Analytical Wealth

Here is a quick look at some graphics related to Citibank's rescue of Wachovia, first a graphic comparing the two banks in terms of branches, total deposits, etc.

Graphic courtesy of the WSJ

While the numbers for % of total deposits is over a year old, it stands to reason that my earlier suspicion that Citibank violated the rule of no one bank having more than 10% of the nation's deposits via a merger or buyout is correct. Because even with a significant amount of money being pulled out of Wachovia it looks like Citigroup now has more than 10% of the nation's deposits. However it's not just Citibank, because  it appears (based on the graphic below) that J.P. Morgan violated the rule when it took over WAMU.

Graphic courtesy of the WSJ

The reason I'm pointing this out is that we've already seen what can happen when too much financial influence/power/impact is concentrated in too few companies, we saw it with AIG and we saw it with the Mortgage GSEs. While the rescues of WAMU and Wachovia were absolutely necessary and I 'm not disputing the need to suspend certain rules in times like this, I do think the nation's banking regulators need to think about the future and how to handle these newly created banking giants.

While placing caps on how large a company can grow does make me very uncomfortable , it's hard to argue with the idea that breaking these companies up, forcing them to sell branches, deposits, etc, is probably in the best interests of the economy. No matter what we do as far as regulation, the banking industry changing its behavior, etc, etc, it's inevitable that we will have banking and/or economic crises in the future, and when that time comes I'd feel safer if 30-40% of the nation's deposits weren't concentrated within the hands of a very small number of players.

Let's not forget that over the course of two trading/business days the record for the nation's largest bank failure was broken twice: first by WAMU and then by Wachovia, do we really want to risk a situation where one of the big three finds themselves in a similar position down the road? 

After all Citigroup isn't out of the woods yet, and who is to say that next time there is a major crisis it won't be Bank of America and J.P. Morgan who are the ones in trouble? Considering their size who would be available to rescue them?

While the business world will balk at size limits, it's hard to make the argument that it's against the public's interest to prevent financial institutions from becoming large enough to threaten the global financial system if they were to run into trouble.

Should the executives of one company be allowed to have the power to take down the global financial markets if they make the wrong decisions?

You can read more on the Wachovia rescue and the changing retail banking industry here.

Sources:

The WSJ: "Citi, U.S. Rescue Wachovia" -- David Enrich, Matthew Karnitschnig, September 30, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 30, 2008 at 08:02 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a look at a graphical timeline representing the performance of the Dow as yesterday's events unfolded:

Graphic courtesy of the WSJ

Basically the Dow was already having a bad day and the bailout plan failing to pass the house was the cinder block that broke the Camel's back, overall I think it really speaks to how the markets are gripped by fear right now and how they're looking for something, anything to ease fears and inject some confidence into the markets.

In the end I suspect that many investors, traders, fund managers, etc, are as skeptical as to the efficacy of the bailout plan as I am, but they believe that it will cause others to feel more confident and are making their decisions accordingly. It could very well be a situation where the actions of market actors are being primarily driven by their perceptions of aggregate market confidence, as opposed to what they think the market's actual fundamentals are.

All that being said what happens when the bailout plan fails to generate the dividends that many expect it too, what happens when we've spent hundreds of billions of dollars and there has been little improvement in the credit markets, housing, etc, etc?

The fallout from that situation could make yesterday look like a cakewalk.

The graphic above comes from an article discussing the failure of the bailout plan and the resultant drop in the Dow, you can read more here.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Financial Psychology | Politics & Business on September 30, 2008 at 07:22 AM | Permalink | Comments (0) | TrackBacks (0)

The graphic below depicts the history of various I-Banks over the years:

Graphic courtesy of the WSJ

So the obvious take away from all of this is that the lines between I-Banks and Commercial banks were established in the aftermath of the great Depression, as the thinking was that the combination of the two contributed to the crisis. Now here we are not even ten years after the repeal of Glass-Steagall and we're facing the biggest financial crisis since the great depression; while begs the obvious question: are the two related, or is the crisis more of a function of the way the banks behaved as opposed to how they were structured?

If you ask me the answer is fairly clear: the problems we're having now are primarily a function of risk management, bad lending standards, the explosion in the use of derivatives and the resulting problems of under capitalization and over-leverage. While I think that repealing Glass-Steagall and the implementation of Gramm-Leach-Bliley were indeed part of the problem, it doesn't change the fact that combining I-Banks and a Commercial Banks didn't force executives to begin acting foolishly.

I.e. if the banks had been managed better (regardless of their structure) the current crisis simply wouldn't have happened.

Obviously this question will be debated for well into the current century and it's not a stretch to say that we haven't seen the last of the legal wrangling over the structure of banks, not to mention more changes within the banking sector.

The graphic comes from a WSJ article that discusses the issue in more detail and you can read it here.

Sources:

The WSJ: "Walls Come Down, Reviving Fears of a Falling Titan" -- David Enrich, Damian Paletta, September 23, 2008.

Posted to: Financials | Politics & Business on September 29, 2008 at 03:44 PM | Permalink | Comments (0) | TrackBacks (0)

…….or rather it certainly feels this way doesn't it? Especially if the image had the taxpayers below the bankers about to have bad debt rained down upon them.

Posted to: Randomization on September 29, 2008 at 02:03 PM | Permalink | Comments (0) | TrackBacks (0)

Graphic courtesy of the WSJ

(From the WSJ): "WASHINGTON -- The House of Representatives delivered a stunning defeat to legislation designed to rescue the nation's troubled financial system, sweeping aside a call from President Bush to "send a strong signal" of confidence to markets at home and abroad.

The 228-205 vote Monday exposed deep unease among rank-and-file lawmakers in both parties with what would be an unprecedented intervention in the private sector. The vote came as turmoil in financial markets widened, prompting the Federal Reserve to inject new capital into credit markets and forcing the government-arranged sale of Wachovia Corp. to Citigroup.

Monday, the Dow Jones Industrial Average plummeted 777.68 points, its biggest one-day drop in history. It ended down 7% at 10365.45, down 9.3% since crisis erupted a few weeks ago on Wall Street following the meltdown of Lehman Brothers Holdings. All 30 of the blue-chip indicator's components fell Monday.

The Bush-backed package now faces an uncertain future, though party leaders on both sides of the aisle are sure to consider revising the initiative, which Mr. Bush said Monday is needed to "keep the crisis in our financial system from spreading throughout our economy."

After the vote, House Minority Leader John Boehner (R., Ohio) said there would be an effort to bring back another bill, with further changes. "We've got to find a true middle ground," he said. "We need everybody to calm down and relax and get back to work."

Lawmakers on both sides of the aisle suggested the legislation is not dead. House Speaker Nancy Pelosi (D., Calif.) said at a press conference that the "lines of communication" remain open between policymakers and that Congress needs to take another "bite at the apple" on the market rescue plan legislation.

"It is difficult for me to imagine we would leave the market to its own devices and fears until Friday," said Rep. Adam Putnam (R., Fla.), the third-highest ranking Republican in the House. "We're encouraging members to understand the consequences to doing nothing, but I think members have strong convictions about this bill."

I have to say that I was surprised by the result (and yes favorite reader you were right about this one) as based on the news reports from the weekend, a compromise had been reached, the members of the house were in agreement and the bill was going to pass. I'm also wondering why people were even talking as if they had an agreement when the vote was so contentious, where were the people who voted against it when the "agreement was reached ", at the local pub?

I want to say that the bill's defeat gives way to the possibility of a better solution, improvements being made to the current bill, etc, etc, but at this juncture I think all we can expect is more partisan bickering, and the lack of any real consensus that will allow a deal of any kind to be reached.

Perhaps the area of hope is that maybe the markets will accept that they have to fix the problem themselves, instead of relying on ill-conceived assistance from the government.

You can read more here.

  Sources:

The WSJ: "Bailout Bill Fails in House Vote Amid Defections in Both Parties" -- Greg Hitt, September 29, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Politics & Business on September 29, 2008 at 01:42 PM | Permalink | Comments (0) | TrackBacks (0)

Whenever a corporate bailout package is sold to "the people" the primary selling point is always that it's "the best thing for the economy" , which is (in many ways) disingenuous and honest at the same time. Because while we all have a vested interest in maintaining a strong economy, it doesn't change any of the following:

In many cases the taxpayer's daily economic situation won't change as a result of the bailout, all they've done is removed the risk of an economic downturn by taking on the risk of a failing/flailing company. In other words the taxpayer's choices are: "pay for the bailout and keep things the same, or refuse to fund the bailout and risk an economic downturn".

E.g. if the treasury buys $400 billion worth of bad mortgage securities tomorrow the  banks will be better off, but many folks on Main St. won't see their own situations improve one iota.

The taxpayer is effectively bailing out executives, companies, major shareholders (in some cases), etc, who will receive a disproportionate share of the benefits in comparison to the taxpayer, and who wouldn't have suffered as much if the company had been allowed to fail and the economy did in fact suffer.

In instances where the government receives a return or profits from the money spent on the bailout, the funds are put back into the treasury and are not distributed back to the taxpayer in the form of a tax refund, dividend check, etc.

In short: tax payer dollars are used to fund bailouts based on the idea of the intangible benefits they will receive, whilst everyone else involves is allowed to reap the tangible benefits without having put any skin in the game. Case in point: the automakers spent millions on lobbyists to "encourage" Congress to approve a package of low cost loans for their industry, or to put it another way: "the automakers spent millions to encourage Congress to give them billions of dollars of our money".

Perhaps the best way to explain the current bailout is as follows:

Banks are going to receive money from the taxpayer on terms that they would never agree to if they were lending money to us, as part of a scheme that will allegedly make it easier for us to be their customers.

Considering the above shouldn't the banks have to give US as taxpayers something out of respect for the fact that we could potentially fork over as much as $7k per taxpayer to help them, especially since the help they're going to be receiving from taxpayers is likely to enable them to generate profits for years (if not decades) into the future as a result? 

For instance let's say the government winds up forking over $X per taxpayer to Wall St., wouldn't it be great if 0.5X of the debt a particular taxpayer owes banks participating in the plan would be forgiven? I.e. let's say the plan costs $5k per taxpayer and Bank ABC participates in the plan, as a taxpayer I'm allowed to instruct Bank ABC to knock $2.5k off of my mortgage balance.

How about a bailout plan that issues warrants for an equivalent amount of shares of stock to each taxpayer, or to provide low cost loans to low income Americans? If taxpayer money is being used to rescue an insurance company how about forcing that company to provide low cost insurance to low income Americans?

In other words if our politicians are right in that we have a vested interest in seeing Wall St. return to record profits in a few years, they should be working towards making sure we receive something for our investment in the economy's future. Something beyond the usual promise of: "help these wealthy companies stay that way and the economy will be better".

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | Politics & Business | U.S. Economy on September 29, 2008 at 09:55 AM | Permalink | Comments (2) | TrackBacks (0)

Back in '00/'01 I had a consulting engagement with a mortgage lender that allowed me the opportunity to see various aspects of the business from the inside, in light of the recent "Market Ruckus" I've been thinking about the company's lending standards for its subprime mortgages…….

….namely the fact that the standards they used to originate subprime loans in '00 - '01 would've been considered prime standards (or even super prime in some cases) during the housing boom, at least with regards to down payments, loan to income ratio and monthly payment vs. monthly income. In other words while their customers may have had lower FICO scores, they were held to a standards around income and down payments that only prime and super prime customers had to adhere to during the boom.

This came to mind when I was thinking about the lending standards I encountered while applying for a mortgage in the spring of '06, and how the bar was markedly lower despite the fact that I was applying for a prime loan.

Mind you this is just one lender and the experience of one borrower, however it does provide some insights into the sharp decline in lending standards during the boom and the so called "tightening" standards now.

In other words when we talk about "credit tightening" for consumers we have to make sure we differentiate between credit crunch related tightening and a return to sensible lending standards that only seem tight in comparison to recent times, but are probably right in line (if not still looser) than the credit standards of the pre-housing boom period. In other words in some cases standards aren't necessarily tight on an absolute basis, they're tight in comparison to recent history but not in comparison to a time when the financial sector was markedly more stable.

SO even when the credit crunch subsides, the economy recovers and the banking environment returns to normalcy, one should expect that lending standards will still be tighter compared to where they were during the boom. Or at least one would HOPE that standards are tighter than they were during the housing boom but are about the same in comparison to the pre-boom period, otherwise we're likely to be in this mess all over again. 

Posted to: Financials | Real Estate on September 29, 2008 at 09:43 AM | Permalink | Comments (0) | TrackBacks (0)

A quick morning mix tape that will cover a wide variety of topics; there is so much going on this morning that it's not even funny.

Nouriel Roubini AKA "Dr. Doom ", shreds the bailout plan into tiny little pieces in a blog post on his web site, it's great read that not only attacks the core components of the plan but looks at it within the perspective of past financial crises and the impact of government intervention, etc.

Here is a look from the Financial Times at the multi-nation deal to rescue Fortis; methinks we'll be seeing more of this in the coming weeks and that the culprit will (in the end) be tracked back the massive surge in derivatives in the late 90s. It's nothing terribly complicate if you use esoteric instruments to hide the fact that you're under capitalized, it doesn't take much to make the entire house of cards to come crashing down upon you.

Speaking of which here is another Financial Times report on the U.K. being forced to nationalize yet another mortgage lender, and like Northern Rock, Fortis, IndyMac, WAMU, etc, etc, it's the same story as usual: an overleveraged and undercapitalized bank bites the dust. 

Here is a look at some "disturbing" aspects of the bailout bill courtesy of the "rebel traders"; which suggest that more financial chicanery may be a foot in the near future.

Michael Panzer asks the very valid question: "why in such a rush to pass the bailout bill?", based on his analysis it has more to do with the Fed's balance sheet than it does the dangers facing the economy.

The Financial Times reports on the asset sales that AIG is planning in order to raise capital, and pay back the loan they received from the Fed.

Here is a look at a study that concluded that banning shorting actually hurts the market in terms of creating hyper volatility, and/or resulting in certain equities being overvalued. In the end I don't think this falls into the realm of "innovative thought", because how can a market function properly if you start removing key components of it and/or telling the participants they can only act a certain way towards certain assets?

A bank in Spain is giving away scooters in exchange for new deposits; if that doesn't scream desperate for cash I don't know what does. 

E.g. is the market truly helped by banning shorting on Ford, as if a pernicious legion of short sellers is the reason behind their low stock price and not their massive business problems?

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | Politics & Business | U.S. Economy on September 29, 2008 at 09:18 AM | Permalink | Comments (0) | TrackBacks (0)

Let's take a look at the summary of the current proposal before Congress, as well as taking a look at how the bailout will actually function.

First here is the summary of the draft proposal currently sitting before Congress: 

(From the WSJ):

I. Stabilizing the Economy

The Emergency Economic Stabilization Act of 2008 (EESA) provides up to $700 billion to the Secretary of the Treasury to buy mortgages and other assets that are clogging the balance sheets of financial institutions and making it difficult for working families, small businesses, and other companies to access credit, which is vital to a strong and stable economy. EESA also establishes a program that would allow companies to insure their troubled assets.

II. Homeownership Preservation

EESA requires the Treasury to modify troubled loans – many the result of predatory lending practices – wherever possible to help American families keep their homes. It also directs other federal agencies to modify loans that they own or control. Finally, it improves the HOPE for Homeowners program by expanding eligibility and increasing the tools available to the Department of Housing and Urban Development to help more families keep their homes.

III. Taxpayer Protection

Taxpayers should not be expected to pay for Wall Street's mistakes. The legislation requires companies that sell some of their bad assets to the government to provide warrants so that taxpayers will benefit from any future growth these companies may experience as a result of participation in this program. The legislation also requires the President to submit legislation that would cover any losses to taxpayers resulting from this program by charging a small, broad-based fee on all financial institutions.

IV. No Windfalls for Executives

Executives who made bad decisions should not be allowed to dump their bad assets on the government, and then walk away with millions of dollars in bonuses. In order to participate in this program, companies will lose certain tax benefits and, in some cases, must limit executive pay. In addition, the bill limits "golden parachutes" and requires that unearned bonuses be returned.

V. Strong Oversight

Rather than giving the Treasury all the funds at once, the legislation gives the Treasury $250 billion immediately, then requires the President to certify that additional funds are needed ($100 billion, then $350 billion subject to Congressional disapproval). The Treasury must report on the use of the funds and the progress in addressing the crisis. EESA also establishes an Oversight Board so that the Treasury cannot act in an arbitrary manner. It also establishes a special inspector general to protect against waste, fraud and abuse."

Here are some additional clarifications on key aspects of the bill:

(From Forbes): "Under the legislation Treasury will be granted $700 billion in phases to acquire bad mortgage assets from financial institutions at a price it determines or through auction with a market price. If the Treasury decides to take the first option it will have some authority to determine the executive compensation structure of the firm.

If firms sell more than $300 million in assets in the auction, they will lose the ability to deduct the salaries of their top five individuals that have exceeded $500,000. For participating firms there will also be a surtax of 20% on retirement packages of top executives who are involuntarily terminated from their firms, or lose their jobs as a result of the firm's failure.

According to the terms of the bailout agreement, the Treasury would be allowed to buy $250 billion in troubled assets immediately. The president could request an additional $100 billion at any time. Congress has the right to not approve the remaining $350 billion; however, that action is subject to the president's veto. Since there is no date associated with this final amount, all of the money could be spent by the Treasury relatively quickly. Paulson has indicated that Treasury may be prepared to start purchasing assets within weeks."

Finally here is a graphic depicting how the bailout plan might workout in practice:

Graphic courtesy of the WSJ

While I'm much happier with current proposal than I was with what the Treasury proposed last week, let's be clear that my "happiness" is in terms of the current proposal being a lesser bad idea than the original.

Let's look at some of the specifics:

Executive Compensation: I wonder if the limits on compensation will have much teeth, because I could see a company saying: "okay we were going to give you $15 million, but due to taxes imposed under EESA we'll just have to give you $11". Whether it's $15 million or $11 million the fact that the executive received anything is theft pure and simple, and when you consider that who is making decisions on compensation, the amount of securities to sell, etc, it's hard to believe that executives are truly going to suffer.

Protecting the Taxpayer: while I like the idea of a fee imposed on all institutions in order to recoup the taxpayer's losses under the program, I'll reserve judgment (positive or negative) until I see how much the fee is and what the overall program looks like. At this juncture there is little point in saying much about something that is completely hypothetical.

Mortgage Modification : the inherent problem with mortgage modification is that you can't "modify" your way out of a situation where the homeowner simply spent above their means, without reducing principle, handing them cash, supplementing their income, etc. It's great to say that you'll "encourage" servicers to modify loans, or modify the ones you currently own, but affordability is the true root cause here. In my opinion while these provisions may help "some" homeowners, it will have a rather limited effect on declining housing values, foreclosures, etc.

Funds Allocation : the thing I like the most about the plan is that it's only releasing $250 billion up front, with another $100 billion via Presidential approval and the final $350 billion being released only via Congressional approval. For me this isn't just about limiting taxpayer liability in case the first "dose" of cash unclogs things, it presents the opportunity to shift course if/when the plan proves to be ineffective and/or to refocus on root causes as opposed to symptoms. 

At the end of the day I think the current plan is just a moderately improved version of something that was a bad idea in the first place, if you want to fix the financial system address the issue of derivatives, regulatory arbitrage, undercapitalization, over leverage, etc, not just one of the symptoms. I suspect that I'm not the only one who is of this opinion, because if the recent performance of the credit markets, capital markets, et al, are of any indication the market is none too impressed by the bailout plan either.

If the bill is passed by Congress and signed into law by the President the question we should all begin asking ourselves is: "what happens 2-3 months from now when it becomes readily apparent that we created the wrong plan for the wrong problem?"

You can read more here(the WSJ), here(Forbes) and here(full text of the bill).

Sources:

The WSJ: "Summary of Draft Proposal to Rescue U.S. Financial Markets" -- September 28, 2008.

Forbes: "What's in the Bailout Deal" -- Brian Wingfield and Joshua Sambrun, September 28, 2008.

Posted to: Financials | Politics & Business | U.S. Economy on September 29, 2008 at 08:55 AM | Permalink | Comments (0) | TrackBacks (0)

Wachovia is effectively the nation's largest failed bank ever as their banking operations were sold to Citibank this morning in a deal orchestrated by the FDIC:

(From The WSJ): "Citigroup Inc. agreed to acquire Wachovia Corp.'s banking operations on Monday for $2.1 billion in stock and will assume another $53 billion in Wachovia debt. Federal banking regulators pushed the deal by agreeing to share a portion of future losses that Wachovia's failing mortgage portfolio could generate.

Citi's purchase of the fabled Charlotte bank marks another deal orchestrated by the federal government, this time by the Federal Deposit Insurance Corporation, and one in which the agency could be on the hook for loan losses.

"The FDIC has agreed to provide loss protection in connection with approximately $312 billion of mortgage-related and other Wachovia assets," Citigroup said in a statement.

The Federal Reserve and Treasury Department were also part of the effort, another sign of how proactive the government has been in preventing ailing financial firms from failing and instead pushing for stronger firms to acquire some assets of the weaker companies…

...The FDIC said the deal was reached in concurrence with it, the Federal Reserve Board and the U.S. Treasury Department. "There will be no interruption in services, and bank customers should expect business as usual," FDIC Chairwoman Sheila Bair said.

In a separate statement, Fed Chairman Ben Bernanke said he welcomes the Wachovia bailout deal and supports the timely actions taken by the FDIC. He added that the FDIC action shows the government is committed to U.S. financial stability.

The FDIC sought to calm any concerns the Citigroup and Wachovia deal might have on financial markets.

"On the whole, the commercial banking system in the U.S. remains well capitalized," Ms. Bair said. "This morning's decision was made under extraordinary circumstances with significant consultation among the regulators and Treasury."

The FDIC said the move was necessary to "avoid serious adverse effects on economic conditions and financial stability."

For Citigroup, it is a rapid transformation from one of Wall Street's biggest losers to a "pillar of strength," as top executives began calling the company earlier this month, and a testament to the torment sweeping the banking sector.

Over the past year, Citigroup has racked up more than $40 billion in write-downs and other losses stemming from the mortgage meltdown. The company was a leader in creating and marketing some of the exotic securities that have been at the heart of the credit crunch. Its stock price has shriveled to less than $20, compared to more than $50 early last summer.

Citigroup is buying what the FDIC said is "the bulk of" Wachovia's assets and liabilities, including five depository institutions, and assumes the company's senior and subordinated debt. Not being sold are the A.G. Edwards brokerage division and Evergreen Investments operations.

The FDIC also has entered into a loss-sharing arrangement on a pre-identified pool of loans under which Citigroup will absorb up to $42 billion of losses on a $312 billion pool of loans, with the FDIC covering anything beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing the risk."

While not a "true banking failure" per se, it really should be considered as one due to the fact that what the FDIC did was orchestrate (and backstop, contribute to, et al) the sale of Wachovia to Citibank before they were forced to shut the bank down. In other words the only difference between the WAMU failure last week and the Wachovia "sale" today is a couple of hours, and/or the fact that Wachovia was sold before it "officially" failed.

Either way the fact that two major national banks have failed within the course of 3 business days is truly mind boggling, a year ago these were major national banks with aggregate market caps topping 9 figures and now they're being sold off for a fraction of their former value.

Another mind boggling component about the entire situation is that not too long ago people were whispering things about Citibank having major issues, needing to be sold and/or broken up, etc, and now here they are rescuing another flailing financial institution.

Considering the size of Citibank (and Wachovia for that matter) I'm assuming the  rules around no bank being allowed to have more than 10% of the nation's deposits via a buyout have been thrown out the window, because I'm not sure of the exact percentages at play here it's not a stretch to hypothesize that Citibank is over that limit now.

Aside from the usual thoughts around the banking environment having changed dramatically over the past three weeks consider this one instead: as a result of the failures, consolidation, et al  of the past nine months one could argue that the U.S. banking environment is more risk laden as we have significantly fewer players being controlled by a smaller number of people.

You can read more here.

Sources:

The WSJ: "Citigroup to Acquire Wachovia Assets" -- Marshall Eckblad, September 29, 2008 .

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 29, 2008 at 07:58 AM | Permalink | Comments (0) | TrackBacks (0)

Lot's of quotes and analogies being thrown around to describe the current crisis and the proposed bailout plan, I figure it would be remiss of me to "join the crowd" and not offer my take:

In my view the current bailout plan is akin to asking the victims of car theft to purchase cars for the thieves, pay for their insurance and a year's worth of gas, so that the they can be spared the personal, financial and daily life disruption of future thefts. "If you buy the car thieves cars and give them money, they won't have to steal yours and everyone will be better off".

Now the above sounds like a ridiculous notion but it is in fact, very similar to what we're being asked to do with the bailout plan: give our money to the criminals who have destroyed the economy, so that they'll be better able to function and the larger economy will be better off.

At the end of the day no sane person disputes that something needs to be done and that a stronger economy is everyone's best interest, what many (like myself) have a problem with is that:

It's the wrong solution: focusing on bad debt securities instead of overleveraged and undercapitalized banks; if you want to cure  disease you need to treat the cause not the symptoms. 

The lack of penalties : apparently no one in Washington has the courage to propose a solution that is aimed at protecting the economy and the average citizen, while punishing (severely) those who caused the crisis. Remember it's not exactly difficult to shore up the banking system whilst simultaneously dropping the hammer on those who caused the crisis.

It's not the mere idea of the bailout it's the message behind this one and the way in which it's being presented to us:

"protect yourselves and the economy by using your money to take on the risk for the mistakes of Wall St"

as opposed to:

"Wall St has put you at risk so we're going to make these investments in Main St. to help you weather the storm, and while we do have to help the banks we're going to punish them severely for both causing the problem and needing taxpayer help. Finally we're going to funnel direct benefits to the taxpayer from the banks that receive help, whether it's a one time tax refund, cheaper loans, etc, etc".

I have zero problems with the idea that the Government is going to have to help the banks for the good of the company, I DO have a problem with Washington's lack of intelligence with respect to the nature of the solution, and their lack of courage with respect to punishing Wall St., showing respect for the taxpayer and the solution's overall execution.

Don't even get me started on the fact that the plan is being credited as being capable of affecting things it will have little to no influence over, E.g. housing prices, consumer spending and job creation… just to name a few.

Posted to: Financials | U.S. Economy on September 27, 2008 at 01:57 PM | Permalink | Comments (1) | TrackBacks (0)

An amazing blog post from Barry at the Big Picture Blog today (in fact it's an editorial in Today's Barons), a quick excerpt:

(From the Big Picture):

"To : Washington, D.C.

From : Wall Street

Re : Credit Crisis

Dear D.C.,

WOW, WE'VE MADE QUITE A MESS OF THINGS here on Wall Street: Fannie and Freddie in conservatorship, investment banks in the tank, AIG nationalized. Thanks for sending us your new trillion-dollar bailout.

We on Wall Street feel somewhat compelled to take at least some responsibility. We used excessive leverage, failed to maintain adequate capital, engaged in reckless speculation, created new complex derivatives. We focused on short-term profits at the expense of sustainability. We not only undermined our own firms, we destabilized the financial sector and roiled the global economy, to boot. And we got huge bonuses.

But here's a news flash for you, D.C.: We could not have done it without you. We may be drunks, but you were our enablers: Your legislative, executive, and administrative decisions made possible all that we did. Our recklessness would not have reached its soaring heights but for your governmental incompetence. "

I have nothing to add but to say: "Amen".

Read the rest here, now.

Sources:

The Big Picture: "A Memo Found in The Street" -- Barry Ritholtz, September 27, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | U.S. Economy on September 27, 2008 at 01:23 PM | Permalink | Comments (0) | TrackBacks (0)

….but the man has a very solid argument for why he should be #1.

Posted to: Sports on September 27, 2008 at 01:14 PM | Permalink | Comments (0) | TrackBacks (0)

Damn, I didn't know those assets were that bad….

…..they'll be infecting balance sheets for centuries! Or serving as a burden to future taxpayers, one or the other.

Posted to: Randomization on September 26, 2008 at 12:40 PM | Permalink | Comments (0) | TrackBacks (0)

Let's take a break from the usual discussions of pending economic doom, ill-conceived bailouts and failed banks shall we?

(From the NY Times): "It was as though Michael Deane, a 32-year-old transplant from London, did not get the memo that crime is way down in Manhattan. He looked like something out of “Death Wish” as he drove slowly past his Riverside Drive apartment in broad daylight, his bloodshot eyes darting from pedestrians to parked cars to old people sitting on park benches.

Near his building, a man washing windows with a bottle of Windex returned his stare, but Mr. Deane kept driving. Would getting sprayed with Windex kill him? Something to think about.

He had been sneaking around like a noir hero for two and a half weeks, finding new and shadowy exits to his regular places. He was tired from lack of sleep, and while it was early yet, he was looking forward to a stiff cocktail when he got upstairs.

But first he had to get there alive. He parked his car a couple of blocks away and started the treacherous walk, his only friend of late tucked under his black shirt, a curiously damp bulge.

His yellow-and-orange Uzi-style squirt gun.

Mr. Deane, a freelance audio-visual technician, was becoming a player to be reckoned with in this year’s StreetWars tournament. With only a few days left, he stood a fighting chance at being the last person standing, the $500 prize in one hand and his dripping gun in the other. But with the pool dwindling, his own killer could not be far.

When StreetWars started on Sept. 7 , each of the 250-plus contestants was handed a black envelope marked “Shadow Government,” with the name, home address, workplace, e-mail, cellphone number and photograph of a player to kill by squirting. After each kill, the shooter acquires the dead rival’s target and begins stalking this new person, all the while looking over a shoulder for whoever is hunting him. It is permissible to shoot in self-defense...

...StreetWars was created in 2004 by Franz Aliquo, then a 28-year-old securities lawyer, as a cure for a boredom phase he was working through. Mr. Aliquo named himself Supreme Commander and, with a friend known as Mustache Commander and other helpers, has held several killing tournaments in New York, San Francisco, Chicago, London and Paris. The game resembles the 1980s campus phenomenon Assassin, itself a reminder of the 1985 film “Gotcha!” starring Anthony Edwards and his paintball gun.

The contestants are mostly in their 20s or early 30s, from what could be called the kickball set; about 35 percent in the current war are women. “We had a 76-year-old grandmother in San Francisco,” said Mr. Aliquo, who lives in Long Island City, Queens, and now is the events director at Thrillist.com , a Website that distributes daily emails of events in various cities. “She got two kills.”

As someone who spent a lot of time engaged in squirt gun battles as a kid (I used to build custom water weapons actually, but perhaps that's a story for another time), I can't wait for this to come to Seattle.

You can read more here, and here.

Sources:

The NY Times: "The Shadowy, Wet World of Squirt-Gun Assassins" -- Michael Wilson, September 26, 2008.

Posted to: Randomization on September 26, 2008 at 12:38 PM | Permalink | Comments (0) | TrackBacks (0)

Interesting article from the NY Times on the need for better set of regulations for the financial industry, as well as various aspects of past financial crisis:

(From the NY Times): " Either Barack Obama or John McCain could well become the first U.S. president since John F. Kennedy to be elected during a recession, not to mention a financial crisis. What sort of nation will the winner inherit? Although the string of bank failures and panic on Wall Street has overtones of the 1930s, the risk is less a repeat of the Great Depression than that of another Japan, which, following a stock-market and real-estate mania that peaked in 1989, suffered through a so-called “lost decade” — 10 years of economic stagnation and a seemingly unending cycle of falling asset values and government bailouts...

...contagion is like a flood. It finds its way into the part you don’t protect.” In 1929 and its aftermath, that meant stocks purchased on credit and bank deposits. The protections added in the 1930s were remarkable, and their effect endures. Today, though banks are under pressure, their depositors sleep soundly. People lose jobs but they receive unemployment and continue to spend.

But those protections are hardly enough. Financial innovation ever seeks the freest terrain. The last generation has witnessed a hothouse of new financial products — really a new, more supple notion of finance, and one that is incredibly complex. But the basic securities architecture from the New Deal remains unchanged and has even been loosened.

A generation ago, if you bought an insurance policy against a default, the insurer who sold it was required to maintain adequate capital. Today, you can enter into a credit-default swap (A.I.G. wrote billions of dollars worth) even if your capital is insufficient. Every derivative (thanks to Wall Street’s successful lobbying) was declared to be not a security, and thus largely outside the sight of the Securities and Exchange Commission. Our umpires have been watching the wrong field.

This is not to say that Washington is the main culprit. Markets were incredibly foolish. The dubious mortgages that were written, the credit ratings that blessed them and the trust that banks put in them were speculative and stupid. But we know that people do foolish things. Markets almost demand it. If you are Lehman Brothers and you do not borrow, you do not earn as much as your peers; then your stock falls and you get taken over. So you borrow. Only regulation can check this instinct. Investment banks should be subject to limits on leverage; hedge funds need scrutiny; and more. Alan Blinder, the former Fed vice chairman, says the next president and Congress will have to redraw the entire regulatory map, because “it’s been shown to be wanting.” Amen. "

While I definitely believe that we need a new set of regulations (or to "redraw the regulatory map") , the thing that concerns me is that creating new regulations always seems to be a tug of war between innovation & growth vs. control & safety. When times are good regulations are relaxed and a lot of risk is introduced into the equation, and when times are bad people overreact and perhaps regulate too strongly.

In my view what's needed is not so much a new regulatory map but a completely different mindset towards creating regulations in the first place, more specifically creating an environment that allows people to innovate but prevents them from getting into trouble/creating another crisis. In other words everyone involved should be on the same page: "while we want to foster innovation it's just not in anyone's interest to remove regulations that would make it easier to create future economic crises, so let's always err on the conservative side".

Of course politicians and the banks agreeing to an approach like this is just wishful thinking on my part, and the likely scenario is a set of knee jerk overly strong regulations that will be gradually phased out as the economy improves….

…unfortunately we all know how that story is likely to end.

You can read more here.

Sources:

The NY Times: "Regulator in Chief" --  Roger Lowenstein, September 26, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | Politics & Business on September 26, 2008 at 11:58 AM | Permalink | Comments (0) | TrackBacks (0)

I will never understand why people feel the need to include all of the recipients names in the "To" or "CC" lines of a mass e-mail (for some sort of company related announcement), or the inability of allegedly highly educated and intelligent people to respond to said e-mails via using "reply" instead of "reply-all". I (for one) don't need to see conversations between Nigel, Misty, Brooke and Tony (*Names changed to protect the e-mail misusing cretins) around their inability to use the new time keeping system for consultants; I've got an idea, click "reply" and stop clogging the inboxes of your colleagues.

Yes, I'm ranting, but I received about, oh, 50 e-mails this morning on a thread about changing a time entry system for consultants on-site with a client, and I've had it. It's also worth noting that this has been going on since about TUESDAY!

Posted to: Randomization on September 26, 2008 at 11:28 AM | Permalink | Comments (0) | TrackBacks (0)

Quick thoughts on the WAMU failure:

Long-time coming: while I'm sure the media (and others) will characterize WAMU as a victim of the credit crunch, or perhaps Congress not moving fast enough to pass the bailout bill, the fact remains that WAMU's struggles started in '05/'06 when they began scaling back lending operations, closing branches, etc, due to problems within their mortgage business. Let's also not forget that WAMU started trying to expand its subprime credit card business last summer, despite ample evidence that it was time to pull back (if not exit) from that business.

I have some friends who used to work at WAMU as loan officers from '03 -- '06 and they're not exactly surprised right now, as they were first hand witnesses to the decline in the health of WAMU's lending business back in the '04 - '06 time period.

While it may seem that the WAMU failure just set upon us with dizzying speed the real truth is that it's just the result of malaise that has been lingering about for some time, it just took a while for the house of cards to collapse.

The Bailout: WAMU failing in the midst of contentious discussions on the bailout package will raise the very obvious question of: "would the bailout package have saved WAMU?" In my opinion it's highly unlikely that the bailout package (as constructed) would've saved WAMU, at best it would've prolonged the inevitable but I doubt it would've saved the company. At the end of the day WAMU was an undercapitalized and overleveraged institution that was losing money, while ridding itself of bad assets would've helped it wouldn't have solved the company's core problems.

Better yet the fact that no one stepped up to buy WAMU until the company had failed and could be purchased at a fire sale price, more or less answers the question as to whether or not the bailout fund could've saved the company. Because it's an indicator that the company's problems were so great that the simple shedding of bad assets (or another company taking them on via a buyout), would still leave you with a company that was so stricken with malaise that it wasn't worth buying at anything higher than a fire sale price.

Finally I've been a WAMU customer for some time and I'm a little sad (if not unnerved) to see a MY Bank let a lone a bank of that size collapse, and while I had already pulled out some of my funds I hadn't completely abandoned ship in the hopes that things would work out. At this juncture I'm more concerned for my friends that work there and the folks who always helped me with my business accounts, than I am for my money that's still on deposit as the combination of J.P. Morgan and the FDIC will keep that safe. I'm also concerned about the impact on the economy of the Seattle area as WAMU was a fairly large employer, and the pending job losses (employees, vendors, dependent businesses, et al) will definitely have a negative impact. 

Something I will do (however) is provide regular updates on what the experience is like for the customer of a failed bank that has been taken over/assumed by another institution, because while there are a lot of articles out there around "what happens when your bank fails", I haven't seen any written from a first hand perspective.

You can read more on the situation here (FT) , here (Reuters) , here (the Economist), here (WSJ) and here (The Seattle Times).

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 26, 2008 at 10:50 AM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting graphic from the WSJ depicting the surpluses (a spurious notion to be sure) and deficits incurred by our government since 1980:

Graphic courtesy of the WSJ

The graphic comes from an article from the WSJ that suggests that the aggregate cost of the Government's bailouts and interventions will be less than the estimated number of around $1.4 trillion :

(From the WSJ): "...there are a few reasons why the government's interventions probably won't be quite as expensive as people think. For starters, some experts say it's far from certain that the U.S. government will even need all the money it has budgeted. They say policy makers set their spending limits on the high side to make clear to investors that the government would do whatever it takes to make financial markets work again. And once the government's rescue program begins to establish prices for currently unmarketable securities, the hope is that the market will start functioning again before the U.S. actually has to buy $700 billion worth of them.

Regardless of how much the government actually spends, the impact on the budget deficit will be further limited because budget rules allow the government to treat such debt as a "means of financing." Only the anticipated losses on the investments, plus interest costs, would show up as additions to the deficit.

Ultimately, as Mr. Bernanke suggested, the government stands to get a lot of its money back on the securities it buys. It can sell them off or hold them as investments, depending on market conditions.

Just how much the government can recover is unclear. The Fed chairman told lawmakers he expects it to be a "substantial amount," and he compared the process to an art auction. "Just as when you sell a painting at Sotheby's, nobody knows what it's worth until the auction is over," Mr. Bernanke said."

The problem here is that we're talking about investing in the worse assets the banking industry has to offer and/or shoring up poorly run companies like the Mortgage GSEs, not to mention the fact that it's not a given that we've already seen the worse of the crisis. In other words it's quite possible that there are hundreds of billions worth of hidden costs, and/or that things won't work out as well as Paulson and Bernanke have predicted.

After all these are the some individuals who were trying to assure that things were contained last year.

Finally I could care less about the current "budget rules", as a concerned citizen the fact that the government is taking on new debt to spent amounts that are a multiple of this year's projected deficit makes me more than a little nervous.

You can read more here.

Sources:

The WSJ: "Cutting Back the Rescue's $700 Billion Price Tag" -- John D. McKinnon, September 24, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.   

Posted to: Politics & Business | U.S. Economy on September 26, 2008 at 09:20 AM | Permalink | Comments (0) | TrackBacks (0)

Despite the previous announcement that an "in principle" agreement had been reached, it appears that talks on the bailout plan stalled last night:

(From the WSJ): "WASHINGTON -- Wrangling among the nation's top political leaders threw the Bush administration's $700 billion bailout plan into disarray late Thursday, despite a dramatic day of negotiations on Capitol Hill that seemed to promise a deal.

Negotiators broke off talks Thursday night with no agreement and with plans to reconvene in the morning, without House Republicans. It was the Republicans' surprise championing of a competing plan late Thursday that derailed a carefully crafted compromise previously taking shape.

Also raising the stakes: The demise of Washington Mutual Inc., the largest banking failure in U.S. history, sent a fresh message to Washington of the fragility of the financial system…

...Earlier in the day, congressional leaders had hammered together the outline of a compromise that involved allotting the bailout money in installments. It was widely expected to result in a deal. However a pivotal afternoon meeting at the White House, attended by President George W. Bush, congressional leaders and the two presidential candidates, broke with no agreement.

One cause of the delay: opposition from House Republicans who have tried to fashion an alternative plan that, instead of relying heavily on taxpayer money, could let banks buy insurance for the troubled assets weighing down their books."

I hope the opponents to the program prevail and succeed in crafting an alternative solution because at the end of the day the current one is STILL an Enron style SPE for the financial sector; the question is whether or not they will have the political muscle to do it and/or if they'll change course and rush to a solution in the wake of the WAMU failure.

Perhaps the bigger question is whether not they're capable of even drafting a viable solution, after all consider the solution that's currently on the table!

Here is a quick look at the current proposal as it stood last night:

Graphics courtesy of the WSJ

Looking at the plan I'm not especially keen on the treasury secretary being the one who will set standards/limits on executive pay, after all won't these executives be his former Wall St. friends AND wasn’t he the one insisting that no penalties should be in the plan because it will discourage banks from participating? But hey, at least the provision is currently in the plan.

I'm on the fence about loan modification because a significant % of the people that are facing foreclosure simply bought homes they couldn't afford, however if their tax dollars are going to be used to bailout the banks it's not entirely unfair for them to see some benefit. However at the end of the day if you can't afford you can't afford it, and a better solution is to help those people get into an sustainable housing situation instead of just delaying the inevitable.

I do like the oversight board because the initial proposal that gave the treasury secretary unlimited power over $700 billion was patently absurd; I also like the idea of parceling out the funds ($250 billion initially, $100 billion by request and $350 billion via congressional approval) as it allows for the opportunity to scale things back, shift gears or cancel the program all together.

However at the end of the day the bailout (as currently envisioned) is an ill-conceived solution to a singular symptom that won't be able to solve the real problem, so while I'm  encouraged by certain aspects of it I would rather the whole thing is scrapped and an alternative solution crafted.

You can read more here, and articles around the talks resuming here and here.

Sources:

The WSJ: "Bailout Negotiations in Disarray" -- Greg Hitt, Damian Paletta and Deborah Salomon, September 26, 2008. 

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | Politics & Business | U.S. Economy on September 26, 2008 at 08:51 AM | Permalink | Comments (0) | TrackBacks (0)

In lighter news here is a look at McCain's new economic plan, courtesy of the Onion:

*It goes without saying that this is satire and not meant to be taken seriously…...but just in case.....

Posted to: Randomization on September 25, 2008 at 10:35 AM | Permalink | Comments (0) | TrackBacks (0)

(From the FT): "Chris Dodd, chairman of the US Senate Banking Committee, said on Thursday that negotiators had reached ”fundamental agreement” on the principles of the proposed $700bn bail-out of Wall Street.

Mr. Dodd expressed confidence that the plan could be acted on “expeditiously” and would send a message to the markets."

Robert Bennett, the Republican Senator from Utah, commented: “I now expect we will indeed have a plan that can pass the House, pass the Senate, be signed by the president and bring a sense of certainty to this crisis that is still roiling in the markets."

Bond yields moved higher on the news while the dollar strengthened…

...Democrats and Republicans alike have so far resisted the administration’s demands for runner-stamp approval of the deal and are pushing for amendments. The Democratic aide to a senior congressional leader told the Financial Times that legislators were inching closer to a compromise, with key House and Senate members scheduled to meet on Thursday morning to put the finishing touches on a bipartisan bill.

Nancy Pelosi, the Democratic House Speaker, said Congress was “committed to passing bipartisan legislation that will stabilise the markets, protect taxpayers, establish tough oversight, and curb excessive CEO compensation. And we will pass it soon”.

Mr. Bush signaled willingness to accept changes to his proposal, including the creation of a bipartisan board to oversee implementation of the bail-out and measures to prevent “failed executives” profiting from public funds."

At this point I think we still have to wait and see what the final provisions of the bill are before passing final judgment, but my initial prediction is that it will only be "less" abysmal than the original proposal but abysmal nonetheless. In my view so much fear and hysteria has been whipped over the need for immediate action that the government is more interested in doing "something" even if it's the wrong thing, then they are in doing the right thing or crafting a plan that would be efficient, effective and respectful to the taxpayer.

Last September I wrote an article on the Fed's first rate cut of the credit crisis, in which I noted that it would have little impact on mortgage rates, housing prices, the credit crunch itself, etc, etc, because it wasn't addressing the core problem. Now here we are a year later and once again the government is fighting a symptom (toxic mortgage securities), instead  of focusing on the core problem (undercapitalized and overleveraged financial institutions).

Where do we go next when the plan is implemented and many of our current economic woes remain?

You can read more here.

Sources:

The Financial Times: "Negotiators close in on bail-out deal" -- Andrew Ward, September 25, 2008.

Posted to: Financials | Politics & Business | U.S. Economy on September 25, 2008 at 10:11 AM | Permalink | Comments (0) | TrackBacks (0)

In a move that isn't likely to get much attention due the current row over the banking industry bailout, Congress approved $25 billion worth of low cost loans for the auto industry today:

(From the FT): "The House of Representatives on Wednesday approved a $25bn package of low-cost loans to help hard-pressed carmakers and their suppliers finance plant modernisation at a time of restricted access to public capital ­markets.

The automotive loans are separate from the proposed $700bn bail-out for the banking sector, which is still being debated in Congress. The House approved the measure 370-58, setting the stage for Senate approval within days.

The industry’s case has been helped by the fact that Michigan and Ohio, the two states most dependent on the car industry, are key swing states in the November 4 presidential election.

Executives of General Motors, Ford Motor and Chrysler and their suppliers have lobbied heavily for the loans. Both presidential ­candidates, John McCain and Barack Obama, have expressed support…

...The loans were originally authorised in an energy bill passed last December to finance the retooling of plants for more fuel-efficient vehicles, especially hybrid and electric cars. But they have become a crucial prop for Detroit carmakers.

The continuing resolution provides funding for $7.5bn, which is the estimated subsidy on the loans – in other words, the cost to the government of providing them at well below market rates.

The loans will not take effect until the energy department has written detailed regulations dealing with, among other issues, which investments will qualify and conditions for repayment. Congress has directed the department to begin writing the regulations quickly and will provide any extra staff required to do so. One lobbyist said he hoped the regulations would be completed by early 2009.

All carmakers and suppliers with operations in the US are theoretically eligible. However, the energy bill restricts benefits to plants that have been in operation for at least 20 years, thereby excluding most foreign carmakers.

A Toyota spokesman said his company was agnostic on whether it derived any benefits. It has kept a low profile in the debate on the loans."

At some point we (as a nation) are going to have to abandon the idea that we're  free market capitalist society, and just admit that we're "convenience economy" we're socialist when its convenient and blow the free-market horn when that's convenient as well. Or perhaps we have a free market economy when it works, but the government is always ready to step in and help Corporate America clean up its mistakes.

Mind you I'm not disputing the sheer economic value of the domestic auto industry or the need for them to retool, I would just rather any help from the government come with some sort of penalty, higher cost or a more tangible benefit to taxpayers at large. For instance if the auto industry has to borrow money from the government to operate, than they should be required to provide low cost auto loans to low income people, or provide job training, employment, etc, to same. Additionally a % of their future profits should be kicked back to the taxpayer as well.

For me it's not so much the value of any benefit I receive personally if/when the government has to bailout or help a particular company it's the overall principle of the thing, it's a lot easier to support bailouts (and trust the politicians making the decisions) when they treat the taxpayer with respect and outline the direct benefits we'll receive as opposed to saying: "do it for the economy".

You can read more here.

Sources:

The Financial Times: "House clears $25bn for carmakers" -- Bernard Simon, September 25, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice

Posted to: Auto Industry on September 25, 2008 at 09:32 AM | Permalink | Comments (0) | TrackBacks (0)

Today's edition will be short and sweet, just a couple of things I'm reading and thought you'd find interesting:

An article from Forbes that asks the rather important question: "Who bails out the U.S. Government?", while discussing the bailouts, the moral hazards introduced  and the likely negative impact from the government's recent actions.

While I think the bailout plan will get pushed through, at least there is some bipartisan opposition to the plan from high ranking members of Congress; in related news the Congressional Budget Office told the house budget committee that the total cost of the bailout was impossible to estimate. Here is some additional coverage from the FT on the topic.

Again, while I think the plan will still be rushed through, the fact that there are some in the government who are fighting this ridiculous idea gives me "some" hope for a better solution.

A page from the FT with numerous articles and resources related to the current "row" on Wall St.

An article from Seeking Alpha that presents the idea that the U.S. has gone from capitalism to socialism: "privatizing gains and socializing losses"; while statements like these often fell into the realm of knee jerk reactions to things we don't like, it's something that's hard to argue with in light of recent events.

However on some level you have to admit that our economy has always had some cleverly disguised socialist elements, after all weren't the mortgage GSEs nothing more than hybrids of socialist and capitalism? Ironically the reasons the GSE failed weren't because the two goals were in opposition to each other but because the capitalist and socialist goals were both rather synergistic (in this case), and the companies overreached on both fronts.

Article discussing triple digit increases in foreclosures in some of the country's wealthiest areas.

Also from Forbes here is a profile of recently disposed Circuit City CEO Phillip J. Schoonover; I wish someone would pay me that much to run a company into the ground. Hell, I'd do it for a mere $200k + a Maserati GranTurismo.  

The way certain CEOs are paid you almost have to wonder if an incentive even exists for them manage risk properly, manage the company well and generate solid results. When the choices are becoming a "multi-millionaire" vs. "a richer multi-millionaire", human nature seems to dictate that you won't always get the best results out of these individuals.

Speaking of which an article from the Richmond Times discusses how Mr. Schoonover may walk away with a $1.8 million severance package, I don't know what's worse the severance package or the fact that an individual interviewed for the article said that: "There is no blood on his hands. He gave a bad situation a good try," she said."

I guess she's ignoring the fact of how easy it is/was to make money selling electronics during his tenure and how the companies that didn't only had bad management to blame, not to mention the slew of bad decisions that made the situation worse.

But at least he tried right? 

Sources:

The Richmond Times Dispatch: "Circuit City CEO severance" -- Louis Lloyd, September 24, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Business Commentary | Financials | U.S. Economy on September 24, 2008 at 12:58 PM | Permalink | Comments (0) | TrackBacks (0)

Various individuals (many of whom I respect greatly) have been sounding the call to stop talking about the "moral hazard" introduced into the markets by the recent round of bailouts, typically pointing towards the massive losses in shareholder equity as evidence that perhaps the moral hazard doesn't exist. The other argument is that there is no point in complaining about the moral hazard once the city is already burning, just do whatever you can to put the fire out.

While I don't completely disagree with these points I think that a key point has been missed by those saying we should ignore the moral hazard:

The moral hazard isn't so much the bailout itself it's the way the bailout is being executed, more specifically it's the fact that Wall St. is being allowed to socialize their losses with minimal penalties, will benefit more from the bailout than the taxpayer and their executives are walking away with generous severance packages.

Now why is that a hazard?

Because it creates a win/win by a lesser amount situation for corporate executives who get to walk away from shattered companies with severance packages that exceed the net worth of 99% of the population.

Obviously no one wants the company they're managing to fail, and it's highly unlikely that the Executives of Freddie, Fannie, Bear, Lehman, et al, would have made many of the decisions they did if they know what the future outcome will be.

However when you know you can walk away with your multi-million dollar severance, will be allowed to privatize your losses if the worse happens, the government will insure money market funds if "the buck is broken" , etc, etc, it leads one to make riskier choices than they would otherwise.

Which CEO is likely to manage risk more conservatively: the one that knows that if the worse happens he/she will be forced to surrender the bulk of their assets, their company will be orderly liquidated and they may face civil penalties or the one that knows they can walk with a eight figure severance like the former CEO of Freddie Mac?

The moral hazard doesn’t exist due to the mere existence of a bailout it exists due to the way the bailout is conducted, the moral hazard isn't about receiving a bailout it's about receiving a bailout without suffering severe penalties. Yes there are many who lost dearly as a result of their companies collapsing but they're many who didn't, and the fact that there are people involved with bailed out companies that didn't really lose anything is the essence of the moral hazard. 

Case in point: the treasury's proposal for the bailout of the financial sector makes no mention of penalties, whilst insisting that the best solution for everyone is to dump the financial sector's mistakes onto the balance sheet of the taxpayer. Where exactly is the penalty for the financial sector in this scenario where the banks get to use the taxpayer as an Enron style SPE to dump their toxic assets on?

Another example are the financial writers (many of whom with former or current ties to Wall St.) who have been crying for the government to save Wall St. firms for months, as if keeping their buddies employed is synonymous with the best interests of Joe sixpack.

While I don't dispute the need for some sort of government intervention, the way the bailout is being proposed, the fact that the CEOs of Fannie and Freddie walked away with $23 MILLION in severance, the attitude of entitlement from certain individuals, et al, is the reason the current slate of bailouts constitute an extreme moral hazard.

No company receiving a red cent in assistance from the Federal Government should be allowed to continue to exist, the assistance should be provided in order to facilitate an orderly dismantling, liquidation, et al, of the core business in a manner similar to a bankruptcy or FDIC receivership. Executives in charge of these companies should be forced to surrender compensation going back to '06, all severance and retirement packages should be rescinded and they should have to surrender the majority of their personal assets.

If the financial sector must be bailed out to protect the economy so be it, but make it as painful and difficult as possible for those receiving bailouts so that no one benefits from having run a company into the ground and endangering the economy.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice. The author is also patiently waiting for his "student loan, housing and general expenses bailout" , because he feels it would be better for the economy if he spent that money with local retailers instead of on his bills.

Posted to: Financial Markets | Global Economy on September 24, 2008 at 12:45 PM | Permalink | Comments (0) | TrackBacks (0)

Housing continues to get worse (so much for the bottom that has been loudly proclaimed nearly every month since late spring/early summer):

(From the FT): "New data on Wednesday showed that existing home sales dropped by 2.2 per cent in August, which was much worse than expected and highlighted the continuing downturn in the US housing market.

The median existing home price fell 9.5 per cent to $203,100, the sharpest drop on record.

Meanwhile, the inventories of previously owned homes for sale fell 7 per cent to a supply of 10.4 months – its lowest level since March. A significant further drop supply of existing and new homes on sale is viewed as necessary for the recovery of the housing market.

However ,many of the sales at the moment are of properties that have been foreclosed on or being sold by homeowners whose properties have fallen below the value of their mortgages.

“There has been no meaningful change in the level of activity since late last fall,” said Ian Shepherdson of High Frequency Economics.“The NAR estimates that 35 per cent to 40 per cent of all sales are of distressed property, so underlying private activity is weaker than the headlines and there is little sign of imminent improvement.”"

The other issue is that the inventory measured in this story is the inventory of homes that are "currently on sale", it doesn't measure homes that are unoccupied by the owners but have been pulled off the market, foreclosed homes that haven't put up for sale yet, etc.

I.e. to say that thinks are weaker than the numbers indicate is an understatement to be sure.

In the end though the only numbers that truly matter are the inventory numbers, and to put them into the proper perspective take a look at the chart below:

Graphic courtesy of the WSJ

As you can see housing inventory remained fairly constant from '00 well into the housing boom and then suddenly spiked in '05, and even though inventories declined last month there needs to be a massive drop in unsold inventory for housing prices to stabilize.  Furthermore the drop in inventories would have to include many of the homes that aren't yet reflected in current inventory data.

Finally while the bailout plan will be marketed as a way to ease the pain from the housing crisis understand that you simply cannot legislate away the inventory problem, or the very necessary correction in housing prices without some sort of extreme action. I.e. the housing correction will continue to run its course unless the government starts handing out money for people to buy houses with and/or starts bulldozing unsold inventory.

You can read more from the FT here, and WSJ coverage on the impact of the bailout plan on the housing market here.

Sources:

The Financial Times: "US Home sales much worse than expected" -- James Politi, September 24, 2008.

Posted to: Real Estate | U.S. Economy on September 24, 2008 at 09:30 AM | Permalink | Comments (0) | TrackBacks (0)

Barry Ritholtz has a brilliant post on his "Big Picture Blog" that lists out 14 questions he'd like to ask Hank Paulson and Ben Bernanke, a quick excerpt follows below:

(From the Big Picture): " You two gentlemen have been wrong about the Housing crisis, missed the leverage problem, and understated the derivative issue. Recall the overuse of the word "Contained." Indeed, you two have been wrong about nearly everything financially related since this crisis began years ago.

Question : Why should we trust your judgment on the largest bailout in American history? "

Barry hit the nail on the head: why would any sane person trust someone who has shown no understanding of a problem with the task of fixing it?!

The rest of the questions are just as good, read them now!

Sources:

The Big Picture: "14 Questions for Paulson and Bernanke" -- Barry Ritholtz, September 23, 2008.

Posted to: Financials | U.S. Economy on September 24, 2008 at 09:07 AM | Permalink | Comments (0) | TrackBacks (0)

After a little over two years as CEO of Circuit City, the board has finally woken up and ousted Phillip J. Schoonover, who despite being brought in to turn the company around has done nothing but preside over its near demise:

(From the WSJ): "The head of Circuit City Stores Inc. was forced out by the company's board Monday after months of lackluster sales and an aborted takeover effort by Blockbuster Inc. that cast doubts on the future of the nation's second-largest electronics retailer.

Philip J. Schoonover, who served as chairman, president and chief executive officer, was brought in from industry leader Best Buy Co. four years ago to turn around Circuit City. Instead, the 48-year-old executive, who was named CEO two years ago, presided over a further decline in the company's fortunes.

Mr. Schoonover, who couldn't be reached for comment, was immediately succeeded by James A. Marcum, who will serve as acting president and CEO. Mr. Marcum was elected to the board in June after being nominated by activist investor Mark J. Wattles, whose investment firm owns 6.5% of Circuit City.

Mr. Marcum, 49, was formerly an operating partner of Tri-Artisan Capital Partners LLC, a merchant-banking firm, and was a senior executive at Hollywood Entertainment Corp., a home-video retailer founded by Mr. Wattles.

Circuit City's board elected as its chairman Allen B. King, 62, a former chairman of tobacco company Universal Corp.

"A change in leadership at the chief executive officer level is always a difficult decision," Mr. King said in a statement, adding that Circuit City's board "is committed to accelerating the pace of the company's turnaround."

Circuit City's new leaders are actively soliciting bids for the Richmond, Va., company.

Blockbuster's unsolicited offer to buy Circuit City for $1 billion, or about $6 to $8 a share, ended in July when the video-rental giant got cold feet. Colin McGranahan, retail analyst at Sanford C. Bernstein & Co., said Mr. Schoonover made several blunders over the years, such as replacing 10% of the highest-paid, most-seasoned staff in the company's stores, in an effort to reduce costs and recoup losses caused by falling TV prices."

To get an idea of how bad Mr. Schoonover's tenure as CEO was, take a look at the chart below depicting the 94% decline in CC's stock price since he took over as CEO on 6/27/2006:

It's no secret that I've been calling for Schoonover's head for months, I'm just wondering why it took the board so long to do so. I understand the need to take a long-term view on things and let a turnaround strategy play out, however the fact that CC was unable to generate a profit in the same consumer environment that allowed Best Buy to remain relatively stable (even in this economy) and electronics to be a bright spot for other retailers should've been a hint.

I.e. it isn't exactly difficult to make money selling electronics in the current consumer environment, so if your CEO can't manage to do that turnaround or no….

Moving forward I think a buyout is a moot point for long-term shareholders (as opposed to people who may buy in now as an arbitrage play), as no buyer is going to pay a large enough premium to help them recapture their lost equity. There have been rumors, initial talks and even bids for the company at much higher share prices that all fell through, so at this point most potential buyers are probably waiting for the share price to fall further and/or won't pay much more than the current share price.

Remember CC has been looking for a buyer for months and they weren't able to get one when the market cap was over 4X higher.

The other question is: will the new buyer actually be interested in turning the company around or will the plan be to liquidate the company in a manner similar to what happened with CompUSA?

In many respects shareholders would be better off if the new management seeks some outside investment in order to shore up the balance sheet, whilst trying to turn the company around without selling it outright.

No matter what happens in the future one key thing has changed for Circuit City shareholders and employees: they now have hope after two years of watching their company go down the drain. Only time will tell if that hope materializes into a significant and tangible improvement in the company's health.

You can read more on the subject here, and here.

Sources:

The Wall St. Journal: "Circuit City's Chief Executive Is Ousted" -- Miguel Bustillo and Ann Zimmerman.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Retail on September 24, 2008 at 08:37 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a graphic depicting the volatility in the markets yesterday (9/22/08):

Graphic courtesy of the WSJ

One thing though: the dollar didn't weaken due to fears that the U.S. will have to effectively print more money, it weakened because the U.S. IS going to have to print more money.

While I think the markets will stabilize even if this ill-fated bailout is pushed through understand that the economic consequences will be severe, Mr. Paulson makes it sound as if you can push through a plan like this without paying a heavy price in terms of the weakening dollar and skyrocketing commodities prices.

Mind you we're going to pay huge penalties for this plan even if it's wildly successful, but since anyone with common sense knows that the plan is a god awful idea and won't succeed as planned….

You can read more about yesterday's volatility here.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets on September 23, 2008 at 05:52 PM | Permalink | Comments (0) | TrackBacks (0)

Here is the full testimony of Paulson's testimony before the Senate Banking Committee:

(From the WSJ): "Recent Actions regarding Government Sponsored Entities, Investment Banks and other Financial Institutions

Chairman Dodd, Senator Shelby, members of the committee, thank you for the opportunity to appear before you today. I appreciate that this is a difficult period for the American people. I also appreciate that Congressional leaders and the Administration are working closely together so that we can help the American people by quickly enacting a program to stabilize our financial system.

We must do so in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten American families’ financial well-being, the viability of businesses both small and large, and the very health of our economy.

The events leading us here began many years ago, starting with bad lending practices by banks and financial institutions, and by borrowers taking out mortgages they couldn’t afford. We’ve seen the results on homeowners – higher foreclosure rates affecting individuals and neighborhoods. And now we are seeing the impact on financial institutions. These bad loans have created a chain reaction and last week our credit markets froze – even some Main Street non-financial companies had trouble financing their normal business operations. If that situation were to persist, it would threaten all parts of our economy.

As we’ve worked through this period of market turmoil, we have acted on a case-by-case basis — addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner. We have also taken a number of powerful tactical steps to increase confidence in the system, including a temporary guaranty program for the U.S. money market mutual fund industry. These steps have been necessary but not sufficient.

More is needed. We saw market turmoil reach a new level last week, and spill over into the rest of the economy. We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil.

And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth.

We have proposed a program to remove troubled assets from the system. This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence. It must also protect the taxpayer to the maximum extent possible, and include provisions that ensure transparency and oversight while also ensuring the program can be implemented quickly and run effectively.

The market turmoil we are experiencing today poses great risk to US taxpayers. When the financial system doesn’t work as it should, Americans’ personal savings, and the ability of consumers and businesses to finance spending, investment and job creation are threatened.

The ultimate taxpayer protection will be the market stability provided as we remove the troubled assets from our financial system. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund everyday needs and economic expansion.

Over these past days, it has become clear that there is bipartisan consensus for an urgent legislative solution. We need to build upon this spirit to enact this bill quickly and cleanly, and avoid slowing it down with other provisions that are unrelated or don’t have broad support. This troubled asset purchase program on its own is the single most effective thing we can do to help homeowners, the American people and stimulate our economy.

Earlier this year, Congress and the Administration came together quickly and effectively to enact a stimulus package that has helped hard-working Americans and boosted our economy. We acted cooperatively and faster than anyone thought possible. Today we face a much more challenging situation that requires bipartisan discipline and urgency.

When we get through this difficult period, which we will, our next task must be to address the problems in our financial system through a reform program that fixes our outdated financial regulatory structure, and provides strong measures to address other flaws and excesses. I have already put forward my recommendations on this subject. Many of you also have strong views, based on your expertise. We must have that critical debate, but we must get through this period first.

Right now, all of us are focused on the immediate need to stabilize our financial system, and I believe we share the conviction that this is in the best interest of all Americans.

Thank you."

I get it, it all makes sense now: Mr. Paulson is going to protect us by giving our money to the banks to buy their bad investments, even if it means that he has to overpay for them and the companies receiving bailouts aren't required to face penalties, are allowed to use the taxpayers to fund an Enron style SPE for their bad assets and the taxpayer receives none of their post bailout gains. 

I wonder how he said all of this with a straight face: "troubled asset relief program?!" He makes it sound as if the toxic mortgage securities simply came over the border one night and infected the nation's banks and are on the verge of infecting the wallets and bank accounts of the average citizen.

Not to mention the fact that the real problem is under capitalized and over-leveraged banks, not mortgage securities.

Maybe I'm just being an irritable financial Calvinist today, but I'm still having trouble wrapping my head around the fact that our government is preparing to spend 700 billion dollars on a bank rescue plan that lacks any significant penalties,  and doesn't address the real problem (under-capitalization) that is facing the banks.

Our government is turned into a satire of itself, a truly disturbing thought all things considered.

You can read more on the subject here.

Sources:

The WSJ: "Paulson Testimony on Turmoil in U.S. Credit Markets" -- September 23, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Politics & Business on September 23, 2008 at 12:04 PM | Permalink | Comments (0) | TrackBacks (0)

It appears that the short-selling ban is likely to be extended to include non-financial companies, as more and more companies apply for "short-selling protection" and both GE and GM were added to the list of stocks that are "protected" from short-selling.

(From the Financial Times): "More companies in the UK and the US have been appealing to regulators for protection from short selling after the practice was banned or restricted for banks and other financial stocks in many countries last week.

The Securities and Exchange Commission on Monday gave exchanges control of the list of US stocks protected from short sellers, which was extended to an extra 96 companies. New restricted stocks include carmaker General Motors, industrial group General Electric and GLG Partners, the hedge fund.

Calls for protection have come particularly from property groups, where trade bodies fear their shares could come under assault from short sellers. Short sellers aim to profit from falling prices by borrowing shares and selling them in the hope of buying them back for less.

General Electric said it had requested that the SEC should place it on the list, while GM said it had not asked to be included. Under the new SEC rules, companies can opt out of the list, although the New York Stock Exchange said that none had so far."

I'm starting to become of the opinion that belief in the "short-selling" menace should serve as some sort of "market IQ test", if you actually believe that the stocks of malaise ridden companies are going down the tubes due to short-sellers and not to leaking money like a sieve, being deep in debt, insolvent, etc, then, well……

E.g. if you think that the decline in GM's share price is primarily due to short-sellers and not their actual business problems, I have a bridge to sell you.

What's next are they going to ban market declines all together? Are they going to start arresting investors who make perfectly rational decisions like, well, selling garbage stocks, because it puts downwards pressure on prices?

Last week I felt like we were living in historic and extremely interesting times, now I'm starting to think that the times are becoming absurd.

You can read more on the subject here.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Investing on September 23, 2008 at 11:24 AM | Permalink | Comments (0) | TrackBacks (0)

Don't be surprised if oil makes another bull run and we see additional consequences in the FOREX world as a result of the Government's recent round of bailouts, you can't make plans to borrow nearly a trillion dollars (probably more when all is said and done) to fund various bailouts without suffering any negative consequences:

(From the Associated Press): "NEW YORK – Oil prices spiked more than $25 a barrel Monday — the biggest one-day price jump ever — as anxiety over the government's $700 billion bailout plan battered the dollar and touched off frenzied buying of safe-haven investments including crude.

Light, sweet crude for October delivery jumped as much as $25.45 to $130 a barrel on the New York Mercantile Exchange before falling back somewhat to trade at $122.60,up $18.05. The contract was set to expire at the end of the day, adding to the volatility; the October price began accelerating sharply in the last hour of regular trading.

The November contract, scheduled to become the front-month contract at the end of Monday's session, was trading at $108.80, up $6.05.

Crude has gained about $40 in a dramatic four-day rally that has at least temporarily halted oil's steep two-month slide below $100. At this rate, crude is within striking distance of its all-time record of $147.27, reached in July.

"We're off to the races again in crude," said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates in Galena, Ill. "There's a renewed scramble for commodities because of a general weakness in the dollar."

The Nymex temporarily halted electronic crude oil trading after prices breached the $10 daily trading limit. Trading resumed seconds later after the daily limit was increased…

..."They're going to have to continue auctioning off a whole lot of Treasurys to finance these projects, so the dollar is going to suffer," said Matt Zeman, head trader at LaSalle Futures in Chicago. "Right now it's fear and anxiety driving people who want tangible assets.

The 115-nation euro rose to $1.4781 in afternoon trading, up from the $1.4470 on Friday. A weak greenback was a catalyst for the commodities boom of the past year, and analysts said large investment funds were expected to pour money back into the sector. "

Perhaps the most important question(s) are: "how long is our economy going to suffer from the 1-2 punch of the current financial crisis AND its cures?" How far will the dollar fall and oil gain once the bailout plan proves to be largely ineffective? 

There is no such thing as a free lunch and we're going to be paying for/suffering from the current crisis well into the next decade if not beyond. 

You can read the original article in full here, and coverage from the WSJ here.

Sources:

The Associated Press (via Yahoo News): "Oil spikes $25 a barrel on anxiety over US bailout" -- September 22, 2008.

Posted to: Energy | FOREX | U.S. Economy on September 22, 2008 at 10:57 AM | Permalink | Comments (0) | TrackBacks (0)

The only thing satirical about this is that these executives smilingly ask the government for help as opposed to forlornly asking the taxpayers directly, but in the end, what's the difference?

Posted to: Randomization on September 22, 2008 at 10:33 AM | Permalink | Comments (0) | TrackBacks (0)

The usual collection of news stories and other items I think you may find interesting:

You can read more on the Treasury's plans to communize, err…bailout our financial sector here.

A great read from the financial times discussing the rapid changes to the world of finance over the past two weeks:

(From the FT): "In the space of just two momentous weeks, the landscape of global finance has been dramatically transformed. President George W. Bush’s administration has mounted a multi-billion-dollar rescue of the financial system at the cost of inflicting severe damage on the US model of free-market capitalism.

Heavy costs will be inflicted on the American taxpayer, who is now subsidising Wall Street – and indeed financial institutions around the world – in a bail-out of unprecedented size."

To say that these bailout(s) may turn into cures that were worse than the disease (for the American economy and taxpayer in particular) is likely to be the understatement of this century, because the recent round of bailouts are going to amplify the already daunting financial problems facing the U.S. with respect to debt and unfunded liabilities. 

An excellent read on how derivatives are the true root cause of the current financial crisis, thus lending more credence to the argument that the real problem is undercapitalization and derivatives abuse, not falling housing prices.

Morgan Stanley finds a deal via selling a 20% stake to Mitsubishi UFJ in what is easily a better deal than merging with or selling itself to Wachovia; while I understood Morgan's need to pull of deal and shore-up its business, partnering with Wachovia and their rapidly growing mortgage related malaise was not the way to go in my view.

Another view on the treasury's bailout plan that isn't quite as harshly critical as my own (and supports the need for the bailout), yet notes how it won't save many weak institutions and shouldn't be considered a "green light" to buy financial stocks.

An article from Seeking Alpha that discuses how current bailout constitutes throwing money at the symptoms as opposed to the root causes; the article's most important point (in my opinion) is the fact that we're only going to get ONE chance to throw $700 billion at this problem and it's a waste (if not ruinous) to throw it at a symptom (toxic securities) rather than a root cause.

Another Seeking Alpha article discusses the potential negative consequences from the recent ban on short-selling. In many ways the hysteria over short-selling smells of fear and desperation to me, i.e. people who would rather blame invisible financial terrorists than to accept the problems many companies are facing.

In fact I daresay that many of them are attempting to put forth the idea that as long as a company's stock price is healthy they can continue to operate indefinitely even if they're insolvent, which makes one wonder: "are they more concerned about stock prices or the health of the underlying business? Better yet, why is it a bad thing when a weak company has a weak stock price but a good thing when a weak company has an inflated one?"

Sources:

The Financial Times: "Capitalism in convulsion: Toxic assets head towards the public balance sheet" -- John Plender, September 19, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Financials | Global Economy | Investing | Politics & Business | U.S. Economy on September 22, 2008 at 10:29 AM | Permalink | Comments (0) | TrackBacks (0)

Per a statement released by the Fed last night the independent Investment Banking era is dead:

(From the Federal Reserve): " The Federal Reserve Board on Sunday approved, pending a statutory five-day antitrust waiting period, the applications of Goldman Sachs and Morgan Stanley to become bank holding companies. 

To provide increased liquidity support to these firms as they transition to managing their funding within a bank holding company structure, the Federal Reserve Board authorized the Federal Reserve Bank of New York to extend credit to the U.S. broker-dealer subsidiaries of Goldman Sachs and Morgan Stanley against all types of collateral that may be pledged at the Federal Reserve's primary credit facility for depository institutions or at the existing Primary Dealer Credit Facility (PDCF); the Federal Reserve has also made these collateral arrangements available to the broker-dealer subsidiary of Merrill Lynch. In addition, the Board also authorized the Federal Reserve Bank of New York to extend credit to the London-based broker-dealer subsidiaries of Goldman Sachs, Morgan Stanley, and Merrill Lynch against collateral that would be eligible to be pledged at the PDCF."

The above was followed very quickly by another press release announcing that the Goldman and Morgan transactions could proceed immediately without the five day waiting period:

(From the Federal Reserve): "Based on consultation with the Department of Justice regarding the applications of Goldman Sachs and Morgan Stanley to become bank holding companies, the Federal Reserve Board announced on Monday that the transactions may be consummated immediately without the application of the five-day antitrust waiting period."

Methinks that the government and the I-Banks in question more or less colluded on this one in order to ensure that Goldman and Morgan were as stable and safe as possible.

Overall this means that the era of light regulation, cheap money policy/low interest rates, financial innovations, etc, which saw the rise in subprime lending, derivatives trading, mortgage securities/CDOs, etc, etc, has destroyed the financial world as we once knew it. Around this time last year we were dealing with the shuttering of small mortgage lenders, "surprise" losses being reported by some of the banks and the beginning of the write down era, and now we're facing the complete restructuring of the financial sector and a world of banking that will never be the same.

Both the Fed and the Treasury have attempted to intervene in the markets in ways that were supposed to improve things, mitigate the damage, ease the pain, etc, and yet here we are. Might it be that they're focusing on symptoms and not the core problems, on top of not accepting that certain things (like the very necessary housing price correction) need to be allowed to run their course?

You can read the official order approving the formation of Goldman Sachs as a Bank Holding Company here(PDF File), and the official order for Morgan Stanley here(PDF File). You can also find FT coverage of the subject here.

Sources:

The Federal Reserve : "2008 Banking and Consumer Regulatory Policy" -- September 21, 2008.  

The Federal Reserve : "2008 Banking and Consumer Regulatory Policy" -- September 22, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | Politics & Business | U.S. Economy on September 22, 2008 at 09:59 AM | Permalink | Comments (0) | TrackBacks (0)

Here is the exact wording (as of yesterday at least) of the treasury's bailout proposal to congress:

(From the WSJ):

"Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.

(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia."

This entire enterprise is patently absurd and reads like something I'd expect to read on the Onion.com, not something that is being legitimately proposed by the U.S. Treasury.

The things that bother me the most about this proposal are as follows:

Mortgage securities are a symptom of a problem not the actual problem : the real problem is undercapitalized and overleveraged financial institutions investing in and/or borrowing against overvalued debt securities and other derivative instruments. Allowing the banks to dump their bad investments onto the taxpayer does nothing to solve the core problem. The whole thing is analogous to someone who has an underwater primary mortgage and HELOC debt against their home equal to 15X it's current value, and a 3rd party claiming to be able to resolve the situation by buying the house and paying the primary mortgage.

Any sensible person would call that 3rd party a snake oil salesmen, yes? So why is anyone in their right mind even taking the treasury's proposal seriously, is our government that clueless about the financial markets, economy, et al?

The language around protecting the taxpayer : how in god's name can you claim to be protecting the taxpayer when you're proposing to offload $700 billion worth of the financial industry's mistakes on them? You want to protect the taxpayer? Burn this proposal and apologize to the taxpayer for even drafting it, then require that banks raise more capital and work on fixing the actual problems facing our economy.

Mortgage Securities didn't fall out of the sky : much of the rhetoric in support of this proposal makes the situation sound as if toxic mortgage securities simply fell out of the sky and "happened" to the banks, as opposed to them being a calamity of their own making. The banks created this problem and they should be made to suffer mightily for it as opposed to being able to dump their bad investments on to the taxpayer. I'd rather the government just let more banks fail and the $700 billion be used to cushion the blow to the individual citizen, than for them to use OUR money to bailout irresponsible companies and their executives.

No language around penalties for banks receiving bailouts: one would think that any bank that sells its mortgage securities to this entity would face some rather stiff penalties for being bailed out by taxpayers, yet nothing of the sort is said on the subject in the Treasury's proposal. In my view any bank that receives a bailout should be treated as if it was in FDIC receivership, its assets liquidated and the proceeds used to reimburse taxpayers, bondholders and shareholders (in that order). Furthermore executives should be forced to surrender their compensation from this calendar year and the year before (at least).

The goal of the bailout shouldn't be to enrich irresponsible banks and their executives, it should be viewed as a last resort measure that the banks should be incentivized to avoid at all costs because without penalties the bailout is nothing more than an Enron style SPE for the financial sector.

Section Eight : I found section eight to be so disturbing I was thinking about it in my sleep this morning! The sheer audacity of the Treasury department to propose that they should be given $700 billion worth of taxpayer money to bailout the financial sector, whilst not being subject to any kind of review, audit, oversight, et al, is truly egregious.  Better yet we have a %700 billion taxpayer funded bailout of an elite few that isn't subject to a lick of governance and oversight, which sounds like many different things (near-fascist and communist comes to mind) with none of them including Capitalist, Free Enterprise or Democracy.

Sources:

The WSJ: "Treasury's Financial-Bailout Proposal to Congress"  -- September 20, 2008.

Posted to: Financial Markets | Financials | Politics & Business on September 22, 2008 at 09:31 AM | Permalink | Comments (0) | TrackBacks (0)

Interesting graphic from the WSJ depicting a timeline of the various interventions (and their cost) into the markets executed by the government over the past week or so:

Graphic courtesy of the WSJ

A truly historic eleven day span  to say the least, and it possible that over the next week we'll see even more (and bigger) bailouts in the form of RTC 2.0; the financial sector as we once knew it is no more and it's quite possible that the same will be said for American style Capitalism as well.

Speaking of historic check out this story from NPR's marketplace that discusses the phenomenon of "negative yield treasury bills", that's right T-Bills with a negative yield.

If that doesn't say that insanity has gripped the financial world I don't know what does.

They say "may you always live in interesting times", well call me a boring but I'd prefer them not to be THIS interesting. 

You can read more from the WSJ here.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Financials on September 19, 2008 at 10:54 AM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting article from the FT that discusses a better solution for the current crisis than the RTC:

(From the Financial Times): " We have a full blown panic in financial markets. Any but the safest assets are being heavily discounted. Policymakers have to be thinking in more radical terms than they have done so far to fight the contagion. But that is no reason to do the wrong thing.

There seems to be an impression that the real problem continues to be the liquidity of mortgage-backed securities. Hence the proposal to set up a government agency to buy these securities from distressed banks, akin to the role played by the Resolution Trust Corporation in the 1980s. There are concerns with this proposal. First, even though the illiquidity of the market for mortgage-backed securities, and the substantial markdown in prices of these assets, was responsible for the losses suffered by financial institutions, simply attempting to halt further falls in asset prices will not restore sanity to the financial system. The real problem is the financial system has too little capital. Buying assets at the current depressed market price will not help. And overpaying substantially for these assets will reward the shareholders of the most incompetent or risk-seeking banks, who hold the largest amounts of this now-toxic waste, with the most taxpayer dollars.

The second concern, however, is that because financial companies have too little capital and are unwilling to raise more, a variety of other asset markets risk becoming illiquid as financial companies sell assets. In how many markets can the agency buy assets? And how deep will its pockets be? The danger of overpaying for assets, with too small a war chest, spread too thinly, is that the agency will taken some distressed assets off the hands of a few companies, even while speculators bet on the price falling once the agency has to exit the markets because it runs out of money. And unfortunately, the war chest it will take for any government agency to stabilise markets in the face of speculative attacks can be substantial indeed...

...I would propose a more direct solution. The need of the hour is to recapitalise the financial system. Why not ask the shareholders of financial companies to do it? Financial companies have been reluctant to raise capital thus far. One difficulty is that an equity issuance may send a negative signal, suggesting to the market that there are more losses to come. It may also be difficult for them to cut dividends to stem the outflow of capital, for such cuts may signal management’s lack of confidence in the company’s future. Another difficulty comes from what is known as the debt overhang problem: when a highly indebted entity issues equity, much of the value raised effectively bolsters the value of the risky debt. Because of this value transfer, essentially at the expense of existing equity, equity holders are unlikely to look upon a recapitalisation favourably. Yet this reluctance is hurting the system, and ultimately, financial company shareholders.

The public purpose is served by forcing companies to raise capital. Unfortunately, regulators may also be reluctant to force individual companies to raise capital until they are well and truly undercapitalised, for fear of sending wrong signals to the market about their health. But by then it may be too late. "

What I like about this article is that it gets right down to brass tax and discusses the real problem:

We have an undercapitalized financial system that has overleveraged itself on the back of spurious assets; after all wasn't the AIG rescue an exercise in preventing the banks from losing their tools of regulatory arbitrage that allows them to carry less capital?

In other words not only is RTC 2.0 is the wrong solution (in of itself) it doesn't really address the true problem of undercapitalization, and is just the latest in a series of grand schemes (mortgage rescue plans anyone?) that attack symptoms whilst ignoring the real root cause. 

Final thought: until we address the issues with derivatives as discussed by Warren Buffet in '03 we're not really going to make any real headway towards fixing this crisis or preventing a future one, because the derivative problem or "time bomb" will still be in a position to wreck havoc on the economy and the markets.

You can read the entire article here.

Sources:

The Financial Time: "Desperate times need the right measures" -- Raghuram Rajan, September 19, 2008.  

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 19, 2008 at 10:08 AM | Permalink | Comments (0) | TrackBacks (0)

All of the jubilance in financial markets today over the U.S. Government proposal to create a RTC 2.0 that would buy-up the bad mortgage assets of the banks, in order to prop up/save/rescue the financial system, as a cure for the credit crunch, etc, has a rather glaring fatal flaw:

The first RTC wasn't created to buy toxic assets from struggling banks it was created to assume assets from failed ones, since it didn't have an investment in the assets and was merely holding them it wasn't exactly vulnerable to issues round pricing, raising funds, having enough resources to buy all of the assets, etc, etc.

The new RTC as proposed by the government would amount to a government sponsored Enron style SPE that would be used to artificially prop up banks by taking on their toxic assets (with taxpayer money), enriching shareholders, executives, and bond-holders in the process, whilst saddling taxpayers with more debts and liabilities created by Wall St.

Not to mention the fact(s) that it's almost guaranteed that the banks will inflate the prices of the assets they sell, and the government doesn't exactly have the resources to buy up all the toxic mortgage paper out there. We're already at a point where the government is arranging special bond sales/borrowing money from China to pay for the current slate of bailouts, can our government (better yet future generations) afford to take on more debt? 

In my view RTC 2.0 is a non-starter and would be nothing more than another financial GSE that would grow out of control and create another risk to the economy.

Finally let's discuss the proposal to insure money market funds in order to shore up investor confidence and prevent them from "breaking the buck", in the end it’s all pretty simple: the government shouldn't be in the business of insuring investment, and you have can't have a capitalist economy when the government is backstopping risk for people's investments. Guaranteeing investment risk may shore-up confidence but it also inspires recklessness, as risk is what modulates people's investment behavior towards smart and prudent choices.

I understand that the current economic crisis requires radical solutions, but solutions that will inspire WORSE behavior than that that caused the current crisis AND constitutes a dismantling of our economic system are patently fatuous and unacceptable.

Not too long ago I said that the government take over of Fannie Mae and Freddie Mac constituted the veritable death knell of American style capitalism. I now fear that recent actions by our government may constitute the birth of a new economic system tries to backstop all risk in the economy, encourages bad behavior on the part of executives, provides artificial rewards to a chosen few, artificially props things up, and mortgages its future and punishes the taxpayer in the process.

While certain actions of the government were necessary considering the alternative (AIG, the GSEs), it doesn't change the fact that the combination of the way things were executed, the nature of other actions (fund insurance, RTC 2.0) and the lack of any real action towards implementing real regulatory reform all up to a rather negative economic big picture moving forward.

Posted to: Financials | U.S. Economy on September 19, 2008 at 08:15 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a graphic from the Financial Times depicting Lehman's last eight days:

Graphic courtesy of the Financial Times

You can click here to get access to the interactive graphic on the FT web site, along with additional information on Lehman Brother's recent history, share price, etc, etc.

Looking at the timeline can you really make the case (as many have) that short-sellers are to blame when Lehman has been trying to sell all (or part of itself) for over a month, and no one was willing to do it once they reviewed the books? Could it just be that their balance sheet was so stricken with malaise that no sane person would want to buy it?

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 19, 2008 at 07:33 AM | Permalink | Comments (0) | TrackBacks (0)

A couple of interesting tidbits on the SEC's new short-selling rule:

(From Infectious Greed): "...consider the practical consequences of making it impossible to short financials (and don't even get me started about disallowing all shorting): What happens, for example, if you're running a long/short quant fund with billions of dollars and hundreds of positions? Do you give the money back now that you can't trade on the short side of your fund? Do you push all the short trades through ETFs? Do you abandon the entire financial sector? And who do you sue when your fund blows up because you're not sector neutral? Short-only funds are, of course, now, turned into commercial real estate companies.

Absurd. Bad enough to have idiot financial services busting themselves and markets with 30x leverage built on a tissue of toxic CDOs, but now we have frantic and destructive rulemaking to prevent over-levered nitwits from crumbling. "

Better yet many of the over-levered nitwits who are blaming their problems on short-sellers  run/own hedge funds that are shorting thousands of stocks, which means they're asking the government to keep traders from shorting THEM whilst they go ahead and happily short the stocks of other sectors.

Ridiculous, no?

Speaking of ridiculous, here quick list of some of the stocks that have been banned from being sold short:

(From Infectious Greed): "Some SEC dyslexic likely meant MPB, which is Mid Penn Bancorp, and they blocked shorting of MBP instead, which is Metabolic Pharmaceuticals.

Lehman is on the list, which is hugely reassuring given its current bankruptcy status.

The SEC is blocking shorting of NAHC, which is Nigerian Aviation Holding Company. Damn Nigerians. It's not enough they have all the best scams; they get shorts blocked too.

Silver State Bancorp is on the list. Recall, it's a failed bank already seized by the FDIC."

Like I said, ridiculous.

You can read WSJ coverage of the new short-selling rules here.

Sources:

Infectious Greed: "SEC Wants to do Half Pakistan: No Short Selling" -- Paul Kedrosky, September 18, 2008.

Infectious Greed: "Details on the SEC's New No-Shorting Rule" -- Paul Kedrosky, September 19, 2008. 

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets on September 19, 2008 at 07:22 AM | Permalink | Comments (0) | TrackBacks (0)

Interesting little tidbit from the WSJ on AIG, Lehman and the Mortgage GSEs:

(From the WSJ): "In two weeks, the federal government has taken over Fannie Mae, Freddie Mac and American International Group, financial giants that a year ago had a combined market value of roughly $260 billion. Today, it is about $6 billion."

In other words a decline of roughly 97.7%, and if you go from their peak market caps (per the graphic below) their aggregate market capitalizations have declined by 420.3 billion dollars or by 98.6% from peak levels.

Graphic courtesy of the WSJ

Now add to the above the fact that come this time next week, WAMU will probably have a new owner, and we may be down to one independent investment bank,  none at all  or foreign entities holding large (if not controlling stakes) in same.

This is quickly turning into one of those moments where there was a financial world that existed before 9/8/08 and a completely different one that existed afterwards.

You can read the WSJ article in full here.

Sources:

The WSJ: "The Street's Fate Is in the Hands of Uncle Sam" -- Mark Gongloff, September 18, 2008

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 18, 2008 at 04:30 PM | Permalink | Comments (0) | TrackBacks (0)

Sometimes I think that the markets and politicians are out of touch with reality, how else do you explain the trotting out of the same old tired "short-selling menace" dead horse, as if the collapse in the share prices of the mortgage GSEs, Lehman and AIG was the fault of short-sellers and not because the companies were insolvent?

I repeat the companies were insolvent and their stock is now priced accordingly it's as simple as that, remove short-sellers from the picture and the end result is identical. To claim otherwise/blame short-sellers, is to say that Lehman could've been insolvent for months on end and still had a healthy stock price if those pesky short-sellers weren't in the picture.

Some of the people complaining about short-sellers act as if no one ever sells a stock of a struggling company as part of cutting their losses as opposed to doing it as part of a short-sale; not to mention the fact that there is always a buyer at the other end of any sale whether it's to take profits, cut one's losses or sell short.

Did any of these people consider that the massive selloff in certain financial stocks is really about legitimate worries about the solvency of various companies, general fear about the markets and people trying to cut their losses? Wasn't it a perfectly rational decision to liquidate one's position in AIG or Lehman over the past couple of weeks due to their weak financial position/pending insolvency?

Would any of the people complaining about short-sellers have held on to a position in AIG past Monday?

From my perspective the whole thing reeks of desperation and an unwillingness to accept the fact that the financial world is riddled with insolvent and near insolvent companies, so they seek to find a scapegoat to blame for declining stock prices as opposed to accepting reality. Personally I think the argument loses quite a bit of credibility when it's mostly focused on financial  stocks as opposed to stocks in general, why aren't people railing against short-selling in retails stocks or the stocks of any of a large number of troubled sectors? 

Mind you I'm not saying that no short-seller has ever skirted the rules, spread rumors or otherwise engaged in malfeasance, however it's not as if people on the long-side never break the rules either, AND most importantly we're talking about companies that are INSOLVENT. Like I said before it's not as if all it takes is the removal of short-sellers for an insolvent company to have a healthy stock price, the only people responsible for taking these companies down are there incompetent managers.

The Lehmans of the world aren't the victims, they're the Villains.

I wonder who will be the scapegoat when short-selling is banned and stocks are still sinking into the basement?

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Financials on September 18, 2008 at 02:58 PM | Permalink | Comments (0) | TrackBacks (0)

A major crisis often causes us to look back and ask ourselves the question: "who saw this coming"? In this case the obvious candidate is the Berkshire Hathaway annual report for 2002, where he referred to derivatives as "time bombs", and as "financial weapons of mass destruction". Considering the way in which Warren categorized the risk from derivatives it's pretty much a given that various passages from the Berkshire annual report for 2002 are going to be referenced to death in the coming weeks, in fact I've already seen two articles referencing them this morning.  

As a result my goal in posting this isn't so much from the perspective of adding something new to the conversation, as it is to share a more complete version than I've seen in other places.

What I will do differently is not to tout the following as evidence of Buffet having "seen this coming" ( I'm not disputing that idea), but to note that plenty of people on Wall St. were operating with the same information he was, and were just as aware of the risks and the fact that a calamity was very likely on the horizon. In other words the big difference between Warren and the rest is that he accepted reality, and they either tried to ignore it/pretend it couldn't happen, let greed blind them or thought they could escape/side-step the pending disaster.

It's analogous to someone who never tries smoking due to the health risks, and another person who tries to deny the risks via pointing to the rare individual who smokes for decades and suffers no ill effects; only in this case the executives who engineered the current financial crisis were addicted to greed instead of nicotine. 

I.e. Warren wasn't so much being an Oracle as he was wisely choosing not to smoke.

(From the Berkshire 2002 Annual Report): "Charlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system…

...Errors will usually be honest, reflecting only the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid (in whole or part) on “earnings” calculated by mark-to-market

accounting. But often there is no real market (think about our contract involving twins) and “mark-to-model” is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counterparties to use fanciful assumptions. In the twins scenario, for example, the two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth…

...The valuation problem is far from academic: In recent years, some huge-scale frauds and near-frauds have been facilitated by derivatives trades. In the energy and electric utility sectors, for example, companies used derivatives and trading activities to report great “earnings” – until the roof fell in when they actually

tried to convert the derivatives-related receivables on their balance sheets into cash. “Mark-to-market” then turned out to be truly “mark-to-myth.”

I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.

Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown.

Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counterparties tend to build up over time. (At Gen Re Securities, we still have $6.5 billion of receivables, though we’ve been in a

liquidation mode for nearly a year.) A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. Under certain circumstances, though, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z. History teaches us that a crisis often causes problems to correlate in a manner undreamed of in more tranquil times.

In banking, the recognition of a “linkage” problem was one of the reasons for the formation of the Federal Reserve System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously-strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. In these industries, firms that are fundamentally solid can become troubled simply because of the travails of other firms further down the chain.

When a “chain reaction” threat exists within an industry, it pays to minimize links of any kind. That’s how we conduct our reinsurance business, and it’s one reason we are exiting derivatives.

Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade, and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies.

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems."

You an read the section of the annual report that discusses derivatives in more detail here, it begins on page 13.

Sources:

Berkshire Hathaway Inc: "2002 Annual Report" -- March 8, 2003.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | Global Economy | U.S. Economy on September 18, 2008 at 11:50 AM | Permalink | Comments (0) | TrackBacks (0)

It certainly feels like we have a "Domino Economy" doesn't it?

Which (of course) begs the question: might it be a good idea to place growth restrictions on certain companies, so that they don't become so entrenched into the domestic (if not global) economy that they're in a position to take the economy down with them if they fail? While I'm very wary of the government getting involved in business and/or the concept of placing restrictions on how large a business can grow, I also don't think it's a good idea for a single company to have the fate of the domestic (or global) economy in its hands either.

Understandably the failure of any large multi-national company will always pose some significant economic risks, but there is a difference between "some risk" and risks so large that the only options are economic cataclysm and a bailout.

I.e. let's do what we can to prevent AIG Pt. 2 from happening, via putting safeguards in place that will prevent another company from being in a position to take down the economy if it were to fail.

I'm sure this sounds radical or even ridiculous to some, but let's not forget that many of the events of the past 12-14 months could've been prevented had the right regulations and policies been put in place.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Business Commentary | Financials | Politics & Business on September 17, 2008 at 02:24 PM | Permalink | Comments (0) | TrackBacks (0)

If you recall back in July I posted about a feature on portfolio.com that had a "voters bracket" to determine who killed the economy, the culprits were folks like former Bear Stearns CEO Jimmy Cayne, Countrywide's Angelo Mozilo, Alan Greenspan, as well as organizations and countries like OPEC, Hedge Funds and China.

Well the votes are in and the winner is:

Alan Greenspan

A relatively easy choice, no?

Anyway, you can see the results of the voting here and view an online video of one of the editors of portfolio.com discussing the results here.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Randomization on September 17, 2008 at 01:05 PM | Permalink | Comments (0) | TrackBacks (0)

Here is the usual "mixture" of news stories and other items I think you may find interesting; it goes without saying that in light of recent events this particular volume will be heavily slanted towards the recent historic government takeovers, bailouts, market upheavals, et al.

Starting off: a graphic depicting the Q2 operating performance of AIG's various businesses in '07 and '08:

Graphic courtesy of the WSJ

An interesting article in the FT discusses the future of banking regulations in the wake of the current crisis. While past crises have spurned plenty of new regulations I doubt we'll see anything major coming out of this one, for many of the people in charge of making these sorts of decisions regulations are more of an ideological argument (for or against) then they're a functional one (best way to resolve a problem), which leads me to believe that we won't see much change.

All that being said I hope I'm wrong on this one.

Here is a link to a rather brief statement from Hank Paulson on the AIG rescue, and a link to a statement from the Fed on same. Some quick facts on the rescue:

The lending facility is for $85 billion and has a 24-month term

The interest rate is 3-month LIBOR (2.88% at the time of publishing) + 8.5; I'd be tempted to call it a "Tony Soprano Rate" but when you consider that many people are paying more than on their credit cards…

The Financial Times has a great diagram (PDF file) that lays out AIG's organization structure; the WSJ had a great breakdown of various numbers related to AIG. 

The front page of the FT had good coverage of the recent round of crisis events in addition to a plan by the treasury's supplemental funding program to cover the Fed's new liabilities AKA "China bailing out the Government that's bailing out the nation's incompetent companies".

An opinion piece in the WSJ proposes creating a agency that would buy-up bad mortgages, mortgage paper, etc; personally I think it sounds like the creation of another GSE Financial Golem for the purpose of artificially propping things up, but that's just me.

Here are a couple of interesting blog posts from Barry Ritholtz on the Lehman and Merrill Lynch news, first a review of the MER buyout and next the lessons learned from the Lehman bankruptcy & Bear Stearns buyout .

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Business Commentary | Economics | Financial Markets | Financials | Global Economy | Politics & Business | U.S. Economy on September 17, 2008 at 10:49 AM | Permalink | Comments (0) | TrackBacks (0)

In case you were wondering who was going to foot the bill for the last ten days worth of rescues, bailouts, takeovers, liquidity infusions, et al, the answer is…. CHINA:

(From the U.S. Treasury): " Washington - The Federal Reserve has announced a series of lending and liquidity initiatives during the past several quarters intended to address heightened liquidity pressures in the financial market, including enhancing its liquidity facilities this week.  To manage the balance sheet impact of these efforts, the Federal Reserve has taken a number of actions, including redeeming and selling securities from the System Open Market Account portfolio.

The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve.  The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives.

Announcements of and participation in auctions conducted under the Supplementary Financing Program will be governed by existing Treasury auction rules.  Treasury will provide as much advance notification as possible regarding the timing, size, and maturity of any bills auctioned for Supplementary Financing Program purposes."

I know, I know, it's not an explicit statement of their intent to just borrow money from China, but let's not forget who is pumping money into our economy via buying bonds from our Government: China, Japan, South Korea and other foreign investors.

It's kind of funny that our government is reviewing SWF investments into American companies in need of cash, when they're just going to turn around and sell bonds to those some governments to finance government led bailouts and rescues.

Sources:

U.S. Department Of The Treasury: "Treasury Announces Supplemental Financing Program" -- September 17, 2008.

Posted to: Financials on September 17, 2008 at 09:50 AM | Permalink | Comments (0) | TrackBacks (0)

In this morning's financial times there is a great piece on the AIG rescue, the potential impact if the government had allowed the company to fail, and the failure of regulation:

(From the FT): "AIG was not too big to fail, but too connected. Bankruptcy would have in effect cancelled the debt insurance that AIG provided, and triggered emergency capital raisings from counterparties around the world. The Fed’s rescue is on punishing terms: AIG must repay the $85bn loan at a storecard-like 8.5 percentage points over Libor, liquidating perfectly fine assets to do so. But resolution – of a sort – has been achieved.

Meantime, chalk this up to a failure of regulation. AIG was laid low by mark-to-market losses in its Financial Products division, which wrote insurance on thousands of fixed income securities held by banks. But what AIGFP offered was not straightforward protection, in the sense of covering for potential losses. It was regulatory arbitrage. Banks that entered credit default swaps with AIGFP could assure auditors and regulators that the risk of the underlying asset going bad was protected, and with a triple-A rated counterparty.

Under international rules on capital adequacy, the banks were therefore allowed to keep less cash in reserve. Holding cash, of course, is what no bank wants to do: the fee paid in premiums over the period of the contract was reckoned to be less than the opportunity cost of keeping cash or cash equivalents on the balance sheet. All this is within the rules: in a recent 10-Q filing, AIG made no secret that FP had been built “to provide regulatory capital relief rather than risk mitigation.” But it should not have been beyond the wit of the Basel II committee to see that dangerous levels of counterparty risk would accumulate in institutions willing, as AIGFP was, to write insurance on very attractive terms.

As CreditSights notes, the Fed’s rescue package has been delicately crafted to avoid any of the buzz words – such as “default, receivership, conservatorship” – that would trigger a credit event for CDS. Regulators are still tiptoeing around instruments they barely understand. The AIG implosion should result in much higher risk-weightings for CDS contracts. That will result in further capital pressures for banks, at the worst possible time. Tough."

In other words by the Government takeover of AIG wasn’t about protecting AIG from collapse, it was about protecting the banks that would've needed to raise cash if AIG had failed. This (of course) brings up the following question: isn't it rather spurious that many banks are only adequately capitalized via "regulatory arbitrage". Doesn't that suggest that many are operating under the illusion of pure financial health and might need to raise more cash anyway?

I know, I know, the system has worked for decades and I'm probably being a reactionary bear on some level. However recent events have made it plainly obvious that many companies in the financial world are always operating on the precipice of disaster, and could easily fall into ruin if the right dominoes fall. Some thought needs to be given towards how to restructure things so that they're better able to survive a crisis, as opposed to being structured in a way that appears to assume that things will always be at least near the best case scenario.

Sources:

The Financial Times: "AIG Rescue" -- September 17, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | U.S. Economy on September 17, 2008 at 09:16 AM | Permalink | Comments (0) | TrackBacks (0)

I posted this before but felt it was especially apropos to post it again in light of recent events:

I suppose I could write something about how our government could barely afford to pay its own liabilities before the recent rescues/take overs, how we're going to be paying for the blowback from the housing boom era for years (if not decades) to come, etc, etc, but I think the picture says it all.

Posted to: Randomization on September 16, 2008 at 07:06 PM | Permalink | Comments (0) | TrackBacks (0)

So much for the end of the Moral Hazard, according to preliminary reports the Fed is going to rescue AIG with a $85 Billion loan:

(From the WSJ): " The U.S. government announced an emergency rescue of American International Group Inc. -- one of the world's biggest insurers -- signaling the intensity of its concerns about the danger a collapse could pose to the financial system.

It's a dramatic turnabout for the federal government, which has strongly resisted overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy.

Just last weekend, the government effectively pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to fail instead of giving it financial support.

The precise details of the government's plans were still being formulated late Tuesday. The primary option being hammered out involved the Fed providing AIG with a short-term "bridge" loan of $85 billion, according to people familiar with the situation. In exchange, the government would receive warrants in AIG representing the right to buy its stock, under certain conditions. That could put the government in a position to potentially control a private insurer, a historic move, particularly considering that AIG isn't directly regulated by the federal government.

The moves capped a day of high drama in Washington. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke convened in the early evening an unexpected meeting of top congressional leaders, including Sen. Harry Reid of Nevada, the majority leader, top members of the Senate Banking Committee and leaders, too, from the House.

Sen. Richard Shelby of Alabama said he didn't receive a "satisfactory" answer from Mr. Paulson in an early conversation about the ultimate scope of government intervention. "I laid out -- where do you stop? Where do you draw the line?"

The Federal Reserve appeared to be motivated in part by worries that Wall Street's financial crisis could begin to spill over into seemingly safe investments held by small investors, such as money-market funds that invest in AIG debt.

Indeed, on Tuesday the $62 billion Primary Fund from the Reserve, a New York money-market firm, said it "broke the buck" -- that is, its net asset value fell below the $1-a-share level that funds like this must maintain. Breaking the buck is an extremely rare occurrence. The fund was pinched by investments in bonds issued by now collapsing Lehman Brothers.

Money-market funds are supposed to be among the safest investments available. No fund in the $3.6 trillion money-market industry has lost money since 1994, when Orange County, Calif., went bankrupt. A number of money-market funds own securities issued by AIG. The firm is also a big insurer of some money-market instruments.

AIG's financial crisis intensified Monday night when its credit rating was downgraded, forcing it to post $14.5 billion in collateral. The insurer has far more than that in assets that it could sell, but it could not get the cash quickly enough to satisfy the collateral demands. That explains the interest in obtaining a bridge loan to carry it through. AIG's board approved the rescue Tuesday night."

As. Mr. Selby asked where will the government "draw the line"?

Is the government planning on backstopping the entire economy in order to prevent a recession?

How far is the government  willing to go with respect to the degree of their overall involvement (financial resources, governance and oversight, etc) with troubled companies? How far is the government planning on going with respect to getting into the "risk mitigation" business, in terms of constantly stepping into rescue Corporate America from its own incompetence? How far is the government willing to go in order to protect the economy from risk (or capitalism depending on your interpretation), in order to create a faux economy where nothing bad ever happens?

When it comes to the questions posed above, your guess is as good as mine.

The only "line" we know much about (at this point) is the one that defines who the government will help, and that line seems to be drawn in terms of how entrenched a particular company is into the larger economy. Because the bailouts/rescue/back-stops of Bear, the Mortgage GSEs and now AIG  seemed to have been motivated more by the desire to protect their bond-holders, derivative holders, etc, etc, from facing significant financial risk (if not failing themselves) then it was about saving the companies receiving bailouts.

Of course this scenario is arguably worse than a bailout (in of itself) as you're not only bailing out a bad company, you're also backstopping the risk of those who invested in an insolvent company/allowed themselves to get overexposed to same. Think about it: AIG will have to pay back the loan in order to free itself of partial government ownership, whilst the bond holders will simply get to enjoy the backstopping of their risk without having to pay the government one red cent for the privilege.

Doesn't that smell fishy to you? At the very least anyone who holds AIG bonds, derivatives, et al, should be forced to surrender some of their gains to the government in exchange for the government protecting their investment.

Furthermore if the government is going to engage in these sorts of activities more thought needs to given towards how to funnel some of the financial benefits (assuming any exist) from these interventionists machinations back to the tax payers (special refunds, etc). It's absurd that the taxpayer provides the cash to rescue these malaise ridden companies, protect bond holders, etc, but isn't even in line to receive any of the benefits.

It's also not a bad idea to force bailed out companies to provide some sort of free or discounted service to low income Americans either, just think about it: we have millions of Americans in need of health insurance whose tax dollars were just used to bailout an INSURANCE COMPANY.

Yes I know AIG doesn't provide primary care insurance products only supplemental and accidental injury ones, however the irony of uninsured taxpayers funding the bailout of an insurance company is highly disturbing to say the least. 

Final Thought: American economic policy appears to be evolving to a place where we allow the financial sector to run amuck via minimal restrictions, and the Government is the ultimate parachute that removes risk from the equation. How can our economy survive if this is the way things are going to be on a go-forward basis?

I'm not so much questioning the government's rescue of AIG as I am the policies that got us to this point, policies that I don't see the government making any move to fix. Without a marked change to the way we regulate the financial sector, manage the economy, etc, we're just going to keep winding up back in these situations.

I.e. "minimal regulation/bailout capitalism" isn't exactly a sustainable economic model.

You can read the entire article from the WSJ here.

Sources:

The WSJ: "U.S. Plans Rescue of AIG to Halt Crisis; Central Banks Inject Cash as Credit Dries Up" -- Matthew Karnitsching, Deborah Solomon and Liam Piven, September 16, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | U.S. Economy on September 16, 2008 at 06:37 PM | Permalink | Comments (0) | TrackBacks (0)

The Economist has a cool online feature called: "Daily Chart", here is a look at a recent one that looks at global energy investments:

Image courtesy of economist.com

(From The Economist.com): "SOME are calling it a clean energy rush. The value of new investment in sustainable energy reached $148.4 billion in 2007, an increase of 60% from the year before. Investments have grown at around the same rate or higher since 2004, according to a study from the United Nations and New Energy Finance, a research firm. Those sums include investments by private-equity and venture-capital firms, money raised through stock offerings, corporate and government money for research and development, and investments in small-scale projects or companies building new renewable energy capacity. Wind-energy projects proved most popular with new investment of over $50 billion in 2007, followed by solar and biofuel."

Fairly interesting stuff especially the breakdown with respect to funding sources as that tends to indicate what types of projects are being financed, think: the difference between a non energy company putting solar panels on an office building vs. companies that are trying to develop electric cars.

In some ways I find the adoption of sustainable energy sources by non-energy companies to be the most encouraging, as it will push our society towards the more rapid adoption of existing technology, push down prices and hopefully lead to some new innovations. While the development of new technologies is great, I don't think we can expect any real go-forward progress until we're doing a better job of adopting the technologies we already have.

Sources:

Economist.com: "Sustained Interest" -- August 12, 2008 

Posted to: Energy on September 16, 2008 at 03:33 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting piece from the Financial Times discussing the "alleged" demise of the moral hazard:

(From the FT): "The Decade of Moral Hazard has ended, as it began, with a weekend of intrigue on Wall Street.

Ten years ago, the New York Federal Reserve brought together the leaders of the biggest Wall Street banks to decide how to deal with the stricken hedge fund Long-Term Capital Management. It had come to grief in the wake of the Russian debt default. Credit markets were frozen.

The Wall Streeters agreed to club together to take over LTCM, the Federal Reserve followed up with cheaper interest rates, and life returned. The move was intensely criticised, not least by former Fed chairman Paul Volcker, who questioned why the weight of the government should be put behind a private investor.

The problem – according to Volcker and many others – was that the LTCM rescue increased “moral hazard”, or the risk that investors would enter into contracts in bad faith. Knowing that the government was there to help them, banks and other investors were free to make irresponsible commitments.

In the five years following LTCM, the S&P financials outperformed the rest of the S&P by a third. All of that outperformance has been wiped out in the past few weeks. Financials’ share of corporate profits rose from below 20 per cent to above 33 per cent (it had been below 5 per cent in the early 1980s). The financial industry’s share of the US gross domestic product rose sharply.

In hindsight, this behaviour by banks was obviously irresponsible. The authorities’ actions over the past weekend will doubtless be debated even longer than the LTCM rescue 10 years before, but that is the context for their decision.

Lehman Brothers’ bankruptcy will not end the credit crisis. But it ends a decade of moral hazard.

Nobody will again assume that the government will bail them out if they lend foolishly."

With all due respect to Mr. Authers I'm not sure that the fact that Lehman was allowed to fail constitutes the end of the Moral Hazard, because Lehman's apples aren't the same as the GSEs & Bear Stearns Oranges. Furthermore the impact of the Lehman Bankruptcy won't be on the same scale as the damage that would've been inflicted if Bear Stearns had gone bankrupt, not to mention the fact that the government simply has far fewer resources to utilize to rescue failing institutions than it did in the past.

However I do agree that it will give the banking industry pause and remove the assumption that government assistance will always be there, now whether or not this truly causes significant changes in banking executive behavior remains to be seen.

Personally I think that it will take more than the Lehman bankruptcy to truly foster changes in the way banking executives behave because there will always be that attitude of: "that won't happen to me"; what needs to happen is for the executives in charge of these malaise ridden enterprises to face some truly harsh consequences for their actions. If you want executives to truly change their stripes force them to confront a future where instead of walking way with a fat severance, they get their assets (including retirement) seized save enough to buy a used Hyundai and rent a modest apartment. Force them to front a future where all earnings (and capital gains) in excess of the median household level are garnished at 100%, and they have to retire off of social security.

I'm not saying that the Lehman bankruptcy won't help, I'm saying that if you really want to change executive behavior you have to dismantle the current environment that allows them to behave like gamblers that can't truly lose. The message from the government should be clear: "While we're not going to punish business failures in general, executives in charge of companies that require government intervention (in order to protect the economy) may very well face harsh financial penalties as a result"

The FT has a video from John with more on the topic that you can view here.

Sources:

The Financial Times: "The Short View: Moral hazard" -- John Authers, September 15, 2008

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 16, 2008 at 03:13 PM | Permalink | Comments (0) | TrackBacks (0)

Obviously the world of banking/finance has changed dramatically in the last 12-14  months, so let's quickly look at the major changes:

The Mortgage GSEs are now under Government control, and their shares are now trading for pennies on the pink sheets.

We started the calendar year with five major independent investment banks and are now down to two, Merrill Lynch and Bear Stearns were saved from collapse via buyouts and Lehman was forced to file for Bankruptcy. Only Morgan Stanley and Goldman Sachs remain.

In the mortgage lending space the country's largest mortgage lender was saved from disaster via being bought out by Bank of America for roughly $4 billion, a steep discount to a company that was worth over $20 billion at the beginning of 2007.

IndyMac was shut down by the FDIC in the largest bank closure since 1984, in fact the size of the IndyMac  closing ($32 billion in deposits) exceeds the size of all banks closures in the last 15 years by nearly 50%. In fact the IndyMac closing (according to the FDIC) has the potential to be the most expensive bank failure in history.

In the last nine months there have been over 3X as many bank failures as there had been in the previous two years; and the FDIC faces a potential shortfall as a result.

It's almost a guarantee that AIG Insurance is going collapse if the company isn't able to raise additional capital, and both WAMU and Wachovia are facing significant struggles of their own.

The FDIC faces a potential funding short-fall due to the recent

What makes all of the above especially significant is that all of the above events have occurred within the last nine months , with the GSE takeover, Lehman Bankruptcy and Merrill Lynch buyout all happening within the last 10 days.

So much for the cry of "subprime containment" that certain individuals were preaching (still) at around this time last year.

Does all of this mean that we're on the precipice of a financial cataclysm? Not in my view (and it's no secret that I tend to lean towards the bearish side of things) because we still have areas of strength left within the nation's financial system, however all of the above are symptoms (if not extreme symptoms) of what is turning into the largest banking shake-up since the great depression. While the current times may not be exactly pleasant they're undoubtedly historic on a magnitude that's rarely witnessed, as the events of the past year simply don't fall into the realm of your typical failures, mergers and buyouts.  

Things already look markedly different and the banking crisis has yet to fully run its course, 3, 5, 10 years from now the banking environment will undoubtedly be un-recognizable in comparison to how it looked at the beginning of last year.

Sources:

The WSJ: "FDIC Weighs Tapping Treasury as Funds Run Low" -- Damian Paletta and Jessica Holzer, August 27, 2008.

CNNMoney.com: "Regulators size troubled IndyMac" -- Catherine Clifford, Chris Isidore, July 11, 2008.

The WSJ: "Old School Banks Emerge Atop New World of Finance" -- Carrick Mollenkamp, Mark Whitehouse.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials | U.S. Economy on September 16, 2008 at 02:23 PM | Permalink | Comments (0) | TrackBacks (0)

An interesting aside to the Lehman Brother's bankruptcy, the Asset Management subsidiary of the company wasn't included in the filing:

(From the WSJ): "Lehman Brothers' decision to exclude Neuberger Berman, its asset management business, from this morning's historic bankruptcy filing didn't come as a surprise Wall Street analysts.

The 69-year-old wealth management company, which became part of Lehman Brothers in 2003, remains a strong business within the asset management industry - a financial services sector that's insulated somewhat from Wall Street's present chaos, according to analysts. Asset management firms, in general, aren't exposed to the direct credit risks that are the basis for recurring market turmoil, says Michael S. Kim, an analyst with Sandler O'Neill & Partners in New York.

Strong, free cash-flow - or earnings adjusted for non-cash expenses and capital expenditures - strong margins and recurring revenue stream from management fees paid as a percentage of assets, all partly insulate asset management companies from Wall Street's credit crisis. "The factors all provide a level of stability with earnings and growth potential going forward," says Kim.

"Neuberger Berman would look to be a franchise that would survive independently," says William R. Katz, an analyst with Buckingham Research in New York. "The money managers have good reputations - they have the relationships with the clients," he says. The fees that clients are paying for money management services will remain in tact, regardless of the business form in which the company ultimately emerges, says Katz."

I wonder if the reason many Asset Management companies haven't suffered from the credit crisis has more to do with their risk management practices/investment choices, then it is an intrinsic part of the way they operate? After all suffering from the credit crisis isn't so much a function of simply being exposed to the credit markets, as it is a function of investment choices and risk management. To say otherwise presents the credit crunch as if it's some sort of disease that banks just "catch", as opposed to it being a calamity of their own making.

To my mind the fact that many asset management firms have escaped the credit crunch relatively unscathed says a lot about the way they approach risk management, even if the intrinsic nature of their business does offer a degree of protection.

You can read more on the subject here.

Sources:

The WSJ: "Neuberger Berman Investors Have Nothing to Fear" -- Suzanne Barlyn, September 15, 2008

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financials on September 15, 2008 at 11:13 AM | Permalink | Comments (0) | TrackBacks (0)

It's rather disgusting/disturbing that the government is taking money from individuals who are struggling with their own debt problems, and using that money to back-stop the debts of two companies that were into the ground by CEOs who were given severance packages that exceed the annual income and/or net worth of 99% of the population.

As the nine people who read this blog are aware I'm rarely fond of populist arguments related to business and economics (because I often find them to be more knee-jerk than logical), however in this case certain recent events are too egregious to  chalk-up to mere knee-jerk populist sentiments.

Posted to: Corporate Absurdity | Politics & Business on September 12, 2008 at 01:33 PM | Permalink | Comments (0) | TrackBacks (0)

August's retail sales report came out today and for some bizarre reason many in the media are reporting the data as a decline of -0.3%, despite the fact that the -0.3% is the month to month decline from July '08, and retail sales were actually up 1.6% on a YoY basis.

(From the U.S. Census Bureau): "The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for August, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $381.2 billion, a decrease of 0.3 percent (±0.5%)* from the previous month, but 1.6 percent (±0.7%) above August 2007. Total sales for the June through August 2008 period were up 2.3 percent (±0.5%) from the same period a year ago. The June to July 2008 percent change was revised from -0.1 percent (±0.5%)* to -0.5 percent (±0.3%).

Retail trade sales were down 0.3 percent (±0.5%)* from July 2008, but were 1.3 percent (±0.7%) above last year. Gasoline station sales were up 22.5 percent (±1.8%) from August 2007 and sales of food and beverage stores were up 6.9 percent (±0.8%) from last year."

After months of reporting the numbers on a YoY basis they're now reporting it on a month to month basis, despite the fact that the YoY number is more positive than the month to month one?

Weird.

All that being said the YoY increase was largely driven by increases in food and gas prices; here is a look at % YoY change in retail sales over specific categories, I broke out a number for retail excluding gas, groceries, cars, etc, in order to get a handle on spending on discretionary purchases.

Retail (excluding Groceries, Motor vehicles & Parts, Health & Personal Care, and Gas Stations): 7.79%

Car Dealers: -14.9%

Furniture & Home Furnishings Stores: -6.77%

Electronics & Appliance Stores: 1.19% 

Building Materials & Garden Supply Stores:   -2.67%

Grocery Stores: 6.89%

Gas Stations: 22.54% *Recent price declines aren't as important as the YoY change in terms of the cost impact to a household's budget.

Clothing: 1.20%

Health & Personal Care Stores: 3.22%

Judging by the sampling above it appears that consumers are only spending more (on a nominal basis at least) in areas where they're forced to due to higher gas prices, food prices, etc, and are undoubtedly receiving fewer goods per dollar than they used to. Let's also not forget that spending on gasoline has been increasing all year despite the fact that gasoline "consumption" is decreasing. It's also worth noting that the YoY decline in discretionary spending (as I've defined it at least) is probably greater than the numbers suggest, as inflation from higher energy prices impacts nearly all businesses in one way or another.

While a recent WSJ blog post suggested that we may be at the "End Golden Age of Consumer Spending ", I think we have to withhold judgment on that one until such time where the economy has recovered and consumer spending is still declining/stagnant.  At this point I think a likely scenario is that some consumers will indeed pull back on spending, with the rest returning to their old habits once the economy recovers. Either way it's all speculation at this point and it remains to be seen how it will all shake out.

You can read the Census Bureau report in its entirety here.

Sources:

U.S. Census Bureau: "Advance Monthly Sales For Retail Trade And Food Services; August 2008" -- September 12, 2008.

Posted to: Retail | U.S. Economy on September 12, 2008 at 01:24 PM | Permalink | Comments (0) | TrackBacks (0)

Normally I find most arguments against a particular CEO's compensation to be knee-jerk  and populist as it seems to be more about a visceral reaction to the amount then the value delivered to shareholders, after all it's rare that someone expresses the compensation as a % of value delivered. This is not to say that some pay packages aren't ridiculous just noting where I think certain arguments come from; regardless it's up to the shareholders to police it not the government.

However in this case………...

By mismanaging their respective companies to the point of needing a taxpayer funded bailout Daniel Mudd and Richard Syron have effectively stolen from the American people, why these clowns weren't given anything more than a 20 day old moldy sandwich and a kick in the a** is beyond me. Instead of allowing their severance packages to be paid the government should be doing something to hold them accountable, not handing them (what is effectively tax payer money) as a reward for getting the sack.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice. The author doesn't advocate that incompetent CEOs be kicked in the a**, nor does he support the feeding of moldy food to individuals he deems unsavory and/or incompetent.

Posted to: Corporate Absurdity | Financials | Politics & Business on September 11, 2008 at 03:18 PM | Permalink | Comments (0) | TrackBacks (0)

Interesting graphic depicting the original sales prices, opening bids and final sale prices for a recent condo auction in California (typical discount of 40% from the original asking price):

Graphic courtesy of the WSJ

The graphic comes from an article discussing how the condo glut is pushing developers to conduct fire sale auctions. In order to get an idea of how large the condo problem is in some cities refer to the passage below:

(From the WSJ): "in the Miami area, where overbuilding has left the city, by some estimates with a 35-year supply of condos. Peter Zalewski of Condo Vultures Realty LLC compiled data showing that only 53% of the 20,000 Miami condos built since 2003 have been sold."

In other words many developers built units to meet the inflated demand from speculators, over-spenders, a market flooded with cash from bad lending standards, etc, to such an extent that it may very well take a multi-decade time period for  condo inventories in certain cities to normalize. Especially when you consider that there are still a significant number of condo projects that are coming online in the near future.

It's a situation that's good for buyers, bad for developers and bad for prices; it also suggests that some of the symptoms/pain from the current housing crisis may be with us for well into the next decade if not the one after that.

Sources:

The Wall St. Journal : "Condo-Minimum" -- Jonathan Karp,  September 10, 2008.

Posted to: Real Estate on September 10, 2008 at 02:45 PM | Permalink | Comments (0) | TrackBacks (0)

If you want to see how clueless the NAR's Chief Economist is (as are many in the Real Estate Industry), look no further than the recent home sales report:

(From the NY Times): "The National Association of Realtors said its seasonally adjusted index of pending sales for existing homes fell 3.2 percent to a reading of 86.5 from an upwardly revised June reading of 89.4. The index was 6.8 percent below year-ago levels.

Home sales are considered pending when the seller has accepted an offer, but the deal has not closed. Typically there is a one- to two-month lag before a sale is completed.

Wall Street economists surveyed by Thomson/IFR had predicted the index would fall to 88.6. The index, which sunk to a record low of 83 in March, stood at 92.2 in July 2007.

Lawrence Yun, the trade group’s chief economist, forecasts that home sales are on a pace to fall 11 percent from last year to just over 5 million in 2008. Mr. Yun said stringent lending criteria by Fannie Mae and Freddie Mac — the mortgage finance companies taken over by the government this weekend — held back sales activity.

Many in the real estate industry are hopeful that these standards will be relaxed with Fannie and Freddie under government control, but the outlook remains uncertain."

Hello McFly , lax lending standards are large part of the reason we have a credit crunch, housing crisis, et al, not to mention the fact that the mortgage GSEs did (in fact) increase their investment activities over the past 12 months and nearly went under despite their allegedly "stringent" lending criteria.

Blaming the GSE's lending criteria for a slowdown in home sale is idiotic when the real truth is that housing is going through a necessary correction after a period of hyper-inflation driven by bad lending standards, and people spending above their means, a reality that few (apparently) wish to accept. Not to mention the fact that asking for the GSE's lending criteria to be relaxed is asinine, when it's plainly obvious to anyone who has a solid grasp of 4th math that what the GSEs need to do is reduce their scope, drastically curtail their investment activities and focus on getting their finances in order.

Anyone pushing for the GSEs to relax their standards increase their investment activities/scope, etc, is practically begging for disaster

Unfortunately I hold the minority opinion on this one, because the government is pushing to expand the size of the mortgage GSEs investment portfolios (a move that is supported by many)  and will (in all likelihood) create a bigger economic calamity down the line.

As for the NAR's report itself the results aren't especially surprising, and they're a clear example of why it's better to focus on multi-month trends as opposed to declaring a housing bottom based on the data from one month.

You can read the entire article here.

Sources :

The Associated Press (Via the NY Times): "Pending Home Sales Declined in July" -- September 9, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Real Estate on September 10, 2008 at 12:19 PM | Permalink | Comments (0) | TrackBacks (0)

The usual sampling of various stories on business, economics and other topics I think you may find interesting; this edition is a mixture of old and new links as I've had some of these laying around for a week or three.

The FT's John Gapper writes about how the GSE bailout is tremendously beneficial for foreign investors but may pose severe risks for the regional banks.

A link to the WSJ's coverage of the GSE bailout can be found here.

T Boone Pickens has a web site touting his energy plan, which you can find here.

In lighter news, here is a link to an interview with the engineer who designed the McLaren F1. 

The BOJ Chief states that the global slowdown is a good thing in terms of it being a necessary economic adjustment; not saying I agree with all of his comments but it was refreshing to hear a central bank governor acknowledge the fact that downturns are often necessary parts of the economic cycle. As opposed to the usual commentary that gives one the impression that some of these individuals are trying to manage the economy like a children's soccer game where no one loses.

Here is an interesting column from the FT discussing how one should be wary of "Bear Rallies"; perhaps what's most interesting about the article is that it was written in January. After all I'm sure you remember January, AKA the time when many were proclaiming the market bottom was here like it was going out of style.

Here are some interesting reads related to the banking crisis, bank failures, et al:

One that attempts to put recent bank failures in their proper context in terms of the aggregate size of the failed banks vs. the size of the overall banking system, and in comparison to the S & L crisis.

The second article is bit more bearish and discuss pending failures of commercial and retail banks, the explosion in the number of banking start-ups, etc.

Here is a link to an interactive graphic summarizing economic activity across the country, it's part of a larger discussion around the Fed's "Beige Book".

Here is an article discussing the declining % of equities held by institutional investors, and the role institutional investors are playing in corporate governance. I have to wonder if individual investors truly own a smaller % of equities, or if what's really happening is that more individuals own stocks via 401ks, mutual funds, etc, than they did in the past.

Here is a link to the web site for the I.O.U.S.A. movie; and a link to NPR coverage on the movie as well.

A Financial Times story discusses the relationship between retail failures and REITs that own malls, shopping centers, etc; the whole thing is fairly simple really: retail stores are the customers of the mall/shopping center REITs and as stores close they find it hard to locate new tenants.

As for the fate of Boscov's (the retailer that's the primary focus of the article), their situation sounds more like a weak retailer for whom the economic downturn was the final nail in the coffin rather than a retailer that was truly "taken down" by economy. The retailers I've read about (over the last six months or so) that are either going of business, declaring bankruptcy, on the brink, etc, were always retailers that were having problems when the economy was strong. As a result I think it's a little intellectually dishonest to try and make the claim that they're truly victims of a bad economy.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Auto Industry | Financial Markets | Retail | U.S. Economy on September 9, 2008 at 09:05 AM | Permalink | Comments (0) | TrackBacks (0)

Here is an old link from the London Telegraph that is rather apropos considering recent events: "If we take away risk, then capitalism is finished" . The article was written in response to the British Government's offer of backing/liquidity to troubled British banks, an action that came in the aftermath of the British Government guaranteeing the deposits and debts of Northern Rock Bank.

The key thing about this article is that it was written last September, a few months before Northern Rock was nationalized, the Fed's backing of the Bear Stearns the take over, the Fed providing a securities lending facility to the Investment Banks, providing similar liquidity/lending facilities (as the British Government) to our banking system, the Mortgage GSE take over, etc.

The article was great when I first read a few days after it was published and it now reads like an eerie harbinger of the future, especially when you consider the additional intervention that might be required of the U.S. government for the auto industry and financial sector. 

A quick excerpt follows below:

(From the London Telegraph): "Just as war is too important to be left to generals, the economy is too important to be left to politicians.

This was blindingly clear from the antics on Monday, when a bank in no danger of failing was underwritten by the Government.

It was underwritten because a thin-skinned Prime Minister who, as Chancellor, had not presided over the economy with the brilliance he claimed, was shamed by the spectacle of a run on a bank being beamed around the world and making an international laughing stock of our financial system…

...Taxpayers have now become bankers. At a stroke, the fundamentals of the capitalist creed on which many of us thought our economy was based are compromised. There is no price on risk, except that paid by the state with our money.

Many in the financial world have what we might call a conservative interpretation of the idea of lender of last resort, and so do I.

I think it was shared by the Governor of the Bank of England, Mervyn King. It was that the Bank will lend at an appropriately stiff interest rate to any solvent financial institution that has a temporary liquidity problem, so it can right itself.

This is roughly what Mr King said, and did, last week, when Northern Rock was given a cash lifeline. The Governor could, or should, have done no more.

He is not a political figure, and it would have been most improper for him to act as one. It would also have been most improper of him to extend the role of lender of last resort to an extreme that imperilled the very notion of capitalism. That is the sort of thing idiot politicians do and, by God, have they gone and done it."

Sources:

The Telegraph: If we take away risk, then capitalism is finished" -- Simon Heffer, September 19, 2007.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Global Economy | Real Estate | U.S. Economy on September 9, 2008 at 08:58 AM | Permalink | Comments (0) | TrackBacks (0)

Great blog post from the FT's John Gapper on a possible future of the mortgage GSEs:

(From FT): "Fannie was originally established in 1938 to buy and hold mortgages insured by the federal government through the Federal Housing Administration. The idea was to provide government backing so that low income families could afford to buy homes.

That was clear enough: Fannie was a public entity with an explicitly social purpose. The problem came in 1968 when it was re-chartered into a government-sponsored private corporation that could buy all kinds of mortgages and securitise them to provide general liquidity in the housing market.

James Surowiecki has recorded the curious fact that the fateful change in 1968 was due to Lyndon Johnson wanting to get housing debt off the government books. In other words, Fannie and later Freddie became off-balance sheet vehicles for the government.

But we know what happened. Fannie and Freddie skillfully worked the ambiguity about whether they were really government-backed entities or private ones. They steadily expanded their balance sheets and profits on a slim capital base because investors assumed the government stood behind them.

Their half-public, half-private status has to be ended if a repeat of the debacle is to be avoided.

For my money, it would be damaging to have Fannie or Freddie survive as private entities in the long-term because, since the government has come to their rescue once, everyone will believe it would happen again.

I think the best idea would be to reverse the misguided 1968 charter entirely. If either is to survive in the long term, it should be as a public agency with explicit and limited social aims.

The evidence is that the private mortgage market as a whole can survive quite well without a federal agency in the middle: most other countries do quite well without one. If it cannot, then taxpayers’ money should not be used to prop it up."

I couldn't agree more the mortgage GSEs were a disaster that was forty-years in the making, now that they've been bailed out the potential for a future calamity is significantly increased as government backing is now explicit as opposed to the implicit guarantee that existed before. Furthermore if they're to exist on a go-forward basis they should be public agencies with a rather limited scope. Their mission should be to enable home ownership for those on the lower end of the economic scale, as opposed to the present when their scope includes homes that less than 5% of the population can afford. The goal shouldn't be to subsidize the entire housing market, but to enable home ownership for those that need it the most.

Sources:

The Financial Times: "The diminished future of Fannie and Freddie" -- John Gapper, September 8, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Posted to: Financial Markets | Politics & Business | U.S. Economy on September 8, 2008 at 02:07 PM | Permalink | Comments (0) | TrackBacks (0)

The first thing I thought of when I heard of the Government takeover of the Mortgage GSEs was: "is American style capitalism dead?". Can we claim to have a free market, lightly regulated economic system when our government steps in (with taxpayer funds no less)  to back-stop the risk created by irresponsible corporate managers? Does capitalism even exist in an environment where companies above a certain size are deemed too big too fail, and can always count on some sort of government intervention?

While removing risk from the equation may be appealing to some, risk is what guides capitalist activities, allocates capital effectively, separates the wheat from the chaff, etc, remove risk from the equation and capitalism dies. American Capitalism may have died this day as the government has sent the message that companies over a certain size will be prevented from failing, and set the economic policy goals of removing risk from capitalism, to impede natural economic cycles and to do whatever it takes to prop up the economy/avoid economic downturns.

The actions of the government in this situation could be the beginning of a form of "pseudo-socialist-capitalism " where we abandon the concept of free markets, and instead try to use the government to prop up the economy in a fashion that is reminiscent of children's soccer games where neither team loses.

Another issue is the sheer lack of Accountability on the part of the executives and politicians whose job it was to steer the mortgage GSEs in the right direction. Despite nearly unleashing an economic weapon of mass destruction on the global economy (let alone the domestic one), they will not face any significant penalties aside from a few top executives losing their jobs whilst probably keeping all of the bonuses received, salary, separation packages, retirement benefits, etc.

Mind you there are plenty of losers in situations like this, people have lost their jobs, shareholders may not have been 100% wiped out but the journey to this point wasn't pretty, etc, etc, but the people at the helm of this disaster will not face any significant penalties and will keep the benefits generated by the very actions that caused this situation.

If a situation where corporate managers can act like gamblers that can only win but never lose isn't the definition of a moral hazard, than I don't know what is.

Another issue is that if the government is to assume the role of "protecting the economy" from the risks imposed by various companies failing, then it should take the necessary steps to offset that risk by better monitoring & regulating business activities that could lead to a bailout in the first place.

"You can't have your de-regulation and eat your near penalty free bailout cake too".

It's patently fatuous to have an economic policy that says that certain companies can't be allowed to fail, while simultaneously allowing irresponsible managers to run amuck and create the need for the bailouts in the first place.

Moving forward Detroit is asking for billions in Government sponsored loans, and there is a strong likelihood that there could be retail and/or investment banks that require bailouts as well. Where will it al