Analytical Wealth

Even  in an environment where even a Financial Calvinist like myself think some industries should be bailed out, you have to admit that this is not only funny, but sadly accurate.

Posted to: Randomization on October 30, 2008 at 10:28 AM | Permalink | Comments (0) | TrackBacks (0)

The graphic below contains all you need to know about the Fed's rate cuts over the past year:

Graphic Courtesy of the WSJ

Notice how the Fed's rate cuts have had little effect on mortgage rates and corporate bonds rates? Thus lending credence to my theory from last year (after the first rate cut) that the rate cuts would have little impact on the credit crunch since it was a function of loan losses, bad risk management, investors losing money, derivatives abuse, etc, as opposed to being a function of high interest rates.

Taking it a bit further: you can cut interest rates to zero and it won't change the reality of overleveraged and undercapitalized banks that are facing escalating loan losses, or a nation full of borrowers that are either overleveraged (in general) and/or struggling with mortgages they can't afford.

Not to mention the fact that it's illogical to think that you can solve a problem that was partially caused by low interest rates with low interest rates.

Now I suppose you could interpret this to mean that things would be markedly worse without the Fed's rate cuts. You could also say that the Fed simply misinterpreted the impact of their rate cuts on the credit crunch; after all weren't the rate cuts supposed to make mortgage rates fall, give relief to ARM borrowers, etc?

Either way the Federal Reserve and Wall St. have both become over dependent on rate cuts as a way to generate growth, and now with interest rates at 1.0% maybe both parties will begin to focus on the economy's actual problems instead of hoping rate cuts will magically fix things. 

Of course we have a nation of analysts, pundits, politicians and policy makers who can't seem to tell the difference between a root cause problem and a symptom, so perhaps I'm being too optimistic.

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: U.S. Economy on October 30, 2008 at 09:58 AM | Permalink | Comments (0) | TrackBacks (0)

Due to slow to moderate adoption (depending on how you look at it) many retailers are planning to slash the price of their Blu-Ray Players both now and during the coming Holiday season.

(From the WSJ): "Electronics manufacturers and retail chains are slashing prices of Blu-ray players in a bid to boost adoption of the high-definition movie format, which has yet to catch on with American consumers.

Entry-level Blu-ray players have dropped to below $230 at major retailers including Target Corp., Wal-Mart Stores Inc. and Best Buy Co. Some experts predict that promotional prices may fall below $150 on Black Friday, the big shopping day after Thanksgiving. Earlier this year, most Blu-ray players retailed for $400 or so.

Sales picked up at Best Buy after prices were cut, said Mike Mohan, Best Buy's senior vice president of consumer electronics. Still, he said, some consumers may not understand the benefits of the technology, which can offer crisper images than standard DVDs when viewed on high-definition TVs.

"We have a job to do in explaining to customers why Blu-ray is important," Mr. Mohan said.

Another impediment to Blu-ray adoption: The price of Blu-ray discs, at about $30, is still often twice that of DVDs.

Industry analysts believe stores may have been overly optimistic in ordering Blu-ray players for the holiday season. That's another factor behind the price cuts, especially since some older models in retailer inventories can't connect to the Internet, which is necessary to tap interactive features on some Blu-ray discs."

Personally I think that Blu-Ray has a couple of things working against it when it comes to mass adoption by consumers:

Appeal : something like Blu-Ray is going to appeal more to the enthusiast crowd then it will to be the average person. I have both a Blu-Ray and a HD DVD player and while my girlfriend can readily see the improvement in picture quality, she has no motivation to run out and purchase her own Blu-Ray player to go along with her own HDTV. In fact she tends to roll her eyes when I complain about a favorite movie not being on Blu-Ray (LOTR *AHEM*), and/or want to wait for a movie to arrive from Net Flix instead of just renting it so I can get it on Blu-Ray or HD DVD.

My girlfriend's propensity to make fun of me aside, it's not that many consumers don't see the value in a HD movie format, it's that many of them simply don't care. I think that A/V technologies get to a certain quality point where it reaches a level of diminishing returns (in the eyes of the consumer at least), and certain high-end technologies will always appeal more to the enthusiast.

Media Catalogue : if you go to Best Buy's web site they have approximately 1,113 total Blu-Ray movies available and 76,995 standard DVD movies available, making it quite possible that many people would be buying a Blu-Ray player to play only a handful of movies. While they can just as easily play all of their standard DVDs on a Blu-Ray payer, the purchase probably doesn't make sense for many people when you can buy a solid upconverting DVD player for less than $75.00 that many consumers will be more than happy with.

Cost: based on the above cost is a major issue as well, it doesn't much sense to buy a Blu-Ray player (for the non enthusiast) if you're rarely going to use it, especially when the image quality between using a Blu-Ray player as an upconverter vs. a upconverting standard DVD player is often negligible.

HDTV Adoption : at the end of the day not everyone has a HDTV (how else do you explain the popularity of digital conversion boxes? ), and of the people with flat screen digital TVs many of them have lower end units that probably don't display images at 1080p, thus making it less likely that they can even use a Blu-Ray player and/or truly benefit if they did.

Now see my first point.

Now does any of this mean that I'm down on Blu-Ray? Of course not, I'm planning to buy a new one (maybe two actually) this Holiday season, am excited both about the possibilities in the audiophile recordings arena and the fact that high-end manufacturers have started producing Blu-Ray players. However I think retailers and manufacturers need to be realistic, and understand that widespread adoption won't occur until the media catalogue catches up, the price difference becomes somewhat negligible and the adoption of true HDTVs becomes more widespread.

Still none of the above changes the fact that many consumers still won't care and will be more than satisfied with the picture quality of standard DVDs that are upconverted to 1080p.

Sources:

The WSJ: "Retailers lash Blu-Ray Player Prices" -- Miguel Bustillo, October 28, 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: Techie-Science Stuff on October 29, 2008 at 12:44 PM | Permalink | Comments (0) | TrackBacks (0)

…and this is what happens when the people we task with saving us, are individuals who either got us into this mess and/or don't understand what's going on in the first place.

Posted to: Randomization on October 29, 2008 at 12:07 PM | Permalink | Comments (0) | TrackBacks (0)

In the prior post we discussed the problems with the automakers, now let's discuss the problems faced by Car Dealers:

(From the WSJ): "With credit drying up and new-vehicle sales slumping to a 25-year low, car dealerships from New Jersey to California are going out of business at an accelerating pace, threatening greater economic pain for communities around the country.

Graphic courtesy of the WSJ

The National Automobile Dealers Association estimates 700 new-car dealerships will close this year, up from 430 last year, and taking with them an estimated 37,100 jobs. That is a heavy blow to a key piece of the U.S. economy. The country's 20,700 dealerships accounted for $693 billion in sales last year, or 18% of all retail sales, according to NADA. Dealership wages and salaries make up 13% of the nation's retail payroll.

The rapid disappearance of dealers could also complicate the challenges facing General Motors Corp., Chrysler LLC and Ford Motor Co. After years of market-share losses, each has been left with more dealers than they need, and have been pushing dealers to consolidate. But a sudden loss of some of the bigger players could make it harder for the Big Three to maintain sales. GM, for example, suffered a setback recently when Bill Heard Enterprises Inc., one of the largest sellers of Chevrolet-brand vehicles in the country, filed for bankruptcy-court protection and closed its chain of 14 stores.

"The most serious concern for dealerships at the moment is liquidity," said Paul Melville, a partner at consulting firm Grant Thornton LLP. "That's worse for the Detroit Three because of the high amount of lease sales." Auto dealers tied to Detroit have struggled amid falling sales and leases of Big Three vehicles. Tightened credit in the past few months has made it difficult for many to stay in business."

Let's see: the automakers themselves haven't been able to make money from producing cars for a couple of years running, it's no longer profitable to lease the cars (and that's where a large % of Detroit's sales came from) and now the Dealer's are having trouble making money from selling the cars.

You can read more here.

As if the sudden surge in dealership closings wasn't enough, many of the big car dealership holding firms have written down the value of their Domestic franchises to zero.

(From the WSJ): "DETROIT -- Two big auto dealership chains delivered more bad news for domestic car makers: Many Detroit auto franchises have become practically worthless.

In third-quarter earnings reports Tuesday, Group 1 Automotive Inc. and Sonic Automotive Inc. announced charges of a combined $51 million reflecting declining "franchise value" for stores that sell brands from General Motors Corp., Ford Motor Co., and Chrysler LLC. Franchise value is a measure of the potential profit a company can make from holding the right to sell new vehicles and to provide warranty repairs for a certain make of automobiles.

Group 1, the fourth-largest dealership chain in the U.S., took a write-down of $30 million related to its Detroit-brand dealerships. Sonic, the third-largest chain, reported a write-down of $21 million.

In a telephone interview, Group 1 Chief Executive Earl Hesterburg said Group 1's charge means the company has essentially written off the value of its GM, Ford and Chrysler stores. "We have a Ford store in Lubbock, Texas, that is very profitable, but that tends to be the exception," he said.

The charges pushed both dealership chains into the red. Group 1 reported a net loss of $20.6 million, compared with a profit of $20.8 million a year ago, while Sonic lost $25.3 million in the third quarter, compared to a profit of $26.1 million a year ago.

More similar write-downs could be coming from other dealership chains in the next week or so. AutoNation Inc., the largest U.S. chain of auto dealerships, reports its third quarter earnings early next month. The company declined to comment ahead of its announcement"

You can read more here.

So on top of the 37,100 jobs that have already lost to dealer closings, it appears inevitable that we're going to lose thousands more as the companies that own the franchises that have "zero value" aren't going to keep them open forever. Furthermore 2009 is nearly upon us and it's quite likely that this is a trend that has escalated over the course of 2008, suggesting that 2009 will be even worse (or at least equal) in the realm of dealer closings and/or franchise write downs

At the moment Detroit is facing a 1-2 punch of an economic climate that's making it hard for their dealerships to be successful on top of simply having too many of them in the first place, as a result it's likely that there will be too many dealership closings (in relation to demand) and they'll face an issue where they won't have enough dealerships to sell new cars and/or provide service to existing customers.

Needless to say this will only make it harder for the Domestic Auto Manufacturers to recover, especially since entrepreneurs aren't exactly going to be too keen on becoming dealers for a Detroit Brand. Especially when the foreign manufacturers simply aren't suffering to the same degree as Detroit (declining sale sure, but they can lease cars profitably, aren't facing a rash of dealer closings, etc), which will only make foreign nameplates more attractive to the companies already in this business and those looking to enter it.

Sources:

The WSJ: "Big Car Retailers Write Off Domestic Brands" -- Kate Linebaugh, Neal E. Boudette, October 29, 2008.

The WSJ: "More Car Dealers Shut Down" -- Kate Linebaugh, October 28, 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 October 29, 2008 at 11:58 AM | Permalink | Comments (0) | TrackBacks (0)

A recent FT article discussing a study by the NY Federal Reserve that estimated that each job within NYC's financial industry was responsible for generating 2.5 additional jobs within the city, got me thinking about the number of jobs that are dependant on the American auto industry. I started to do some research on the subject and wasn’t to find anything tremendously concrete, I found numbers as low as two for specific communities and recall a range of 7-9 being thrown out during a NPR story a few year's back but wasn’t able to find it to confirm.

Still while a specific Wall St. job may carry a higher salary, it's quite possible that auto industry jobs may have a larger economic impact due to the large number of actors involved in producing, selling and maintaining a car, the fact auto industry layoffs occur in large bunches, and are indicative of economic problems (e.g. eroding demand) impacting the industry as a whole.

You don't need to be an economist to realize that a single automotive plan probably has more support staff and ancillary industries dependent on it, than your typical banking office, not to mention the fact that Wall St. layoffs aren't usually the result of the closing down an entire operation the way auto industry plant closings are.

Just think about it:

Eroding demand hurts sales at various dealerships around the country who are then forced to cut back on sales staff, repair staff, etc, less demand means less need for a particular plant, and closing that plant hurts parts manufacturers, the shipping companies that deliver parts, food services, grounds keeping, etc, etc.

You could very well have a situation where a specific community loses two jobs per job lost at the local plant, multiple jobs are lost elsewhere and the whole thing is reflective of job losses (say from dealership closings, demand erosion) that occurred prior to the plant needing to be closed in the first place.

It's also worth noting that the loss of a single job at a company like GM very likely has an adverse effect on people who may not lose their jobs, but may suffer a negative economic consequence just the same. 

So maybe nine (albeit an unconfirmed anecdotal data point) isn't so ridiculous after all.

Detroit has on aggregate (based on the most recent data* I could find) about 581k employees, which means that the potential for job loss (if Detroit crumbles) within the larger economy is anywhere from 1.1 million to as many as 4.5 million, in addition to the jobs lost  at the actual automaker. As a result the baseline "job risk" is about 1.7 to 5+ million, and that doesn't take into account the people who would keep their jobs but suffer negative consequences, the jobs dependent on the additional jobs lost, etc, etc.

The job loss issue isn't one to be taken lightly, because at the end of the day these are some of the only people who are actually making money within the American auto industry.

I don't know about you but considering the magnitude of the risk (job loss), on top of the jobs, businesses, etc, that have already been lost (or stand to be lost in the future), I think the Government has to be looking at Detroit as a crisis on part with A.I.G., the Mortgage GSEs, etc. So while I hate to even write these words out, I think that at this point the Government has no choice but to step in and Nationalize Detroit.

When GM's only solution to their problems is desperate ploy to try and merge with Chrysler just to have access to their cash and credit lines, even though it will only exacerbate their medium to long-term problems of too many brands, too much debt, a bloated infrastructure, etc, etc, then you know the end is nigh for Detroit, especially when GM has to beg the Government for money to even pull the deal off in the first place.

The only solution is some combination of bankruptcy and nationalization that allows Detroit to get out from under its debts, continue to operate (and not cause massive damage to the American economy), while they find a way to cut down the bloat, produce better products and refashion themselves as competitive companies.

I would love it if there was another solution but at this point I just don't see one, the Government either has to step in and guarantee that these companies continue to operate for the good of the economy, or allow them to keep mucking around and delaying their inevitable doom.

I think that on an emotional level no one wants to suffer the Black eye to the American business psyche that would occur if Detroit was nationalized, I think that our national pride wants us to believe that Detroit will find a way.

But here is the thing: we simply cannot continue to allow these companies continue to crumble before our eyes based on hope and nationalism because the risks are just too great, especially in light of the current economic crisis. 

Sources:

Employee Count Data from Yahoo Finance & Google Financ e as of 10/29/2008.

The Financial Times:   "Wall St faces up to 78,000 job losses" -- Daniel Pimlott, October 23, 2008.

Posted to: Auto Industry on October 29, 2008 at 10:41 AM | Permalink | Comments (0) | TrackBacks (0)

I linked to this story yesterday but figured I'd discuss it directly as it still has me shaking my head in disbelief:

(From BBC News): " Japanese banking giant Mitsubishi UFJ Financial is to ask investors for up to 990bn yen ($10.5bn; £6.85bn) in a bid to strengthen its funding levels.

Like other finance firms, the bank - which is buying part of Morgan Stanley for $9bn - has seen its market value shrink in the falling stock market.

It will issue common stock of 600 billion yen and 390 billion yen of preferred shares…

..."The group aims for enhanced stabilisation of its financial base and further corporate growth as a global financial group by implementing this capital reinforcement," Mitsubishi Financial said in a statement.

Compared with banks in the West, Japanese firms have suffered less of the fall-out from sub-prime-related mortgages in the US. This has allowed them to swallow up parts of various Wall Street businesses.

But the slowing economy is also making life more difficult for Japanese firms.

Credit rating agency Standard & Poor's said the Japanese economy's slowdown was putting "increasing pressure" on the bank's asset quality and that its profitability was being further cut by "reduced demand among borrowers and a decrease in fee income"...

...Mitsubishi UFJ announced in September it was buying a slice of Morgan Stanley.

It is the biggest overseas acquisition by a Japanese finance firm and will make Mitsubishi UFJ the biggest shareholder in the US bank.

It has also said it will pay $3.5bn in cash to take full control of UnionBanCal, California's second-biggest bank, and will raise its stake in Japanese consumer lender Acom to 40% from 16%."

Banks typically ask their customers to balance their checkbooks properly, not write checks against phantom funds, etc, yet hasn't Mitsubishi effectively written a bad check by spending $12.5 billion on overseas investments and acquisitions only to turn around and have to raise $10.5 billion in order to be properly capitalized.

Anyone else see a problem with this picture?

Yes, yes, I know, I'm oversimplifying (somewhat), things change on a dime these days, and maybe, just maybe, it was honest mistake where someone underestimated the impact of a weakening economy, falling markets, etc, on their capitalization levels, and maybe I'm just being hyper-critical.

But we're talking about the world's second largest bank that's in one of the world's most powerful economies, this isn't just a simple mistake it's a symptom of how disconnected bankers (on a global level) are with reality and how they never seem to notice their capitalization problems until it's nearly too late.

It's no wonder that the majority of the banks of the G7 nations are undercapitalized, the people who are supposed to be minding the store are either mathematically challenged or think that they can't get away with not being properly capitalized.

You can read more here(BBC) and here(FT).  

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 October 29, 2008 at 08:40 AM | Permalink | Comments (0) | TrackBacks (0)

Following on a topic I touched upon yesterday, here is tidbit from the WSJ on how the banks receiving the next round of cash infusions plan to use the money:

(From the WSJ): "The federal government's bank-rescue plan will spread more than $15 billion among 10 regional banks, those companies announced Monday. But some banks acknowledged that perhaps only a small chunk of the money would be funneled into loans.

That deepened criticism from some lawmakers that Treasury Secretary Henry Paulson should have set tougher conditions on the $250 billion being pumped into the U.S. banking industry through capital infusions. "In their eagerness to get everyone on board, I think they failed to make the program stringent enough," Sen. Charles Schumer (D, N.Y.) said in an interview.

Monday's announcements ranged from credit-card issuer Capital One Financial Corp., based in McLean, Va., and approved for $3.55 billion in taxpayer-funded capital, to First Niagara Financial Group Inc., a 114-branch Lockport, N.Y., bank that will get $186 million.

Nearly $35 billion in capital infusions have been disclosed since Friday, led by the $7.7 billion in cash that PNC Financial Services Group Inc., Pittsburgh, is using to buy National City Corp. for $4.69 billion in stock. The first nine banks in the Troubled Asset Relief Program are getting an additional $125 billion, meaning the Treasury Department now has doled out roughly two-thirds of its planned injections…

...Several banks said Monday they plan to use their new capital to make loans and possibly buy weakened rivals. Others suggested a substantial increase in loan volume is unlikely as long as the U.S. economy is troubled, since that is likely to worsen loan delinquencies and charge-offs.

James M. Wells III, chairman, president and chief executive of SunTrust Banks Inc., said the Atlanta bank will engage in "prudent deployment" of "some" of the $3.5 billion for which it was approved in "expansion of careful lending" and potential acquisitions, according to a statement. SunTrust also slashed its dividend Monday by 30%.

First Niagara President and CEO John R. Koelmel said the bank is "strongly committed to supporting the economy in upstate New York." In a conference call last week, Mr. Koelmel said that First Niagara was "clearly looking longer term, and opportunities would certainly include M&A at that point, as well as continued organic growth."

Zions Bancorp, Salt Lake City, is expected to announce later this week that the Treasury Department has approved its application for a sizable infusion, according to a person familiar with the matter. A Zions executive said last week the company wasn't likely to plow much government capital into new loans unless Zions also could increase its deposits.

Synovus Financial Corp., a Columbus, Ga., bank, applied Friday for government capital, spokesman Gregory Hudgison said. Other banks are still working on applications. Still others haven't decided whether to apply."

I think the people who are criticizing the banks for not lending out the bulk of the funds they receive from the Government need to stop and think for a second: if the banks are electing not to use their newfound capital to engage in a profit generating activity (lending), doesn't that suggest that they have some other needs/problems/etc that they need to use that capital for?

In other words isn't it a bit unrealistic to ask banks that are both undercapitalized and are facing rapidly escalating loan losses, to lend out the very capital they need to hang on to in order to address issues that could potentially destroy them and have taken down other banks?

The thing that bothers me the most about this issue is that instead of complaining that the banks aren't lending, why aren't the politicians asking the regulators going in and evaluating each bank's capitalization needs (immediate term and to insulate against future loan losses), and then determining what % (if any) of the received capital could reasonably be used for lending? There is no point in complaining about how the banks (or a particular bank) is using the capital its getting from the government, without having some sort of mathematical argument/justification around how a particular bank could realistically use new capital based on their financial situation.

I find the fact that certain politicians can't seem to grasp this relatively simple idea, especially when they're the ones who are supposed to guide the nation out of this crisis, are in charge of regulating/managing our nation's banking infrastructure, etc, to be quite disturbing. I have no problems with stipulations being placed on the banks that are receiving capital, but I think they need to be realistic and considered against the financial situations the banks are in. The firing off of complaints without any mathematical justification behind them is patently fatuous, especially when the complaints are coming from the people who are allegedly going to save us. 

Do we want to create a situation like Japan has with Mitsubishi UFJ where the bank invested $9 Billion in Morgan Stanley, only to have to run around and raise additional cash a few weeks later due to having its own capitalization problems? 

I.e. there are some VERY valid reasons for the banks to hoard the capital infusions they're receiving from the government, in fact you could argue that due to being undercapitalized many banks don't exactly have any choice but to hang on to the vast majority of the capital they're raising from the government and other sources.

Finally I think that the volume of bank lending needs to be put in the proper perspective: the banks got themselves into trouble by lending too much (and with poor standards to boot), so in relative terms lending has to slow down compared to were it was during the credit boom. Like it or not many consumers were extended credit lines that were too high in comparison to their income, lending standards were too low, etc, etc. So for the future viability of our banking system, lending needs to be reigned in, credit lines SHOULD be cut, people/businesses who could get credit before shouldn't be able to get it now, etc, etc.

It's a harsh reality, but it's one that we all have to accept.

When evaluating lending volume we need to compare now to before the credit boom, as opposed to comparing present times to a time period where the banks were lending irresponsibly.

You can read more here, and get a chart of the banks that have received capital here.

You can also read another article discussing how small (and healthy) community banks are worried their larger peer will use Government capital to swallow them up, and how they want to reduce the % of deposits any one bank is allowed to have (currently at 10%).

Sources:

The WSJ: "Much Bank Aid May Not Go to Loans" -- David Enrich, Robin Sidel and Michael R.  Crittenden, October 28, 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 October 28, 2008 at 06:56 PM | Permalink | Comments (0) | TrackBacks (0)

After the housing crisis subsides (or eases enough for people to start thinking seriously about the future) there will be some talk and thought given to policy changes with respect to housing, namely the nation's attitude towards subprime mortgages, assistance programs to low income borrowers, the role of FHA, the GSEs, etc.

The obvious/easy/popular solution will be to reign in lending to low income folks, and change policy attitudes that are more focused on getting people into homes as opposed to putting them into a sustainable housing situation whether they're owning or renting. However while measures like these would be a good idea it's important to realize that this crisis goes way beyond subprime loans to low income people, and that it was actually a function of bad mortgage lending to borrowers at all levels, not to mention problems with consumer debt in general, syndicated loans for PE buyouts, etc, etc.

In other words: we need to rethink our nation's entire attitude towards housing, home ownership, etc, whether we're talking about low income homebuyers or highly affluent ones; a couple of ideas:

Education : we need a massive education program that teaches people the truth about how homeownership actually works, as opposed to the truth as presented by the NAR and/or people trying to sell you a mortgage or a house. People need to understand that a home is where you live not an investment, and that while they do offer some financial benefits they're still a major liability that needs to be managed properly. The goal shouldn't be to buy a home from the perspective of the potential returns, the goal should be to buy an affordable home that you can enjoy.

Better yet we need to educate people so that they understand what true financial sustainability is, so that their decisions won't be based on expecting stability via a specific action in of itself (owning vs. renting), and will instead be based on the impact of a particular decision on their own personal balance sheet. Whether we're talking about affluent individuals who would be better off buying a $300k home than a $400k one, or middle class and low income ones who should spend a few years saving money and paying down debt instead of taking on a subprime mortgage, we need to get people to start thinking in terms of sustainability.

Most importantly: the current crisis would be markedly smaller if borrowers (of all types) had made smarter decisions and elected to take out the typical mortgages of old, instead of risking their financial futures with the exotic mortgage products of the housing boom.

At the end of the day nothing will do more to avert future housing crises than a massive dose of education.

Government Programs : building on the above all government programs that are designed to enable more citizens to purchase homes should be more focused on putting people into sustainable housing situations, more than they should be on enabling people to buy homes in general. Instead of subsidizing the purchase of a home by someone who can't quite afford it, the goal should be to work with citizens to get them into a stronger financial position so that they're not in need of a Government subsidy in the first place. It's all a matter of approach, instead of working to get person "X" into a house, address the issue of why they're coming to the government for help in the first place.

Mortgage GSEs: in addition to my prior ideas on scaling back the GSEs and breaking them into multiple smaller companies, the size of the mortgages that the GSEs purchase should be limited to the value of a median house in a particular region. The reason for this is simple: the government should only be helping average citizens purchase houses, as opposed to the current situation where they're indirectly subsidizing mortgages that only 5% of the population can afford.

In the end these are only a couple of ideas and overhauling the nation's mindset around housing (at the political and average citizen levels) is a huge job, however if we don't start taking some critical steps towards changing how this nation views housing we're going to find ourselves back in this situation again sooner rather than later.

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 October 28, 2008 at 09:32 AM | Permalink | Comments (0) | TrackBacks (0)

Now for some humor courtesy of the Onion (which of curse means that the following post is Satire and is not meant to be taken seriously):

(From The Onion): "NEW YORK—According to an alarming new study published Monday in The Journal Of Applied Behavioral Science, the time-honored American activity of swaggering, an extremely arrogant manner of walking, has dropped by nearly 90 percent since 2007.

Graphic courtesy of The Onion.

The severe economic turmoil of recent weeks and the United States' diminished credibility and moral standing on the world stage are just two of the major factors named in the study as contributing to the precipitous decline in self-important locomotion.

"Our research indicates that American swaggering has dropped to levels drastically lower even than those reached during the savings and loan crisis of the late 1980s," said Dr. Lionel Macleod, a New York University behavioral psychology professor and lead author of the report. "Sadly, a brash, wide-legged gait accompanied by an overconfident smile and one jauntily raised eyebrow may soon be a thing of the past."

The study, which observed random cross sections of ambulatory subjects in three major metropolitan centers, including New York, Chicago, and Houston, found several worrisome deficiencies in once-cocksure American walking.

"The average stride has decreased from 2.5 feet in length to mere 11-inch shuffling steps, and the angle of a walker's torso in relation to his waist has gone from a confident 28-degree backward lean to a pitiful 67-degree bent-over slouch," Macleod said. "Perhaps most distressing is the near-total absence of Americans making imaginary guns with their fingers and 'shooting' at passersby while winking."

Macleod said that his research team witnessed several other behaviors directly related to the decline in swaggering. Most notably, moping is up 67 percent, and is often accompanied by head-hanging and the jamming of one's hands deep into one's pockets. In addition, the practice of sheepishly kicking a tin can down the street was exhibited by 22 percent of those monitored.

Macleod theorized that slinking is likely on the rise as well, but was careful to point out that those walking in this manner are adept at passing by unnoticed and are thus extremely difficult to observe."

As usual with the Onion, BRILLIANT - you can read the rest of the article here.

Sources:

The Onion: "Swaggering Down 87%" -- October 24, 2008.

Posted to: Randomization on October 27, 2008 at 03:04 PM | Permalink | Comments (0) | TrackBacks (0)

I think that anyone who is talking about foreclosure/homeowner rescue, needs to refer to the graphic below (granted it's a few months old, but I doubt the numbers have changed to an extent where it impacts my general thesis, in fact they would probably just strengthen my argument) depicting the default rate for various types of mortgages.

Graphic courtesy of the WSJ.

Notice how the prime fixed rate mortgages have barely moved, and it's the subprime and prime exotic mortgages that are showing a surge in the number of defaults?

In other words the problem is the origination of loans to people who either couldn't afford it, or were on terms that weren't sustainable/affordable at super low teaser rates. Not to mention the fact that 25-33% of all houses bought during the boom were purchased by speculators, who (in many cases) are now stuck with homes they either can't sell or rent out profitably.

Considering the factors that are driving foreclosures, how (pray tell) can you legislate, modify, etc, the problem away without giving out a straight up subsidy to enable people to afford things that are beyond their means?

Simple: you can't.

That's why all efforts to halt foreclosures to date have been largely ineffective at worse and are only delaying the inevitable at best, because they ignore the realities around sustainability and affordability that are the root cause of the problem. The goal(s) of people who want to help those facing foreclosure shouldn't be to help them stay in homes they can't afford, it should be to mitigate the impact of the situation, and help them get into a sustainable housing situation.

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 October 27, 2008 at 02:56 PM | Permalink | Comments (0) | TrackBacks (0)

I was stricken with Malaise when the first round of TARP capital injections into the banks went out, so I didn't get a chance to comment when it was  new/breaking story. However now that I'm feeling better and the Government is injecting cash into a smaller group of banks, I figure I'll take the time to share a few thoughts.

For what it's worth I do support the capital injections (in principle) I just have a couple of issues with the way the plan was executed:

Shotgun Approach:   the plan appears to have been executed as if the goal was to shore up confidence into the banking system by injecting capital from the government, as opposed to resolving the root cause problem (falling markets, the credit crunch, et al) of an undercapitalized banking system. In other words forcing X number of banks to accept cash injections doesn't necessarily solve anything, and it would've been smarter to assess each bank's capital needs and then give them a choice of either raising the money from investors or accepting cash from the government. The benefit to this approach is that it allows the strong banks to distinguish themselves (either by not needing capital or by being able to raise it), and it allows for a smarter use of taxpayer dollars by focusing resources on where they're most needed.

In other words the mere presence of the Government isn't going to necessarily solve anything, and it's smarter to focus on the core issues and not take actions that (to an extent) penalize the companies that don't need government help in the first place.

Capital Usage and Consolidation: at the moment there are some legitimate fears that larger banks will use their capital injections to buy smaller and/or weaker Rivals (fears that were probably heightened by PNC's purchase of National City Bank), as opposed to using the capital to increase lending. On one hand you might say that some of these fears are overblown because an undercapitalized bank might just hang on to the cash and use it to shore up their balance sheet, on the other it's quite possible that banks could use Government cash to buy smaller rivals and strengthen their own balance sheets via absorbing the assets of a rival.

In truth this is a two-fold issue as you're talking about placing limits on bank consolidation (either for the duration of the crisis and/or on a go-forward basis), and placing parameters around how the banks can use taxpayer funds.

Around the issue of bank consolidation I fully agree that some limits should be implemented, as we're already suffering from the systemic risk created when a small number of companies control too large a % of the nation's deposits, banking resources, etc. However I fully accept that there are plenty of situations where it's still in the best interests of the banking system for the Government to facilitate the absorption of Bank A by Bank B. I think that the Government needs to take the approach of spreading risk around as opposed to creating more of it, perhaps the next Wachovia should be split-up and spread around to various regional banks instead of being swallowed up by a single acquirer.

I don't think it's in the public interest to create more banks who hold 10% (or more) of the nation's deposits, I'd rather have a banking system where 8 banks hold 40% of the country's deposits than to have one where 4 banks hold same.

With respect to parameters around how the banks use the capital the story is simple, the Government injected cash into the banks hoping to stimulate a certain type of behavior without (instead) dictating how the banks could use the capital. Granted asking an undercapitalized bank to increase its lending activities just because it received capital is a bit spurious, however there needed to be more teeth (or at least carrots and sticks) in the capitalization agreements that would ensure the banks used the capital in a way that serves the public's interest as opposed to their own.

Lending: the undercapitalization problem isn't actually a new one as many banks were merely using regulatory arbitrage and/or derivatives to appear properly capitalized during the credit boom, what's happened over the past 18 months or so is that those spurious "capitalization strategies" were exposed after years of poor lending standards, poor risk management, etc. This creates a problem when you inject money into the banks in hopes that they'll lend again, because many banks need to reign in lending AND raise capital in order to shore up their balance sheets/get properly capitalized.

E.g. proper expectations need to be set for go-forward lending, and the banks have to first recapitalize and then raise capital on top of that in order to truly loosen the lending reigns.

Overall the capital injections were the right way to go and I am playing (to some extent) Monday morning QB here, however considering everything that's at stake it's important to approach these problems in the right way so that effective solutions can be implemented. Moving forward the Treasury needs to think more in terms of solving the brass tax root cause problem s, as opposed to approaching things as if all it will take to fix things is a little dash of confidence. 

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 October 27, 2008 at 01:27 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a rather humorous image, it's a photo of a memorial outside of the bank of England for "The Boom Economy"

Graphic courtesy of the WSJ

The image comes from an article that discusses how the impact the current downturn may have on London's role as a global financial center.

(From the WSJ):   " LONDON -- Outside the Bank of England, a makeshift memorial recently appeared: a lamppost decorated with flowers and a sign: "In Loving Memory of the Boom Economy."

The financial crisis is hitting many drivers of London's growth as a global financial capital in recent years. London's economy appears to be changing in fundamental ways, and, with it, the psyche of the City.

In remarks that drove down the pound against the dollar, Bank of England Gov. Mervyn King said Tuesday evening that "it now seems likely that the U.K. economy is entering a recession."

In London, finance professionals who had come from all parts of the globe to make their fortunes have been going back home. The once-booming business of creating complex debt investment products, much of it centered in London, has all but disappeared, along with thousands of jobs.

The U.K. markets regulator is promising heavier regulation, putting an end to the hands-off approach that had been part of London's appeal to banks and overseas companies. And financial problems elsewhere are forcing banks and wealthy individuals to pull out money they had parked in London, leaving businesses from real-estate developers to retailers bereft of financing...

...It all adds up to a troubling scenario for the U.K., the world's fifth-largest economy. According to government statistics, London's financial hub alone generates about 4% of U.K. economic output, and the financial-services sector accounts for more than a fifth of all U.K. jobs, compared with 6% in the U.S. Over the three years until the end of 2007, financial services in the U.K. grew almost four times the speed of the rest of the economy, at 9.4% compared with 2.5%.

Just last year British officials were hailing London as the world's most important financial center, over New York. Now both cities have been hit hard by the financial crisis. But while New York is the financial center of the world's largest economy, London is dependent on international business that some in the City fear may not return to the same levels as the boom years.

London's problems started even before the recent financial crisis hit full force. Rising emerging-market centers such as Dubai and Moscow have been competing for business that had been London's. Residents of London have increasingly complained about the city's high cost of living and creaky infrastructure. Members of London's important insurance community had been moving to lower-tax domiciles.

London has weathered previous downturns and survived other threats to its competitiveness. In the late 1990s some bankers and politicians predicted that the introduction of the euro would turn Frankfurt into Europe's pre-eminent financial center. Instead, London gained ground as the common currency made it easier for one city to dominate the region."

At this point I think it's too soon to speculate on whether or not London will retain its position as the world's financial center, because many of the things happening now are being driven by a global financial crisis more than they are being driven by systemic changes within the U.K. that may make London a less attractive place to do business. People are being driven out because they're not making money and/or certain markets are disappearing/collapsing, they're not running to another place with healthy financial markets.

I.e. everyone is hurting right now, and it's too soon to tell how everything will play out in the end. 

Not to mention the fact that London is still the world's most international city (based on the number of languages spoken), and Geographically it's hard to beat  in terms of ease of travel to other nations (despite the best efforts of the clowns running Heathrow) and access to the financial markets of other regions. When dealing with time differences it's much easier to interact with the markets (or business partners) in Asia, Europe and the U.S. from London, than from many of the world's other major cities.

At least that was my experience when working from London (during business trips) back when I ran a global IT services business, and had managers to interact with in Asia, Europe and the U.S. It was a lot easier to work somewhat normal hours and still meet/interact with all of my managers on a given day, as opposed to some people being ignored, having to meet with people at 11 PM, etc.

The other thing to consider is that Dubai is in the middle of the world's most volatile region and Russia is not without its own political problems, in comparison the U.K. is a significantly more stable and safe place to operate. 

In the end I would be surprised if London didn't retain its title as the world's financial center even if their dominance slips a bit, at the end of the day there isn't a "perfect" market to operate in (they all have their pros and cons) and all things considered London is hard to beat.

Of course, London is my favorite city so perhaps I'm a little biased.

You can read more here.

Final note: if you're ever in London I'd suggest you stop by the Bank of England Museum , as it provides not only a interesting history of British Banking but a fascinating history of banking in general. Probably the most interesting part of my visit were the exhibits on past economic policy debates, especially the fact that there were debates in the 1600s on interest rates, balanced budgets, national debt, etc, that closely mirrored ones being currently held in the U.S.

Sources:

The WSJ: "Turmoil Batters London's Status as Financial Center" -- Alistair Macdonald, Cassell Bryan-Low, October 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: Global Economy on October 22, 2008 at 01:31 PM | Permalink | Comments (0) | TrackBacks (0)

If you want to understand the changing world of consumer credit, and how an increase in the number of credit cards issued to subprime credit customers drove changes in the low income retail space, look to this story from the WSJ discussing the surging popularity of layaway plans:

(From the WSJ): "Layaway, a payment practice that was made popular during the Great Depression but nearly became extinct due to the instant gratification of credit cards, is back in fashion thanks to the credit crunch.

Only a handful of national retailers still let consumers put purchases aside until they have paid for them in full. Many of those companies -- which include TJX Cos., parent of TJ Maxx and Marshalls; Burlington Coat Factory Warehouse Corp.; and Kmart, part of Sears Holdings Corp. -- report that demand for layaway is stronger than it has been in years.

With credit-card companies tightening limits and offering fewer specialty card promotions amid the continuing credit crisis, many consumers may not be able to tap credit cards as much this holiday season, experts predict. Meanwhile, retailers report that many customers spooked by the slumping economy are either already saddled with debt or determined not to be, all of which is making layaway are more enticing option.

Demand has surged so much at Kmart, in fact, that the discount retailer decided to tout its commitment to layaway as the centerpiece of a national advertising campaign.

Layaway plans aren't free -- most stores charge a fee for setting aside the merchandise, and ask for a down payment. Kmart requires customers to pay a $5 service fee and a $10 cancellation fee upfront, or put down 10% of the item's cost, whichever is greater. Customers must make biweekly payments over eight weeks to pay the balance. In case of default, the item goes back into stock and the customer receives a refund, minus the $15.

Several layaway Web sites sprung up earlier this decade to fill the void left after Wal-Mart Stores Inc. and other major retailers discontinued the seemingly outmoded service -- and they are also reporting a big bump in business. ELayaway.com, which offers iPods, Hewlett-Packard laptops and clothes from the Gap on virtual layaway for a 1.9% fee of the cost of the item plus taxes, said traffic has increased 91% over last year. Customers can choose eLayaway as a payment option on affiliated Web sites or can shop at www.eLayaway.com, and receive the item in the mail once the payments are made in full.

Many of the site's customers are victims of the subprime-mortgage mess or simply have bad credit, said Michael Bilello, eLayaway's senior vice president of business development. He said that five major big-box retailers had contacted the company in recent weeks about adding an eLayaway payment option to their Web sites or putting eLayaway kiosks in stores.

John Pace, a Connecticut audio-equipment salesman, purchased a diamond engagement ring he plans to give to his girlfriend later this year from a jewelry site that featured eLayaway.com as a payment method. He also used the service to buy some Callaway golf clubs to send as Christmas presents, as well as a few clubs for himself.

"I remember growing up with layaway, and it seemed like the fee was reasonable," said 41-year-old Mr. Pace. "Being in sales, I have good months and bad months, and this way I don't max out a credit card."

When looking at this situation its obvious that layaway was a victim of the subprime credit card business (rent to own may have been a culprit as well), and now that banks are slashing credit lines, consumers are dealing with maxed out credit cards, etc, people are turning back to layaway as a way to finance purchases. At this point the surge in the popularity of layaway is probably more indicative of the financial health of subprime credit consumers then it is about the availability of consumer credit overall, because (generally speaking) layaway isn't exactly something that is in the financial vocabulary of the typical middle class/prime consumer. However based on the comments eLayaway's business development executive it appears that consumers that would typically fall into the middle class/prime category may begin using layaway as well.

Furthermore if you start seeing layaway kiosks in stores like Best Buy, especially if those stores are in solidly middle class areas, it could be an indicator of a trend towards middle class consumers being forced to adopt "financial services" that are typically the domain of the low income consumer. Think check cashing, pay day loans, rent to own retailers, etc.

The fact that layaway plans aren't especially "sexy", offer delayed gratification and are often the punch line in a comedian's joke about growing up poor, suggests that people are only turning to them as a last resort, underscoring the changes in buying habits amongst subprime credit consumers.   

All that being said consumers turning to layaway and effectively making cash purchases of products over time, as opposed to going into debt and paying interest isn't exactly a bad thing. While some may see this trend as a collapse in the democratization as credit (a spurious notion to be sure), it doesn't do anyone any good (subprime consumers especially) to finance consumption with debt and layaway plans might very well induce some needed financial discipline into the populace.

Either way I'd rather see people spend $5-15.00 to buy something with layaway, then to put it on a credit card, not pay it off quickly and wind up racking up large interest expenses. Layaway might not be "sexy" but for low income people it's probably better than subprime credit cards, or paying loan shark like fees/costs to buy something via rent to own.

Sources:

The WSJ: "Layaway Is Making a Comeback" -- Miguel Bustillo, October 22, 2008.

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: Retail | U.S. Economy on October 22, 2008 at 12:33 PM | Permalink | Comments (0) | TrackBacks (0)

Let's start the day off with some humor……

*Note the following post is satire and is not meant to be taken seriously; no traders were hurt during the creation of this story, the tales of dog piles are all false.

(From the Onion): NEW YORK—Wall Street investors experienced a sudden surge in optimism Tuesday when, after six tumultuous weeks that saw record drops in the Dow Jones industrial average, a $1 bill was spotted on the floor of the New York Stock Exchange.

The dollar bill was discovered in the northwest corner of the trading floor at approximately 12:05 p.m., and its condition was reported as "crinkled, but real." Word of the tangible denomination of U.S. currency spread quickly across the NYSE, sending traders into a frenzied rush of shouting, arm-flailing, hooting, hollering, and, according to eyewitnesses, at least one dog pile.

"With credit frozen and the commercial paper market poised on the brink of collapse, this is the most promising development I've seen on Wall Street in months," said floor trader Tim Formato, one of hundreds who gathered around the $1 bill and excitedly called their clients to inform them that they were looking at actual U.S. tender. "I think I touched it."

According to witnesses, the trading floor was soon abuzz with energy, as traders pointed at the dollar and repeatedly shouted "Look!" and "Money!" A proposal to divide the $1 note into 1,300 equal pieces and distribute them amongst investors was considered, but ultimately rejected. Early reports estimate the dollar may have passed through as many as 65 hands before disappearing in the late afternoon.

The bill's absence, however, did not deter the growing enthusiasm from those on the trading floor. By 2:15 p.m., more than 60,000 shares had been purchased in the new publicly traded asset, DLR, after brokers placed a flurry of calls advising their investors to buy into the booming single-dollar market.

By the close of day, economists were estimating the dollar bill's net worth at just under $270 million.

"We couldn't be in a better situation right now," trader Patrick Kady said. "Unless of course it had been a euro."

However, some financial advisers are warning against the rampant speculation the dollar has caused on Wall Street. Many have cautioned investors not to make rash decisions, such as liquidating all their low-risk government bonds in order to sniff the green paper bill for just a minute.

"I bet it smells like rose petals," mutual funds specialist Ken Stoute said. "My friend's friend Tim Formato? He's on the board at Westminster Securities and he says he touched it. He said it was warm and soft and wonderful. He said he knows where it is now, and I can put in an option on seeing it tomorrow for only $85."

As always with the Onion Brilliant ; the rest of the article is just as funny and 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; and as expressed before the preceding post is satire and is not mean to be taken seriously.

Posted to: Randomization on October 22, 2008 at 08:29 AM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting graphic that looks at various personal finance metrics related to the baby boomer and silent generations:

Graphic courtesy of the WSJ.

It's worth noting that the data above probably doesn't include a lot of the stock market losses from the past month or so; and it may not anticipate a prolonged recession occurring that spans multiple years and/or the U.S. having its own lost decade. Additionally (and I hate to harp on this point) adjusting the numbers for inflation is somewhat spurious, as the inflationary figures produced by the Government lag the real inflation actually felt by consumers in their wallets. Finally the numbers above are averages and as such are heavily influenced by outliers (Baby Boomers dominate the Forbes 400 after all), as a result the typical situation being faced by the average middle income boomer (especially when you factor in my other caveats) will undoubtedly be much worse come 2015.

The graphic comes from a WSJ article that discusses the economic impact of changing demographics on the economy of the U.S., as well as the propensity of the Baby Boomers spend instead of save, in addition to using debt to finance their lifestyles.

(From the WSJ): "Affluent Boomers had more to spend than most of their Depression-baby parents could have dreamed. Their appetites buoyed sales of everything from Bavarian sedans to Sumatran coffee to Swedish furniture. Boomers could make or break a brand. Boomers embraced Toyota, and helped make it the world's dominant car maker. They shunned Oldsmobile, and it died. Boomers have driven the explosive growth of the computer and consumer electronics industries, accounting for half the money spent on techno-gadgets, big-screen televisions, laptops and the like, according to McKinsey.

When Boomers ran out of cash, they financed their dreams. The U.S. household saving rate plunged to 2% of income in the 2000-2005 period, when Boomers were hitting their earning peak, from 10% during the early 1980s. Imposing McMansions sheltered occupants with five-figure credit-card balances, exotic balloon mortgages and V-8 powered sport-utility vehicles financed over five and six years, all adjuncts to a lifestyle that depended on cheap credit and cheap oil…

…Until now. Some economists and demographers say the Baby Boomers themselves are driving the current turmoil. As Boomers send their kids out into the world, they are entering the phase of life when income starts to fall, spending slows and houses get sold. The same generational heft that Boomers used to create fads for hula hoops, sport-utility vehicles and Harleys will now work against them as all of them rush to cash out and slow down at once. That puts more houses up for sale to far fewer buyers: a younger generation that is also less able to afford them.

"The generational crash is when there are too many older homeowners and not enough buyers," says Dowell Myers, a University of Southern California professor.

"This is like winter coming," adds Harry S. Dent, an author and consultant who says the U.S. is headed for a slump that will last until 2020. It will take that long for the financial wreckage from this boom-bust cycle to be cleared away, he says, and for the 79.4 million strong "Millennial Generation" -- most of whom are still in high school or college -- to enter adulthood and start buying homes, cars and gadgets of their own. "It happens once every 80 years," Mr. Dent says of this sort of demographics-driven economic cycle. "It's going to be difficult.

But even if these pessimistic views prove overdone, the U.S. economy will need to find a way to grow without relying on Boomers spending their last dimes. Companies that depend on Boomers are hunkering down for the short term and re-evaluating what it will take to succeed long term."

I think it will be hard to make predictions in a situation like this as it's a largely unprecedented economic shift, and it's hard to identify all the areas that will be affected as the boomers are forced to pull back on their spending and/or change their financial habits. While some of the predictions (generally) will be spot on, I suspect that there are probably dozens of unforeseen consequences and changes that we won't be able to predict and will have to just react to once they happen.

For instance as the Baby Boomers pull back it will force many people my age (late 20s early 30s) to pull back on their own spending, as I'm aware of multiple people my age who are being subsidized by their parents in some fashion (despite the fact that many of them have middle to upper middle class incomes. While only a small minority % of my peers are in this situation (at least to my knowledge), it will still have a significant impact as people are forced to re-adjust, operate without a safety net, cut back on luxuries, etc.

Even if it's only 5% of boomer spawn that have to cut back on discretionary spending due to no longer having parents that pay car notes for them, pay their insurance, cell phone bills, etc, it's going to have a marked impact on someone.

How the economy fares over the next 5-10 years is probably the biggest  "X factor" with regards to this demographic shift, as it could very well be the biggest driver of changes to Baby Boomer financial habits. A prolonged recession could force people to pull back on their spending earlier than anticipated, push some into bankruptcy, force others to delay retirement/stay in the workforce longer, their kids may graduate college with higher debt loads, etc.

It could also create a situation where the offspring of the boomers decide to live a less ostentatious lifestyle as a result of watching their parents struggle financially/live above their means. Just as I have peers who are being subsidized by their parents I have others who significantly more frugal than their parents/live below their means, as they don't want to encounter any of the hardships their parents did and/or just want to be more financially stable.

No matter how this all plays out it's going to be interesting, and calls for a resetting of expectations within certain industries (retail in particular) around future spending patterns, willingness to embrace debt, etc.

You can read more here.

Sources:

The WSJ: "Boomer Bust: How Will the Economy Rebound Without Post-War Babies Financing Their Harleys?" -- Joe White, October 21, 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: U.S. Economy on October 21, 2008 at 02:05 PM | Permalink | Comments (0) | TrackBacks (0)

To be sure it's easy to look at images like the above and jump on the bandwagon of: "the Nation's economy is a mess, and it's all the fault of those clowns on Wall St." However the truth is that things are a bit more complicated.

While the clowns on Wall St are definitely at fault, so are your neighbors who bought homes they couldn't afford and/or who used HELOCs and other forms of credit to finance a lifestyle above their means. You also have the investors who cheered on the companies who used debt to finance buybacks instead of asking the question: "is it perhaps a bad idea to spend future earnings by taking on debt, just to push up the stock price in the present?" You have Real Estate agents (like one who was working with a friend of mine) who did things like advising their clients to use exotic mortgages to buy a home they couldn't afford because: "this house will be selling for $150k more by next year, so you can just sell it, reap a quick profit and THEN buy a house that is more within your budget".

E.g. while the people on Wall St. laid the foundation that allowed the credit madness of '02 - '07 (and the last 20 years really) to occur, it doesn't change the fact that from CEOs to Soccer Moms this nation's economy was truly struck down by citizenry with abysmal financial habits at all levels. It wasn't just greedy bankers and subprime borrowers, the crisis was caused by bankers, executives, politicians and citizens (at all income levels) making bad financial decisions.

So on a go forward the question offered is: are we going to continue to place all the blame squarely at the feet of "some" of the guilty parties, or are we going to acknowledge the blame at all levels? While the former isn't necessarily a waste of time (nothing wrong with putting the feet of some of these bankers to the fire), it doesn't change the fact that many an average citizen needs to change their habits as well.

If we were a nation of savers Wall St. wouldn't have been in a position to cause this crisis in the first place.

Posted to: U.S. Economy on October 21, 2008 at 12:58 PM | Permalink | Comments (0) | TrackBacks (0)

(From the WSJ): "The steady stream of bad news coming from the U.S. automotive industry prompted one Texas dealer to take some creative license on its latest incentive: Buy a new car, get 50 shares of General Motors stock.

Frank Kent Motor Co., based in Fort Worth, will give away the shares to the first 100 customers who buy a Cadillac, Buick, Pontiac, GMC or Hummer. The stock gift, currently valued around $325, would be in addition to any incentive offered on the vehicles.

"We thought this would be a way for us to break through the clutter that is out there, give back to our customers and hopefully create some more faith in America and GM," said co-owner Will Churchill.

Dealers and auto makers have been pushing incentive boundaries all year amid a souring economy that has kept consumers out of showrooms. Earlier this year, Chrysler offered a gasoline card that locked in costs for buyers of new vehicles at $2.99 a gallon for three years. Volkswagen offered to deposit $1,500 into a college account for customers who make a down payment on the new Routan minivan. A few dealerships have even offered half off their pickup-truck inventory.

The stock gift could raise some eyebrows since GM shares are at their lowest levels in six decades. The dealership has already spent $30,000 to buy about 5,000 shares in preparation for the offer, Mr. Churchill said...

...October is shaping up to be one of the worst sales months for U.S. dealers this year. Sales of cars and light trucks in September dropped 27% from a year earlier to 964,873 vehicles, the first time since February 1993 that monthly sales fell below one million.

Ford Motor sales have dropped 17% through Sept. 30 while GM has declined 18% and Chrysler has fallen 25%. The declining sales have fueled speculation that there could be a U.S. auto maker consolidation with GM acquiring Chrysler."

The fundamental problem with the incentive and promotional programs offered by Detroit is that by establishing themselves as the low cost provider, they're actually cementing the idea(s) in the minds of customers that they're products are lesser/inferior/not as valuable as those offered by the competition. In other words when Consumers elect to spend more money on a Honda Accord vs. a Chevy Malibu they feel like they're getting more value for their money, so offering a Chevy Malibu for less (or selling it with deep discounts, incentives, etc) simply validates the consumer's original opinion.

E.g. discounts aren't going to work in a marketplace where the consumer has explicit stated that they would rather pay more for the competitor's products.

Better yet who has the more valuable product: the company that has to give away part of the company and bribe you with heavy incentives to buy their cars, or the company that offers minimal incentives and sells more cars despite having higher prices? Detroit cannot sell the American consumer on the value of their products when they have to damn near give them away in order to get them off the lots.

Not to mention the fact that the foreign automakers are often a more attractive array of products; no one cares if a product they're not interested in is on sale/offered at a steep discount. It's hard to sell people on the idea of "Buy American/Have Faith in Ford/GM/Chrysler", if the consumer question feels as if they have to choose between the foreign car they want and a domestic one they think is inferior/they're not especially interested in. At least, that's often how I feel when I get ads in the mail from the local domestic dealers.

Mind you I understand the potential economic damage that would be caused by one of the Big 3 failing, but what average consumer can afford to make a $20-$30k sacrifice just to save Detroit? 

Discounts aren't the solution, Detroit has to rebuild their brands, sell the consumer on the value of their cars and simply build world-beater products so that the guy with the Accord feels like he got a raw deal compared to his neighbor with the Malibu.

Admitted the above is easier said then done and it's a hard think to think about when you're just trying to product market share and halt sliding sales, but it's the only thing that will save Detroit in the long run.

Of course for the time being Detroit has to worry about its immediate survival and at this point (recent merger deals notwithstanding) I think the American car companies my have to become GSEs to survive, it's fatuous to think that two failing companies that are burdened with product duplication, weak brands and debt up to the stratosphere can survive by joining forces. GM already has too many brands and buying Chrysler's (with what money?!) isn't going to solve anything; it's nothing more than a desperate shot to get at Chrysler's credit lines and is only a very short-term solution that creates significantly larger medium to long-term problems.

You can read more here.

Sources:

The WSJ: "Buy a Car, Get a Stake in Company" -- Jeff Bennett, October 20, 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 October 20, 2008 at 06:46 PM | Permalink | Comments (0) | TrackBacks (0)

A rare instance of malaise (Strep and a Sinus infection) has had me down for the count this week, hence the reason things have been quiet around here lately. I'm still feeling rather sick but am suffering from "Cabin Fever" so I'm going to start posting again soon, just do me a favor and not tell my physician who would rather I do nothing for several more days ;)

Posted to: Housekeeping on October 17, 2008 at 11:35 AM | Permalink | Comments (0) | TrackBacks (0)

Another quick update on the British Banking bailout, namely the British Government injecting of £37 Billion into RBS, Lloyds and HBOS today:

(From BBC News): " Shares in Royal Bank of Scotland, Lloyds TSB and HBOS have fallen sharply despite the UK government's £37bn rescue package for the three banks.

The plan is meant to secure the banks' futures, but it also means profits will have to be shared with the government.

HBOS closed down 27.5%, Lloyds TSB was 14.5% lower and RBS down 8.4%.

In return for the injection of taxpayers' money, the government will also get a say in how the banks are run, including executive bonuses.

BBC business editor Robert Peston said the banks faced "absolute humiliation".

It would "count as perhaps the most extraordinary day in British banking history", he added.

Graphic courtesy of the BBC.

'Extraordinary times'

RBS will receive £20bn of taxpayers' money with a further £17bn to be put into HBOS and Lloyds TSB. Barclays intends to raise £6.5bn without government help….

...As a condition of the deal, the government has insisted that senior directors should get no cash bonuses this year, with future bonuses to be paid in the form of shares - a move aimed at encouraging management to take a more long-term approach.

HBOS will raise £11.5bn from taxpayers, made up of £8.5bn in ordinary shares and £3bn in preference shares, while Lloyds TSB is to get £5.5bn.

The money is conditional on the merger of the banks going through...

...Barclays has said it is to raise £6.5bn of new capital. The bank is to raise the money from private investors, rather than going to the government.

Barclays also said it would scrap its final dividend payout for 2008, saving it £2bn.

Our business editor said it was not wrong to describe the part-ownership of RBS, Lloyds TSB and HBOS as nationalisation, but the situation was very different from Northern Rock and Bradford and Bingley, which had seen private investors lose their holding.

"Shareholders will continue to own a big chunk of the banks," he said."

Now that is how you conduct a bailout: the banks suffer severe humiliation, bonuses are forbidden, you have banks like Barclay's that are trying to avoid participating, and there is a very strong motive for the banks to get healthy and rid themselves of government support as soon as possible.

One would hope that our own government shows similar courage and respect for the taxpayer as it negotiates a stabilization plan with the CEOs of America's top banks today. However let's not forget that our government is negotiating a plan WITH the CEOs and is trying to encourage them to participate in the plan, a opposed to the Britons whose government first created a plan and then negotiated the terms under which the banks could receive help if they weren't able to raise cash elsewhere.

The difference in approach is likely to define how our plan differs from the British one, both in terms of implementation and the terms under which the banks receive assistance.

Turning our focus back to the British banks it's worth nothing that not all of their major banks received assistance (most notably HSBC), which suggests that the banks that didn't receive a cash injection and/or were able to raise cash themselves will be able to establish further dominance in that market/be the cream of the British banking crop. After all who is going to be more attractive to customers, investors and potential employees, the bank that had to be nationalized or the one that managed to survive the crisis on its own?

You can read more on the situation in the U.K. here.

Sources:

BBC News : "Bank shares fall despite bail-out" -- October 13, 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 | Global Economy on October 13, 2008 at 09:01 AM | Permalink | Comments (0) | TrackBacks (0)

Here are some quick updates on Banking rescues within the EU and other parts of the world:

(From the FT): " The German and French government on Monday unveiled plans to restore liquidity and inject fresh capital into their banking sectors – as part of a coordinated bailout campaign by western governments.

Berlin’s bill to shore up the country’s ailing banking and insurance sector was potentially worth up to €470bn, while France’s plan totalled €340bn. Details also began to emerge of the plan to recapitalise US banks and other financial institutions.

taly was among other countries poised for a bailout announcement after Britain said it would inject £37bn into Royal Bank of Scotland, HBOS and Lloyds TSB. News that the German bill was on its way to chancellor Angela Merkel’s cabinet sent the Frankfurt stock exchange soaring. The exchange’s blue-chip DAX index was up 6.53 per cent, or 296.53 points by mid-morning.

Gordon Brown, the British prime minister, said that he expected other countries to follow his country’s “unprecedented but essential” bailout . “In extraordinary times, [with] our financial markets ceasing to work, the government cannot just leave people on their own to be buffeted about,” he told a news conference in Downing Street.

Spain on Monday said it would provide up to €100bn of guarantees for new debt issued by commercial banks in 2008 and an unspecified further amount next year as part of a eurozone plan to restore confidence in the financial system. José Luis Rodríguez Zapatero, the prime minister, made the announcement after an emergency cabinet meeting following the eurozone summit in Paris at the weekend.

Mr Zapatero said the cabinet had also approved a measure allowing the government to buy bank shares, although ministers say they do not see the need at this stage to inject capital into Spanish financial institutions.

In other moves, Australia and New Zealand announced guarantees for all bank deposits, as did the United Arab Emirates , while Saudi Arabia cut its interest rates.

The Swedish government said on Monday it would unveil steps to safeguard their financial sector in the next few days, but did not plan to inject capital into the Nordic country’s banks. Norway announced at the weekend it would offer its commercial banks up to $55.4bn in government bonds in exchange for mortgage debt and Portugal said it would make as much as €20bn ($27bn) available in guarantees for its bank's financing."

At this point while not a truly unified plan I think that this is still as good as it's going to get (for now) because you can't truly deploy a unified solution to the banking crisis when each nation has it's own set of problems, even if they're all being impacted by a fairly common cause (the credit bubble, derivatives, etc). While I think the markets will rally in the short-term, I think the market jubilance will be short-lived because not all of the bailout plans address the banking system's core issues and many of their problems simply need to run their course.

In other words while the recent actions of various governments around the world are a good first step, there is still a need to address deeper seated root causes/systemic issues and a reform of the global banking system.

Over the long-term this situation illustrates the need for there to be better international coordination between domestic banking regulators, and more thought given on how to keep financial contagion from spreading globally. Global leaders should be thinking about how to identify root causes of future financial crisis, and the tools they need to fix things when they're still small problems so that they don't become potential global financial cataclysm size problems later.

After all it's not as if no one saw many of the events of the past 18 months coming; the world would've been a lot better of if the people who are tasked with protecting the banking system had stepped in back in '06 as by that time there was plenty of evidence of the coming storm. Granted there were many conflicting views at the time and many bears didn't predict a crisis of the magnitude we've seen over the past six weeks, however regulators should always err on the side of caution as their primary duty is to protect the banking system. In fact due to the risks that troubled banks pose to the global economy both banking executives and regulators should always err on the side of caution, because it's better to be less profitable and safe then more profitable for a few years and the next Wachovia afterwards.

Finally on a go-forward basis the banks are going to have be to regulated more closely/encouraged to be more conservative, because a lot of the government interventions are going to benefit banks that profitable/viable and/or are just near the brink of disaster. Thus creating a situation where banking executives could very well believe that they can make riskier choices because government help is available if they get near trouble, as the level of fear around future crisis will be so great that the government may be willing to step in proactively just to make sure that there is no chance of the bank needing more help later.

You can read more here.

Sources:

The Financial Times: "Europe acts to rescue banks" --Bertrand Benoit, October 13, 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 | Global Economy on October 13, 2008 at 08:35 AM | Permalink | Comments (0) | TrackBacks (0)

You have to admit, he's got a point……….

But seriously the problem with derivatives is that 90% of the people who are involved them are doing so based on improper assumptions, and don't fully understand the instruments they're dealing with.

Just think about:  lot of mortgage securities were marketed, sold, etc, based on the idea that "property values always go up",  "people always pay their mortgages" and the use of mortgage related securities and derivatives dilutes the risk to the point where no one really suffers. Now these ideas sound ludicrous in light of the events of the past 12 months, but they should sound equally ludicrous to anyone who remembers the S & L crisis and the fact that it took most of the 90s for many real estate markets to recoup their losses from the late 80s/early 90s.

I.e.  in many cases derivatives amount to financial alchemy, and at the end of the day alchemy is NOT science.

Posted to: Financials | Randomization on October 13, 2008 at 07:37 AM | Permalink | Comments (0) | TrackBacks (0)

Here is the usual "mixture" of relevant news stories and other items I think you may find interesting, I meant to publish many of these items last week so you'll have a mixture of the old and the new in this edition. Think of it as both a look back and a look forward:

Here is a link to review of a interesting book by Martin Wolf that discusses the need to "fix the global finance system", not so much in terms of the roots of the current crisis but in terms of what he believes to be an "unsustainable" current account deficit.

I think that as the current crisis progresses (and as we move past it) there will be a tendency to start pointing figures, and naming villains for the current crisis, when in truth it's probably smarter to look at the uber-big picture and consider systemic roots to the problem. I haven't read the book and can't comment on its content directly, but at first glance it at least "seems" like the type of thinking we need to truly fix the multitude of systemic issues facing the global economy. 

An interesting FT article that discusses Paulson's embrace of a U.K. style banking bailout system, and how he should both follow the U.K's lead whilst also developing some additional features that are more suited to America's specific problems.

Spanish Bank Santander SA is in talks to take full control of Sovereign Bancorp, in what could be a sign of a future trend as the banks of various foreign nations use currency imbalances and/or stronger balance sheets to acquire some of our ailing banks. While I'm sure there will be some protectionist grumbling over this (if my prediction is correct), it doesn't change the fact that our own banking system doesn't have the resources to absorb all of our struggling banks so we don't exactly have a choice right now.

Speaking of which here is an update on MUFG's proposed investment in Morgan Stanley, needless to say recent events have led to a change in terms that is going to give MUFG a sweeter deal overall.

Direct borrowing from the Fed has soared to $430 billion as the government continues to pull out all of the stops in its attempts to either slow down mitigate or end the credit crunch; considering the fact that we could very well  a protracted slow down and/or tightness in the credit markets it's scary to think about how much money the Fed and the Treasury are going to have injected into the economy when all is said and done.

Apropos of the above here is an interesting commentary from the FT proposing a bailout plan here China makes a direct loan to the U.S. Government, for use in bailing out our banks based on the idea that indirect loans via bonds will be insufficient. You can find additional commentary here(FT - Commentary) , and a section from the FT on the Icelandic economic crisis here.

Instead of discussing the merits of the plan I will offer the following question instead: "if the U.S. did indeed directly borrow 100s of billions from a foreign nation, could we even continue to call ourselves a superpower anymore?"

Here is a commentary from the FT that provides a high level overview of the Crisis in Iceland; the FT has devoted considerable effort to covering the topic and this particular commentary is a good jumping off point to additional links, news, information, etc. 

I think more efforts need to be made towards fixing things so we're not just pumping money into a broken system, as at present it feels like the Fed and the Treasury are just throwing as much money a the problem as possible in hopes that things just start magically working again. 

Time for a little humor: a story from NPR discusses a depression era movie that despite being written 70 years ago as a satire of the nation's economic problems during the 30s, still seems completely relevant (if not an eerie harbinger of the future) in the light of the nation's current economic crisis.

While I've never seen the movie what  heard on NPR and some reading I did online about it has me itching to find a copy and watch it pronto, not to mention wondering if today's filmmakers will attempt to produce something similar in response to the current crisis.

Here is a look at the share price performance of the U.K.'s largest banks on Tuesday (10-07-08), which led to the creation of the bailout plan for their banking system:

Graphic courtesy of the WSJ

The graphic comes from an article discussing the problems within the British banking sector, and the government's plan to halt the crisis, which you can read here.

Over the long-term it's going to be interesting to see not only how the British banks fare compared to our own (especially since Barclay's purchased many of Lehman's assets), but how this situation impacts the "war" between London and NYC to be the world's financial center. While one could make a valid argument that London already won, it doesn't change the fact that the global banking environment will be drastically different 3-7 years from now.

For all we know SWFs, Japanese (or some other Asian nation) may wind up controlling a lot of the assets of the U.S and European banks, it sounds far-fetched but it's not exactly improbable either.

In a sad "sign of our times" the Debt clock in NYC no longer has enough digits to track the national debt and will be retrofitted to include two additional digits, oh for those halcyon days when the clock was actually turned off.

Posted to: Financials | Global Economy | U.S. Economy on October 12, 2008 at 11:36 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a look at a story from last week that didn't receive as much credit as it should've, as everyone's attention was on last week's market crash:

(From the FT): "The percentage of large syndicated US loans rated as problematic has nearly tripled in the last year, highlighting the damage done by the lax underwriting standards of the private equity boom, a report by US regulators showed on Wednesday.

During 2006 and early 2007, leading banks competed fiercely to lend to private equity groups, often dispensing with the usual covenants meant to secure such credits in a development that led to the so-called “cov-light loan”.

The annual federal “shared national credits” survey - which examines credit committments of more than $20m held by three or more banks - found that $373.4bn of such loans faced actual or potential difficulties at the end of the second quarter.

That was an increase of $259.3bn from the total of “criticised” loans during the previous year. Such problem credits accounted for 13.4 per cent of the total held by lenders in the US, up from 5 per cent the previous year, the survey showed.

The report by banking regulators including the Federal Reserve said many of the loans in the “criticised” category could migrate to more severe classifications, suggested default risk is increasing.

So-callled “classified” credits - rated as substandard, doubtful, or loss-making by the regulators - rose 128 per cent to $163.1bn, or 5.8 per cent of the total, up from 3.1 per cent in 2007."

The most obvious implication here is that the bad lending standards in the private equity space undoubtedly had an effect similar to one seen in the housing market: easy access to money inflated asset values, and fed speculative and overly exuberant behavior. The sudden surge in defaults indicate that many of the deals done in '07 and '06 simply aren't generating enough profit to service the debt used to finance the buyout, and while the economic downturn is a factor it doesn't change the fact that many PE firms simply overpaid.

I.e. the buyout craze had many firms overly focused on simply closing "a deal", as opposed to closing a "profitable or smart deal", because I'm sure that even without an economic downturn many firms would still be looking back and realizing that they paid too much.  

Overall this situation is just another example of how bad lending standards were a problem across many types of loans not just mortgages and other types of consumer loans, and  how on a go-forward basis all credit users (be they corporations or consumers) are going to have to adjust both their habits and their expectations with regards to credit.

You can read more here.

Sources:

The Financial Times: "Problem loans nearly triple in the US" -- Julie MacIntosh, Franceso Guerrera and Joanna Chung, October 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: Financials on October 12, 2008 at 11:10 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a quick update on the latest developments with the British Government's plans to bailout its banking system:

(From the FT): "Britain was on Sunday preparing to pump about £39bn into three of the country’s largest banks in a broad-based recapitalisation that could see the UK government end up with controlling stakes in Royal Bank of Scotland and HBOS.

Top executives from RBS, HBOS, Lloyds TSB and Barclays were last night locked in talks with government officials in a frantic attempt to hammer out details of the capital increase before the markets reopen on Monday.

Under the plans being discussed, RBS is likely to raise as much as £20bn in fresh capital. Of this, £15bn would come in the form of a placing of ordinary shares with the government, with the remainder in the form of preferred shares. Existing RBS shareholders will given an opportunity to buy the shares, but if they do not the government is expected to be left with a controlling stake in the bank.

Sir Fred Goodwin, RBS’s embattled chief executive, is expected to step down, to be replaced by Stephen Hester, the former banker who is currently chief executive of British Land. Sir Fred will become by far British banking’s biggest casualty of the credit crisis.

HBOS is expected to raise around £12bn, of which £9bn would be in the form of ordinary shares while Lloyds TSB - with which it is due to merge - is expected to raise a total of around £7bn. The capital increase and the prospect of a large government shareholding may also prompt Lloyds to rethink the terms of its planned takeover of HBOS, announced last month.

Barclays executives were also last night locked in negotiations with the government over its capital needs. The bank is maintaining it will raise around £7bn in new capital but is asking for the time to find the money without calling on the government.

The fundraising talks come just a few days after the government unveiled a £400bn bailout package designed to recapitalise the banks and unfreeze the inter-bank lending markets in an effort to avert a severe recession. However, the recapitalisation envisaged in the earlier scheme would only have given the government preferred shares with no voting rights.

The government is expected to inject equity in the banks by creating a Bank Reconstruction Fund, which could provide at least £50bn of capital."

It's going to be interesting to see how all of this is going to play out, as the overall cost of receiving funds from the Government (monetary, loss of control, various mandates on pay, behavior, etc) will undoubtedly motivate the banks to pull out all the stops to raise capital. On the other hand receiving an infusion of capital from the government may very well assist with those capital raising efforts, as it could give potential investors more confidence .

Either way I like the fact that the bank aren't especially excited about participating in the plan and will only participate in they have no other options, because not only will it motivate the banks to save themselves but it will also motivate them to raise the cash necessary to back any loans, buy back the preferred shares, etc.

Like I said before if you're going to bailout companies because it's necessary for the health of the economy structure it in a way that is painful for the companies receiving help, so it motivates them to either find a way save themselves without government assistance and/or to repay their debt to the taxpayer as soon as possible.

You can read more here.

Sources:

The Financial Times: "U.K. to inject £39bn into banks" -- Peter Thai Larsen, Jane Croft, Jean Eaglesham and Kate Burgess, October 13, 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 | Global Economy on October 12, 2008 at 10:09 PM | Permalink | Comments (0) | TrackBacks (0)

Apparently the government has woken up and decided to move forward with a plan to take equity stakes in the nation's banks:

(From the Associated Press): "WASHINGTON - Treasury Secretary Henry Paulson said Friday that the Bush administration will move ahead with a plan to buy stock in financial institutions.

Paulson said the program to purchase stock in financial institutions will be open to a broad array of institutions.

The administration received the authority to make direct purchases of stock in banks in the $700 billion measure Congress passed last week to rescue the nation's financial system.

It would mark the first time the government has taken equity ownership in banks in this manner since a similar program was employed during the Great Depression.

Paulson announced the administration was moving forward with the program during a news conference at the conclusion of discussions among finance officials of the Group of Seven major industrialized countries. That group endorsed the outlines of a sweeping program to combat the worst global credit crisis in decades.

"As we develop plans to purchase equity ... we are working to develop a standardized program that is open to a broad array of financial institutions," Paulson said in a statement.

Paulson said the government's program would be designed to complement the efforts of banks to raise fresh capital from private sources. He said that the government's stock purchases would be of nonvoting shares so that the government will not have power to run the companies.

The purchase of equity stakes in companies would be in addition to the main thrust of the $700 billion rescue effort, which involves purchasing distressed assets off the books of financial institutions as a way of unthawing frozen credit markets and getting banks to resume more normal lending operations.

Paulson told reporters the administration was moving "swiftly and thoughtfully" to implement the new rescue package.

The administration is expected to start making announcements next week of the private sector asset management firms that will be selected to help run the program."

Hey, better late than never; I'm quite pleased that Paulson is shifting gears a bit and deciding to allocate some funds towards equity investments into the banks as it I think it's a vastly superior recapitalization strategy. Perhaps the performance of the Dow over the past week has been the resounding critique that the administration needed in order to encourage them to shift gears. My only concern (at this point) is the funds allocation between direct investments into the banks and TARP's purchase of mortgage securities, because (at this point) it appears that Paulson is still committed to purchasing mortgage securities as part of a banking bailout plan.

Finally isn't it a bit odd that TARP quietly included a provision for the purchase of equity stakes in bank, yet the administration and the politicians in favor of the bill never mentioned it and focused entirely on the aspects of the bill focused on purchasing mortgage securities? Especially when many of the plans most vocal critics favored equity investments in the banks, and mentioning the provision for equity investments would've made it easier to sell the plan to Wall St., the public and other politicians?

Better yet (especially in light of the market's recent performance) it would've been smarter to just sell the plan as a $700 billion appropriation of money, which could be used in a multitude of ways to stabilize the banking system: direct loans, equity investments, debt guarantees, asset purchases, etc, instead of just focusing on one strategy.

But that's just me being a professional critic; at this point I'm just glad the administration is moving forward with the equity investment plan. Let's hope that they eventually abandon the asset purchase plan all together.

You can read more here.

The Associated Press (via Yahoo News): "Paulson endorses bank stock purchase plan" -- Martin Crutsinger, October 10, 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 October 10, 2008 at 03:50 PM | Permalink | Comments (0) | TrackBacks (0)

Perhaps the biggest news in Today's financial markets are the proposals being weighed by the U.S. government to either begin backing bank debt and/or to guarantee all banking deposits:

(From the WSJ): "WASHINGTON -- The U.S. is weighing two dramatic steps to repair ailing financial markets: guaranteeing billions of dollars in bank debt and temporarily insuring all U.S. bank deposits…

...Under the U.K.'s recently announced plan, which it is now pitching to the G-7 members, the British government would guarantee up to £250 billion ($432 billion) in bank debt maturing up to 36 months. The British concept to expand its proposal to other countries has a lot of support from Wall Street and is being pored over by U.S. officials, according to people familiar with the matter.

White House spokesman Tony Fratto said the U.S. "is reviewing the idea and discussing it with our British counterparts."

The move to back all U.S. bank deposits, which is only in the discussion stage, would be aimed at preventing a further exodus of cash from financial institutions, including small and regional banks, some of which are buckling under the strain of nervous customers. In recent weeks, customers have pulled money out of some healthy community banks under the assumption that the government will only insure all the depositors of larger banks in the event of a failure...

...One major flaw in the global banking system, and a sign that problems extend beyond whether U.S. homeowners can pay their mortgages, is the fact that banks don't trust each other enough to loan beyond an overnight period. That means that cash isn't being circulated through the financial system and banks are relying too heavily on short-term loans, which does little to help pay off looming debts. Banks are hoarding cash, both to cover their debts and to improve their year-end books.

The plan in the U.K. was hammered out by Treasury Chief Alistair Darling as well as the chief executives of major British banks earlier this week after a sharp drop in U.K. bank stocks.

In the U.S., some $99 billion in just one type of bank debt is coming due between now and the end of the year. Hundreds of billions of dollars will need to be paid in the U.S. and Europe. Government backing would make it easier to issue new debt to help pay for that.

The problems in so-called interbank lending, or short-term loans made between banks, date to August 2007. Markets froze after a little-known German lender called IKB Deutsche Industriebank AG ended up with big debts it couldn't pay. More recently, the bankruptcy-court filing of Lehman Brothers Holdings Inc. sparked a new freeze in the interbank-borrowing market when money-market funds, laden with Lehman debt, yanked their cash out of the commercial-paper market, a vital cog in how companies fund their short-term obligations…

...Customers' fears have spurred bank runs across the country, especially at wounded financial institutions. IndyMac and Washington Mutual Inc. collapsed, in part, because of late runs on their deposits. Wachovia, which came close to failing twice in recent weeks, has seen large outflows of deposits since last week, according to someone familiar with the matter. Wachovia declined to comment on its deposits."

First off: it's worth noting the British Government stepped in to guarantee the deposits and debt of Northern Rock Bank last September, and was still forced to nationalize the bank after a multi-month search to find investors and/or buyers for the bank failed. Meaning: a bank in trouble is a bank in trouble and investors, customers and potential buyers will still avoid it like the plague despite the presence of a Government guarantee. The problem isn't so much a lack of faith in the strength of the guarantee per se, it's the fact that it doesn't truly address the root causes of the bank's problems.

With that being said let's quickly discuss the merits of both proposals:

Guaranteeing Deposits: the problem with this proposal is that it assumes that the people who make runs on banks are making rational decisions based on the amount of FDIC insurance available, as opposed to emotional decisions based on simply not trusting their bank, the FDIC and perhaps even the Government. The people who are making the runs on the banks (for the most part) aren't the depositors with several hundred thousand (or more) in the bank, they're the depositors who live paycheck to paycheck, just have several thousand in the bank and/or whose account balances are nowhere near the current (or past) FDIC insurance levels.

When these people make runs on banks it's never a question of the FDIC not providing enough protection as they don't have enough money for that to be an issue in the first place, instead it's a function of fear and simply not trusting the overall process (or bureaucracy) that is supposed to protect them.  They're people who need access to all of their funds and can't risk their money being temporarily inaccessible while a bank changes hands, after its closed down, etc, etc.

E.g. deposit insurance levels are only relevant to 100% rational actors and/or folks whose account balances exceed the current insurance limits.

While guaranteeing all deposits may inject some confidence into the markets, it will do very little to alter the actions of the people who are making the bank runs in the first place.

Guaranteeing Debt : more than anything this is just a stop-gap measure that will help the banks issue new debt to service their existing debt (which sounds like a problem in of itself) , as well as a desperate effort to get the banks to starting lending more to each other in general. However the problem with this measure is that it's not doing much to address the reasons why the banks aren't lending to each other in the first place: they're undercapitalized, overleveraged, suffering from increasing loan losses (across all types of loans, consumer and corporate) and know their peers are in the same boat.

While guaranteeing debt should help to stimulate things in the short-term, inter-bank lending won't increase over the medium to long-term until you address the core issues of leverage and capitalization. The problem with this measure (and others like it) is that it assumes that the credit crunch is merely a confidence issue, as opposed to systemic problem caused by banks needing to shore up their balance sheets via increasing the amount of cash on hand and paying down debt.

If the governments of the G-7 nations want to facilitate more inter-bank lending and abate the credit crunch, they need to start focusing on the bank's actual problems, stop viewing the crisis as merely a crisis of confidence and stop  looking for measures that are designed to force a broken system to operate again as if nothing is wrong. The only way to end this crisis is to start working on the bank's actual financial problems over the short to medium term, in addition to starting the planning process for rebuilding the global banking system over the medium to long-term.

While temporary measures may ease short-term pain, they will inevitably do more harm than good as they will prolong the medium term to long-term pain.

You can read more here.

Sources:

The WSJ: "The U.S. Weights Backing Bank Debt" -- Damian Paletta, Carrick Mollenkamp and John D. McKinnon, October 10, 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 | Global Economy | U.S. Economy on October 10, 2008 at 08:28 AM | Permalink | Comments (0) | TrackBacks (0)

Today's WSJ had an interesting, stunning, disturbing or frightening (depending on your mood or interpretation) graphic comparing the last three major market slumps of the past 100 years:

Graphic courtesy of the WSJ

The thing I found most interesting about the above is the fact that there were often multi-year bull runs during the past two protracted bear markets prior to this one, because when we look back on history we often think of past bear markets a one big slump, and assume that if we're in the midst of a multi-year bull market than we simply can't be in bear one. A theory that is blown out of the water when we look back and see that the markets went on a bull run from '34 - '37 (similar trends were seen in the 70s and during the early part of the depression), despite the fact that the country was in the midst of the great depression. The obvious implication is that we may look back on the current era and realize that the bull run of '03 - '07 was nothing more than a brief "bull-blip" during what was primarily a bear market.

The thing is: it's hard to make those kinds of calls while the situation is unfolding as it's something you can only really determine via looking back; it's rather difficult to look at the big picture while you're in the middle of it.

You can read more on the topic from the WSJ here.

Posted to: Financial Markets on October 10, 2008 at 07:03 AM | Permalink | Comments (0) | TrackBacks (0)

In "well duh" news, recent comments by Treasury Secretary Henry Paulson suggests that the U.S. is considering implementing a bank recapitalization that is very similar to the British one, namely the exchange of cash infusions for preferred shares:

(From the FT): "The US could soon follow the UK down the path of using public money to recapitalise weakened financial institutions in return for preference shares.

In Washington on Wednesday, Hank Paulson, Treasury secretary, highlighted the fact that the $700bn rescue legislation passed last week allowed the government to recapitalise banks in addition to its core purpose of buying troubled assets.

"We will use all the tools we've been given to maximum effectiveness, including strengthening the capitalisation of financial institutions of every size," he told a press conference.

This change in tone from the top follows a shift in the debate within the US administration, which is increasingly sympathetic towards the idea of government-led recapitalisation.

The Federal Reserve - while very supportive of the asset purchase plan - has believed for at least four months that recapitalisation of the banking system is the most potent way to fight the credit squeeze.

But the Treasury has hitherto been skeptical about recapitalisation, in part because of concern over the degree of government intervention this would imply.

Now the Treasury seems to have come round to the view that direct recapitalisation makes sense on economic grounds - though the US is certain to tailor its approach to its own domestic conditions.

One person who discussed the issue with the administration this week said there appeared to be sufficient consensus for such a move to happen as early as next week, depending on market developments. The asset purchase plan is scheduled to be launched next month.

Advocates of this approach within US policy circles argue that the government should go beyond recapitalisation of failing companies and inject public capital into institutions that have been weakened by market stress but are not on the brink of bankruptcy.

This would allow such companies to resume more normal lending activities and thereby moderate the credit squeeze. The model would be Warren Buffett's investments in Goldman Sachs and General Electric. In effect, Mr Buffett sold Goldman and GE an insurance policy against the possibility that their existing equity would not be enough to meet potential losses.

This insurance policy came in the form of a purchase of preferred shares, which pay out ahead of common stock, with a high yield - the "fee" on the insurance.

Goldman and GE can buy back the preferred stock at a premium - terminating the insurance policy - once the crisis is over."

Assuming that this isn't just talk and the U.S. actually goes through with this, why didn't they just do this in the first damn place especially when participating banks could've already have started receiving cash infusions and TARP isn't scheduled to kick-off until next month? The whole thing is pretty ridiculous when TARP I was just signed into law last week, and now the government is already considering planning and executing TARP II before TARP I even gets started.

SO let's say that TARP II is executed next week and the Government proceeds to pour 100s of billions of dollars into the banks, what exactly would be the point of TARP I at that point, would it truly be a tool to help the economy or does it become an even more glaring "gift" to the banking system? Better yet why execute TARP I at all if the option of injecting cash into the banks in exchange for preferred shares is now on the table? Aren't preferred shares a markedly superior investment in comparison to overpriced MBSs, considering that the former locks you into any upside and the latter is highly speculative and may not turn a profit at all? 

I.e. isn't spending the initial $250 billion of the fund from TARP I on preferred shares instead of the mortgage securities the banks don't want a more responsible use of taxpayer dollars?

After all if the mere fact that the Treasury is going to overpay for the mortgage securities it buys from the banks means that the chances of making profit on these securities is greatly reduced just due to the price being paid; last time I checked: "buy high and sell higher" wasn't exactly a solid investment strategy.

Yet, that's what the government is trying to sell us on: "buy high and sell higher".

The whole thing makes one wonder on a whole host of fronts………...

You can read more here.

Sources:

The Financial Times: "US may follow UK on bank bail-outs" -- Krishna Guha, James Politi, October 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: Financials | Politics & Business | U.S. Economy on October 9, 2008 at 12:58 PM | Permalink | Comments (0) | TrackBacks (0)

I meant to write about this a few days ago but the situation had me so irritated I was having difficulty writing cogent thoughts about it, in any event here are some facts, figures, news items and commentary related to Lehman Brother's collapse.

First, here is a look at the contrast between their internal struggles and what they said publically:

(From the WSJ's Law Blog):

• On September 9, Lehman’s stock plunged 45% on news that a potential deal with Korea Development Bank fell through.
• As Lehman’s “clearing bank,” J.P. Morgan acted as the financial middleman between Lehman and its clients. Steven Black, co-CEO of J.P. Morgan’s investment bank, told Fuld that in order to protect itself and its clients, JPM needed $5 billion in additional collateral — over and above the $5 billion J.P. Morgan had demanded five days earlier, which had yet to be paid. Fuld persuaded Black to settle for $3 billion right away.
• That evening, top Lehman execs discussed the need to raise between $3 billion and $5 billion to shore up capital by early 2009. That evening, discussions with outside bankers about possible capital raising ended without any formal plan. Lehman execs arranged a conference call for the next day to announce earnings ahead of schedule and to disclose plans for a restructuring. The bankers counseled Lehman against holding the call, warning there were too many open questions about the firm’s finances.
• On next day’s conference call, the firm announced that it expected its largest quarterly loss ever, $3.9 billion, driven largely by declines in real-estate valuations. CEO Fuld said the firm intended to sell a majority stake in its investment-management division and would cut its dividend. Lehman executives didn’t say anything about needing to raise capital.
• On the call, a Deutsche Bank analyst asked whether Lehman would need to raise $4 billion as part of the plan. Lehman’s CFO, Ian Lowitt, replied: “We don’t feel that we need to raise that extra amount.” At another point, Lowitt said: “Our capital position at the moment is strong.”
• By Sunday, Sept. 14, Lehman, its lawyers and officials from the New York Fed determined that Lehman must file for bankruptcy.

Obviously the above could very well create some significant legal issues for various Lehman Execs, the WSJ's Law Blog discusses the subject here,  you can read about an FBI Inquiry here and other investigations here.

Following on the above let's take an additional look at some of the issues Lehman was dealing with in its final days:

(From the WSJ): "In the weeks before it collapsed, Lehman Brothers Holdings Inc. went to great lengths to conceal how fast it was careening toward the financial precipice.

The ailing securities firm quietly tapped the European Central Bank and the Federal Reserve as financial lifelines. On Sept. 10, one day after Lehman executives calculated the firm needed at least $3 billion in fresh capital, the firm assured investors on a conference call it needed no new capital at all. Lehman said its massive real-estate portfolio was valued properly, but Wall Street executives who have seen it say it was overvalued by more than $10 billion. As hedge-fund clients began yanking their money from Lehman, the firm assured them it was on solid financial footing.

On Sept. 11, J.P. Morgan Chase & Co. effectively ended Lehman's campaign to appear strong. In its capacity as a middleman between Lehman and its clients, J.P. Morgan knew more about Lehman's predicament than most outsiders, and it didn't like what it saw. J.P. Morgan demanded from Lehman $5 billion in additional collateral -- easy-to-sell securities to cover lending positions that J.P. Morgan's clients had with Lehman -- repeating an unmet request from a week earlier, people familiar with the situation say.

It was a knockout blow. That $5 billion collateral call, coupled with a huge outflow of money from Lehman's hedge-fund clients, so weakened the 158-year-old Wall Street firm that it sought Chapter 11 bankruptcy protection four days later."

You can read more on the above here.

Now let's take a look at Richard Fuld's testimony before Congress on the issue:

(From the WSJ): "In his first public statements since Lehman filed for bankruptcy protection Sept. 15, Mr. Fuld testified that he didn't deceive investors and others about the securities firm's financial health. This was despite repeated internal warnings, cited by lawmakers, that Lehman was on shaky ground.

In sometimes halting language, Mr. Fuld said that while he takes responsibility for decisions the firm made, he believes that Lehman was brought down by outside forces including lax oversight and "short sellers," traders who were betting Lehman's stock price would fall…

...Meanwhile, lawmakers estimated that Mr. Fuld pocketed roughly $480 million in pay since 2000. He suggested that his pay was closer to $350 million in that time and noted that Lehman's compensation system ties executive pay to performance. He said his 2007 pay, most of which came in Lehman stock, was nearly wiped out because of Lehman's bankruptcy filing…

For much of the almost-three-hour session, lawmakers asked Mr. Fuld about the juxtaposition of upbeat public comments he and other Lehman executives made about the firm and the dire internal view of the Lehman's growing problems.

Lawmakers cited a Wall Street Journal page-one article Monday that examined the lengths Lehman went to conceal its deteriorating financial condition in its last week. The article raised a number of questions, including whether Lehman executives knew, but didn't disclose, that the firm needed to raise capital ahead of a critical Lehman conference call with investors on Sept. 10, five days before it filed for bankruptcy protection.

Mr. Fuld told lawmakers "there was no intent to mislead anyone." He said he believed on Sept. 10 that Lehman was adequately capitalized and that future capital raises would depend on how much money the firm could drum up through the sale of assets and a planned restructuring.

Lawmakers also pointed to an internal Lehman document from June that questioned how the firm had allowed itself to become so exposed to the real-estate market and didn't show enough discipline in allocating its capital. "That is not what you told the public," said Rep. Brian Higgins, a New York Democrat.

Mr. Fuld said he didn't recall seeing the June talking points."

You can read more of the above here.

Let's quickly dissect some of the nonsense contained within Richard Fuld's (who henceforth shall be referred to as Elmer Fudd on this blog) testimony before Congress:

Oversight: how can one claim responsibility whilst at the same time blaming regulators (lax oversight) for allowing him to screw up, effectively making the claim that he's only a mere child and while he "takes responsibility" he can't truly be responsible since it's really the job of those providing oversight to keep him out of trouble? The statement doesn't even make sense and is extremely hypocritical, when I'm sure Elmer would've been one of the first ones crying to his lobbyist if the government had tightened regulations on the financial industry during the housing boom.

Misleading Statements: this is one of those cases when it would've been better for Elmer not to say anything at all, as all he's done here is to reveal himself to be a criminal at worst and a liar at best. Internal documents, discussions and even his own actions as CEO reveal that there was a marked difference between what was being said/done internally and was being said in public. For instance: how in he world can he defend the fact that he claimed that the company didn't need outside capital when an internal analysis had revealed the opposite AND the company was facing a collateral call from J.P. Morgan?

Perhaps Elmer should've been asked: "why are you continuing to make misleading statements NOW?!"

Short-Sellers: blaming short-sellers and negative rumors for "taking the company down" is especially ironic in light of the fact that Elmer was effectively trying to inflate the company's stock and keep customers from defecting by lying about Lehman's financial health. I suppose in Elmer's cartoon world one can lie all they want as long as it's to push a company's stock up, but if customers flee to protect themselves, if investors make a valid decision to sell a bad stock and if short-sellers short a stock of a company in trouble it's a pernicious act. Perhaps Elmer is merely self-centered and thinks customers and the market are just supposed to serve him.

Of course it's worth noting that there are some in the business media who believe that short-sellers are the blame for Lehman's demise as well, so it's not just Elmer who is trying to pretend that an insolvent company can operate indefinitely as long as it has a healthy stock price.

The real issue here is that short-sellers didn't take Lehman down, Elmer and the other executives in charge of the company are the ones responsible. To blame short-sellers would mean we'd have to ignore the $5 billion collateral call from J.P. Morgan Chase, the $3.9 billion quarterly loss and the need to raise another $3-5 billion in collateral. Not to mention the overvalued real estate portfolio and a host of other financial issues, which were making other I-Banks very wary of the company especially after they had looked through the company's books.

In other words in order to blame short-sellers with a straight face one would have to ignore Lehman's malaise ridden balance sheet, and pretend that it was a perfectly healthy company that would still be doing just fine if a bunch of short-sellers hadn't targeted the company with false rumors. 

I.e. there were very legitimate reasons to short Lehman's stock that had nothing to do spreading false rumors or breaking the law in anyway, shape or form.

The ultimate hypocrisy is that the Hedge Fund clients (that Lehman was begging not to leave) engage in the shorting of  stocks on a regular basis, and I'm sure that Lehman's proprietary trading units and the Hedge Funds they own have done the same. In other words: Lehman is only against short-selling when they think they can blame it for their problems/use it to deflect attention from their own issues/defect blame away from their executives. 

While troubled times often precipitate the designation of Hobgoblins we can blame for our woes it's time we start holding the feet of these executives to the fire and force them to take FULL responsibility,  Elmer Fudd stood before Congress and effectively lied through his teeth and blamed everyone in the world but himself by telling lie after lie after lie. Anyone looking for a classic example of audacity or "chutzpah" needs to look no further than Elmer's "performance" before Congress. 

Or maybe it wasn't audacity at all, maybe it was just a series bold faced lies, or the actions of an individual with a persecution complex who doesn't believe he should have to face any consequences for his actions and nothing is his fault.

How else can you explain an individual who purports to claim responsibility for the demise of his company, yet blames "outside forces" as the ultimate cause despite the very real problems within the company?

Either way it's no wonder that companies like Lehman are failing when their executives seem incapable of admitting that they're even fallible, let alone that they could possibly be responsible for their companies going down the tubes.

Finally while Elmer's performance was farcical in nature so were the Congressional hearings themselves, after all when is the last time that Congressional hearings involving corporate executives (outside of Enron) has led to any sort of changes, persons being held responsible, etc, etc? They're nothing more than dog and pony shows that insult the intelligence of the American people via claiming to be a method by which Congress will "get to the bottom of this, or do something to address the problem.

In all likelihood Elmer will ride off into the sunset with his $350 million dollar and aside from facing a few protestors and angry ex-employees here and there he will suffer very little consequences, thus setting the stage for the next round of corporate executives to behave in a similar manner. 

Sources:

The WSJ Law Blog: "Liability for Lehman? -- Our Capital Position at the Moment is Strong" -- Dan Slater, October 6, 2008 .

The WSJ : "The Two Faces of Lehman's Fall" -- Carrick Mollenkamp, Susanne Craig, Jeffrey McCracken and John Hilsenrath, October 6, 2008.

The WSJ: "Lawmakers Lay Into Lehman CEO" -- Susanne Craig, October 7,2008.

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 October 9, 2008 at 12:17 PM | Permalink | Comments (0) | TrackBacks (0)

A lot of the pro-TARP rhetoric that was floating around up to the bill's passage revolved around the idea that even if it wasn't the best idea, there wasn't enough time to come up with something better, something had to be passed immediately, there weren't really any better alternatives, etc, etc.  Arguments that have since been blown out of the water by the fact that the Brits were able to put together a vastly superior bailout plan for their banks in less than 24-hours. In other words: it wasn't that TARP was the best option given time constraints, the nature of the problem, etc, it was just the only solution that our government had the courage to put forth at the time.

Truth be told the British didn't come up with anything especially innovative they just used the fairly obvious solution for the problem at hand, a solution was being suggested by many of TARPs critics in op-ed pieces, news articles, within  the blogosphere, etc.  The only difference between the British government and the American one, is that their politicians had the courage to do not only the right thing for the taxpayer, but to do the right thing for the banking system.

The problem was never a lack of time, the magnitude of the problem, etc, it was simply a case of a lack of leadership, integrity and courage. What other conclusions can we come to as taxpayers in America when another government was able to draft a vastly superior plan in so short a time?

The British response to their on banking crisis coupled with the utter disgrace that is TARP reveals the need for stronger economic leadership in Washington, leadership that I don't think either party is really capable of delivering right now.  Over the long-term the only we're going to get past the current crisis AND not suffer from a new crisis in the medium term that's an after effect of this one, is if we put in a new crop of politicians who can provide the level of economic leadership we need to turn this thing around.

Until we get a set of real economic leaders in Washington, along with a set of corporate executives who are both honest and prudent in their approach to managing our nation's top companies, we can expect a protracted period of recession and stagnation stemming from the current crisis, and a fresh new set of crises down the road that will probably be the cost for the so called solutions to this one.

Posted to: Politics & Business on October 8, 2008 at 05:29 PM | Permalink | Comments (0) | TrackBacks (0)

Here is the full text of the Fed's announcement that it is going to start buying Commercial Paper:

(From the Federal Reserve): "The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve's existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households."

The phrase to zero in on is: "eliminating much of the risk that eligible issuers will not be able to repay investors ", which means that the Fed isn't just buying some debt to add liquidity to the market they're telling investors that they don't have to worry about losing money because certain commercial paper transactions will be backed up by the U.S. Government.

Anyone see a problem with this? The Fed stepping in to effectively guarantee commercial transactions? Anyone consider what kind of long-term moral hazard it could introduce, and what kind of irresponsible behavior it could encourage in the present now that some people are able to lend without the risk of losing money?

Yes, yes, I know only the companies with the strongest credit ratings, collateral, etc, who pay fees can participate, but having Fed backing is still an explicit guarantee that will make it easier to place the paper. After all it was the Fed said it was going to eliminate the risk in this market, not me.

Long-term I have to wonder where this nation's economy is going on a structural or policy basis as the Government steps in time and time again (do we even need to say that the Auto Industry is next?) to subsidize, back-stop or in other ways bailout various companies, markets and industries. Can we even call ourselves a free-market capitalist nation anymore after the events of the past 4 weeks, especially when it's going to take years for the government to unwind itself from private industry after the current round of bailouts, subsidies, rescues, etc? 

While I understand that in some instances intervention is needed, I think you have the balance that against the risk of introducing extreme moral hazards, and the fact that you can't "intervene or legislate away" the root causes of the current crisis: bad risk management, over-leverage, under-capitalization and investors losing money. Throwing money at symptoms whilst ignoring the root causes is nothing more than throwing good money after bad.

Finally thought(s): the size of the commercial paper market (by many accounts) is in $1.3-$2 Trillion dollar range, how much money is the Fed going to have to put into this market in order to truly impact it and what will that do the dollar, the national debt, etc? What happens if the Fed guaranteeing the debts of certain issuers results in even more money flowing into this market? What happens if the Fed's intervention creates two tiers of commercial paper: the stuff backstopped by the Fed and everything else, could that cause the bulk of the money to flow to the former this creating another "clog" in the market? 

Sources:

The Federal Reserve: " Board announces creation of the Commercial Paper Funding Facility (CPFF) to help provide liquidity to term funding markets" -- October 7, 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 October 8, 2008 at 05:00 PM | Permalink | Comments (0) | TrackBacks (0)

Following on yesterday's discussion of Britain's TARP here is a look at the latest news on the plan, which provides more details than what were available yesterday:

(From BBC News): " The UK government has announced a package of measures aimed at rescuing the banking system that makes available £400bn ($692bn) of fresh money.

It will initially make extra capital available to eight of the UK's largest banks and building societies in return for preference shares in them.

It is "designed to put the British banking system on a sounder footing", said Prime Minister Gordon Brown.

Some bank shares rose on the news although the main FTSE 100 index fell.

Shares in HBOS, the UK's biggest mortgage lender, ended up 24.5%, and Royal Bank of Scotland was 0.8% higher - trimming earlier gains. Shares in Lloyds TSB fell 7% and Barclays was down 2.4%.

The fall on the FTSE 100, which ended down 5.18% at 4,366.69 points, also came despite co-ordinated interest rate cuts from the Bank of England, European Central Bank and Federal Reserve.

The key points of the plan are:

Banks will have to increase their capital by at least £25bn and can borrow from the government to do so.

An additional £25bn in extra capital will be available in exchange for preference shares.

£100bn will be available in short-term loans from the Bank of England, on top of an existing loan facility worth £100bn.

Up to £250bn in loan guarantees will be available at commercial rates to encourage banks to lend to each other.

To participate in the scheme banks will have to sign up to an FSA agreement on executive pay and dividends.

Falling Shares

BBC business editor Robert Peston said that it was understandable that shares had fallen following news of the government's package.

"What Gordon Brown and central banks have done today should stave off economic Armageddon - but it's probably too late to save us from months, or even years, of sluggish growth."

He said that HBOS shares had risen strongly because it would be more likely to benefit from the plan than its peers.

Preference shares pay a fixed rate of interest instead of a dividend, which has to be paid before other shareholders receive anything, but they do not carry voting rights.

Taxpayers may even end up making a profit from the shares, but that is by no means guaranteed.

Robert Peston said there would be strings attached for banks that take the government money.

"Taking taxpayers' money will not be a licence to trade as normal," he said.

Negotiations will take place with each participating institution that will require them to extend normal credit lines to homeowners and small businesses, in addition to rules on executive pay and dividends to other shareholders. "

The graphic below provides a high-level overview of the plan:

Graphic courtesy of the BBC.

What a novel idea: instead of overpaying for the bank's worst assets based on the idea that you "might" be able to sell them for a profit later, you instead  inject cash into the banks in exchange for interest payments and/or preferred shares, set capitalization standards, mandate behavior towards consumers, mandate standards around executive pay and dividends and (most importantly) effectively guarantee that the taxpayer gets to benefit from any upside. Furthermore the plan is relatively simple and can be enacted rather quickly, so you avoid issues around a slow ramp up time, administrative difficulties, it's easier to shift course if new or different actions are needed, etc.

Perhaps the best part of the British bailout plan is the fact that the banks are being treated in the same manner that they would treat each other, or any other business that was desperately in need of cash and/or outside investment.

I.e. in the space of less than 24-hours the British Government has embarrassed our Government's feeble attempt to bailout our banking system, especially since their plan took over a week to put together and is a pork-laden insult that will prove to be largely ineffective.

Mind you I don't especially like bailouts because of the moral hazards introduced, the way the taxpayers are treated and the overall message it sends to a society, however in some cases bailouts are indeed necessary, and if you're going to do a bailout something like the current solution being put into action by the British is not a bad way to go.

At this juncture the American taxpayer needs to pose the following question to their representatives in Congress: "Why didn't you display the leadership, courage and integrity to put forth a similar plan, especially when many critics of TARP suggested the very same thing and something like the British plan would be easier to implement?"

You can read more here.

Sources:

BBC News: "Central banks cut interest rates" -- October 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: Financials on October 8, 2008 at 11:16 AM | Permalink | Comments (0) | TrackBacks (0)

All satire aside it's pretty hard to think of a reason why many of today's banking executives aren't just modern day privateers…..

……or at least, I can't think of one.

Posted to: Randomization on October 8, 2008 at 09:13 AM | Permalink | Comments (0) | TrackBacks (0)

It appears our British Cousins (okay MY cousins ) have decided to execute their own version of TARP in response to the global banking crisis:

(From the FT): "Britain’s largest banks will be part-nationalised on Wednesday morning after Gordon Brown took the momentous decision to pump tens of billions of pounds of public money into the sector to avert a banking collapse.

The massive public bail-out comes after a day of turmoil on the London stock exchange, where shares in banking group RBS fell 39 per cent to add to a 20 per cent tumble the day before. Rival HBOS fell 41 per cent.

Faced with an intensifying banking crisis, the prime minister sanctioned moves for the taxpayer to recapitalise Britain’s leading banks in an effort to restore confidence in the system and to allow them to start lending again. The total cost of the scheme was estimated at £35bn-£50bn – roughly equal to £1,400-£2,000 per taxpayer – although final details were being hammered out overnight before a statement by Alistair Darling, chancellor, this morning.

Royal Bank of Scotland, Barclays and Lloyds TSB – which is in the midst of a takeover of HBOS – are expected to be the main recipients of the capital. It was unclear whether HSBC, which already has stronger capital reserves, would participate in the plan, although if it does it is likely to take a smaller

amount.

The bail-out is likely to be executed through the government acquiring preferred shares guaranteeing a fixed rate of interest, although it was unclear last night if the banks could issue such securities without offering existing shareholders an opportunity to participate.

The rescue will be presented as part of a wider attempt to reform markets and is expected to include a call to the banks to show responsibility over remuneration for bosses, now that the taxpayer has a direct stake.

Mr Darling, who will make a Commons statement on Wednesday, wanted more time to form a full package but was forced to act by the market chaos and by circulated reports that banks wanted an injection of public money. At £50bn, the recapitalisation of Britain’s banks would more than double planned public borrowing this year, pushing public sector net borrowing close to £100bn and more than 6 per cent of national income, worse than any year since 1994-95.

The recapitalisation will deliver a huge boost to the banks’ core Tier One capital – the preferred measure of balance-sheet strength. This is expected to give the market greater confidence about the banks’ ability to absorb future losses.

However, the government’s move has a broader significance because it will also send a strong signal to the banks’ creditors that they are, in effect, protected from future losses. Concerns about losses among creditors, triggered by the collapse of Lehman Brothers, the Wall Street bank, are the main reason why banks have recently struggled to access the funding markets."

As all well know I'm not especially fond of the idea of handing over taxpayer money to private enterprises when they get into trouble, BUT at least this is an infusion of cash in exchange for preferred shares (and possibly dividends, profit sharing, etc), meaning that the banks are now effectively in debt to the taxpayer.

E.g. if you're going to do something like this have the taxpayer "locked in" to receive the upside due to having ownership in the companies being bailed out, instead of letting the companies being bailed out get off scot free via dumping their bad assets on taxpayers. 

Still it's a bad harbinger for the future when it appears that the governments of many of the world's strongest economies are going to have to execute some sort of de facto nationalization program in order to save their banking systems. At this juncture the bailout plans being executed via various governments aren't so much injecting life into the banking sector, as they're trying to keep the fire from spreading/putting a floor on the damage.

I.e. small cataclysms instead of gargantuan ones.

Of course this also begs the question: were their economies ever that strong in the first place, if their banks were overleveraged to the point of not being strong enough to survive a downturn/if their economies were largely built on debt and over-leverage?

You can read more on the subject here(FT), here(BBC News), and here(FT).

Sources:

The Financial Times: "Massive rescue plan for banks" -- George Parker, Chris Giles, Tony Barber, October 7, 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 | Global Economy on October 7, 2008 at 09:47 PM | Permalink | Comments (0) | TrackBacks (0)

Today's quote of the day comes from Warren Buffett:

"Price is what you pay. Value is what you get"

I.e. a stock should be considered cheap if the value of the stock exceeds its current price, not just because the stock is cheap on an absolute basis.

This is a very important distinction to make in today's market, what with fresh market bottoms being called everyday and banking executives blaming "rumors, short-sellers and other Hobgoblins" for the demise of their companies (as if the stock price of an insolvent company being propped up by lies and subterfuge is better for investors in the long run). 

During times like these investors (everyone really) needs to focus on the financial health of the underlying security and not get too wrapped up in what the current stock price is,  because a healthy company with a depressed stock price is a good investment, whilst a weak company with a healthy stock price is nothing more than a house of cards.

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 October 7, 2008 at 09:30 PM | Permalink | Comments (0) | TrackBacks (0)

(From the WSJ) : "Credit-market deterioration in the second half of September is enough to push the U.S. economy into recession, forecasters for the National Association for Business Economics say in their latest survey.

The 48 economists in the NABE panel say gross domestic product will decline 1.1% this quarter and 0.5% in the first quarter of 2009 if credit conditions don’t improve by year end. The survey was taken last Wednesday and Thursday as a follow-up to a NABE poll of its forecasters in mid-September. In the earlier survey, the panel said GDP would increase 0.1% — essentially flat performance — in the current quarter and a 1.3% increase next year according to the median view of forecasts.

The weak credit markets also mean higher unemployment. The jobless rate would hit 7% by mid-2009 under current conditions, compared to the 6.4% estimated in the initial survey, the panelists said.

For 2009, the NABE follow-up survey last week said the government’s $700 billion rescue plan “would blunt much of the economic decline that might otherwise develop.” Real GDP growth in 2009 would be about 0.75 percentage point lower next year without the government’s plan, and the unemployment rate at the end of next year would be half a percentage point higher.

In addition, stock prices — measured by the S&P 500 — would be 10% lower by the end of this year than they’d be if no plan were in place, the panel said. "

Following on the above here is a graphical look at various economic indicators that seem to indicate a high probability of recession:

Graphic courtesy of the WSJ

In other bloody obvious news scientists predict falling hitting your thumb with a hammer is likely to cause pain; but seriously I don't think it really matters what the official prediction is because to many households it has felt like a recession for months and they've been modifying their financial habits accordingly. Main St isn't going to suddenly feel more or less confident if the NABE tells we are or are not in a recession.

The distinction is purely academic at this point.

In my view businesses and consumers are dealing with significantly tougher economic times than they did in the last recession, so it doesn't make sense to waste much time worrying about whether or not the recession is "official". Especially when the typical citizen would laugh in your face if you told them "we're not actually in a recession right now", people based their perceptions on their own economic struggles not the pronouncements of the NABE.

The typical household is primarily concerned about the pain being inflicted upon them by the current economic environment and how to mitigate it; politicians, executives, analysts and economists need to get in touch with reality and start thinking about the "boots on the ground view" , as opposed to the one defined by macroeconomic indicators.

Sources:

The WSJ: "NABE Credit Turmoil Tips U.S. Into Recession" -- Sudeep Reddy, October 6, 2008.

Posted to: U.S. Economy on October 6, 2008 at 09:58 AM | Permalink | Comments (0) | TrackBacks (0)

Yeah, yeah, yeah, I know, the Cynical Bear is rubbing it in a bit………

….but you have to admit that this is hilarious!

Posted to: Randomization on October 6, 2008 at 09:17 AM | Permalink | Comments (0) | TrackBacks (0)

Last week the Fed took various steps to inject dollars/liquidity into the global markets, here is a look at their plans to increase the magnitude of those efforts:

(From Bloomberg): "The Federal Reserve will double its auctions of cash to banks to as much as $900 billion and is considering further steps to unfreeze short-term lending markets as the credit crunch deepens.

``The Federal Reserve stands ready to take additional measures as necessary to foster liquid money-market conditions,'' the central bank said in a statement released in Washington today. Fed and Treasury officials are ``consulting with market participants on ways to provide additional support for term unsecured funding markets,'' the statement said.

Today's steps follow a hoarding of cash by banks that sent the premium on the three-month London interbank offered rate over the Fed's benchmark interest rate to a record. Industrial companies are also finding it harder to raise cash after the market for commercial paper shrank to a three-year low as investors flee even borrowers with few links to mortgages.

``It is pretty much all out war,'' said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd., New York. ``They are pulling out all the stops to try and get borrowers and lenders to meet and do transactions once again.''

Implementing part of last week's emergency legislation to shore up the financial industry, the Fed said today it will begin paying interest on the cash reserves banks hold at the central bank. The step should give Fed officials greater power to inject cash into banks without interfering with their benchmark interest rate, which stands at 2 percent.

Bernanke Speech

Fed Chairman Ben S. Bernanke's speech on the economic outlook tomorrow in Washington should give an indication of whether U.S. central bankers are prepared to cut the main rate before the next meeting Oct. 28-29, Rupkey said.

As part of today's steps, the Fed will increase its auctions under the 28-day and 84-day Term Auction Facility operations to $150 billion each. The two forward TAF auctions in November will be increased to $150 billion each, the Fed said.

Money market rates are climbing worldwide on concern the deepening credit crisis will cause more financial firms to collapse. Three-month Libor climbed to 4.29 percent today, the biggest premium over the Fed's benchmark since the central bank began using a target for the overnight federal funds rate between banks as its main tool around 1990."

The Fed is flooding the global markets with dollars and yet LIBOR continues to increase and the credit crunch continues to get worse, which begs the question: how many dollars are needed, what happens when all of those dollars flow back into the global economy and what will be the long-term effects of the Fed deflating our currency into monopoly money?

I understand the need for drastic measures for drastic problems and I'm not necessarily disputing the need for the Fed's recent actions, I'm just asking the question: will this cure turn out to be worse than the disease?

You can read the article in full here(Bloomberg), and the Press Release from the Fed that also discusses changes brought about by the signing of TARP here.

Sources:

Bloomberg: "Fed Boosts Cash Auctions to $900 Billion, May Do More" -- Scott Lanman, Craig Torres, October 6, 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 | Global Economy on October 6, 2008 at 08:59 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a look at the steps various governments are taking in response to a growing banking crisis in the Eurozone:

Graphic courtesy of the WSJ

(From the WSJ): "...The crisis in Europe now has broadened from the implosion of U.S. mortgage-related assets to a mounting unwillingness among European banks to lend to one another and a growing loss of confidence among investors and in some cases depositors. Adding to the predicament, governments from Ireland to Germany are trying to reassure their increasingly anxious voters. Denmark and Austria were also preparing extra protection for consumer deposits in the wake of the German move.

Other European banks could face similar funding strains to those of Fortis and Hypo, requiring public or private financial aid, as investors avoid making the kind of short-term loans that banks depend on for funding. In a sign that banks' borrowing costs are rising, the euro London interbank offered rate, or Libor, a measure of the rates at which banks lend to one another, hit 5.33% Friday, compared with 4.95% on Sept. 1.

Sunday's frantic and disparate moves raise questions about whether European governments, regulators and bankers have a comprehensive approach to addressing the deepening financial crisis. Some of Europe's largest economies are already flirting with recession.

"It's been a shocking reality check for everyone, and the specter of a vicious downward spiral of financial conditions and economic growth has now taken a very definite and concrete shape in everyone's mind," UniCredit global chief economist Marco Annunziata told clients in a note. Mr. Annunziata's note wasn't directly referring to UniCredit's situation."

The global banking system is so interconnected right now that if the governments of the world truly want to deploy a solution to the problem they're going to have to work together, because the current semi-coordinated patchwork of solutions will only affect their micro (domestic) problems as opposed to the macro environment the banks operate in. Meaning: the political and banking leaders of the world need to meet together and find a solution to this thing NOW.

A "show of solidarity" has its value, but without a unified and coordinated solution to the crisis things are going to get a lot worse before they get better.

You can read more here.

Sources:

WSJ: "Europe Races to Shore Up Banks as Crisis Spread" -- Marcus Walker, Sabrina Cohen, Dana Cimilluca, David Gauthier-Villars, October 6, 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 | Global Economy on October 6, 2008 at 08:48 AM | Permalink | Comments (0) | TrackBacks (0)

On Friday the markets fell despite (or in response to) the passage of the bailout bill, today we're experiencing a global sell off,, and domestically the Dow is down by about 4% (at the time I was writing this) and the S & P is down by about 5%.  Meanwhile the credit crunch continues to deepen despite the passage of the bailout bill and the recent moves by the Fed to flood the world with dollars.

Obviously things are continuing to get worse despite the best efforts of the U.S. Government, the Fed and their counterparts around the world, which begs the question: are they merely preventing things from getting worse (mitigating a calamity into mere disaster) , are their actions insufficient with respect to the scope of the problem, are they merely attacking the wrong problem, or is it a combination of all three?

My view is that while their actions are serving to mute things a bit, the real problem is a fundamental problem with the banks operate, their financial structure (use of derivatives to meet capital requirements, credit default swaps as regulatory arbitrage, etc) and the way they're regulated. Not to mention the fact that the problem is being approach (for the most part) as if it's merely a crisis of confidence, as opposed to a crisis created by financial institutions that are simply losing money on bad investments, are insolvent (or close), on top of being over leveraged and under capitalized.

While you can't fix a broken system overnight, pumping money into a broken system in order to prop it up until "things get better " isn't exactly a good idea either. It's somewhat analogous to just giving Advil to a patient with a broken leg, instead of giving them Advil, setting their leg and making future arrangements for physical therapy once the leg heals.

In other words the problem with the current round of solutions is that the governments and central banks of the world are focused on handing out pain killers, instead of thinking in terms of: easing today's pain, working on solving root causes and making future plans to avert the next round of crises.

It sounds like a tall order (it is) and it's hard to think on multiple fronts in the middle of a crisis, but do we have any other choice if the alternative (Advil) isn't going to solve any of the fundamental problems at the heart of the crisis?

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 | U.S. Economy on October 6, 2008 at 08:13 AM | Permalink | Comments (0) | TrackBacks (0)

A quick mix tape of the usual types of things, with this one heavily slanted (for obvious reasons) towards issues related to the bailout, financials, etc:

First off a graphic looking at consumer spending over the past quarter, it comes from a WSJ article discussing the high probability that consumer spending will be down for all of Q3.

Graphic courtesy of the WSJ .

Now I (and others) have been arguing that consumer spending numbers have been inflated by higher grocery and gasoline prices for well over a year now, and that spending has been negative over that time period when you account for inflation. But perhaps the more striking argument is that consumer spending is still down on a nominal basis in spite of the inflationary pressures.

Here is a WSJ op-ed discussing the need and strategies to recapitalize the banks , as the bailout plan moves forward I think the need to recapitalize the banks will become more glaring, it will be interesting to see how this is accomplished at the bank level (raising capital from investors) and at the government level (bailout plans, TARP V2.0). With respect to raising cash from investors it goes without saying that the government will have to be more receptive to allowing SWF to take huge stakes in our banks, and/or takeovers by foreign banks.

Needless to say it's unlikely that we've seen the last of the major sweeping changes to our banking system.

In a story that wasn't followed much Farmer Mac (a GSE focused on the farming industry) was rescued by a consortium of lenders; while the scale of this rescue was rather small by recent standards ($65 million) it does beg the question: in instances where we see the need for a GSE to be created, do we really want the government managing them? I'm not sure if private sector oversight boards are the way go to either (it's not like they do a great job in corporate America) but some other method of providing oversight is obviously needed.

Here is a look at an interesting way to approach FOREX: the Big Mac Index , it's a method used by The Economist to compare the relative value of various currencies to one another based on the cost of a Big Mac. Not sure I completely agree with using something as unappetizing as a Big Mac to determine the relative value of various currencies, but it's rather interesting nonetheless.

Here is a look at the way in which auto lenders are being effected by the credit crunch and the impact it's having on auto sales; I find this one interesting because one hand the auto lenders are facing some very real funding issues and on the other many of them have a history of bad lending habits (in my opinion at least).

Just think about it the average term and amount for auto loans had been steadily increasing until recently (per data from the Federal Reserve ), at a rate that far outpaces the typical increase in people's incomes. For example for the year 2000 the Avg. car loan was for $20,923.00 and the average term was 54.9 months, in 2004 it was $24,888.00 loan with a term of 60.5 months and in 2007 it topped out at  $28,287 and 62.0 respectively.

Furthermore I'm sure that on an anecdotal basis we all know of people who have financed cars whose value far exceeded their income, when it comes to cars it appears as if people were basing their affordability assessment based on what someone would let them finance.

On a go-forward basis both auto lenders and auto manufacturers are going to have reset a lot of their expectations, because the days of easy credit (even after the economy recovers) have gone for the short-medium term.

Paul Kedrosky has a humorous post compared Credit Default Swaps to the Rodent's of Unusual Size from "The Princess Bride" , all kidding aside he makes some very valid points around how the CDSs are likely to wreck havoc on the credit markets and often when people aren't expecting them to.

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 | Financials | U.S. Economy on October 3, 2008 at 03:28 PM | Permalink | Comments (0) | TrackBacks (0)

It's official: the pork laden , ill-conceived bailout bill has passed the house and been signed by the President, or as this cynical Calvinistic individual would like to say it:

After letting laissez-faire economics run amuck and nearly bring the world's economies and financial systems to its knees, the government has decided to go the opposite direction via  ramming a so called "rescue bill" down the throats of American citizens that hands over 100s of billions of dollars to Wall St. The situation would be tolerable if the plan was likely to work, but instead we were force fed a plan that isn't really capable of delivering on its promises around housing , and won't really be able to help the banks either .

Maybe the markets realized this today and that's why they actually fell after the bill was passed, with the S & P 500 closing below the level it was at when the first bill failed to pass the house. Now was it due to the passage of the bill, the sheer weight of the economic problems the country is facing or because the passage was anti-climatic?

At this point I'm not sure, however if the markets continue to worsen in the weeks and months after the bill is passed and there isn't (at least) a short-term "pop", it doesn't bode well for the future.

Either way even if there is some short-term improvement in the credit and financial markets once the rescue plan is put into action, I anticipate a huge let down once the plan fails to show results. In fact the let down from a bailout plan that fails to deliver is more worrisome to me than the impact of not having a plan (even a bad one) at all.

Something that irritates me to no end is the fact that the people who created the plan and are now tasked with managing it, are (by varying degrees) responsible for either running the mortgage GSEs into the ground, the overall crisis in general or both. I.e. the people who have allegedly just "saved us all" are also the ones who got us into this mess in the first place . Wall St. couldn't have nearly destroyed the economy if the clowns in Washington hadn't facilitated the whole debacle, looked the other way or were just too ignorant to know what was going on.

The whole thing feels analogous to asking the person who stole your car and sold it for drug money, to track down your car and deliver it back to you for a fee. Obviously no one would ever do such a ridiculous thing, yet here we are doing that very same thing with the government and our economy.

Regardless the individuals who have been pleading for the government to save them from their own stupidity have finally gotten their wish, and now we're going to see how effective the rescue bill will truly be and what the short, medium, and long-term impacts will be.

At this juncture the big question isn't so much on the pending efficacy (or lack of thereof) of TARP, but how will the nation react when we still have a crisis six months now and need to put our heads together to draft a new solution? Will we get it right the next time?

You can read more here(WSJ) , and here(NYT) .

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 October 3, 2008 at 02:22 PM | Permalink | Comments (0) | TrackBacks (0)

Aside from the passage of the bailout bill probably one of the bigger stories today is Wells Fargo swooping in to "steal" the Wachovia buyout out from under Citigroup, a move that Citigroup is protesting vehemently as they already had an agreement in place and had been providing liquidity (not to mention confidence) to Wachovia.

(From the FT): "Wells Fargo on Friday sparked a regulatory and legal row with a surprise $15.1bn all-share offer for Wachovia, trumping Citigroup’s $2.2bn government-aided deal to buy most of the sixth-largest US lender.

Stunned Citigroup officials - who first heard of the Wells deal just before dawn on Friday - threatened to seek an injunction to stop the transaction or demand substantial damages.

Citi - which was left as the only bidder after San Francisco-based Wells abandoned talks with Wachovia last weekend - was also considering whether to raise its offer, with a decision expected in days, people close to the situation said.

The extraordinary turn of events left regulators and officials scrambling to resolve the tug-of-war over Wachovia, whose shares had plunged on fears over its troubled mortgage assets.

The regulators - including the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation - were understood to be unhappy with the Wells offer. They were concerned that if Citigroup loses Wachovia it could discourage banks from co-operating in future rescue operations."

As a businessman I understand Citigroup's perspective, they had an agreement in place, had been providing funding to Wachovia and expect the deal to be honored, but as a taxpayer (and as someone with a vested interest in the health of our economy and financial system) I like the Wells Fargo deal better because it doesn’t require the already strapped FDIC to absorb losses from Wachovia's mortgage portfolio. Better yet, despite the rumblings around Wells Fargo they're still financial healthier than Citigroup, and it just makes more sense for Wachovia to be absorbed into Wells than into a bank that is still reporting losses and plenty of problems of its own.

Unique (and/or desperate) times call for in kind solutions and I think the Wells Fargo deal is simply a better one for the American taxpayer, our Economy and our Banking system and is the one that the FDIC should support.

The FDIC should simply rescind their support of the Citigroup/Wachovia buyout, gently encourage them (along with the Fed and Treasury) to back off, and they should require Wells to compensate Citi for the liquidity it had been providing Wachovia before the deal with Wells Fargo was announced.

Again while I respect the fact that Citigroup feels that they had a deal and it should be honored it doesn't change the fact that they can't pull it off without help from the government, so I'm rather struck by the audacity of City to more or less insist that the taxpayer help them buy Wachovia when there is another suitor around who can afford to buy the company without help from the FDIC.

Buying Wachovia is as much about protecting the economy as it is about business, and Citi should be gracious enough to understand that Wells buying Wachovia is simply better for the common good and just walk away from the situation. 

As for other banks seeing the situation as a reason to not to participate in future rescue operations: I would think that nation's banking executives as capable of behaving like adults, and understanding that this is a rather unique situation especially since one deal requires taxpayer support and the other one doesn't. Rescue operations are about protecting the larger banking system AND giving healthier banks the opportunity to pick up assets on the cheap, and if the nature of this deal discourages other banking executives from participating in rescue operations (especially given everything at stake), then we have MUCH, MUCH bigger problems to deal with.

You can read more here(FT) and here(WSJ).

Sources:

The Financial Times: "Citigroup moves to thwart Wells-Wachovia deal" --  Francesco Guerrera, Saskia Scholtes,  Joanna Chung and Krishna Guha, October 3, 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 October 3, 2008 at 01:02 PM | Permalink | Comments (0) | TrackBacks (0)

I knew Valdermort was behind this!

Posted to: Randomization on October 3, 2008 at 12:30 AM | Permalink | Comments (0) | TrackBacks (0)

It's no secret that I'm of the opinion that Congressional hearings are often a waste of time, that the politicians on the Senate Banking and House Financial Services Committee are clueless and that Congress is to blame for mismanaging the Mortgage GSEs. Lest you think that I simply like bashing politicians for fun and sport, here is a look at some excerpts from the hearings on Fannie and Freddie after the latter's accounting issues came to light:

(From the WSJ): "Rep. Barney Frank (D., Mass.): I worry, frankly, that there's a tension here. The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios. . .

Rep. Maxine Waters (D., Calif.), speaking to Housing and Urban Development Secretary Mel Martinez: Secretary Martinez, if it ain't broke, why do you want to fix it? Have the GSEs [government-sponsored enterprises] ever missed their housing goals?

House Financial Services Committee hearing, Sept. 25, 2003:

Rep. Frank: I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . . .

House Financial Services Committee hearing, Sept. 25, 2003:

Rep. Gregory Meeks, (D., N.Y.): . . . I am just pissed off at Ofheo [Office of Federal Housing Enterprise Oversight] because if it wasn't for you I don't think that we would be here in the first place.

And Freddie Mac, who on its own, you know, came out front and indicated it is wrong, and now the problem that we have and that we are faced with is maybe some individuals who wanted to do away with GSEs in the first place, you have given them an excuse to try to have this forum so that we can talk about it and maybe change the direction and the mission of what the GSEs had, which they have done a tremendous job. . .

Senate Banking Committee, Oct. 16, 2003:

Sen. Charles Schumer (D., N.Y.): And my worry is that we're using the recent safety and soundness concerns, particularly with Freddie, and with a poor regulator, as a straw man to curtail Fannie and Freddie's mission. And I don't think there is any doubt that there are some in the administration who don't believe in Fannie and Freddie altogether, say let the private sector do it. That would be sort of an ideological position.

Mr. Raines: But more importantly, banks are in a far more risky business than we are.

Senate Banking Committee, Feb. 24-25, 2004:

Sen. Thomas Carper (D., Del.): What is the wrong that we're trying to right here? What is the potential harm that we're trying to avert?

Federal Reserve Chairman Alan Greenspan: Well, I think that that is a very good question, senator.

What we're trying to avert is we have in our financial system right now two very large and growing financial institutions which are very effective and are essentially capable of gaining market shares in a very major market to a large extent as a consequence of what is perceived to be a subsidy that prevents the markets from adjusting appropriately, prevents competition and the normal adjustment processes that we see on a day-by-day basis from functioning in a way that creates stability. . . . And so what we have is a structure here in which a very rapidly growing organization, holding assets and financing them by subsidized debt, is growing in a manner which really does not in and of itself contribute to either home ownership or necessarily liquidity or other aspects of the financial markets. . . .

Sen. Richard Shelby (R., Ala.): [T]he federal government has [an] ambiguous relationship with the GSEs. And how do we actually get rid of that ambiguity is a complicated, tricky thing. I don't know how we do it.

I mean, you've alluded to it a little bit, but how do we define the relationship? It's important, is it not?

Mr. Greenspan: Yes. Of all the issues that have been discussed today, I think that is the most difficult one. Because you cannot have, in a rational government or a rational society, two fundamentally different views as to what will happen under a certain event. Because it invites crisis, and it invites instability. . .

Sen. Christopher Dodd (D., Conn.): I, just briefly will say, Mr. Chairman, obviously, like most of us here, this is one of the great success stories of all time. And we don't want to lose sight of that and [what] has been pointed out by all of our witnesses here, obviously, the 70% of Americans who own their own homes today, in no small measure, due because of the work that's been done here. And that shouldn't be lost in this debate and discussion. . .

* * *

Senate Banking Committee, April 6, 2005:

Sen. Schumer: I'll lay my marker down right now, Mr. Chairman. I think Fannie and Freddie need some changes, but I don't think they need dramatic restructuring in terms of their mission, in terms of their role in the secondary mortgage market, et cetera. Change some of the accounting and regulatory issues, yes, but don't undo Fannie and Freddie"

So what's missing from these conversations? A constructive dialogue around the risks to the global economy if the mortgage GSEs were to run into trouble (let alone fail), how best to manage the mortgage GSEs and a frank discussion around their financial health. After all shouldn't  these discussions have been focused on financial health and management strategy, with the goal of reducing the risks the GSEs posed to the economy and insuring their on-going financial health?

So why is it that the dialogue was really about one party believing that the other simply didn't believe in the mission of the GSEs and was just out to destroy them for ideological reasons? Why weren't our politicians able to put aside the political grand standing on homeownership, put away their partisan politics, read the balance sheets of the two companies and focus on the core issue: maintaining the financial health of Fannie Mae and Freddie Mac on a go-forward basis?

In my view the answer is that the mortgage GSEs were seen more as vehicles for politician gain then they were seen as vital parts of the global financial system; as long as home ownership rates were going up, as long as someone felt their community "needed the GSEs", and as long as touting the mission of Fannie and Freddie served their purposes they had zero interest in tinkering with the two companies.

For evidence of this look no further than the fact that Congress authorized the GSEs to expand the scope of their investment activities after the onset of the credit crunch, despite the fact that both companies began losing money once the housing downturn hit (and even when they did it was due to tax treatment). Again, Congress wasn't especially interested in maintaining the financial health of the mortgage GSEs, they just wanted to appear as if they were doing something to halt the slide in housing prices.

Apparently speaking honestly with the American people about the fact that housing prices were hyper-inflated during the boom, and that the real estate market was going through a very necessary correction, was simply not an option for them.

The recent problems with the mortgage GSEs could've been avoided if Congress had reined them in years ago (or the very least in the wake of the credit crunch), instead of choosing politics over common business sense. After all there were many analysts and notables (such as Warren Buffett) who warned about the risks posed by Fannie and Freddie, so it's not like Congress can say that no one warned them. While it's fair to deride their executives for running the companies into the ground, the politicians on Congress' banking and financial services committees deserve a large share of the blame as well.

All of this begs the question: can we really trust politicians to manage entities like the GSEs or any other key private sector investments/companies, et al, if there is a risk that their political aims, partisan politics/bickering, et al could prevent them from making the right decisions?

Final thought: does anyone else  feel nervous about the fact that the very people who ran the GSEs into the ground are now working on the bailout bill? How about the fact that they will be working on additional solutions to the current crisis, new banking regulations, etc?

You can read the transcript excerpts in full here.

Sources:

The WSJ: "What They Said About Fan and Fred" -- October 2, 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 October 3, 2008 at 12:15 AM | Permalink | Comments (0) | TrackBacks (0)

Note: I posted this back in May in the wake of the Credit Crunch and the Bear Stearns collapse, in light of recent events and the prevalence of banking executives walking away with millions after their companies are bailed out, they get the sack etc, I felt it was apropos enough to post it again.

Perhaps the most telling thing about the article is that it was written on January 5th, thus it predates the Bear Stearns collapse, the Lehman Bankruptcy, AIG, the Mortgage GSEs, the record for the largest bank failure getting broken three times in a matter of weeks, etc, etc, and it's more relevant NOW than it was then!

*An additional note for the Yanks in the audience: in British English (or as my father says ACTUAL English ) a “punter” is a gambler.

The original blog post follows below with only a few very tiny minor changes to language and grammar in the 2nd to last paragraph. 

Whilst this article from the telegraph is several months old, it’s still a fantastic commentary on the Banking Industry. Even though it’s focused on British Banking industry you could easily just replace the names of their banks with Americans ones and leave the entire article intact. Considering everything that has happened since this article was written, it’s an even more apt description of banking industry nonsense than it was back in January.  

(From the Telegraph): “About 10 years ago, I had lunch with some directors of C. Hoare & Co, the independent private bank, at its head office in Fleet Street. They were extremely courteous, but also rather odd: there was no sales pitch…

…Bemused by my hosts' PR-lite table manners, I started firing questions. "The bank has been around since 1672, yet has only two branches - what are your plans for expansion?"

The most senior director present, I think it was Henry Hoare, replied: "We don't really have any. We believe we have about the right number of customers and are not interested in getting bigger just for the sake of it."…

..But here's the rub: Hoare & Co is no ordinary bank. It is wholly owned by Hoare family members and is financed entirely by them on an unlimited liability basis. They are on the hook for every penny, which helps to explain the bank's statement: "We have a highly conservative attitude to risk."

So conservative, in fact, that even after more than 330 years, Hoare & Co's balance sheet is barely above £1bn: small change in the world of high finance. But the bank is still standing and, unlike some of its more ambitious competitors, has no need to pass round the hat for emergency funds...

...How many of these bankers, I wonder, would have been quite so keen to punt on financial products they clearly did not understand if, like the partners at Hoare & Co, they had been forced to play the tables with their own chips?

How many would have been promoting no-deposit, 125pc of collateral, six-times salary, self-verifiable mortgages at the top of a rip-roaring housing market if, in making such loans, they had to put at risk their own homes?

As it was - and no doubt will be again, because the industry is blighted by boardroom amnesia - these executives were able to enjoy a gigantic one-way bet. When, instead of boring old banking, they had a wild day at the races and won, it was huge bonuses all round. On the other hand, if their gambles failed, not to worry, seven-figure salaries remained intact and, in extremis, there was always the safety net of jackpot pay-offs for destroying value.”

Articulated above is a key root cause of our global financial crisis, the people making the bad decisions were making "one-way bets", they win big if they're right and win small if they're wrong. So it’s no wonder the entire financial system is in a mess. Can you imagine how the executives of institutions like Citibank and Merrill Lynch would’ve behaved if they were risking present and future compensation, in addition to having to give back past bonuses? How would’ve Chuck Prince and Stanley O’Neal have behaved if they knew they would be leaving their respective CEO jobs with a bill from the shareholders, instead of large checks if/when they were sacked?

The position of financial executive shouldn't be one where you can risk the economy and shareholder equity but bear zero risk yourself; a change is needed because you can’t really expect people to manage risk properly when they’re only risking not receiving a larger payout as opposed to no payout at all. Of course this is all wishful thinking since the banking system was designed by bankers, and they’re not going to re-engineer it in a way that forces them to shoulder more risk.

You can read the article in full here.

Sources:

The Telegraph: “Bankers would not be punters if they were forced to pay all losses” – Jeff Randall, January 5, 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 October 2, 2008 at 01:16 PM | Permalink | Comments (0) | TrackBacks (0)

Last week Martin Wolf of the Financial Times had a great article on the bailout plan that I neglected to post, here is a quick excerpt:

(From the Financial Times): "What then is the challenge? The answer given by Hank Paulson, the all-action US Treasury secretary, last Friday, in announcing his “troubled asset relief programme”, is that “the underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy.” The core challenge, then, is viewed as illiquidity, not insolvency. By creating a market for the toxic assets, Mr Paulson hopes to halt the spiral of falling prices and bankruptcies.

I suggest we should take a broader view of events. The aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007 (see charts). The balance sheets of the financial sector exploded, as did the sector’s notional profitability. But leverage, alas, works both ways.

Graphic courtesy of the Financial Times

Since US net international debt was 39 per cent of GDP at the end of 2007, virtually all of this debt is an asset of another domestic entity and would net out to zero. But when the gross debt stock is huge and economic conditions difficult, the chances that many entities are bankrupt is high. When people fear mass insolvency, lenders stop lending and the indebted stop spending. The result can be the “debt deflation”, described by the American economist, Irving Fisher, in 1933 and experienced by Japan in the 1990s.

Given the recent explosion in leverage, the challenge is unlikely to be one of mispricing of the toxic mortgage-backed securities alone. Many people and institutions made leveraged bets that have since gone sour. Their debt cannot be repaid. Creditors are responding accordingly.

Now turn to the criteria to be used in judging the intervention. First, it would deal with the systemic threat. Second, it would minimise damage to incentives. Third, it would come at minimum cost and risk to the taxpayer. Not least, it would be consistent with ideas of social justice.

The fundamental problem with the Paulson scheme, as proposed, is then that it is neither a necessary nor an efficient solution. It is not necessary, because the Federal Reserve is able to manage illiquidity through its many lender-of-last resort operations. It is not efficient, because it can only deal with insolvency by buying bad assets at far above their true value, thereby guaranteeing big losses for taxpayers and providing an open-ended bail-out to the most irresponsible investors"

I think the key to all of this is that if the government buys assets on which the banks are levered up 7,12,15,20:1 (or more), it won't solve their insolvency issues even if Paulson pays the full "Mark to Model" price from the time of the credit boom. Forget the arguments over the lack of penalties for the banks, lack of respect for the taxpayer, the nonsensical notion that the government will make money from the bailout, etc, etc, the fact that's not sufficient enough to address the issues of over leverage, under capitalization and over insolvency is all that matters.

Now this was written on 9/23/08 back when Paulson's initial proposal was first created, and despite all of the machinations in Congress, the plan's changes, etc, the plan's fatal flaw with respect to its inability to address the insolvency problem remains. If that doesn't articulate why this plan is a bad idea than I don't know what does.

Finally something else that really needs to be discussed is that our nation's debt addiction has reached a veritable crescendo that threatens to throw the nation (if not the global economic system) into ruin. The nation's consumer, corporate and government(taxpayer) has reached a level that is simply unsustainable over the short-term, let alone the medium or long-term. If we really want to address the roots of the current economic crisis, we as a nation have to start making some tough choices and reset our expectations around consumption, money management and use of debt.

You can read more here.

Sources:

The Financial Times: "Paulson’s plan was not a true solution to the crisis" -- Martin Wolf, 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: Politics & Business | U.S. Economy on October 2, 2008 at 12:23 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a collection of graphics from the WSJ depicting a timeline of the markets, the performance of various major market indices and the performance of the 30 companies that make up the Dow:

First a timeline of the Q3 performance of the Dow, including notations for various key events related to interest rates, the credit crunch, bailouts, et al.

Graphic Courtesy of WSJ

Here is a look at the performance of the major market indices over the same time period:

Graphic Courtesy of WSJ

Here is a look at the performance of the components of the Dow over the course of Q3:

Graphic Courtesy of WSJ

Ironically enough despite the fact that the current crisis originated in the financial sector it was the financials (especially if you remove AIG) that out performed the rest of the Dow, of course it goes without saying that the financial companies in the Dow are (largely) the cream of the crop and stronger than the rest. Still, an interesting trend to be sure.

Needless to say Q3 was a truly historic time that will be analyzed for decades, but to thing to remember is that it's not so much the crisis in of itself that's important it's our RESPONSE to it that truly matters. When I think about the current response it's not the response in of itself that bothers me, it's the fact that I don't see any momentum building towards long-term solutions that will prevent similar crises in the future.

Something I'm hoping for is a complete change in corporate governance (especially in the banking sector), where we as investors (as a society really) no longer allow corporate executives to behave as gamblers who can't lose. Because if we got that one change a lot of other problems will solve themselves.

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 October 2, 2008 at 11:37 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a chart from the economist looking at the cost of various bailouts (expressed as % of GDP) in the U.S. and other countries:

Graphic courtesy of the Economist.

When we look at the cost of some of these other bailouts it definitely puts ours in the proper perspective, as spending 6 % of GDP is a drop in the bucket compared to the 31% that South Korea spent. However it's important not to focus too much on cost as it is to consider the efficacy of the dollars being spent, and to ask ourselves if the proper steps are being taken to prevent similar crises in the future.

Posted to: Global Economy on October 2, 2008 at 10:48 AM | Permalink | Comments (0) | TrackBacks (0)

For the record this is satire and I'm not making the claim that this is how the bailout money will be spent, BUT……

Graphic courtesy of the Onion.

….. if this was the bailout plan at least it would be funny

Posted to: Randomization on October 2, 2008 at 10:37 AM | Permalink | Comments (0) | TrackBacks (0)

Interesting little tidbit from the WSJ's "Real Time Economics Blog" around the economic literacy levels of the members of Congress:

(From the WSJ): "As Congress works on one of the most important pieces of economic legislation in a generation, a Washington research group has pointed out that more than 8 in 10 members of Congress don’t have a formal educational background in the business, economics, or finance fields.

The research by the Center for Economic and Entrepreneurial Literacy , which aims to educate the general public about finance issues, showed that about 14% have degrees in economics-related fields and just 6.7% specifically have an economics degree. More than 30% of members have degrees in politics and government, while 18% majored in humanities.

“It’s interesting that those who are responsible for solving the biggest economic crisis in generations don’t have the educational background to know the difference between commercial paper and copy machine paper,” said James Bowers , managing director of CEEL."

CEEL looked only at undergraduate majors or minors and graduate degrees in economics, business and finance. Law degrees weren’t included in the tally.

Such a rubric leaves off Senate Banking Committee Chairman Chris Dodd and ranking member Richard Shelby , as well as House Financial Services Committee Chairman Barney Frank and ranking member Spencer Bachus . They all have law degrees, but don’t have formal education in other economics-related fields. "

Personally I think the real problem here isn't so much the lack of formal education as it is the lack of formal EXPERIENCE in the world's of business and/or finance, as the business world is full of people who majored in Engineering, Humanities, Law or Mathematics who go on to become quite successful in the business world. It's not that our Congress isn't full of educated people it's that it isn't necessarily full of educated BUSINESS PEOPLE, and more specifically business people who have a solid understanding of the dynamics at play in this particular crisis.

After all when you hear the rhetoric coming out of Washington around the bailout plan (for and against), the potential benefits/costs/negative aspects of it, not to mention the usual rhetoric around economic and business issues, it's quite clear that most of these individuals are rather clueless. So for me it's not so much their educational background as it is their working knowledgebase.

Still the point around economic illiteracy at the average citizen level and within our government is very valid, it's quite rare to hear a politician speak knowledgeably on business or economics instead of just parroting their political party's ideological talking points.

You can read more here.

Sources:

The WSJ: "Real Time Economics: Most Lawmakers Don't Have Economic Education" -- Phil Izzo, October 1, 2008.

Posted to: Politics & Business on October 1, 2008 at 01:28 PM | Permalink | Comments (0) | TrackBacks (0)

For the record this plan is slightly tongue in cheek, but at the end of the day if the Government can come up with a ridiculous plan why can't I come up with a more viable plan that's just ridiculous expensive? To set the proper context let's assume that (for some reason) the Government is going to spend $500-$700 billion to bailout the economy and so the only question is "how" the Government will spend the money as opposed to IF.

Let's assume that the government is going to spend $500 billion in this particular instance within the following areas:

Infrastructure : over the medium term (let along the long-term) it's going to be harder to build a strong economy if our roads and bridges are falling apart, so one pillar of the plan would be to spend $100 billion on infrastructure projects. This investment would benefit the nation tremendously as it would create jobs, inject cash into the economy and strengthen our infrastructure for the future.

Savings Plan : part of the reason for the anger over the current bailout is because it feels like (and largely is) a transfer of wealth from the taxpayer to Wall St, however the anger taxpayers feel doesn't change the fact that the banks are desperately in need of capital and the Government has to do something to shore up our banking system. My savings plan idea is a potential solution:

$2,000 ($200 billion total) per taxpayer would be directed towards the banks in the form of a CD in the name of each taxpayer, the idea is that the banks would receive a large cash infusion and the taxpayer would receive a base interest rate + a % of the profits the bank is able to generate with that money. After a time period of 12-36 months the principle is returned to the treasury (the and the taxpayer receives their share of the interest and profits, and the bank should have (in that interim time period) recapitalized itself so that it no longer needs the infusion from the government.

The plan doesn't sound as sexy as allowing the banks to dump bad mortgage securities on the taxpayer, but I seriously doubt the financial systems are going to be as frozen up if $150-$200 billion is injected into them overnight and the cost is slightly higher than a high yield CD.

Consumer Debt : create a two-fold economic stimulus plan that pays out $1k per taxpayer in cash for them to use however they like, and that also allows them to assign an additional $1k to any bank they owe debt to (debt free taxpayers could add to the CD above). This would (again) infuse the banking system with $100s of billions yet deliver significant benefits to the taxpayer as well. While it doesn't have the allure of being able to allegedly sell mortgage securities for a profit in the future, it would be able to deliver a significant amount of tax revenue in the form of increased banking profits and consumer spending.

Another  potential addition to the plan could be $50-$100 billion worth of need based grants for college students (and/or for any worker seeking continuing education), which would not only enable more people to get educated, but reduce their debt burdens post college. 

Like I said in the introduction I mean for this to be slightly tongue in cheek but seriously illustrative of some ideas that could be used to assign direct benefits from the bailout to the consumer and to the banks at the same time, because if we're just to hand over $700 billion without focusing on the recapitalization issue and/or overpaying for mortgage securities we could just as easily redirect those funds to something significantly more beneficial. 

After all my "tongue in cheek but with a degree of seriousness" plan would cost $100-$200 billion less, shore up the nation's infrastructure and create millions of jobs, increase savings rates, reduce consumer debt and stimulate consumer spending in one fell swoop. Obviously it doesn't have the potential of turning a profit and/or breaking even and would be a lot more expensive, but to say that the current plan is going to be profitable is somewhat spurious, not to mention the fact that the benefits are directed at a few and it misses a lot of core problems facing the banking industry.

I.e. as I said in the opening, why can't I create a somewhat ridiculous plan of my own while simultaneously creating one with more benefits?

Posted to: Randomization on October 1, 2008 at 12:55 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a quick at various news stories and other items I think you may find interesting:

You can read a revised copy of the bailout bill here,   the biggest changes to the new bill appear to be a measuring raising FDIC insurance to $250k (meaningless to all but a small % of U.S. citizens) and raising the ceiling (it's now unlimited) on the amount the FDIC can borrow from the treasury.

While many are touting the raising of the FDIC limit as a way to prevent runs on banks I have to say I'm rather skeptical, because I suspect that the people who get scared the most are folks of average means that can't risk losing a cent or having access to their funds interrupted. Raising the limit to $250k isn't going to stop scared consumers with more pedestrian account balances from running scared from troubled banks.

You can also read additional coverage from the WSJ on the revised bill here.

A story in the FT around the dollar breaching $1.40 against the Euro, and how many analysts are thinking the dollar will continue to gain strength in the future. While I don't think the analysts arguments are totally invalid per se, I think the combination of the bailout plan and Bernanke flooding the world with dollars will combine to deflate the dollar past the short-term. You can't just flood the world with dollars and expect them to increase in value at the same time.

You can get up to date currency rates from Bloomberg here.

Speaking of which here is an article that suggest that Oil Prices are going to skyrocket as a result of the above, and while I think many will balk at his argument you can't ignore the supply and demand issues and the inflationary scenario caused by a weakening U.S. dollar.

Warren Buffett is continuing to take advantage of depressed stock prices by injecting $3 billion into GE shares; something tells me that when he was predicting this crisis back in '02 he was also researching potential investments he could snap up for cheap once the market tanked. Don't be surprised if you see him making some more high profile investments in the near future.

Auto Sales plummeted in September due to usual/expected problems around credit, higher gas prices, economic worries, slumping demand for SUVs, etc.

I suspect that the auto industry won't quite "recover" even when the economy does, because the hey day of the SUVs is over and an economic crisis of this magnitude is likely to influence customer behavior for decades, meaning many people who used to buy a new cars long before their current one needed replacing may decide to instead keep their cars for a few years longer.

I'm thinking of scenarios where a household decides to delay their usual car upgrade/replacement cycle due to the economy, realizes along the way that the current vehicle is perfectly fine and that good economic times or not they're not losing anything by hanging on to the car for a few more years, thus leading to a change in behavior where they start hanging on to their cars for longer periods of time.

While this is somewhat anecdotal and based on my own experiences around delaying my planned new car purchase due to worries about the larger economy (it felt irresponsible to be honest) as opposed to issues with my own finances, it still stands to reason that the current crisis could effect significant changes in consumer behavior and  the car industry could suffer as a result.

In an era where a well maintained car can easily last for 7-10 years with minimal losses in performance, aesthetics, etc, the usual 3-5 year replacement cycle isn't exactly necessary. 

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 | Energy | FOREX | Financials | Politics & Business | U.S. Economy on October 1, 2008 at 12:06 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an extremely humorous (yet economically valid) blog post from Mark Perry's Carpe Diem blog:

(From Carpe Diem): "If you had purchased $1,000 of Delta Air Lines stock one year ago, you would have $49 left.

With Fannie Mae , you would have $2.50 left of the original $1,000.

With AIG , you would have less than $15 left.

But, if you had purchased $1,000 worth of beer one year ago, drunk all of the beer, then turned in the cans for the aluminum recycling REFUND, you would have $214 cash.

Based on the above, the best current investment advice is to drink heavily and recycle."

Hilarious, especially when you consider that at least with the Beer (or Soda for non drinkers) you would've at least have received something of value for the $1,000 you spent; you can read more from Mark's blog here. Since this blog post made me laugh I'll forgive him for being a U. Michigan supporter.

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. Furthermore the author doesn't advocate the drinking of Beer in mass quantities, nor does he suggest that beer (and/or soda drinking) constitutes a valid investment strategy.

Posted to: Randomization on October 1, 2008 at 11:10 AM | Permalink | Comments (0) | TrackBacks (0)

The bailout reminds me of a Hail Mary pass thrown to the 5th wide receiver who is being covered by three defenders and is currently on the 5-yard line, whilst the team's future hall of famer is standing wide open in the middle of the end zone. Sure the 5th wide receiver may catch the ball and yes it would set you up for the field goal that could send the game into OT, but throwing the ball to a triple covered 5th WR instead of your wide open hall of famer is a recipe for disaster.

Ignoring my football analogy for a moment, perhaps the biggest problem with the bailout (aside from my usual gripes) is that the plan's proponents are setting improper expectations around the plan's benefits, by assigning benefits to it that the plan simply isn't capable of delivering upon. The problem with this is two fold: one it suggests that the framers of the plan haven't a bloody clue as to the true dynamics of the economic malaise affecting the country, and it could potentially set the nation up for a even greater confidence crisis when the plan fails to deliver.

In order to illustrate this point further let's take a look at some of the plan's alleged benefits:

Housing Prices: the housing boom was caused by bad lending standards, hyper-expectations and overspending, remove these bad policies/actions/habits from the system and the housing market is going through a necessary (and proper) correction. A correction that won't be complete until inventories are back to historical levels, and the historical ratio of median income of housing prices is restored.

Nothing short of a Federal agency that demolishes unsold houses and/or gives people money to buy houses that are above their income range can halt the correction, unless (of course) we return to the bad habits of old, but look at where that got us. The claims that the bailout bill can halt the slide in housing prices are fatuous at best, and indicative of the level of ignorant pervasive throughout Washington as to the true causes of the housing crisis. The idea that stabilizing the market for mortgage securities can positively impact housing prices when illiquid mortgage securities have nothing to do with housing prices, is like attempting to wag the dog via his whiskers.

Perhaps the bigger issue here is that people are refusing to accept that the housing market is going through a very necessary adjustment after a period of hyperinflation, and are looking for something, anything to

re-inflate the housing market even if it brings dire consequences down the road.

Foreclosures: the spike in foreclosures isn't so much a function of "bad loan terms" as it is a function of people in homes they can't afford, and people struggling to make ends meet due to job loss, general economic pressures, etc. To understand the former all you have to do is read an advertisement for an ARM loan from the housing boom era (and even now to a lesser extent), these and other exotic loan products were advertised as a way for an individual to buy "more house" than they could afford with a conventional loan, with the obvious implication that they can only afford the teaser rate.

The government's ability to modify loans at will aside, how exactly can you "modify" someone out of a situation they could never afford in the first place.

Consumer Spending: up until last year consumer spending was a product of credit abuse and the housing boom, remove those factors from the mix and add in escalating prices for food, gas, healthcare, etc, and you get a protracted decline in consumer spending. While the bailout "may" get the credit markets moving again, it's not exactly going to do much to put more cash in the pockets of the average citizen.

I suppose you could argue that easier access to credit will make it easier for consumers to borrow the money they need, however that's not exactly a viable solution over the medium term let alone the long-term. Furthermore aren't we in this mess because the entire nation (government, consumers, corporations, et al) spent more than they earned and lived above their means?

Consumer Lending: a lot has been made about tightening credit standards and the impact on the consumer, however it's important to put this discussion into the proper context by asking the question: are standards tighter by historical standards or in comparison to the housing boom era? While this is something that is hard to quantify precisely I'm of the opinion that the answer leans more towards the latter, and that people's expectations are still inflated after years of easy credit.

Meaning: even if the credit markets are magically healthy tomorrow it's not realistic to expect (or sensible even) the banks to return to the lending standards of old, after all isn't that what got us into this mess in the first place?

Tighter lending standards are here to stay (at least if the banks have any sense) and are a necessary part of having a stable banking system over the long-term, so people are going to have to adjust their expectations around the availability of consumer credit and consumer spending strength on a go forward basis.

The Dollar : perhaps the thing that confounds me the most about the bailout plan are the expectations (by some) that the plan will help to strengthen the dollar, an expectation that seems (to me) to be so out of touch with reality that it's not even funny. A nation cannot flood the markets with $700 billion dollars that it has to borrow from overseas and expect that its currency will rise in value at the same time, while the dollar may rise over the very short-term due to increased confidence in the U.S. economy the medium to long-term impact will be currency deflation. 

Commodities : while not cited as a benefit of the bailout plan it's worth mentioning that due to the currency deflating effects of the plan, it stands to reason we're going to see sharp spikes in the prices for oil and other commodities.

It appears that one of the key goals of the plan is to inject a heavy dose of confidence into the markets, what happens to that confidence when many of the same problems remain and crop of new ones appear? Will the markets take a deep breath, accept reality and start thinking in terms of long-term solutions, or will we see the very consequences the bailout plan is touted as being able to prevent?

Only time will tell.

I suppose when it comes to this bailout we're all waiting to see if the 5th WR catches the ball and manages to get out of bounds in time to stop the clock for the field goal attempt, or if the defenders either intercept it or bat it away.

IT goes without saying that in my view even if the 5th WR catches the ball he won't make it out of bounds in time, and even if the best case scenario (the field goal) comes to pass, I think this team is still going to lose the game in OT.

Posted to: Politics & Business | U.S. Economy on October 1, 2008 at 11:03 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a look at the Government's presence (or investment) in various companies due to bailouts, rescues, etc.

Graphic courtesy of the WSJ

When you look at the potential losses the FDIC had to take on in order  for Citigroup to buy Wachovia, it's laughable that the Government is trying to make the claim that Wachovia wasn't a bank failure, at the end of the day the government stepped in, agreed to take on losses and brokered the bank's sale to Citigroup. If that doesn't spell F-A-I-L-U-R-E I don't know what does, it seems to me that the only difference is that  Wachovia was sold AS it was failing and WAMU was sold right after. Regardless at the end of the day the FDIC's exposure to the Wachovia deal is far greater than its exposure the WAMU failure, so trying to classify Wachovia as anything other than a failure is rather silly.

Looking at the government's growing de facto hedge fund (or private equity) portfolio, you have to wonder who in the government is going to be responsible for managing these investments, what sort of oversight will be involved, who will be making managerial and strategic decisions, accountability back to the taxpayer, etc, etc. After all it's not like the government has significant experience in these areas or a great track record with respect to its own finances.

Just think about it: the same government that is going to managing (in all likelihood) well in excess of $1 trillion in private sector investments, is the same one that failed to step in and revamp the Mortgage GSEs after both of their accounting scandals in the early 00s, and instead allowed them to expand their investment activities after they began reporting losses last year.

I don't know about you but thinking about the government's failure with the mortgage GSEs doesn't exactly fill me with confidence around their ability to manage their new round of investments.

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 October 1, 2008 at 09:04 AM | Permalink |