=20601087&sid=aSHCAI3Cwt38&refer=home)

What's up with Inflation?

As we have watched FED go on a spree of interest rate cuts to bring back the economy to its equilibrium growth path, inflation has been creeping on us. It is no secret, nor rocket science which we learned during our years in college that there is a trade-off between GDP growth and Inflation. After the publication of the Barro-Gordon model and a series of papers by Prescott it has become a general concensus that central banks are able to stimulate economic growth through interest rate cuts, but only in the short-run. In the long-run (3+ years) this will bring nothing but higher inflation.
So is FED on a suicidal mission? Maybe! Or maybe it sees a 2nd great depression if it does not act accordingly, where high inflation is a peanuts trade-off.
ECB (European Central Bank) has been acting differently and in line with its mandate (maintain medium-term inflation close, but above 2%) coinciding with most scientific recommendations.
Anyway for anyone interested in finding more about optimal monetary policy rules, one can consult a benchmark manual by "Walsh", or the original paper by Barro-Gordon.

Predicted inflation rates for next year in US should be +4% and in Europe somewhere close to 4%. What I have found during this last week is that there are some market instruments that are pricing only 1.5% inflation for both economies, which seems quite unlikely.

Investment Strategy: Long French & US 1 year Inflation Linked Bonds and Short French & US government bonds

The yield between inflation linked bonds and government bonds is interpreted as the expected inflation rate which for these two countries is currently at 1.5% and much below the expected value, so I would expect for this spread to widen to at least 3-4% meaning that the inflation linked bond price should go down in relation to the government bonds.

Is cold war heading our way?

In the news today: NATO to "impose" economic sanctions on Russia, well not actually sanctions per se, but downgrade Russia on its "Morale" scale. Why is that?
The obvious reason is due to its recent -defensive- attack on Georgia. So let us jump directly to the facts:

1 - South Ossetia gained its de facto independence in the early 90s
2 - Georgia on its quest to join NATO and thus obliged to resolve all its internal conflicts (and not willing to recognize South Ossetias independence). The most radical, but maybe most effective solution was to fire a few thousands rounds of ammunition on civilians in hope to regain their loyalty through fear.
3 - Russia, standing by, watching how heads were flying from the shoulders of innocent civilians decided to intervene. Rockets were being fired from the other side of the border, so a small invasion was inevitable in order to stop the fires.
4 - Russia is accused of invading a sovereign country, but not Georgia, its tanks were standing on the other side of the border.
5 - In mass media Georgia's aggression is placed on the back shelf, as though it never happened and world leaders continue to encourage it to join their North Atlantic Alliance.

Now the questions:

1 - Why did the US aknowledge Kosovo's independence, but not South Ossetias's?
2 - Why did the UN exclude the clause "prohibiting the use of force against breaking away republics"?
3 - Why did nobody listen to the Russian representative at the UN council concerning the domino effect after Kosovo's independence?
4 - US is talking about infringement of the sovereign rights, and what has it been doing in Iraq for the past 6 years?
5 - Who attacked South Ossetia?

As one ancient Greek philosopher once said: It is much more difficult to find a good question that the answer to it

US is in favor of a free market economy, competition and everything that come included, but is concerned about rising energy prices, slowing down of its economy and the rising of new super powers. So the best strategy is to place a few missiles in the east and in a few decades use the power of military pressure to obtain the desired effects (including violation of rights of sovereign states).
"It is sad that say, but a new political and military game is coming our way"

So what investment strategy could one adopt to make some money on this?
1 - Short everything
2 - Buy a few Put Options on the stock indices's of conflicting countries (US, Russia, Germany, France and any other developed country). For example there are some at-the-money put options on the NASDAQ index (ticker QQQQ), with strike price 48, strike date 2010 and selling for 6.11 USD.
3 - Long some Gas futures as disruption of Russian supply is unavoidable and the prices are already pretty low.

Crude, Gas spread || MTLR:RTS || High Risk Premium

1 - A significant spread has appeared between Crude and Gas future contracts (traded on NYMEX), and appears to be short-term deviation from the rational: Rises in Crude prices should contribute to rises in Gas prices and not vice-versa. When one energy source raises in price, consumers and producers should tend to prefer the cheaper source thus raising its price to higher levels through higher demand. A possible explanation for current situation is either due to high speculation in crude contracts or large lately discovered gas reserves.
The logical continuation would be for the spread Crude / Gas contracts to shrink.

Trading strategy: Short Crude contracts & Long Gas Contracts

2 - After a few harsh comments by Mr. Puting directed to the CEO of SG Mechel (a Russian Mining company) drove its shares by ~50% and what seems to be a clear overreaction by the market. Link: http://markets.ft.com/tearsheets/performance.asp?s=MTLR%3ARTS

Trading strategy: Long MTLR:RTS

3 - The US sub prime crisis has lifted overall risk aversion in the country and in fact around the world. This has led to increases in credit (risk) spreads priced into bonds across all the spectrum of ratings. This might be reasonable for junk / high yield bonds, but unrealistic for investment grade, especially the ones high above on the rating ladder (AAA and AA+).

Trading strategy: Short US treasury bills & Long AAA corporate bonds with ~1 year maturity