Monthly Archives: July 2012
LIBOR has an influence on interest rates around the world; but recently there have been some questions raised about the rigging of interest rates. Barclays already had to pay over $45 million in fines and it looks like there may be many more fines, and possibly lawsuits to come. Many say that regulators should impose more fines on some of the other 16 banks that are members of the British Bankers Association in hopes that there will never be a repeat.
LIBOR is the London Interbank Offered Rate which is the rate which these 16 banks charge one another for short term deposits and loans. This rate becomes a benchmark for interest rates set worldwide. It influences literally hundreds of trillions of dollars. LIBOR has an influence on various financial contracts corporate loans such as those managed by companies such as Effi Enterprises, interest rate swaps and floating rate mortgages.
Presently, there is much talk about criminal charges and possible jail terms for those involved. Asia, Europe, Canada and the US are investigating what looks like a huge picture of deceit and avarice. Banks must submit their data to be used in calculating the LIBOR; but in order to hide their own institution’s financial problems, or to boost profits for traders, they have submitted falsified data. Remember, that the LIBOR influences interest rates around the world so the repercussions of these devious acts are felt worldwide. Because it affects interest rates, investment firms like Effi Enterprises have been affected by the lowered benchmark.
Lawsuits are pending but as they are pursued they can mean global financial disaster. Municipal governments and investment firms purchased bonds or have entered into financial contracts which were based on LIBOR. They are now asking for compensation from the banks since they intentionally manipulated the benchmark. If the suits take place as it is assumed they will we are talking about potentially tens of billions of dollars that will have to be paid out.
Just so we understand how large of an impact this could have let’s say that LIBOR was only 0.1 percent off for one year. In that time the incongruity on the $300 trillion of swaps could easily mean that the rates were off by up to about $300 billion. This is just one type of contract; it doesn’t even take into account all the other types of contracts or any punitive damages that might be sought. It’s big enough the entire banking system could be crippled.
One suggested option would be for the banks to set up a compensation fund for the victims of LIBOR so that all the banks could pool resources to pay out. An administrator would need to be independent but he could generate a transparent formula which could estimate and calculate the damages that have been done. If the banks at least attempt to right the wrong clients might be more willing to settle instead of pursuing litigation which would be much more costly.
Of course this would take much cooperation among these banks. They would need to decide how much LIBOR had been skewed because of the misreports. Then they would also have to decide how much of the financial liability each bank should be responsible for. Government involvement could help to expedite the process. There may be more regulations set by governments which could help improve the bank’s transparency. Had they maintained transparency this would have never happened in the first place. Perhaps this is a lesson for all of those who deal with financial institutions. Consumers and businesses can benefit from open and honest transparency.
LIBOR is an acronym for London Interbank Offered Rate. It is basically an interest rate used on the federal level. It’s the interest rate that is charged between banks for loans. As far as interest rates it is the busiest in the world of finance. There are a number of banks which participate in the money market in London and they offer short term deposits to each other. LIBOR is what is used to determine the price of several other financial derivatives. These include items such as futures for interest rates, Eurodollars and swaps. This is very influential throughout the world of finance as it affects more than just the Pound Sterling. It is also important to other currencies like the US Dollar, Canadian Dollar, Japanese Yen and the Swiss Franc.
Every morning in London at 11:00 am LIBOR is set. The exact rate is found by averaging the various interest rates which are being offered by the banks in membership with the British Bankers Association. It is calculated for different time frames from as short as a day to a full year. The banks may offer varying rates throughout each day but the rate set is fixed for a 24 hour time frame. Even when the instantaneous rate and LIBOR are different it is a very small increment and for a short time.
Eurodollar futures are the most important of the derivatives which are related to LIBOR. Eurodollars are basically US monies which are deposited in banks which are outside the United States, generally in Europe. These Eurodollars are traded in Chicago at the Chicago Mercantile Exchange. Depositors outside the country are not subjected to the margin requirements enforced by the Federal Reserve which gives the depositor more leverage over the funds. LIBOR determines the interest rate which is paid on these Eurodollars and these futures provide ways to bet or hedge against the changes in the future interest rate.
There are 16 member banks in the British Bankers Association and they control the rates on about $360 trillion worth in the financial markets and products around the world. This includes the adjustable rate mortgages (ARM), which is where it affects the average Joe. When the interest rates are stable it provides several decent options for those wishing to purchase homes. For these mortgages it means no negative amortization and usually there are fair rates in terms of repayment. Usually the ARM is guided by the 6 month LIBOR plus somewhere between 2 and 3 percent.
LIBOR’s influence affects more than just the homeowner it also affects the entrepreneur and loans for small businesses, students and credit cards. It is all good while the economic climate is stable and LIBOR is doing well. But when economic uncertainty looms, particularly in the developed countries then the rates become volatile. This makes it more difficult for the banks to exchange loans among themselves. This in turn makes it more difficult for others to obtain bank loans. The trouble is that when the system is volatile the bank simply raises its interest rates for the borrower, or offers fewer loans.
LIBOR can also affect Federal rate cuts. Usually investors such as Effi Enterprises enjoy it when the Federal government cuts rates. But when LIBOR rates soar it restricts people from obtaining loans. This means that the average person does not benefit from the discounted rate because fewer loans are being offered. For those with a subprime mortgage it is important to keep an eye on LIBOR rates.
Generally the LIBOR rates do not affect the US Dollar or have little effect. It mostly has an impact on the Euro, Japanese Yen and the British Pound. However, for monies from the US which are being held in foreign banks, it is a relevant issue.
There is no doubt that the world of finance needed an across the board overhaul from the small business to the entrepreneur all the way up to the largest of financial institutions. The Dodd-Frank Wall Street Reform Act was a broad piece of legislation which was created to help form and maintain financial stability. The intent was to create new organizations and rules on the federal level which will offer stricter oversight for most financial companies as well as the products that are sold by them. There are several key factors that are thought to be beneficial for the state of the financial world.
The Wall Street Reform Act created the Consumer Financial Protection Bureau (CFPB) which is responsible for educating consumers by creating documents and financial curriculum and making them available to the general public. The CFPB operates under the Federal Reserve and is able to create and enforce applicable rules for various types of financial transactions that consumers may engage in. This includes things like credit cards, home or car loans, payday loans and bank accounts. The intent is to protect the public from various types of scams while assuring the consumer that they will still receive quality financial services which are available and priced in a fair manner in every community. The CFPB provides constant oversight of various organizations such as mortgage companies, debt collectors and credit unions.
The new educational documents help clear up definitions for consumers. The goal is to clearly define financial topics such as penalties, fees, risks and credit scores. This offers an extra layer of protection for consumers since it is less likely that one who is informed will fall victim to frauds and scams. Consumers will also likely experience some changes to their existing accounts. Many banks have stopped charging overdraft fees and not honor payments made which will overdraw the account. Guidelines for qualifying for loans are more stringent, but when you do qualify for a loan you will be able to afford it. This may put pressure on different types of financial institutions to be more creative in order to make a profit. This will mean some new services for their customers, for an additional fee of course.
Insurance, Securitized Investments and Derivatives
Some of the complex financial products are regulated more uniformly for various risks. Financial and safety organizations are held responsible for risks. This means there is additional reviews conducted by the government to ensure product safety but this should make insurance more available in communities which have been underserved. Since the passing of the Dodd Frank Act, derivatives are treated closer to securities which require full disclosure of any involved risks as well as exchange trading which is centralized. Mortgage-backed securities and other creators of various securitized investments are required to maintain what is termed an equity stake.
New Indicators for the Economy
The government guarantees no bailout and those acquisition industries and traditional mergers must have a growth strategy and are now required to have an exit strategy. This restricts the size as well as the complexity of financial institutions. There are several new evaluation measures in place which prevent financial upheaval in larger companies which of course, has a wide range of economic repercussions.
This is simply a brief overview of the economic benefits that have been realized from the passing of the Dodd Frank Act. In one way it makes consumers be more hands-on with their own finances and for some this means that they now must hire a financial expert. The goal of this legislation was to provide protection for consumers by requiring higher standards of financial institutions. It puts much more information into the hands of consumers and makes financial institutions more accountable for their products and services.
Private Equity is funds that are invested into companies that are unlisted. A private equity fund is used by investors and a firm to purchase a company; either private or public. The company generally has great growth potential and sometimes they are either under-performing or undervalued. The private equity firm will invest in the company using many different sources such as time, talent, energy as well as capital to help improve the performance and prospects of the company. They will invest in the company for a few years typically somewhere around 4 or 5 years, but occasionally up to 6 or 7 years. After it has invested and improved the company they will sell the company. Private equity is considered a short term investment in a company that is already established. Of course the hope for this type of investment is that the company is sold for a substantial capital gain. Effi Enterprises is one such company which offers private equity to companies which are in the high tech field or in the medical market. This type of private investing of time, capital and other resources is beneficial for businesses which are in trouble and need help to maintain for a while until a real profit is realized. The main goal of private equity investing is to increase the value of the company so that investors do not suffer loss but end up with a substantial capital gain instead.
Who Can Get Private Equity?
On one hand the answer to this question is any company that is established and has a solid business plan with goals for growth can obtain private equity funding. But it is really a lot more complex. Every fund has its own sectors. In each sector are identifiable areas of growth or very specific expertise. These segments are considered carefully as the ones which can perform well in the market over the short term are the ones which are set apart as having the most potential. Companies such as Effi Enterprises will look at the different sectors separately and try to determine which ones will grow at a faster rate than others. The ones that have the most potential for the quickest growth are identified for investment possibilities.
How does Private Equity work?
It is certainly not a quick process to obtain private equity funding. It can take 6 months, a year or even longer to get it all established. Sign off on this type of deal is done in two stages. The first one is the term sheet phase has to do with the investor which has to outline their specific interests for investing in this particular company and draw up the final contracts. Basically a term sheet begins with an evaluation of the business. It is a rather informal evaluation that would last about 4 weeks. Then the term sheet is issued which lists the intent to invest and lines out all the particular terms. Then comes the confirmation. This entire process can take about 4 or 5 months; it depends on how much needs to be verified.
Private Equity funds are a way of raising capital for a company; but it is not a quick fix. Before the business can go public or seek a buyout there is much work to be done. Each Private Equity team will have its own idea of how it is all going to work together. But the main goal is to sell the company through some means in the end. Usually this will be an IPO or buyout. Investment firms will take their own unique approach to achieving these end results. Many will take a hands-on up close and personal way to help and others will be less involved but supportive. The end goal is for everyone to make a profit.
Hedge Funds are types of partnership investment opportunities. Sometimes these are formed as a limited partnership or a limited liability company just in case the company goes under or bankrupt, creditors will not be able to try to get more money from the investors than the amounts they contributed to the hedge fund. These are a very risky type of investment which many shy away from while others flock to it. Some feel that the greater the risk the higher the return can be in the end. A hedge fund manager will use money that has been deposited with his company by investor and use it to invest in another company looking for a profitable return on the funds.
The main purpose of a hedge fund is to capitalize on the market and be able to make money whether the market is increasing or decreasing. This type of private investing is a way to sort of outperform the market. This type of private investing is not like mutual funds which are run by large public corporations; therefore they are not regulated by entities such as the Securities and Exchange Commission (SEC). This lack of regulations is what makes them be so risky, but is also one thing that makes them more attractive to investors. This is just one type of private investing opportunities which companies such as Effi Enterprises helps locate for start up businesses or struggling companies.
What does a manager do?
Managers of a hedge fund get compensated by earning a percentage of the returns. This is more appealing to many investors since they do not get just a “fee” as a return on their investment. The managers stand to make a lot more profit since the compensation structure can yield a return that is above market value. Without the standard types of regulations, hedge funds can yield a very high return; even though much of the investment is based on speculative results initially. Managers are excellent at using derivatives, like futures contracts or options. These allow a manager to bring in a profit whether or not the stock market goes up or down. Many times they have the option of selling the stocks short which basically means they can use a small amount of money as leverage and remain in control of large quantities of commodities or stocks. And they can select a particular time frame in which they will pay out. This means that they can use timing along with leverage to make a huge return if they correctly predict if the market is going to rise or fall.
New Regulations on Hedge Funds
Recently, there were some new regulations put into place regarding hedge funds. If the hedge fund is valued over $150 million it must be registered with the SEC. The Dodd-Frank Wall Street Reform Act which was enacted in 2010 set up a Financial Stability Oversight Council which watches for this type of private investing that begins to grow too large. Once it is deemed that they are “too large to fail” the Council may recommend the regulating of these funds by the Federal Reserve. The Dodd-Frank Act also set limits for how much a bank can invest in a hedge fund. Hedge funds can only be used by banks on behalf of customers and not simply to boost the corporate profits of the bank.
What happens if the investment is lost?
The hedge fund is very risky for investors. If the investment pays off everyone gets paid, but what happens if the fund loses money? Does the manager still get paid? Absolutely not; they will not get paid if there is a loss. The manager is somewhat protected while it is the investor that stands to lose. However this type of investment is protected from fraudulent activity but many feel that there are not enough regulations in place that can help protect the private investor.
Whether Private Equity investing has a positive effect or a negative effect on the economy is a big topic of debate right now. There are many who can point out all the positives that occur in the economic structure due to private equity; and there are others who can offer examples of ways the economy has been harmed because of this type of investing.
Positive Effects of Private Equity
If you are working at a very disorganized company which is looking at going belly up, having a private equity firm come in and save it may just save your job. For those whose jobs are saved it certainly looks like a good impact on at least the local economy. Many also suppose that companies which are run privately will perform better than those which are publically owned; largely due to the higher level of accountability which is required. When a Private Equity group or firm invests in a company they will sit on the board as a general rule to ensure that the company upholds a high ethical standard. Many officials cannot let some things slide by when your investors are sitting on the board watching every move.
When a private equity firm invests in a company it is usually one in which they already have a high level of expertise and experience in handling. They are more likely to be able to bring in consultants which can enhance the business and help it be more productive or efficient. They have a vested interest and want a good return for themselves as well as their shareholders. These are also long-term investment teams such as those at Effi Enterprises. They are in it for the long haul and are determined to gain long term profitability. The type of patience required can help them stay with a company for 4 or 5 years or longer until there are higher returns in sight. Private Equity can be very good for every size investor.
When greed gets involved, Private Equity can get ugly. Many times a private equity firm can be bad for a company especially if they try to urge the company to incur much debt. This can be disastrous for an already struggling company. Handling funds this way can be very risky especially for smaller companies.
Another negative effect a private equity firm can have is if they lay of lots of workers trying to make the company more efficient. This does not happen a lot – but it does happen and it yields a negative effect on the economy. And if there are negative effects you will likely never hear about it unless there is something that goes terribly wrong. Private companies do not have to share financial reports; public companies do and must remain very transparent.
Private Equity is said to have created a group of super wealthy people. And the troubling part to many is that they do not pay taxes on this income like most of us do. This is because when money is made through investing you get a much lower tax rate called long term capital gains. A lot of times managers are paid by being allotted a certain percentage from set profits. Since their income comes from a type of interest it is considered investment monies; and therefore taxed at the lower rates.
What do you think?
Is private equity hard on the economy? It seems it works with a small or struggling business to help them become more established and this can be a great boost to the economy and save many jobs. Whether or not it is bad for a particular company may be determined by the firm’s perspective and procedures for improving the company they are investing in. But saving a company and keeping it afloat in a troubled economy is certainly a good thing for all persons involved.
There is a vast difference between vulture capital and private equity. But before the details are given we should look at a brief explanation of vulture capital. The term vulture capital is a slang term that is related to venture capital only in a negative connotation. Venture capital is a form of funding for businesses and especially an entrepreneur. When a business is just getting started a company such as Effi Enterprises will become a funding source so that the business has a greater chance of growing. Usually this is in exchange for a percentage of the company’s profits. The term vulture capital is when funds are placed into a business for the purpose of slowly squeezing the life out of the business. A vulture capitalist will have a primary goal of eventually forcing the company out of business and then selling it for a profit. In pre-Reagan days this was called a leveraged buy outs. However, recently some have tried to say that private equity and vulture capital are the same thing.
Different Investment Purposes
Private equity is an investment into a company. Generally, this investment is done through a private equity firm, an angel investor or a venture capital firm. No matter what category the investment falls into, each company will have its own investment strategies, preferences and ways of setting goals. The main purpose is to provide the funds to help the targeted company continue with expansions, develop new products or they may be used to entirely restructure the company’s management or operation.
Some say that private equity is “no better” than the leveraged buyout. However, in a leveraged buyout the vulture capitalist will buy majority control of a firm or business. Usually an investment in made into a business via angel investors or venture capital firms, not for gaining any control, but for the opportunity of investing in emerging companies or entrepreneurship. They will invest in a company, help get it established and up on its feet in exchange for a portion of its profits further down the road.
Private equity and vulture capital are both ways to pour funding into a business. The main difference is that private equity (and real venture capital) will also be willing to pour time and expertise into the company to help it succeed and grow; whereas the vulture capitalist will have the goal of purchasing the majority of the controlling shares in a company for the purpose of liquidation. They both are looking for a profitable return down the road. However, the private equity firm will obtain their profits from helping get the business established until there is a solid profitability from which they can draw. The vulture capitalist is looking to profit from the yields of a liquidated business which is going under. Most investors are looking to put money into a company like “seed” money in hopes that the company will benefit from the investment and be able to work to provide long lasting profits. Vulture capitalists will try to squeeze everything out of a business and the efforts are not at all aimed at the success of a business; but rather at gaining from the loss. Many Vulture capitalists will actually force businesses to go further into debt or incur new loans until their only choice is to file bankruptcy. At this time the Vulture capitalist will profit from the forced liquidation.
Are they Necessary?
In the real business world there is a place for both the private investor and the true Vulture capitalist. Each one of them can play a major role that helps strengthen the economy. Vulture capitalist can have a positive effect if they give a failing business a way to get out gracefully.