The Goldman Case – 2: CDOs

The Goldman case revolves around the CDOs. So, we must begin with these vehicles.

A CDO, or collateralized debt obligation, is a security, only more complex than traditional securities such as stocks and bonds. The complexity is not conceptual, as in, say, quantum mechanics, but procedural and functional. It can be measured by the words that are needed, as per requirement of the law, to describe the structure, pay off pattern and risks of the CDOs in the offering memoranda. These documents can run into hundreds of pages of legalese and still not cover all the material facts. The SEC’s charge against Goldman is precisely this “failure to disclose”, which constitutes fraud under the securities law.

A procedural/functional complexity can best be shown via an an example.

Take a bank which has lent the following amounts to 5 home buyers. The monthly payment for each loan is shown in brackets.

1: $200,000 [$1,150]
2: $240,000 [$1,250]
3: $250,000 [$1,300]
4: $300,000 [$1,700]
5: $260,000 [$1,600]

The total value of the mortgages is $1,250,000; their combined monthly payment, $7,000.

Mortgages are long-term loans, ranging from 10 to 30 years. So, the bank has locked $1,250,000 of its assets for at least a decade. Of course, in that period, it will receive interest and principal which is what banking is all about. But capital is locked and the bank’s ability to lend is reduced. If we assume the bank’s total lending assets to be $100 million and a typical mortgage around $250,000, then the bank can only make 95 loans – and no more. Afterwards, unless it could grow, it would have to seize lending.

We, as a group of investors, approach the bank and offer to buy the mortgages at their full value. The bank welcomes the idea because it would unlock its capital. With the $1,250,000 it gets from us, it could make 5 new loans and generate additional closing fees. In this way, the bank is out of the picture. We are now the owner of a pool of debt totaling $1,250,000 that brings in $7,000 a month.

Money is fungible, which is why we could speak of “one” loan of $1,250,000. We could also divide. For example, we could divide the pool into 10 equal parts of $125,000, with each bringing in $700 in monthly payments. In fact, that would be the math we had to follow if our investor group had 10 partners.

With the total mortgages ($1,250,000) and monthly payments ($7,000) remaining the same, the number of “pieces” the original pool is divided into determines the principal amount and the monthly payment of each piece. If the pool is divided into 100 pieces, each will be worth $12,500 with $70 expected monthly payment.

Such “slicing and dicing” is one of the technical conditions for securitization: selling private, illiquid assets and liabilities to investors. But securitization, precisely because it involves sales, requires the knowledge of market conditions, so that the product would appeal to potential buyers. The list of items to be considered in that regard is a legion. But two factors stand out above the rest.

One is the number of “slices”. Obviously, the more pieces a given pool is divided into, the smaller the principal amount and the monthly payment of each slice. If our pool is divided into 1000 pieces, each will be worth $1,250 with a monthly payment of $7. But, needless to say, if we divide the pool into 1000 pieces, we must sell 1000 pieces. For that, we would need a sales network, a critical factor to consider as few financial institutions have such networks in place. A large volume of products with low principal and monthly payments, further, is a retail product, while a product with a relatively large principal of $125,000 and only in 10 lots, is more geared towards the institutions or “sophisticated investors”. This technical phrase is pivotal to the Goldman case, so we will return to it. I only note here that the retail products, i.e., products that are offered to public, are governed by stricter disclosure requirements.

The other factor to be considered in securitization is the “risk appetite” of the CDO buyers: the yield they seek vs. the risk they are willing to accept. The fact remains that under the best of economic conditions, some borrowers would default. The reasons for default – a loss of job, disability or even death – do not concern us. But if that were to happen, if, for example, borrower 5 were to default, the pool would receive $1,600 less in monthly payments. That would reduce the pool’s annual return from 6.72% (7000 x 12/125,000) to 5.20% (5,400 x 12/125,000). That is a 23% decline, a tremendous loss in the fixed income world. Such potential volatility would keep away many investors. To appeal to them, we must reduce the uncertainty.

Finance professors speak of “risk averse” and “risk appetite” as if they were psychological and genetic attributes of investors. In reality, they are the investing parameters of mutual and pension funds which forbid them from buying any security not rated AAA. As these funds are the largest investors in the CDOs – because they sit on large piles of cash – their concerns must be taken into account.

The risk of our pool as a whole is given and cannot change; it is the risk of default of 1 or more of the 5 original borrowers. But the introduction of some “class system” solves our problem.

Let us “divide” the pool into three “tranches”. We'll call them the equity or first loss (FL) tranche, mezzanine (MZ) tranche and super senior (SS) tranche, and declare:

In the event of a default, the FL tranche, as its name implies, will have to absorb the loss. If more defaults follow, the FL tranche will continue absorbing losses until no more FL tranche is left, after which the MZ tranche will absorb the losses. The SS tranche, as the name implies (it refers to the order of being paid) will be the last piece to be affected by a default. The arrangement follows a “water fall” pattern where the $7,000 monthly income first satisfies the payment for SS, then “flows” to MZ and then, finally to FL.

The last part is the allocation of principal and yield to each tranche. Keeping in mind that the SS tranche is the most popular and that yield has to increase as the riskiness of the tranche increases, we allocate the original $1,250,000 principal and the $7,000 monthly payment in the following way among the tranches.

SS: $700,000 [$3,600]
MZ: $500,000 [$3,000]
FL: $50,000 [$400]

Based on this allocation, the yield for each tranche is as follows:

SS: 3,600 x 12 / 700,000 = 6.17%

MZ: 2,800 x 12 /500,000 = 7.2%

FL: $400 x 12/ 50,000 = 9.6%

The CDO structure is now complete. All we need at this point is to convince a rating agency – S&P’s or Moody’s – that the SS tranche that is “protected” against default by two loss absorbing layers FL and MZ, is as safe as the safest corporate bond or even the U.S. treasuries and therefore, should command AAA rating. With that, our lawyers put all these details into an offering memorandum and we begin contacting investors.

A while back, in discussing the “collapse of the whole intellectual edifice”, I mentioned Kurosowa’s Rashomon in which the director explores the relation between the narrative and Truth: what do we need to know about something so we could say we know it?

What do we now know about the CDOs?

First and foremost, it must be clear why CDOs are called “vehicle” or “structural products”. They are vehicles for transforming: i) the risk of loans from the bank to investors in capital markets; and ii) the risk profile of a given pool of securities from moderately risky to supposedly riskless and very risky – the latter would be SS and FL tranches. As for structured product, it is the very description of how we created the CDO; a CDO is nothing if not a structured product, a fact that is reflected in the limitless flexibility we have in its design.

I am not exaggerating about the limitless flexibility. Let us begin with the number of tranches. I suggested three. You could make it four. Or five. Or six. Or even seven, if you prefer.

Then there is the number of original loans in the pool. I had 5 because that was sufficient for illustration, but CDOs typically have over 100 securities in the pool. That large number is necessary to make the structure robust so that 3 or 4 defaults will not wipe out the entire pool. The ABACUS 2007-AC1 in the center of the Goldman case had 127 securities.

Then there is the matter of allocating the total pool between tranches. I had 56% of the total allocated to the SS tranche (700,000/1,250,000). You could make it 60% or 70%. Likewise with the MZ tranche. Finally, I allocated 4% to the FL tranche, which is just about standard. This tranche, also known as “toxic waste”, is the riskiest tranche and rarely finds any takers. So the originator of the CDO – Goldman, for example – is usually stuck with it. That must have been the reason why Goldman claimed that it had lost $75 million. The loss had to come from the toxic waste piece that the firm could not unload.

Now comes the most complicated part: the pricing and price behavior of the securities in each tranche. In our example, we have allocated $500,000 to the MZ tranche. Assume that we divide it into 1000 securities, each worth $500 and with $3 a month in payments. What would be the price of this security?

On one hand, the security is a simple bond. We price it using standard bond mathematics. We know if the interest rates increase, the bond price would decrease, and vice versa.

But this security is not a stand-alone bond. It is a mezzanine note from a CDO in which cash flows come from a pool of mortgages. If the default in the pool rises, it will first hit the toxic waste tranche, it is true, but by virtue of “eroding” this tranche, it will begin to threaten the MZ tranche. The MZ tranche, in other words, will be riskier. And since the yield of the bond is fixed at 7.2%, its price would drop, even if interest rates remain unchanged.

The same is true for the SS tranche whose price can show no sensitivity to the defaults in the FL tranche – until it does. This is the so-called “cliff effect” that everyone in the CDO market was aware of. Financial Times, March 21, ‘06, p. 25:

[An independent consultant] describes how a CDO tranche can absorb a number of credit events, such as defaults and downgrades, and retain its level of subordination – or the size of the cushion that protects it from losses – until it reaches a point at which one further piece of bad news can push it over the edge. “Several things can go wrong in a deal and it will still be triple-A,” she say. “But then you get one more event and boom!”

You see what I mean by procedural complexity. There is nothing about the CDOs that a 6th grader cannot understand or follow. But no one can account for all the parameters that influence the price of a CDO.

• Are the original mortgages from California, New York, Florida or Chicago? Mortgages from these geographies have different default patterns.

• Are the houses occupied by younger or older occupants? That would impact the default rates.

• Who wrote the mortgages and when? (If Countrywide in 2006, you’d better run for the hills).

• How is the national and regional economy doing? Can it maintain a steady employment rate?

You can write a PhD dissertation on the subject of CDO pricing. You can devote your life to studying the correlation of defaults across the CDO tranches. You would then become a quant, a rocket scientist or a financial engineer, but you would still know nothing about the CDOs either at the individual level so that you could make money from them or at the macro level so could understand what makes these vehicles “tick”.

Here is Exhibit A, a quant with impeccable academic credentials and work experience, writing to make us “understand” the risk of synthetic CDOs. I am not picking on him. I mention him precisely because his paper is well written and a cut above others. I urge you to read it. Yet, here is what the author wrote on page 2:

These “bank balance sheet” deals were motivated by either a desire to hedge credit risk, a desire to reduce regulatory capital, or both. Following these early deals, the same synthetic CDO technology has been used to create CDO tranches with risk-return profiles that investors find attractive. These later deals, driven by the needs of credit investors rather than banks, are termed “arbitrage” deals.

He goes on to opine:

The terminology has taken hold despite the absence of a true “arbitrage,” which can be loosely defined as a risk-free investment with a positive excess return.

What the author is looking at is the genesis of speculative capital: the transformation of hedging to arbitrage; I spend the entirety of Vol. 1 explaining it. But he does not see it because his professors at Stanford and MIT failed to teach him that words have meanings. So, he does not pause on the word arbitrage to ask himself, You, horse’s behind, what does this word exactly mean and why do you have to define one of the key terms of modern finance “loosely”?

Where is the arbitrage in a CDO? You would not see it in a million years by looking at a CDO structure.

Let us return to our example where “we”, a group of investors, approached the bank and offered to buy its mortgages. Why would we do this? What is in it for us?

Taking into account the expenses of creating a CDO – in millions of dollars that we have to pay to agents like Goldman Sachs – we could find easier and better uses for our $1,250,000. So what drives the market? The answer is arbitrage. From Vol. 3:

The point is that arbitrageur, by definition, has no money. That is why he could not put it in the mattress. Yet, to exploit the arbitrage opportunity, he has to create a portfolio that requires an outlay of cash. For that, the moneyless arbitrageur has to go to a lender. He must borrow money. One blushes at emphasizing this point. But the emphasis must be made...

In the example, you assumed that “we”, the group of investors, had $1,250,000. But we did not. Even if we did, the exercise would have been pointless because of its costs.

If the transaction was consummated, we must have borrowed the money. What is more, we’d borrow the money through a Special Investment Vehicle, with a large bank such as Citi as the guarantor, which allowed us to borrow at the commercial paper market at about 2%.

Now, the mystery is solved: borrowing at 2% and lending, i.e., buying the mortgages that yield 6, or 7 or 8%. That is arbitrage for you and God Bless America. See Part 8 of the Anatomy of a Crisis for more details.

But we are not done. The CDO in the center of the Goldman case is a synthetic CDO, where there are no real mortgages. A synthetic CDO “replicates” the behavior of real mortgages. For that, credit default swaps must be brought in.

Malaysia Best Rates 2010 May 26 update

1 month Fix Deposit

Generally now banks are offering 2.50%. Affin bank offers highest rate at 2.55%. However, there are still a few banks offer lower rate than 2.5%. JP Morgan is still offering the lowest at 2.0%

1 year Fix Deposit

Highest offered rates is 3.05% by Affin Bank; followed by 3.0% from AmBank, Bank of Tokyo-Mitsubishi UFJ and RHB Bank.

Base Lending Rate

Most local banks stand at 6.05% now with JP Morgan offers the lowest at 5.65%.

Saving Accounts

Bank Islam offers 1.35% through its Mudharabah and Pewani ( for women above 18 years old ). Women can enjoy up to 1.58% in Pewani saving account if saving is more than RM 5,000.

CIMB's Air Asia Savers Account offers 1.2%.

Don't forget you can get a simple widget

like above to show on your blog / web site.

Just visit here to see how.

Car Loan : NEW Car

Maybank continues to offer the lowest car loan rate starting from 2.7%. However, this is NOT a standard rate apply to all applicants. The actual rate can range up to 4.3%.

Bank Muamalat offers 2.85% for both New and Used cars but it requires an admin charges of RM600.

Most other banks rates offer are 3.25% for New cars.

Car Loan : Used Car

Bank Muamalat offers 2.85% but requires admin charges of RM600.

CIMB offers 3.25% used car loan rate.

Don't forget Car Loan rate is Fix Term Rate

which is effectively a MUCH HIGHER

than variable term rate

like House Loan and Fix Deposit.

House Loan

Affin remains as the best house loan offer at BLR - 2.3%.

Standard Chartered offers BLR - 2.25%

Multi-tiers house loan offers are excluded because it would be impossible to simplify their pro and cons without knowing the actual details of your particular loan details. Hence, only simple and straight forward house loan offers are compared.

Reading Between the Lines: Europeans Will Be Europeans No More

Last week, Greece became the byword for the European “fiscal crisis”. The mainstream press and media pulled out all the stops in hyping an impending doom if the severest austerity measure were not put in place – and soon. The Financial Times had little else in its opinion pages except warnings by its regular and guest columnists about the eurozone’s “race to the bottom”, Europe’s “lack of preparedness for austerity”, Britain’s “lack of preparedness for austerity” and the view in “Germany” – based on interviews with a few Germans – that the trillion dollar aid package was doomed because it did not address the fundamentals, which could only be corrected with more austerity.

The New York Times got into the act, too. It dispatched Tom Friedman to Greece for an interview with Papandreou. Friedman is an idiot, though of the useful kind. Because he never understands what the “shot” is, to show his importance, he reveals whatever he picks up in conversations. He paraphrased the prime minister that in return for the aid package “Greece’s entire economic and political system will have to change for Greeks to deliver their side of this bargain.”

Exactly. I could not have said it better myself. (Do you hear, Prof. Becker?)

FT’s Gideon Rachman is a fool of a different kind. He has business contacts and knows more of what is happening, but only as conveyed to him by business interests. But as the mouthpiece of capital, he uncomprehendingly – and inevitably – reveals more than he intended. Here is some of what he wrote last week, followed by my comments.

Most of the European Union is living beyond its means. Government deficits are out of control and public sector debt is rising. If European governments do not use their new breathing space to control spending, financial markets will get dangerously restless again.

Note the European Union. In Those Overspending Americans, we saw that American consumers were being scorned for spending more than they earn and thus, impeding the economic recovery. That cannot be said of the European consumers. They do not have personal debt the way Americans do precisely because the wages in Europe have kept up with productivity and inflation and the European governments have more generous social programs. Hence, Rachman’s attack on the European Union, by which he means the individual European governments.

Now, look at the threat: What would happen if European governments do not control spending? Will there be the bubonic plague? Will locusts come? Will the world end? No, only “financial markets will get dangerously restless again”.

What are financial markets? They are the province, the realm, of private capital. So, we see who – or rather, what – is pushing for the austerity. Governments, columnists, commentators, politicians are mere proxies. Rachman continues:

Unfortunately, European voters and politicians are simply unprepared for the age of austerity that lies ahead... Many have come to regard early retirement, free public healthcare and generious unemployment benefits, as fundamental rights. They stopped asking, a long time ago, how these things were paid for. It is this sense of entitlement that makes reform so very difficult.

One question, then, Mr. Rachman. If the citizens of the European Union must work till they die, cannot have free healthcare and will have to go hungry when unemployed, what does it mean to be a European? Were not these “entitlements” precisely the core lifestyles issues that the Union promised its citizens and on which the idea of the Union was sold to a skeptical public? Without these entitlements, how would you dangle the prospect of a “European life style” as the role model for the citizens of say, Afghanistan?

The man, though, asks one important question. How are these things paid for, he asks? He implies that these things cannot be paid for, because Europeans cannot afford them, so they have to cut the expenses. But he is being dishonest. There was a time – an extended time, really – when European governments did pay for all those entitlements, which is what made Europe, well, Europe. Come to think of it, even the U.S. companies apparently could afford to pay for such entitlement. In the 1950s, you got a job at GM, supported your family for 30 years, bought a car and a house and then retired with a pension to enjoy the rest of your life.

What happened? The answer, as I pointed out elsewhere, is that the rate of return of capital in the West declined. That is one thing you will not see mentioned in the coverage of the crisis. Necessarily then, the barrage, intended to soften up the rabble for the austerity, focuses on the diversions: overspending, immigrants and playing one group against the other. Rachman:

The growth in the size and power of the EU has fed a dangerous sense of complacency. For the countries of southern and central Europe – who joined later than the inner core – “Brussels” was sold as the ultimate insurance policy. Once they were inside the EU, it was felt that war, dictatorship and poverty were safely consigned to the past. Everybody could aspire to the relatively comfortable, stable lives of the French and Germans... There is already much bitter talk in Greece about the loss of national sovereignty, matched only by bitter talk in Germany about the cost of bailing out the feckless southern Europeans.

The ouzo drinking, grape-leaves eating Greeks thought that EU membership meant class; they were all going to be French and Germans! That is not the attitude of thuggish Rachman. Liberal Paul Krugman concurs:

So, is Greece the next Lehman? No. It isn’t either big enough or interconnected enough to cause global financial markets to freeze up the way they did in 2008.

(Parenthetically, note at the man’s mentality. I wrote about Paul Samuelson comparing the U.S. navy to an apple. Here is his disciple, the Nobel Prize winning columnist of the New York Times comparing a country with a sham operation and concluding that the sham operation – now defunct – was somehow “superior”. Like the under-aged prostitutes who remain in awe of their pimps no matter how much they criticize them, Krugman remains in awe of a place like Lehman – and Goldman and Citi – as the magical places of power run by tough guys such as these.)

Still, some might not have gotten the point. Rachman, a Larry Summers like fellow, spells it out for them:

The idea was that a Union that spanned 27 nations was large enough to protect a unique European social model from the uncertainties of globalisation. At the most fundamental level, the EU does indeed protect. But while Europeans no longer fear foreign armies, they are starting to fear foreign bondholders. Europe’s existence as a “lifestyle superpower” has depended on an ample supply of credit ... [They] are discovering that the “European project” provides no protection against the harshness of the outside world.

Uncertainties of globalisation. The harshness of the “outside world”. Curious admissions these, if you can read between the lines. The pieces are beginning to fall into place.

One question remains: why did Greece – and Spain and Portugal and even Italy – join the eurozone? What was in it for them, if their entire social and political system had to undergo a radical change without any protection against the harshness of the “outside world”?

The answer is that they did not join. They were dragged in against the will of their population. The idea was to bring in the cheap labor of poorer countries in southern Europe to boost the “productivity”. Then the newcomers began to entertain the fantasy that they had joined a country club as members. They were in fact brought in as workers and janitors. The financial crisis provided the opportunity to drive this point home, to disabuse them of their fantasies. What Clinton did to the poor in the “welfare reform”, the eurozone membership is doing to its southern members: their lives, as we know, will change. The target in the two cases is different but the underlying double whammy is the same: to stop paying the poor – there is no free lunch – and force them into the labor market to push down the labor costs to boost productivity. From today’s Financial Times, under the heading “Spain puts labour reform on agenda”:

In Frankfurt, Jean-Claude Trichet, president of the European Central Bank, said controls on public finance were essential to boosting eurozone countries’ economic prospects. “It is a complete fallacy to say that fiscal soundness dampens growth. It is exactly the contrary. It is the absence of fiscal credibility which dampens growth.”

There is no relation whatsoever between growth and spending. How much money you are earning or will earn in the future does not depend on what you spend. Yet, the president of the ECB links the two. Why? Because “fiscal soundness” he mentions is the code word for reducing labor costs by cutting their pay and pensions. That is what the fight is all about: to bring down the labor costs to at least temporarily boost the growth, i.e., increase the rate of return of capital, whose consistent decline in the past decade remains a matter of serious concern to the planners of the European Union.

Individual Tax exemption in Malaysia

Below shows an extraction from Malaysia Income Tax department. Some of the highlights are;

1. maternity expenses, traditional medicines exemption are UNLIMITED !
2. if you were terminated with compensation, some are exempted !
3. Scholarship is exempted, so study Hard !
4. Income derived and remitted from oversea is exempted, so globalize your business !

Do take time and go through below details, I am sure it will spark some innovative ideas if you are in the midst of optimizing your tax plans.

source

Leave passage

Leave passage within Malaysia not exceeding three times in a year and one leave passage outside Malaysia not exceeding RM3000.

Medical and dental benefit

With effect from the year of assessment 2008, medical benefits exempted from tax is expanded to include maternity expenses and traditional medicine like ayurvedic and acupuncture without limit.

Retirement gratuity

The full amount of gratuity received by an employee on retirement from employment is exempt if:

i. The Director General of Inland Revenue is satisfied that the retirement is due to ill health;

ii. Retirement on or after reaching the age of 55 years/compulsory age of retirement and the individual has worked 10 years continuously with the same employer or companies within the same group

iii. The retirement takes place on reaching the compulsory age of retirement pursuant to a contract of employment or collective agreement at the age of 50 but before 55 and that employment has lasted for 10 years with the same employer or with companies in the same group.

Gratuity paid out of public funds

Gratuity paid out of public funds on retirement from an employment under any written law.

Gratuity paid to a contract officer

Gratuity paid out of public funds to a contract officer on termination of a contract of employment regardless of whether the contract is renewed or not.

Compensation for Loss of Employment

This is payment made by an employer to his employee as compensation for loss of employment either before or after the date of termination.

This compensation is exempted from tax

1. If compensation received is due to ill health
2. Compensation received in other cases:
1. Termination before 1st July 2008 - exemption of RM6000 for every completed year of service with the same employer or with companies in the same group
2. Termination on or after 1st July 2008 - exemption of RM10000 for every completed year of service with the same employer or with companies in the same group

Compensation received by a director (not service director) of a Control Company is fully taxable.

Pensions

Pensions received by an individual are exempt under the following conditions:

1. He retires at the age of 55 or at the compulsory age of retirement under any written law; or

2. If the retirement is due to ill health and the pension is received from the government or from an approved pension scheme.
   

For an employee in the public sector who elects for optional retirement, his pension will be taxed until he attains the age of 55 or the compulsory age of retirement under any written law. Where an individual receives more than one pension, the exemption is restricted to the highest pension received.

Death gratuities

Monies received as death gratuity is fully exempted from income tax.

Scholarships

Any monies paid by way of scholarship to an individual whether or not in connection with an employment of that individual is exempted from income tax.

Income of an individual resident in Malaysia in respect of his appearances in cultural performances approved by the Minister

Money received under this category is exempted from tax on condition it is approved by the Minister.

Interest

Income in respect of interest received by individuals resident in Malaysia from money deposited with the following institutions is tax exempt with effect from 30 August 2008:

1. A bank or a finance company licensed or deemed to be licensed under the Banking and Financial Institutions Act 1989;

2. A bank licensed under the Islamic Banking Act 1983;

3. A development financial institution prescribed under the Development Financial Institutions Act 2002;

4. The Lembaga Tabung Haji established under the Tabung Haji Act 1995;

5. The Malaysia Building Society Berhad incorporated under the Companies Act 1965;

6. The Borneo Housing Finance Berhad incorporated under the Companies Act 1965

Dividend

The following dividends are exempt form tax:

1. Dividends received from exempt accounts of companies.

2. Dividends received from co-operative societies.

3. Dividends received from a unit trust approved by the Minister of Finance such as Amanah Saham Bumiputra.

4. Dividends received from a unit trust approved by the Minister of Finance where 90% or more of the investment is in government securities.

Royalty

Royalties received in respect of the use of copyrights/patents are taxable if they exceed the following exemption limits:

No.	Types of Royalty	Exemption (RM)
1	Publication of artistic works/recording discs/tapes	10,000
2	Translation of books/literary works of Education or Attomey or General Chambers	12,000
3	Publication of literary works/original paintings/musical compositions	20,000

However, the exemption stated above does not apply, if the payment received forms part of his emoluments in the exercise of the individual's official duties.

Income Remitted from Outside Malaysia

With effect from the year of assessment 2004, income derived from outside Malaysia and received in Malaysia by resident individual is exempted from tax.

Fees or Honorarium for Expert Services

With effect from the year of assessment 2004, fees or honorarium received by an individual in respect of services provided for purposes of validation, moderation or accreditation of franchised education programmes in higher educational institutions is exempted.

The services provided by an individual concerned have to be verified and acknowledged by the Malaysian Qualifications Agency (MQA). However, the exemption does not apply if the payment received forms part of his emoluments in the exercise of his official duties.

Income Derived from Research Findings

With effect from the year of assessment 2004, income received by an individual from the commercialization of the scientific research finding is given tax exemption of 50% on the statutory income in the basis year for a year of assessment for 5 years from the date the payment is made.

The individual scientist who received the said payment must be a citizen and a resident in Malaysia. The commercialized research findings must be verified by the Ministry of Science, Technology and Environment.

Weekend Musings: Why Bother With Mosquitoes?

James Cayne, the ex-CEO of Bear Stearns, and his lieutenants were called before the Financial Crisis Inquiry Commission I know not for what.

Even when everyone feigned surprise, it was a tired show. Surprise! Cayne did not curse. The Wall Street Journal:

At times, it seemed like the panel was caught off-guard by the matter-of-fact manner, beginning when Mr. Cayne kicked off his testimony by admitting that Bear's leverage was too high.

The New York Times:

He [Cayne] showed little emotion at the hearing, giving no hint of his reputation for outbursts during his nearly 15 years at the helm of the company before stepping down in January 2008.

Sa’di:

What could an old whore do but repent from debauchery and a sacked sheriff from hectoring?

The goon turned walking gentleman offered this gem about the cause of the collapse of his firm. The firm’s collapse, he said, “was due to overwhelming market forces”.

Since the creation and continued operations of Bear Stearns was also the result of market forces, the ex-CEO volunteered that Bear died because it was alive. Try topping that as a “cause of death”.

Paul Friedman, a senior MD running the repo desk, said that “Bear decided in late 2006 to reduce its reliance on short-term unsecured funding, primarily commercial paper ... Despite those efforts, Bear couldn’t have obtained enough long-term financing or made other changes to save it from its eventual demise.”

Recall that the trigger of the crisis was the collapse of two Bear funds in June 2007. So in “late 2006” they already knew they had hit the iceberg, as anyone who knew Bear’s operations knew. The protestations of ignorance and being caught off guard were all lies.

Why would you invite mosquitoes to testify about the cause of malaria?

When to go beyond "Salary" ?

When your personal income increases, you start to pay more taxes too. It was mentioned before there are certain income Stepping that one should watch out for to optimize tax planning. For example, as your total annual income is approaching MYR 100,000 in Malaysia, you are most likely to be paying maximum taxes like a company's ie. 27%.

So you pay about MYR 15,000 taxes so your net income become MYR 85,000 ( exclude other deductions for the purpose of this article ). Then you will proceed paying your due diligences like house loan, car loan and all your other expenses etc. Lets say those total up to MYR 73,000 so you would have a remaining income of MYR 12,000; Or MYR 1,000 a month.

As mentioned before, if the taxation laid upon a business is similar ie. 27%, then perhaps you can create a business of your own. Then sell yourself back to your current employer doing exactly the same stuff so that it has no impact what so ever to your employer's operation (*1).

As a business owner, you should deduct all costs incurred in order to perform your business (job) before you come up with a profit, which is then taxable. Lets say MYR 50,000 of your expenses can be qualified as business expenses. Then you may end up with paying less tax ie. MYR 13,500

$100,000 - $50,000 = $50,000 x 27% = $ 13,500

There are still MYR 23,000 expenses that are not classified as business expenses, hence you will end up with a remaining income of $13,500; instead of just $12,000 if you keep your 'job'.

$50,000 - $13,500 (tax) - $23,000 (non biz expenses) = $13,500

In this scenario simply by changing the 'mode' of how things work can save you a thousand or two. As you may have noticed, the difference is not that big. Hence, if you have been working whole your life; Annual income of MYR 100,000 is the magic number where you should start thinking if you want to continue working a job or start building something of your own.

This difference will become significant as your salary increases beyond MYR 100,000.

However, there are quite a handful of knowledge and skills you will need before you can make a switch like this successfully.

• setting and maintaining a business will cost money
• no employer means no one pays your EPF
• security, liability, risk and reward will have different meanings
• classifying business expenses is an important skill
• all business expenses should help the business grows
• pay yourself maximum non taxable salary, pay yourself EPF ...

In real and practical world, a smart guy doing this would NOT only save a thousand or two. But the actual tax saving should be 50%-80%, ie. from $15,000 to $3,500.

(*1) There WILL BE some impacts to the company especially account and human resource wise. In short, the company saves money by not paying you EPF and other cost to maintain an employee. Hence in practical world, one would ask for more than $100,000 when converting from an employment to a contract staff.

Most of you will think it is NOT possible to switch from an employment to a contractual staff without affecting the operation and yourself, only a few of you will start to think how to make that happen. Like wise, I can assure you that some has already made that switch successfully, although just a handful. But none of them were given any guideline or magic numbers like this article. So you are now equipped better than them. Hope you can get something out of this ...

Epilogue: The Meaning of “System” in Systemic Risk

I was reading about tomorrow’s elections in England, when I thought of Tony Blair which reminded me of the two-part series, The Meaning of “System” in Systemic Risk. I had meant to end the series with an epilogue, but I forgot. So, if you were following it, my apologies for what surely seemed like an abrupt end.

Yet, as Rumi would say, we never really left the subject; all posts on this blog are about systemic risk. Such is the nature of the "relations" about which I have been philosophizing of late. When you get the main relation, the whole, right, the parts, in the forms of individual developments, will confirm, accentuate and strengthen it.

Yesterday, for example, I read that Chancellor Angela Merkel had quoted Swabian housewives to give a lesson to German and European “overspenders”: “One should simply have asked a Swabian housewife. She would have told us her worldly wisdom: in the long run, you can’t live beyond your means.”

I had written about this very topic the day before.

Also, yesterday, Bloomberg reported that the president of the European Central Bank was considering “tossing out” the bank’s rule book to better handle the Greek crisis:

European Central Bank President Jean-Claude Trichet, who capitulated on a January pledge not to relax lending rules for the sake of one country, may have to sacrifice more principles to prevent Greece from bringing down the euro.

Trichet yesterday diluted rules for the second time in a month to guarantee the ECB will keep taking Greek government bonds as collateral for loans. The central bank may have to extend that to other nations, renew a program of lending unlimited cash to banks for a year, and even start buying government debt if the 110 billion-euro ($146 billion) bailout plan for Greece fails to stem the euro’s slide, economists said. “Rather you break the rule book than the euro area,” said [a European economist].

This, too, is familiar to us. Recall that it was Bernanke who first tossed out the rule book, as I discussed here and here.

Returning now to election in England, you would do well to keep in your wholesome remembrance that the heated exchanges on immigration, EU membership and such are campaign tactics meant to highlight the differences among the candidates. These differences are real, to be sure, in the same way that the differences between a wolf, a fox and a coyote are real. But when it comes to farmers’ poultry and livestock, there is a remarkable, and altogether not surprising, convergence of opinion among the three.

The chicken coup and livestock in the British election are the NHS and the government services. Head, they will be sharply cut. Tail, they will be sharply cut. If the coin lands on its edge, they will be sharply cut.

So, what are the messages we have been getting from political leaders and their humble servants, the press?

• People have to spend within their means.

• Governments have to spend within their means.

• The central banks have to toss out their rulebooks.

These issues are linked by one thread: the inability of capital to produce enough profits to regenerate itself. But profit is the driving engine of the existing social systems. It follows, then, that we are facing is the inability of the social system to preserve itself, i.e., the status quo. If profits were workers bees, I suppose you could call the phenomenon colony collapse disorder (CCD) , except that the cause of the disappearance of profits is no mystery to those willing to look.

The technical arguments for the austerity that you hear – that, for example, the population is living longer so there are less workers supporting a larger number of pensioners – have a modicum of truth in them. But they are the description of the effects, and not the cause. The underlying cause of the problem is the fall in the profit rate. That is why workers are laid off, in consequence becoming a double drain on resources: they do not contribute to tax revenues, and, furthermore, receive unemployment benefits.

The problem is actually quite serious. Imagine a 40 year old suburban woman comfortably married to a successful businessman. The husband dies, leaving behind some money, but not much. What are the woman's options, without any work experience or a trust fund to support her?

Realistically, there are two options. She could drastically, very drastically, cut back on her life style – goodbye SUV, good bye expensive handbags, gym and perhaps country club membership, clothes, jewelry – and become a teacher earning enough to put bread on the table. Or she could become a wealthy neighbor’s mistress. Given the mentality and social background of a suburban woman, there is really one choice. That is, there is no alternative.

Consider now, if you will, a political leader whose convictions about social issues – justice, equality, progress – are approximately at the level of the conviction of a suburban housewife about chastity. (Else he would not be a political leader.) Faced with the reality of falling revenues, he would have two alternatives: drastic cuts, or sacrificing convictions in the hope of re-starting revenues. That would be the story of Tony Blair who, as a Labourite, could not tolerate deep social cuts. That left him with no alternative but to embracing the only source of revenue which, for the social system he was elected to lead, was the “entrepreneurship”. All the compromises that followed, followed from there.

Blair, needless to say, is not alone. He is a politician of “our time”, in the sense that I have explained.

What complicates matter is that long term has finally caught up with us. It is now 20 years later and our suburban widow is no longer 40 but 60. Now there is really no alternative to draconian cuts. That is what we are seeing across the Western world.

The politics of the matter do not concern us here; of course politically conscious Greeks are more vocal than the social zombies in much of the Western Europe and the U.S.

What concerns us is the material basis of this phenomenon – the fall in the rate of profit – that is rooted in economics and finance. That is the subject of Vols. 4 and 5 of Speculative Capital. It will also be the subject of future posts on this blog.

Those Overspending Americans

Data released by the Commerce Department today showed that, once again, American consumers are spending more and saving less. As reported in The Financial Times, a JPMorgan analyst interpreted the numbers thus in a note to his clients:

Speculation that consumers are reforming, repenting and rebalancing now looks premature or overstated.

So, we are back to the narrative of irresponsible consumers bringing the U.S. economy to its knees by spending beyond their means. The fault, dear Brutus, is not in stars.

In several places on this blog, I have explained the material basis of this seemingly moral weakness. This time, I will let the vice president of the U.S. explain, as quoted in the same paper (April 21, p. 3)

Mr Biden, who is in charge of Barack Obama’s “middle class task force” said the last US economic cycle, which began in 2001 and ended in 2007, was the first in history that left median incomes where they were at the start.

Yet, over the same period, the growth in productivity, which had traditionally fed through into wage growth, hit record levels ... Economists say that the gap between productivity and wages has turned into a chasm since the last recession began in 2007. Real wage growth between the lat quarter of 2008 and the last quarter of 2009 was negative while productivity rose by 5 per cent.

That is the story in a nutshell. People are spending and not saving because they cannot save, because their income is not sufficient to cover their needs. End of story.

Or not. The truth is that the Morgan analyst is technically right by virtue of the definition of over-spending. If you earn $100 and spend $105, you are spending beyond your means, no matter what the explanation.

That narrow technical point is precisely what is being driven home. No one can spend beyond their means. One must cut down the spending or face bankruptcy and pauperism. Sure, cutting down the spending means less vacation, less meat, less discretionary income and therefore, an overall poorer work force, but so what? You have heard of regulatory arbitrage where the companies shop for the most forgiving regulator and tax arbitrage, when they shop for the most favorable tax treatment. Why not put in place a nice little labor arbitrage?

If you are good with Google, you can find a Bush administration official on the record saying that Americans must “tread water” until the Chinese work force materially catches up with them.

The Goldman Case – 1: Introduction

You must know about the “freak shows” that were popular up until the middle of the last century. These macabre circuses traveled from place to place and exhibited their “freaks”: the elephant man, the snake woman, the scorpion girl and such.

The rabble went and paid to look at the freaks and count their blessings. Imagine being the parents of the “scorpion girl”!

Such naked exploitation of physical deformities is no longer acceptable. But the practice continues under a different guise. The freaks are now the child prodigies. The 5-year old Korean who plays Appassionata. The 4-year old Iranian who has memorized Qur’an –without knowing Arabic, no less! And the usually home-schooled, always awkward 8-year old who can correctly pronounce and spell onomatopoeia, hippocastanaceae and cwm.

These are mechanical performances, of course, like a bear dancing or a dog shaking hands. What these children know of music, religion and language is barely above what a space-traveling “astronaut” chimpanzee knows of Newtonian mechanics. The charade goes on because it promotes the idea of a haphazard and random life in which a lucky few are dealt a winning hand. You, too, could have been a contender, could have had class, if chance had not willed otherwise.

Art, religion and language are social systems that men create in order to survive. They help stabilize the social relations, stability being a prerequisite for reproduction. The more you are aware of these relations, the more “human” you are, the word used here in its social and not biological context. Humanity is precisely the awareness of others, both of people and relations. Exploring these relations is the subject of the humanities. (Exploring the relations in the natural world is the subject of science.)

The social relations, of course, do not have the permanence of natural laws and change with the development of human society. But they, too, are hidden from the view and must be discovered through a process, which is the search for Truth. Only through this process one gains the knowledge of physical and social worlds.

In the physical world, we verify the accuracy of our knowledge in practice. In the social world, the verification comes from the capacity of knowledge to systematically expand ; if such capacity is not present, the knowledge is false. But if knowledge corresponds to the essence of the phenomena, it must logically and perpetually move forward, with each stage containing and explaining whatever existed before. The process cannot contain unresolved contradictions.

Recognizing the Truth, thus, is the meaning and idea of human development. In the case of the writer, the composer, the painter, the philosopher – those, in short, whose vocation is exploring the social relations in search of the Truth – such development must reflect itself in progressive “maturity” of the producer and his works, resulting in ever deeper revelations about human relations.

That is another way of saying that in the investigation of social or natural relations, there are no accidents. But unlike in the natural world where our immediate sense of perception is limited by the properties of the material world – sounds beyond certain frequency we cannot hear, colors beyond certain frequency we cannot see – and must thus await the advancement of tools, the human relations are accessible to all. What is more, if their essence is understood, the understanding cannot but lead to the awareness of even more profound relations.

(Agamben has written about the “destruction of experience”, but he does not explore it from the one angle that can satisfactorily explain the destruction: the inability of the modern man to connect various aspects of his social contacts. That is what the destruction of experience means. Otherwise, experience, in the Kantian sense of the word, which is coming into contact with the outside world, cannot be destroyed. Agamben confuses – i.e., does not distinguish – the experience in the world of social and physical. So when, after a mystifying reference to the destruction of experience, he writes that “Hence, the disappearance of the maxim and the proverb, which were the guise in which experience stood as authority”, he is clearly talking about social experience. Maxims and proverbs work precisely by bringing in an example from the natural world to the social world to highlight social relations. I will return to this common confusion of contemporary Western philosophers in Vol. 5.)

That is why the spectacle a child playing a sonata by a master can only be a showcasing of instrumental skills. The content of the music, its message, can only be conveyed through the experience, a condition which precludes youth.

That is also why you would be hard pressed to name a contemporary writer, artist, philosopher, musician or director whose works have improved with time; I only know of John Berger and, to some extent, Beckett. The cultural personalities in the West are “adult prodigies”. They come to the public's attention with one “brilliant” performance or a “phenomenonal achievement” only to stagnate as the has-beens of the “cultural scene”.

Among the Western writers, Chekhov is the most outstanding example of consistent evolution. Thanks to the money men of commercial theater, many know him as the author of only Cherry Orchid, Three Sisters and Seagull. But his works are a legion. And they get better and more profound as the author ages.

Vladdimir Kataev has written one the most authoritative books on Chekhov accessible to layman. In fact, his “If Only We Could Know!” is so comprehensive that it is difficult to add anything original to it. Kataev explains that Chekhov’s writing is “about a discovery that destroys a previously held, superficial conception of life” and then adds elsewhere: “In Sakhalin [Island], Chekhov witnesses the terrifying extend of the evil prevailing in the world; but what he also realized was how carefully thought out and responsible any word of protest against that evil must be.”

That last comment brings us to the Goldman case.

I am not implying that Goldman is personified evil. On the contrary. The point is that comments that are not responsible and carefully thought-out would have absolutely no impact on the outcome, will achieve nothing and will go nowhere. That is the critical conclusion of a perceptive and mature social observer in his later years. It should not be taken lightly.

Goldman is a giant vampire squid wrapped around the face of humanity.

Goldman is doing God’s work.

Goldman good.

No, bad.

We need to take an objective look at the case. That is why we study finance: to take an objective look at matters of finance.