Analytical Wealth

Over the weekend the NY Times ran an interesting article discussing "Rational Fear" with respect to the economy, the stock market, et al:

(From Breakingviews.com via the NY Times): "Imagine a big control panel for a complicated machine with a big problem. The dials that indicate how well the apparatus is working are showing “Red Alert.” A group of skilled technicians is furiously twisting knobs and pushing levers well into the zones marked “Danger.” But the machine doesn’t seem to be responding.

That machine looks like the world’s economy today. Economic and financial indicators like gross domestic product, trade flows, credit availability and confidence are still going badly wrong. Policy makers are playing the roles of the vainly struggling technicians. They have embarked on a collection of highly hazardous experiments: gargantuan fiscal deficits, ultra-low policy interest rates and increasingly unfettered creation of money.

The dire economy and desperate policy environment make it impossible to know what stocks , bonds and other financial assets are actually worth. Their value will be determined largely by future rates of default and inflation. But those depend on how the technicians’ maneuvers work out.

Everyone involved wants to get the machine back to normal. The technicians think — or hope — that they have found the right way to get from here to there. The general idea is that lots of spending from governments and ultra-easy money from central banks will soon get the credit system working, while the recession will cut destabilizing trade imbalances down to a manageable size.

Some of these technicians claim the pace of economic decline has already started to slow. But these are mostly the same professionals who thought the machine was working until shortly before it went haywire.

Why trust them now? Their theoretical models have been proved inadequate. Nor can they turn to historical precedents, because there has never before been a need to work off so much debt in so many countries."

The author raises a good point in that there are a lot of policy makers, analysts and pundits who talk as if the crisis can be resolved by injecting "confidence" into the system, instead of looking at the things that have caused people to lose confidence in the first place. Fear doesn’t necessarily occur in a vacuum, and in many cases people are afraid due to the very real financial problems they're facing, legitimate concerns about various securities, companies, etc. Portraying the current crisis as a function of confidence is a analogous to telling people trapped in a burning that their fear of fire is the real problem, instead of finding a way to put the fire out.

If you want to help these people feel confident again you have to address their actual problems, as opposed looking for token gestures you can use to make them feel confident in spite of the evidence that tells them that they should be cautious.

This is not to say that people should be paralyzed by fear or let fear control their decisions, but to point out that in many instances the actions that are being chalked up to fear are actually quite rational.

E.g. if someone has some very real concerns about being laid off, cutting back on their spending is a very rational response. After all are the people encouraging them to spend going to pay that person's bills if they are in fact laid off?

Another example are the companies whose collapsing stock prices were often blamed on fear, as if their opaque balance sheets, mounting losses, weak assets, etc, weren't a factor. Fear is only a relevant argument if the company in question was legitimately healthy, as opposed to being in genuine dire straits if not in danger of collapsing.

Instead of dismissing the fears investors, consumers, etc, have about the markets, the economy, the financial sector, perhaps it's time to start addressing the root cause issues that are raising their concerns in the first place.

You can read more here.

Sources:

Breakingviews.com via The NY Times: "In This Economy, Fear is Rational" -- February 22, 2009

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 by M at 01:54 PM | Permalink | Comments (0) | TrackBacks (0)

The CEO of Goldman Sachs wrote an Op-Ed in this morning's FT that discusses some of the mistakes that led to the credit crisis, and proposes a few solutions in terms of regulation and how the banks should approach the markets, risk management and compensation. Finally he puts forth the idea that the current regulatory framework should be left alone (aside from the changes he mentioned) lest it stifle growth, based on the idea that we shouldn't be making changes based on events that will only occur once every 100 years.

The problem with this way of thinking is that he had earlier criticized risk management models that had incorrectly assumed that certain events would only occur once every twenty years, which (if you think about it) contradicts his ideas around regulation. If we already know that the models that estimate certain events will only happen every twenty years are wrong, why should we develop policy based on other assumptions that estimate that the calamity event won't happen for 100 years? Isn't it plainly obvious that ALL of the models are wrong, and we should probably be setting policy based on being able to monitor potential pre-conditions that can create the event, as opposed to simply believing it's unlikely to happen for a long time?

In short while Mr. Blankfein makes some good points in his Op-Ed he's truly asking for the old regulatory framework/the old way of doing business to be left intact, as if that's the only way of generating growth. His statements around admitting mistakes and proposing a few solutions are basically just minor concessions, because he's not really proposing any major changes to the financial world.

While I do agree with some of this proposed solutions I think that we still need a better model if we're to avoid these crises in the future, the old saw of "regulations will destroy growth" rings hollow in the face of the fact that with better regulations we could've largely avoided this crisis in the first place. Last time I checked financial crashes, crises, et al destroy growth, wealth & profits like nothing else on earth, I'd rather enjoy a protracted period of moderate growth than to suffer through a series of booms and busts. 

Sources:

The Financial Times: "Do not destroy the essential catalyst of risk" -- Lloyd Blankfein, February 8, 2009.

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 by M at 11:49 AM | Permalink | Comments (0) | TrackBacks (0)

The usual round of various news stories and other tidbits from around the web that I think you may find interesting:

As Christmas approach many retailers are planning major sales with discounts that are deeper than those offered during Black Friday, which pretty much sums up how dismal this particular shopping season has been for retailers. I suspect the sales will show mixed results due to many consumers being either finished with their shopping for their year, and other consumers just being snowed in.

On a short to medium term basis I'm actually more interested in how many retailers are forced to declare bankruptcy, liquidate, close stores, etc, than I am in the actual sales tallies. While it's practically a given that Circuit City probably won't survive, how many other retailers will join them and how will this impact the overall retail landscape?

I'm also curious as to how the economy will impact grocery stores and pharmacy chains in particular in light of Wal-Mart's success, which I think is primarily driven by people going down market for necessities. The way I see it people are cutting back on discretionary expenses which is hurting chains like Target, Macys, and the rest, and are looking for cheaper sources for food and basics like Laundry Detergent. Let's not forget that some of the big Black Friday bargains were for food, soap and other basics.

It will be interesting to see how things play out in the traditional grocery and pharmacy space.

Speaking of the above here is a link to an article(WSJ) discussing Rite-Aid's recent Q3 loss, now Rite-Aid has been struggling for some time and it makes sense that the current economic climate would only make things worse. However I believe that it's not just a slow economy they have to contend with, it's Wal-Mart's rapidly growing presence in the pharmacy space as well as a slow economy pushing consumers down market.

Quick investing article discussing earnings quality, and how the gap between operating earnings and "as reported" (true earnings) widens during tough economic times.

Here is a link to an interactive graphic from the Financial Times that  details the amount lost by various major investors who were swindled by the Madoff Hedge Fund fraud, as you can see there are some fairly big names on the list, and not all of the swindled investors have been identified yet.

The FT has a page dedicating to covering the Madoff scandal that you can find here, and you can read the WSJ's coverage of same here.

You can read WSJ coverage of the recent rate cuts here, and coverage from the FT on same here.

In "water is wet news" the Dollar plunged against various currencies in wake of the Fed's move to "zero" interest rates; something we can expect more of as the Fed continues it's "flood the world with dollars" strategy. However the dollar's weakness will be muted by the fact that EU and the UK are likely to cut interest rates as well; although it's probable that the former won't cut as aggressively as the latter. On a medium term basis the outlook for the dollar will probably be more dependent on the Fed's ability to clean up the mess caused by excess dollar liquidity, more than it will be on future interest rates, as the impact of the Fed's current actions will be with us for some time.

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 by M at 12:35 PM | Permalink | Comments (0) | TrackBacks (0)

In order to give you a better idea of the degree to which the credit markets are frozen, take a look at the passage below: 

(From the WSJ): "Banks and other finance companies making loans for autos, credit cards and college tuition are having virtually no success in selling those loans to other investors, a potent sign of just how tight credit markets remain.

The market for selling such loans -- by packaging, or securitizing, them into bonds -- had just one $500 million deal for all of October, according to Barclays Capital. That compares with $50.7 billion worth of deals made one year earlier, according to market-research firm Dealogic. The overall market for so-called asset-backed securitization is estimated at $2.5 trillion.

This creates repercussions for lenders and consumers alike.

Banks and other finance companies are stuck holding more loans on their balance sheets, which crimps their ability to offer new loans. That, in turn, shrinks available credit for consumers, who need it to finance an education, buy a new car, or pay for household expenses using a credit card. Banks were already reining in lending to customers as they try to reduce exposure to loans that may ultimately go unpaid.

For years, the asset-backed securitization markets fueled the explosion in consumer borrowing, as it allowed lenders to spread their risk to other investors such as pension funds, hedge funds and insurers. But the securitization pools have dried up after losses in the mortgage markets, where risk was also widely dispersed via securitized bonds.

The October dry spell has caused year-to-date securitization volumes to drop. Credit-card volumes are down 31%, auto loans are off 45% and student loans have fallen about 41%, according to Barclays. October's sole transaction came from AmeriCredit Corp., which provides auto loans to less creditworthy borrowers.

"We are at a standstill," said Craig Leonard, a structured-debt syndicate banker at Barclays Capital said.

The deals that are getting done are also more expensive for the banks. At the end of October, the risk premium charged on a triple-A rated credit-card deal reached 4.67 percentage points over comparable two-year Treasury yields, up almost 3.2 percentage points from June, according to J.P. Morgan data.

Even through June of this year, securities backed by student loans and credit-card debt remained popular with investors. But investors already burned by sinking bond valuations are likely to stay clear of these markets, because of the downturn in the economy and expected increase in job losses."

So the first thing that jumps out is that the securitization market that had (on aggregate) $51 billion worth of transactions last October had only a single $500 million transaction this past one, in other words: the securitization market declined by 99% last month. 

The other issue is that many of the hedge funds that the banks would normally sell securitized loans to no longer exist, the pension funds are trying to preserve capital and the insurers may very well need outside capital infusions just to keep functioning. But the real problem is that the banks used securitization to both spread risk around and raise capital, and now the investors know that these debt securities aren't as safe and dependable as advertised. Especially now that a slowing economy increases the risk inherent in any lending or debt security transaction.

It's hard to get investors to believe in what you're selling when you sold them garbage in the past, and all signs are pointing towards the banks having a weaker pool of customers to deal with on a go-forward basis.

Fixing the situation will require the banks to raise their lending standards so that they're selling higher quality debt securities in the first place, on top of strengthening the economy so that the banks have a stronger pool of customers to work with. Unfortunately while the former is fairly clear cut, the latter is more of an abstraction at the moment.

Moving forward consumers are going to need reset their expectations around credit, because the combination of higher standards (that were too low anyway) and fewer investors in debt securities (fewer hedge funds, other investors being more cautious) is going to make credit harder to come by.

What's unknown at this point is how things will look after the credit crunch: will consumer credit be generally harder to get (compared to the credit boom), or if we'll see more of a "scale back approach where people with $40k/yr salaries will no longer be able to easily finance $45k cars and will have to instead finance $20-$25k ones instead. Hopefully we'll see more of the latter than the former.

On a go-forward basis the ideal situation is one where consumers can easily obtain credit, just not in amounts that are out of touch with one's income level and ability to pay it back. Think: aggregate credit card limits capped at 75% of income, car loans limited to 40-60% of income, mortgages originated at 22-28% of gross monthly, etc.

You can read more here.

Sources:

The WSJ: "Bond Woes Choke Off Some Credit to Consumers" -- Robin Sidel, Prabha Natarajan, November 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 by M at 01:33 PM | Permalink | Comments (0) | TrackBacks (0)

Interesting chart from Paul Kedrosky's "Infectious Greed" Blog, depicting the "net notional" and "gross notional" CDS exposure for various countries and companies.

Courtesy of Infectious Greed

So you're aware the "net notional" reflects the net amount of debt being covered by various CDS, after adjusting for hedges, longs, shorts, etc. The reason for this is that people often hedge their CDS positions, and/or you have situations where party A owes party B $10M, and is also owed $15M by party C, thereby nullifying the amount of net risk involved. Of course that scenario assumes that party C has the money to pay party A, and/or isn't depending on a soon to be insolvent party D as the source of the funds with which to service its debts.

E.g. the net notional exposure may very well be significantly higher than what is indicated here, when you consider that many of the counterparties may be in financial trouble and there is good reason to be suspcious of the models and underlying assumptions that have gone into any derivatives contract written over the past 10 or so years.

Needless to say the situation around CDS definitely needs to be looked at in more detail.

Either way, very interesting data and you can find more of it 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 by M at 12:19 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 by M 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 by M at 07:03 AM | 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 by M at 05:00 PM | 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 by M 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 by M at 09:30 PM | 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 by M 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 by M 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 by M at 02:22 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 by M at 11:37 AM | Permalink | Comments (0) | TrackBacks (0)

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

Graphic courtesy of the WSJ

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

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

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

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

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

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

Posted by M at 07:22 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

Now why is that a hazard?

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

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

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

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

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

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

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

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

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

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

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

Posted by M at 12:45 PM | Permalink | Comments (0) | TrackBacks (0)

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

Graphic courtesy of the WSJ

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

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

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

You can read more about yesterday's volatility here.

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

Posted by M at 05:52 PM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thank you."

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

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

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

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

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

You can read more on the subject here.

Sources:

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

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

Posted by M at 12:04 PM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

You can read more on the subject here.

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

Posted by M at 11:24 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

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

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

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

Sources:

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

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

Posted by M at 10:29 AM | Permalink | Comments (0) | TrackBacks (0)

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

(From the WSJ):

"Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

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

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

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

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

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

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

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

Sec. 3. Considerations.

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

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

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

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

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

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

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

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

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

Sec. 6. Maximum Amount of Authorized Purchases.

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

Sec. 7. Funding.

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

Sec. 8. Review.

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

Sec. 9. Termination of Authority.

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

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

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

Sec. 11. Credit Reform.

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

Sec. 12. Definitions.

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

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

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

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

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

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

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

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

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

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

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

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

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

Sources:

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

Posted by M at 09:31 AM | Permalink | Comments (0) | TrackBacks (0)

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

Graphic courtesy of the WSJ

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

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

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

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

You can read more from the WSJ here.

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

Posted by M at 10:54 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

Ridiculous, no?

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

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

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

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

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

Like I said, ridiculous.

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

Sources:

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

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

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

Posted by M at 07:22 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

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

Posted by M at 02:58 PM | Permalink | Comments (0) | TrackBacks (0)

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

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

Graphic courtesy of the WSJ

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

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

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

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

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

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

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

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

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

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

Posted by M at 10:49 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

You can read the entire article from the WSJ here.

Sources:

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

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

Posted by M at 06:37 PM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Posted by M at 09:05 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

A quick excerpt follows below:

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

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

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

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

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

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

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

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

Sources:

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

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

Posted by M at 08:58 AM | Permalink | Comments (0) | TrackBacks (0)

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

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

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

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

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

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

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

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

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

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

Sources:

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

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

Posted by M at 02:07 PM | Permalink | Comments (0) | TrackBacks (0)

Here are some quick thoughts on the mortgage GSE bailout:

The Mortgage GSE Model is Broken: the problem with the mortgage GSEs is that their business model is broken, they were allowed to grow too large, their investments weren't properly managed and they were able to use dodgy accounting to hide their deficiencies. Pouring in capital into a broken model whilst simultaneously allowing them to expand their investment portfolios does not a solution make.

The government has effectively told the world: "we're not going to fix the model, we're just going to pour taxpayer money into it, prop it up and turn up the volume".

The Government is Responsible: the current situation was 100% avoidable if the government had regulated the mortgage GSEs properly, reined in their investments and taken more drastic steps to prevent them from being a danger to the economy during the GSE's accounting scandals in the early to mid '00s. The fact that the people who created this morass are now in charge of fixing it doesn't exactly fill me with confidence.

In effect the government created a financial Golem, didn't control it properly/let it run amuck and now are trying to convince us that they now have everything under control.

Doesn't Solve Core Problems: while nationalizing the mortgage GSEs removes (at least temporarily) a key risk facing the economy, it doesn't resolve the core issues that are the heart of the credit crisis, housing downturn, the problems within the financial sector, etc. Struggling banks aren't going to start magically making money tomorrow because the GSEs have been nationalized, nor will it help Joe Six Pack pay his mortgage. Like many of the interventionist policies of the past 13-14 months, I suspect it will give the markets a pop temporarily but things will fall back down to earth once reality sets in.

Simply put: the world hasn’t changed "that" much as a result of this action.

Housing : I had to chuckle at Mr. Paulson's comments that he and others were taking "steps" to fix the housing crisis, when the true reality is that an over-inflated market is simply correcting itself and there is nothing to do but to wait it out and let it run its course. Any steps to prevent the housing market's natural correction will do nothing more then to extend the downturn. Housing isn't going to stabilize until the ratio of home values to median incomes returns to historical levels, the % of owner unoccupied homes returns to historical levels as well and prices return to pre housing boom levels.

This isn't a problem you can solve via government intervention, the correction has to run its course; in fact the correction is a good thing because it's a necessary part of establishing stable housing markets for the future.

The Taxpayer Gets the Shaft : From the looks of things the taxpayer is on the hook for the risk stemming from the government's mismanagement of the mortgage GSEs,  but isn't able to participate in any of the upside. In fact all the upside will do is mitigate the risk to the tax payer, in other words: the taxpayer either loses or doesn't win. These sorts of bailout actions would "feel better" if the tax payer was rightfully cut in on any potential upside, the idea that we as taxpayers are being forced to bailout a dodgy organization we had no hand in managing, and are cut out of any upside at the same time is quite disturbing.

Now do I believe that the government should've done nothing and let the financial Golem that is the mortgage GSEs collapse and take the financial markets, the credit markets and the world economy with it?

No.

Instead I blame the government for letting things get to this point in the first place, and not stepping in earlier to rein in the GSEs, restructure them, fix the model before it posed so great a risk that nationalization was the only solution. I'm also very unhappy with the way the taxpayer is being treated, as if we're some sort of insurance plan to protect corporate America from its own stupidity. Especially when other investment and/or retail banks could need rescues, and Detroit is asking for $50 billion in government subsidized loans.

In fact the events of the past 72-hours beg the question: "Is American Capitalism dying and being replaced by some sort of pseudo-socialist construction that works to prop up the economy, remove risk and ensure that there are no longer any losers?"

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 by M at 12:25 PM | Permalink | Comments (0) | TrackBacks (0)

Note: no comic book fans, this post is not about Victor Von Doom the Monarch of Latveria and recurrent nemesis of the Fantastic Four, and no we will NOT be discussing why I know that.

Since the financial markets are arguably the world's greatest argument in favor of perpetual optimism it's not a surprise that skeptics and pessimists are routinely dismissed off hand, however if one believes in Warren Buffett's #1 rule of: "don't lose the money " it makes sense to always lend the pessimist an ear lest you get caught with your financial pants down:

(From the NY Times):   " On Sept. 7, 2006 , Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.

  The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market. And then there was the espouser of doom himself: Roubini was known to be a perpetual pessimist, what economists call a “permabear.” When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.

But Roubini was soon vindicated. In the year that followed, subprime lenders began entering bankruptcy, hedge funds began going under and the stock market plunged. There was declining employment, a deteriorating dollar, ever-increasing evidence of a huge housing bust and a growing air of panic in financial markets as the credit crisis deepened. By late summer, the Federal Reserve was rushing to the rescue, making the first of many unorthodox interventions in the economy, including cutting the lending rate by 50 basis points and buying up tens of billions of dollars in mortgage-backed securities. When Roubini returned to the I.M.F. last September, he delivered a second talk, predicting a growing crisis of solvency that would infect every sector of the financial system. This time, no one laughed. “He sounded like a madman in 2006,” recalls the I.M.F. economist Prakash Loungani, who invited Roubini on both occasions. “He was a prophet when he returned in 2007.”"

Looking beyond the discussion of the current economic crisis this discussion is more one of perceptions, desires and expectations, more than it is about permabears vs. permabulls. In short people don't want the bears to be right so they tend to ignore them and focus on when they're wrong, the converse is true for the bulls people focus on when they're right and ignore the times when they're wrong. After all it's not like Mr. Roubini said anything totally out of left field because there was plenty of objective data floating around to support his thesis, unfortunately people were too invested in the bullish view and chose to ignore the warning signs around them.

This reminds of a co-worker who was convinced I shouldn't have purchased an Audi because "they always have problems" and used every time went to the dealership as evidence of this, despite the fact that (during the time we worked together) my trips to dealer were to replace the brakes and tires at 40k miles, regular oil changes and replacing a few headlights at around 45-50k miles. It's worth mentioning that his Lexus was receiving virtual identical maintenance for similar items, so at the end of the day neither was truly driving a more dependable car (at least over that time interval).

Mind you at the end of the day Lexus is more dependable than Audi, the problem is that he was misinterpreting every trip to the dealer as evidence of this rather then recognizing it as the same routine maintenance his car was receiving. It's no different then Bulls/Bears seizing upon a single data point to support their thesis(s) and ignore the larger body of data that doesn't. E.g. oil drops for a few months and everyone forgets the recent past and the longer term supply and demand issues, or every call of a bottom in housing over the past 18+ months.

The point is that people's general disposition towards the markets can color their interpretation of data that runs contrary to their own, you're overly accepting of data that supports your viewpoint and overly skeptical of data that doesn’t. Now while the market optimists are still winning (on aggregate) it doesn't change the fact that the successful investor knows when to be bearish and when to be bullish, so balanced approach where one interprets data in an objective manner is clearly the best approach.

You can the article in full here.

Sources:

The NY Times : "Dr. Doom" -- Stephen Mihm, August 15, 2008.

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

Posted by M at 10:41 AM | Permalink | Comments (0) | TrackBacks (0)

Sometimes a picture or (in this case) a picture of a financial statement can tell a story (or rather a dismal story) of a thousand words:

Click the Image For a Larger Version

Quick highlights (or lowlights) of the last five quarters:

Losses and Expenses Prior to Tax Treatment (more or less operating losses):  $30.1 Billion

Credit Related Expenses: $13.3 Billion

Tax Treatment Benefits: $6.4 Billion

Net Losses: $7.5 Billion ($9.4 Billion over the last four quarters)

Closing Share Price on August 8, 2007: $64.75

Closing Share Price on August 8, 2008: $9.05/share

YoY Share Price Decline: 86.02%

Aside from the 86% decline in share price, the number that jumps out me the most is the $30.1 billion losses prior to tax treatment and extraordinary items.

Now imagine (if you would) a world where Fannie was 1/5 the size it is now, thereby significantly reducing its potential negative impact on the economy, credit markets, etc. Considering the performance of the past five quarters and the fact that there is always a risk of it happening again even if FNM survives this fiasco, how can any sane person not be in favor of breaking these companies up?

  You can read Fannie Mae's Q2 Investor Summary in full here.

Sources:

Share Data provided by Yahoo! Finance

Fannie Mae: "2008 Q2 10-Q Investor Summary" -- August 8, 2008 .

Posted by M at 10:46 AM | Permalink | Comments (0) | TrackBacks (0)

In the current environment there has been a lot of talk about the role of government with respect to bailouts, regulation and its interactions with private industry. After all it's not too hard to make the argument (in the U.S. at least) that removing certain regulations help create the current economic crisis in the first place, instead of spurring the innovation and growth that were supposed to be the benefits of deregulation.

On the "Creative Capitalism: A Conversation" blog Martin Wolf has a brilliant essay discussing the role of rules, regulations, ethics and social norms in managing an effective AND inclusive capitalist system. A quick excerpt:

(From Creative Capitalism: A Conversation): "Most of the world's poor are poor because they live under confiscatory governments," writes Professor Landsburg. This is true. But what is a confiscatory government? It is just a government run by profit-maximizers. The people running operating a government are doing just what Professor Landsburg and Milton Friedman think everybody in the private sector should be doing: looking out for themselves and their families...

...The palaces and stately homes that litter the landscapes of erstwhile agrarian societies are monuments to the success of this strategy for wealth extraction. The ruler seized as much of the surplus as he could and offered, in return, security from other bandits. He used the surplus to pay his army, police and judges, build fortresses and live as luxurious a life as the technology of the age allowed. To put this in contemporary terms, politics was a wonderful business. In fact, it was almost the only business.

The confiscators whom Professor Landsburg criticizes are operating in this grand tradition: they view politics as a profit-maximizing business opportunity. What's the point of becoming a ruler if one cannot take what one wants? In impoverished societies, far and away the quickest way to become rich -- often the only plausible way to do so -- is to seize power first. This was the path of Suharto, Mobuto and now Mugabe. It was ever thus.

Consider a society in which everybody was a profit-maximizer. What would it be like? It would be one in which rulers, soldiers, judges, bureaucrats would take whatever they could. It would be one in which bribery and corruption were the norms. It would be one in which market capitalism of the kind Professor Landsburg (and I) extol would be impossible. It would be one in which almost everybody would be poor. And because it would be one in which almost everybody was very poor, it would also be one in which the only way to obtain wealth would be to join in the race for political power. This would be all too natural. It would also be a negative-sum society, in which life tended to be nasty brutish and short…

...So the big problem with competitive capitalism is not that it is uncreative. It is certainly highly creative. The problem is that it is unnatural. There have to be rules, ethical norms and institutional constraints governing profit-maximizing behavior, to ensure that the maximization operates for the social good. Of course, pure libertarians would deny this. They believe that a society could be constructed on the basis of voluntary exchange, with no coercion. I think that would last until the first well-organized gang came over the hill, as Thomas Hobbes argued. We need the Leviathan. The question is how we tame it."

I've always felt that a pure free market society that operates on the idea of "voluntary exchange" (or whatever you want to call it), is one of those things that sounds good in theory but falls apart due the realities of human nature.

The marketplace in terms of consumers and workers wouldn't be able to influence positive behavior on the part of businesses due to a lack of choice, not being powerful enough or the fact that they're benefitting from the negative behavior of the very businesses they're supposed to regulate.

Businesses able to freely act in service of their own best interests would also be able to freely act in ways to thwart their competitors, which would (of course) lead to escalation and increasingly ruthless tactics. It could start with companies trying to strong-arm each other's suppliers and then turn into outright suppression, and then needing to align themselves with stronger (and likely more violent) organizations in order to protect themselves. Remember, everyone in this scenario is acting in accordance with the goal of maximizing profit.

If you think about it the above situation already exists in the world today, it's called the world of organized crime. Needless to say the customers of organized crime would like to deal with kinder, gentler gangsters, but those market pressures haven't exactly spawned a kinder, gentler organized crime organization.

Sources:

Creative Capitalism: A Conversation: "What makes creative capitalism possible" -- Martin Wolf, August 4, 2008.

Posted by M at 10:27 AM | Permalink | Comments (0) | TrackBacks (0)

The usual random assortment of various stories I hope you'll find interesting.

Here is a link to an entertaining little video from the FT summarizing the financial/economic events of the past year, the credit crunch, etc; for more FT video coverage of the credit crunch here is an interview with Blackrock CEO Larry Fink where he discusses whether or not the crisis is over.

Here is a story from Felix Salmon (easily one of my favorite financial writers) discussing why the losses from the mortgage crisis/housing crisis/et al, will be with us for some time.

Speaking of the credit crunch and the housing crisis here is an article on Northern Rock's earnings performance over the past six months of this year (a loss of over $1 billion).

Overall I think that when it comes to credit crunch, the housing crisis, et al, the thing to keep in mind is that even as things start to improve the banks, investors, consumers, etc, will all still be dealing with the negative impact of the overall economic crisis for years into the future. Whether it's a $30 billion write down, losing your home, struggling to get above water after maxing out your credit cards, etc, these things take a while to fully recover from even after things start to turn around.

Think: an individual who gets their finances under control and is no longer living paycheck to paycheck, can start saving money again, etc, but their house is under water, they're maxed out on a HELOC and their credit cards are at 95% of their aggregate credit limits.

Put the above into terms relevant for banks, home builders, etc, and that's what the economy will be dealing with for the next couple of years.

Some additional links:

A story from the Christian Science Monitor on the oft-ignored problem of the nation's rising national debt, and how neither candidate truly has a viable solution on the table for dealing with it.

Random bizarre gadgets from Korea; I would get interested in reading the businesses cases that got some of these nonsensical contraptions funded and to know if there was any drinking involved. As a friend of mine said on a product development project we were brought in to consult on after the first round of product launches: "Well if you want the next round to be successful, you might want to base the next round of widgets on market research and not drunken bar conversations".

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article.

Posted by M at 11:29 AM | Permalink | Comments (0) | TrackBacks (0)

Since short-selling is a very divisive issue I wanted to spend a few minutes to quickly clarify a few aspects of my recent post on short-sales , namely that the main points of the articles are as follows:

There is nothing inherently wrong with legal short positions (by default this doesn’t include naked shorts), it’s not anti-capitalist or an attempt to destroy a company. Investors can use short positions to protect one’s investment in a struggling company (put options), and/or to legally profit from a stock’s decline. At the end of the day our markets cannot work if we decide that investors should only be able to take actions based on a positive view of a stock, because the goal of our markets is to match up people with different opinions (bullish, bearish) on the same equities, asset classes, etc.

People interested in fair markets should be concerned about all illegal and unethical behavior, whether that behavior is naked shorting, spreading naked rumors or executives who make blatantly false statements in order to prop up the shares of their companies.

Incompetent and dishonest management teams are the true destroyers of companies and shareholder wealth, not short-sellers. Instead of using short-sellers as the all powerful scapegoat that are “taking down companies”, we should instead turn the microscope on the executives who are truly responsible for destroying companies and eviscerating wealth.

Just think about it: who has the power to move the markets more: executives who promise that the worse is over, a future return to profitability is imminent, there will be no more write downs or future needs to raise capital, etc, or short-sellers? After all if short-sellers could take down any company they wished, wouldn’t they try to take down the healthiest, fastest growing companies out there, due to the higher profit potential?

Overall this article should not be construed as a defense of naked short sellers but as a defense of legal short sellers, a critique of those who ignore lying executives and to pose the question: why are people blaming short-sellers instead of the incompetent managers who are the true destroyers of healthy companies?

Understandably this is a very divisive issue and emotions run hot on this one, I just ask that people listen to what I’m saying first before they respond too quickly and assume I’m writing a defense of naked short-sellers, and to differentiate between naked shorts and legal shorts.

Posted by M at 05:58 AM | Permalink | Comments (0) | TrackBacks (0)

Why are some folks in the business media, corporate leaders, etc, taking the nonsensical position that people who take short positions have no goal other then to destroy a company, even going so far as to say that they're anti-capitalism and/or wealth creation? Based on some of the things I've read lately I think some of the critics of short-sellers would've cheered investors who poured money into CFC after their Q3 '07 earnings report and chided the short-sellers, even though (in the end) it's the short-sellers who created wealth for themselves while the people who went long lost money.

Where is it written that investors can only be bullish? Where is it written that it isn't capitalist to find ways to profit from a company's decline? From my perspective a true capitalist finds way to profit no matter what the situation; there is nothing inherently "less capitalist" about shorting rather than going long because in both cases the goal is to create wealth.

As it is the companies that are targeted by short-sellers are nearly always ones that have fallen on hard times, companies that are losing money, market share, etc, etc. Why are people deriding the people who decide to short these companies in order to profit from the situation, as opposed to those who pour money back into them based on a single quarter's performance being slightly "less bad" then expected? Furthermore it's not like shorts control the markets (short-squeeze anyone?), the markets on aggregate have to believe a particular company is going down hill for the shorts to make money otherwise they'll lose it. All that's happening is that the shorts are recognizing the fact that a company is in trouble before the market does.

Anyone who shorted Enron in February of '01 was simply ahead of the curve, not the source of the company's malaise.

Short-sellers aren't out to destroy companies they're out to profit off of companies that are digging their own graves, pundits shouldn’t be blaming the shorts they should deriding management for creating the situation in the first place.  I find it laughable that anti short-selling pundits will rattle of the names of near insolvent companies that need to be protected from short-sellers, as if they're healthy, growing companies that are being oppressed by capitalist Grinches.

I ask (again) where are all the anti-short seller crusaders when a company's management gives overly bullish statements that later turn out to be false, are they giving these liars a pass because they  care more about supporting the ideology of always being bullish rather than fair markets? As I said before bad management is what destroys wealth and companies not short-sellers, and overly bullish statements by the management teams of companies like Countrywide, Merrill Lynch and Circuit City (just to name a few) have destroyed 100s of billions of shareholder wealth. If the anti short-seller crusaders are truly interested in protecting wealth creation perhaps they should focus on the real enemy: incompetent, overpaid and dishonest management teams who destroy companies and shareholder equity.

The markets should be about finding ethical and moral means of making money and generating wealth, not supporting an ideology that says the markets have to go up and anyone who isn't bullish is "against wealth and capitalism".

Anyone who truly supports fair markets shouldn't be too concerned about whether investors are bullish or bearish, they should only be concerned about whether or not their behavior is legal. I.e. they should be more worried about the recent shenanigans of companies like Merrill Lynch , then they should about people shorting money losing financials with opaque balance sheets . Because dishonest and incompetent management teams are the true destroyer of wealth.

Methinks a lot of the row over short-selling really stems from corporate managers that need a scapegoat to hide their own incompetence, and investors who need same.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article. He also freely admits that he shorts the stocks of companies he finds abysmal and goes long on the companies he believes in.

Posted by M at 09:26 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting FT article that discussing decoupling. The author puts forth the idea that while foreign economies have indeed decoupled from the U.S., their markets haven't because the market's participants simply don't believe it's possible.

It's an interesting idea that flies in the face of the rational markets idea (as have the bubble inducing events of the last 10+ years really), because it suggests that a strong belief about a particular idea will influence people's actions more than sound analysis, economic evidence, etc. After all during the tech booms and housing booms, investors did a LOT of wholesale irrational things due to believing that tech stocks were a can't miss, housing will never go down, there would never be a sharp rise in mortgage defaults, CDOs removed risk from the equation, etc.

I.e. ideological beliefs about finance and economics can trump rational thought, especially if they're profits to be made in the short-term.

No matter how you look at the decoupling argument this particular article is worth a read, you can find it here.

Posted by M at 06:41 AM | Permalink | Comments (0) | TrackBacks (0)

Oil prices are too high? It must be the speculators/hedge funds that are hoarding barrels of oil in their supply closets and artificially driving up energy prices. Is your company's stock tanking? It must be the short-sellers that are beating up on your poor company for pernicious reasons, not because you're losing money and are basically insolvent. Can’t make the mortgage payment on the house you couldn't afford in the first place? It's not your fault it's negative consumer sentiment and the housing crisis that is preventing you from temporarily avoiding disaster by refinancing your way out of it. Running a bank that's losing money and needs a capital infusion? That's not your fault either it’s the big bad credit crunch that's causing the problem, those bad investments you made that caused the credit crunch had nothing to do with it.

Lately it seems that no matter what sort of financial malaise and individual or a company is facing, there is a convenient scapegoat awaiting the call to absolve them of guilt. Better yet there is a convenient scapegoat available and   government intervention at the ready, all to make sure that no one has to face the consequences of their own actions.

My question is: what happens when all of the scapegoats are dead, there is no one left to blame and all of the governments attempted magic cures are used up? Will people still cling to their old notions and invent new methods of escaping reality or will they confront reality, let things run their course and get to the business of truly fixing things?

While I don't know the answer to this question I do know that the answer determines our economic future, because the longer we delay confronting the reality the greater the cost of the eventual real clean-up. 

Posted by M at 11:03 AM | Permalink | Comments (0) | TrackBacks (0)

Supposedly reducing regulation is supposed to spur innovation, create more secure markets, etc, etc, by getting the government out of the way and allowing business and "the market" to decide how best allocate capital. However based on the current economic crisis and a study of recent history, it appears that the opposite is true:

(From the WSJ): "The events of the past few weeks leave U.S. policy makers at a crossroads in a long-running debate about how to police financial markets.

For much of the past quarter-century, policy has tilted away from strict regulation and toward relying on market discipline to keep the financial system on an even keel. Market players, the thinking went, had an incentive not to push themselves or their counterparties too far, because they had too much to lose if they did.

This approach has failed, but finding a workable alternative won't be easy.

Carmen Reinhart, a University of Maryland economist who has studied centuries of financial crises, concludes that blowups happen almost inevitably after financial markets are liberalized or some innovation allows capital to flow more freely.

She and fellow researcher Kenneth Rogoff found that during the loosely regulated 1980s and '90s there were 137 banking crises around the globe, compared with a total of nine during the more tightly regulated '50s, '60s and '70s. Deregulation of interest rates on deposits at U.S. thrifts in the early 1990s, for example, led to a wave of risk-taking and the savings-and-loan crisis.

"Market discipline exists in theory, but in practice, ahead of each crisis, what we see is quite the opposite," Ms. Reinhart says."

Graphic Courtesy of the WSJ.

While I don’t dispute that the era of reduced regulation appears to have led to an increase in banking crisis, it is worth nothing that the global system is larger, more complex and interconnected then it has been in the past. So even if lighter regulation is the root cause behind the increased number of crises, size, interconnectivity and complexity are very likely a key factor as well. It’s easier for a bank to get into trouble if it’s delving into complex and often esoteric financial instruments, then if it’s just taking deposits and originating loans. Still a lot of the complexities are the result of deregulation, so it does almost become a chicken and the egg type of argument.

The problem here seems to be that the goal of the markets is to generate profits (often in the short-term), while the goal of a regulator (a good one anyway ) is to ensure that the banking system remains stable. The problem with self policing is that it assumes that these two goals are always synergistic with one another, that the banks/markets always behave rationally and are always focused on long-term profits over short-term ones. The other issue is that an individual bank will be primarily focused on itself as opposed to the health of the banking sector/the markets overall, so it’s slightly unrealistic to expect a group of self-centered actors to police the whole.

Of course it also goes without saying that regulators can be just as fallible for a wide variety of reasons, relating to staffing levels, having weak abilities to make changes and/or not being able to really respond to innovation until after its already in the marketplace, etc.

All that being said I'm not exactly a proponent of heavy regulation either, because it does stifle innovation and most certainly gets in the way. I think the key is a moderate level of innovation that provides common sense guidelines to keep banks from shooting themselves in the foot, as opposed to strict guidelines that make it difficult for the banks to operate. For example tell the banks that they can originate all of the exotic mortgages they'd like, they just need to have documented evidence that the person can afford the highest possible payment over the next 10-15 years using no more than 28-33% of their gross monthly income.

While it's a complex problem I think it can be solved if regulators think in terms of speed limits and/or parameters that keep the banks out of trouble, as opposed to imposing heavy regulations or letting the markets police themselves.

You can read the article in full here.

Sources:

The Wall St. Journal: "Markets Police Themselves Poorly, But Regulation Has Its Flaws" -- Jon Hilsenrath, July 21, 2008.

Posted by M at 06:14 AM | Permalink | Comments (0) | TrackBacks (0)

Here is an absolute must read from Barry Ritholtz 's big picture blog discussing the collusion of greed, stupidity, denial and arguably madness that has gotten our economy to this point. It's a beautiful piece really, read it now.

The sad part about this whole situation is that it all could've been avoided, if people weren't afraid of the "r" word and weren't so eager to generate imaginary wealth and hope the gravy train would last forever. I.e. if certain bankers and politicians had just acted like bloody adults.

Posted by M at 03:39 PM | Permalink | Comments (0) | TrackBacks (0)

This is some interesting stuff against the backdrop of recent actions by the SEC to curb short selling:

(From the Financial Times): "The cost of borrowing shares for short sales on Wall Street has been rising steeply in recent weeks, hampering the ability of hedge funds and other sophisticated traders to profit from market declines….

...The Securities and Exchange Commission on Tuesday revealed emergency action to clamp down on abusive short-selling, making it more difficult for traders to engage in so-called “naked” short sales of leading financial firms….

…However, the SEC clampdown, which takes effect on Monday, comes against the backdrop of sharply higher borrowing costs for shares – a development that has made it very difficult to short well-known names such as General Motors, traders say.

...“It has become much tougher as the number of funds that want access to stock has gone up,” says the head of prime brokerage at one Wall Street firm. “And stocks these days get hot much more quickly, which makes it even tougher.”...

...Generally, hedge funds borrow shares from money managers such as Fidelity or Barclays Global Investors to make short sales. But even as the demand for shares to borrow has grown, money managers are cutting the number of shares they lend for fear of depressing the market and of not having enough shares on hand to meet their own needs.

Hedge fund managers say they are worried about getting calls from brokers or money managers asking for their shares back, which could lead to a so-called “short squeeze” in which bearish investors have to buy stock to cover their short positions."

IF it's getting harder to short stocks, yet many stocks have plummeted just the same, doesn't that seem to suggest that maybe, just maybe, these companies are victims of their own malaise and not short-sellers? It's patently absurd that a sector that has spend the last year writing down 100s of billions in bad loans (and counting) is whining about short-sellers sending their stock prices down, as if they aren't losing billions and struggling to raise cash in order to survive. Especially when you consider that many of the hedge funds that short stocks are run by the banks, it's as if they're saying: "while no one should be allowed to short us, we're still going to go ahead and short everyone else".

However none one should be surprised about any of this, because this situation is more about self-interest then fairness.

The SEC's move to limit short-selling reminds me of the Marvel Comics "No Prize" of the 1980s, because it's more of a reiteration of a requirement that's already in place more than it is a truly new rule. Personally I believe that the market forces that are making it harder to short stocks will have more of an impact on short-selling then the SEC's new "rule". I wonder who the banks will blame their declining stock prices on after this new rule takes effect?

You can read more on this from the Financial Times here , and additional coverage from the Wall St. Journal here .

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article.

Posted by M at 03:28 PM | Permalink | Comments (0) | TrackBacks (0)

Here are some interesting graphics from the WSJ discussing recent LBO deals, the first looks at the percentage of deals that were abandoned despite having definitive agreements in place.

Graphic courtesy of the WSJ

The second looks at some of the larger deals that failed to close due to problems with financing.

Graphic courtesy of the WSJ

The fact that some of these deals failed to close isn't necessarily the problem it sounds, because some of them (like SLM) were shaky as far as being able to deliver enough of a return to justify the premium paid for the company. During the LBO boom it sometimes seemed like PE firms were doing deals for the sake of doing deals, begging the question: are you doing this deal to generate fees or because it's a good idea? As a result it will be interesting to see if anyone tries to "re-do" these deals at (possibly at lower prices) once financing conditions improve, after all if it was a good idea last year it's probably going to be a good idea in the future. Still, not all of these deals strike me as the ideal PE opportunity of buying a struggling company, turning it around away from the scrutiny of Wall St. and then turning it public again/selling it someone else.

Hence the reason I often felt like PE firms were doing deals for the sake of doing deals during the credit bubble.

All that being said the data is an indication of the impact the credit crunch has had on buyout activity, especially when you see the YoY change in terminated deals from '06 to '07.

The article comes from a larger discussion around the closure of the BCE buyout deal from the WSJ that you can read here . 

Posted by M at 04:44 PM | Permalink | Comments (0) | TrackBacks (0)

Speaking of nutty bubbles here is another one from the 1700s

“In the 1700s, the British empire was the big dog on the block, and that particular block spanned the entire globe. For the British, the eighteenth century was a time of prosperity and opulence, meaning a large section of the population had money to invest and were looking for places to put their money. So, the South Sea Company had no problem attracting investors when, with an IOU to the government worth £10,000,000.00, the company purchased the "rights" to all trade in the South Seas.

The few companies offering stock at that time were all solid but difficult investments to buy. For example, the East India Company was paying out considerable tax-free dividends to their mere 499 investors. The SSC was perched on top of what was perceived to be the most lucrative monopoly on earth.

The first issue of stock didn't even satiate the voracious appetite of the hardcore speculators, let alone the average investors who were assured of this company's coming dominance. The popular conception was that Mexicans and South Americans were just waiting for someone to introduce them to the finery of wool and fleece in exchange for mounds of jewels and gold! So nobody questioned the repeated re-issues of stocks by the South Sea Company--people just bought the expensive stocks as fast as they were offered. It didn't matter either to investors that the company wasn't headed by experienced management. Those who lead the company, however, were born public relations directors, who set up offices furnished with affluence in the most extravagant quarters. People, once they saw the wealth the SSC was "generating," couldn't keep their money from gravitating towards the SSC.

Not long after the emergence of the SSC, another British company, the Mississippi Company, established itself in France. The company was the brainchild of an exiled Brit named John Law. His idea wasn't so much based in trade, but in switching the monetary system from gold and silver into a paper currency system. The Mississippi Company caught the attention of all the continental traders and gave them a space to put their hard-earned dollars. Soon the worth of the Mississippi Company's stock was worth 80 times more than all the gold and silver in France. Law also began collecting defunct companies to add to his massive conglomerate.

Continue reading "More of History's Bubbles" »

Posted by M at 12:20 PM | Permalink | Comments (0) | TrackBacks (0)

I wasn’t going to bother commenting on the recent housing report for a couple of reasons:

1. I would be repeating some of the same comments on housing I’ve been making for the past year.
2. I would be repeating many of the same critiques of the misreporting of economic data that I’ve been making since I started this blog.

To be blunt it isn’t very intellectually stimulating to just freshen up the same analysis you posted a few weeks prior. However I stumbled upon this commentary from TSC’s Marek Fuchs discussing some of the key elements of the bad reporting around the recent housing report, and figured it was worth pointing my readers to since the markets misinterpreted it.

There is also a larger issue here that bears discussion: a key skill people need in order to be successful at managing their own finances, investing, running a business, at their jobs, etc, is to learn how to critically analyze the information they receive. A lot of abysmal if not intellectually dishonest and economic and financial data is released on a daily basis, and it’s important that you’re able to separate the good from the bad and make the right decisions. For instance a lot of investors sent Countrywide’s shares skyrocketing after their Q3 earnings report when the company claimed it would return to profitability in Q4, the thing is there was no logical reason to believe their claim when you consider the negative revenue, rising loan losses, etc. Yet investors fell for it and look at where Countrywide is now.

A less obvious company results example is Circuit City’s recent “profitable” quarter, or the retailer’s whose trumpeted positive results were truly just the beating of lowered expectations that were abysmal on YoY basis. Then you have the markets reacting positively to consumer spending data that is actually rather negative on a YoY basis when you consider inflation.

The list goes on and on and on.

Simply put: a ton of investors are making decisions based on bad economic data, decisions that they’ll eventually pay for. If you want to be successful you need to not only learn how to analyze and critique the information you receive, but understand how the market is likely to misinterpret it as well. The reason for this is twofold:

1. You’ll know the proper investment/trade to make based on the data
2. You’ll also be able to make trades that will take advantage of the decisions made by those who misinterpreted the data.

When I think of the skills one needs to be a successful entrepreneur, investor, etc, I can’t think of one that is more important than critical data analysis. Final thought: are contrarian investors really making money via doing the opposite of the market, or do they just have a better understanding of what is truly going on? In other words are they truly contrarians or are they just making smarter decisions than the masses, and can you truly call it being a contrarian when the masses are just being stupid?

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article.

Posted by M at 11:45 AM | Permalink | Comments (0) | TrackBacks (0)

Yesterday’s NY Times ran a great article discussing the financial health of the Mortgage GSEs and the possible negative impact to the economy if either one needs a rescue.

The overall situation can be summed up as follows: two companies that are losing money, are on somewhat shaky financial ground and potentially have unreported losses, bought 80% of all mortgages sold to investors last quarter. Furthermore congress has lifted their restrictions on investing in mortgages, during a time when it would’ve made more sense to rein in their investments, especially with respect to riskier non-prime mortgages and jumbo mortgages. Finally if either (or both) mortgage GSEs were to need a rescue of some sort, not only would the tax payer be on the hook for trillions but it could cause the credit markets to completely freeze-up.  

To help illustrate the primary issue around capital requirements take a look at a graphic below, which depicts the relative ratio of capital to assets and debt to guaranteed mortgages, as well as the scenarios under which the tax payer is on the hook for their liabilities.

Graphic courtesy of the NY Times

It’s also worth noting that Fannie Mae reported a loss of $2.2 billion for Q1 and analysts expected the losses to continue for the next 2-3 quarters.

Per the article the mortgage GSEs are exceeding their minimum capital requirements by approximately $7 billion, and while the GSEs believe that new revenue and investment dollars will offset any future losses can we afford to risk them being wrong? I contend that the country simply can’t afford to have any two companies in a position to cause such a large negative impact on the economy. From my perspective the mere fact that a significant risk exists is enough for immediate (and potentially drastic) measures to be taken, in order to protect the mortgage market and the larger economy.

(From the NY Times) “…But with mortgage defaults and foreclosures rising, Bush administration officials, regulators and lawmakers are nervously asking whether these two companies, would-be saviors of the housing market, will soon need saving themselves…

…as Wall Street all but abandons the mortgage business, Fannie Mae and Freddie Mac now overwhelmingly dominate it, handling more than 80 percent of all mortgages bought by investors in the first quarter of this year. That is more than double their market share in 2006.

But some financial experts worry that the companies are dangerously close to the edge, especially if home prices go through another steep decline. Their combined cushion of $83 billion — the capital that their regulator requires them to hold — underpins a colossal $5 trillion in debt and other financial commitments.

Continue reading "The Mortgage GSEs Need to be Broken up Before it's too Late" »

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Here is an interesting look at the history of Mars & Wrigley, AKA the stars of what is likely to be one of the biggest (if not the most talked about) M & A deals this year. Perhaps the more interesting part of this deal is that Berkshire is effectively behaving like a bank and co-financing it, the implication for the banks and the likelihood of other big buyout deals this year goes without saying.

 
Graphic courtesy of the WSJ.

You can read more on the deal here. 

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned.

Posted by M at 06:24 AM | Permalink | Comments (0) | TrackBacks (0)

I think buyouts can be great examples of how a company’s stock and the health of the underlying business can “decouple”. Just think about it: the people supporting the buyout are usually only concerned about the premium paid for the stock, rarely do they mention how the synergies between the acquired company and the buyer will lead to greater long-term growth. Oftentimes the supporters of buyouts adopt the attitude of persons who have given up on the company, and just want to collect the highest premium possible when they cash out.

In other words they really aren’t looking at the merits of the deal with respect to the underlying business; they’re just interested in profiting off a short-term increase in the value of the company’s stock. I’d even argue that people argue backwards from a satisfying premium, and fill in the argument that the buyout will help the company.

I.e. while a buyout may help the stock price, it may actually eviscerate the underlying company.

Continue reading "Thoughts on M & A" »

Posted by M at 05:29 AM | Permalink | Comments (0) | TrackBacks (0)

As the months roll on you’re going to read a lot of stuff from various analysts, pundits, *coughs* and uh, bloggers trying to compare the current economic crisis to the various financial crises of the 20^th century. However very few of these commentaries will be delivered by someone who was actually there to witness them, case in point: while I was involved in technology during the tech boom I was a paperboy (and in elementary school) during Black Monday.

In keeping with the above here is a link to a WSJ article containing the excerpts of an interview with Peter Bernstein, a guy who was actually there for every financial crisis of the 20^th century. Whether you agree with what he says or not, the fact remains: he’s no dummy and he did manage to survive several financial crises over his life time, he just might know something.

If and when the WSJ makes the full interview available, I’ll be sure to provide a link.

Posted by M at 01:54 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a great graphic from the WSJ that depicts the performance of various stock indices from around the world; as you can see the U.S. stock market is outperforming the markets of Asia and Europe.

While the Fed and the weak dollar are cited as possible reasons, another is that the performance of various foreign markets reflects investor sentiment around the state of the U.S. economy, AKA the largest market for most foreign companies. Still this is just a snapshot of the past quarter and this same graphic could look significantly different six months from now.

Sources: graphic courtesy of the WSJ.

Posted by M at 12:28 PM | Permalink | Comments (0) | TrackBacks (0)

Arguably, this is only a mild exaggeration as the markets seem to think that the economic data of a single day, week, month, etc, will define reality for generations. The market is gripped by very short-term thinking right now and that needs to change if the markets are too stabilize, as we’re likely to experience a protracted recessionary period and overly reactive thinking will just artificially depress the markets. 

Posted by M at 11:26 AM | Permalink | Comments (0) | TrackBacks (0)

Speaking of Bears, here is a WSJ profile of David Tice a rather “dour bear” and his successful Prudent Bear fund. While the usual story on Tice is that he’s intensely negative about the economy and generates a lot of returns via shorting stocks, one should also note all of the sectors he’s long in. In other words: he’s not bearish about everything he’s just bearish about some things. Better yet, being a bear allows him to identify the sectors to avoid and it informs his decisions on where to go long.

Simply put: being a bear isn’t about being an unnecessarily negative individual, who shorts stocks and wishes for the economy to go bad. Perhaps being a bear is more about protecting one’s assets from overrated and overbought investments/sectors, and identifying hidden opportunities in addition to sectors that will benefit when the worm turns/the market corrects.

Continue reading "David Tice: A Prudent Bear" »

Posted by M at 01:41 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting article from the WSJ discussing the performance of the S & P 500 since 1999; the article makes the case for the U.S. already being stuck in a lost decade because the S & P 500 hasn’t really moved from its 1999 levels. As you can see from the chart below, since ’99 the S & P 500 has been one of the worst performing investments around.

Now does this mean one should abandon the S & P 500 as an investment? No, people who stopped putting money into the S & P 500 in 1999 have fared worse than those that continued to invest, as the performance of the S & P has been positive from mid ’01 to the present.  

Continue reading "The U.S. Already in a Lost Decade" »

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A variety of things in this edition…

Credit Suisse reveals that it has on its own “rogue trading” problems, as the bank warned it would be reporting a loss for Q1 due to traders who inflated the valuation of certain trades. I suspect we’re going to see more and more of this as the year unfolds. The aftermath of a boom/bubble often sees an increase in fraud cases either due to:

1. People trying to illegally prolong the good times
2. The amount of money being made during a bubble often tempts people to break the rules
3. When everyone is making piles of money people are less vigilant about watching the store, so it becomes easier to commit or simply cover-up fraud

The Credit Crunch is spreading to student loans as three rather large banks elect to end their Federal Student Loan programs, the combination of a reduction in federal subsidies and the credit crunch has simply made the business more risky and less profitable. While the three banks only accounted for ½ a percentage of the total federal loans originated last year, this could turn into a troublesome trend if other banks follow suit.

Speaking of HSBC (one of the banks dropping out of the student loan business), recently reported $17 billion worth of losses related to the U.S. mortgage market, however the bank still earned $24.2 billion in annual profits (a 10% YoY increase), despite the banks problems in the U.S. This is an interesting contrast to institutions like Citibank, Merrill Lynch, UBS, et al, who experienced heavy mortgage losses and little to no YoY profit growth if they even generated profits at all. If anything it speaks to the strength of HSBC’s globally diversified business model, and the difference in strength between the foreign banking markets (especially in emerging market economies) vs. the U.S. one. 

Continue reading "News & Notes: March 20, 2008" »

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Here are some interesting graphics from the WSJ’s coverage of the Fed’s “Securities Swap Meet”, the first depicts how the share prices of various financial firms rose in response to the news and the second is a quick summary of the Fed’s actions yesterday. The funny thing about this is that the move does little to change the fortunes of some of these companies, the change in share prices is arguably just wishful thinking on the part of investors.

At this juncture the question offered is: “when it becomes apparent that the swap meet will have limited impact, what will the Fed do next?”

Sources: Graphics courtesy of the WSJ.

Disclosure: at the time of publishing the author held a position in WFC.

Posted by M at 09:10 AM | Permalink | Comments (0) | TrackBacks (0)

Tuesday’s big financial markets news was the announcement by the Fed that it was going to allow securities dealers to use mortgage securities as collateral to borrow government bonds. The goals of this action by the Fed are to inject more liquidity into the mortgage securities market, put downwards pressure on mortgage rates and ease the credit crunch. In response to this action, the Dow soared by 400 points and the share prices of various financial firms enjoyed significant gains on the day.

To be honest I almost didn’t believe the announcement at first, because it just seemed like a sneaky way to allow the brokerage firms to borrow from the Fed.

In my opinion, the Fed’ actions (and those that celebrate them) are indicative of the attitude that the role of the Fed should be to bail out the financial markets from their mistakes, regardless of the future impact/cost of these actions. Furthermore, one day market gains aside I’m simply not convinced that the “securities swap meet” will provide long-term value or even address the problems at hand.

Continue reading "The Fed's Securities Swap Meet" »

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Here is a link to a thought provoking interview with Jim Rogers, who argued during a recent appearance on CNBC that the Fed should be abolished, lest it continue to destroy the economy. I have to say that I don’t completely agree with Jim’s argument to abolish the Fed, as I think the idea of the world’s largest economy operating without a central bank is a bit extreme. However, I do agree with some of his points and have some of my own around the actions of the Fed over the past several years:

1. Trying to save the economy via devaluing our currency is a fatuous idea
2. The nation’s business leaders can’t whine about government regulation and praise free markets one minute and then beg for rate cuts and bailouts the next.
3. “Avoiding recessions at all costs” does not sound fiscal policy make, in fact recessions can actually be a good thing as they can a “detoxifying” effect on the economy. The best thing for the Fed to do right now is to sit back and let the recession run its course, the resulting changes made to business and consumer behavior will be good for the economy over the long-run.
4. The Fed, Consumers and Businesses need to start thinking long-term, not short-term.
5. Businesses and consumers need to learn to live with the consequences of their financial decisions.
6. The interventionist activities of the Fed come with a cost that is often greater than simply allowing things to run its course, see points #3, #4, and #5. 

Acknowledgements: a thank you to Paul Kedrosky’s “Infectious Greed” blog for bringing the link to my attention  

Continue reading "Abolish the Fed?" »

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I haven’t written one of these days in weeks so this iteration of news & notes will be a collection of interesting stories old and new, in fact I may make a couple of news and notes  posts this week.

The Swedish Krone is the “Hot Currency” right now as it stands to appreciate significantly against the Dollar, Pound and Euro, due to a combination of rising oil prices and their central bank rising interest rates. If the world’s economic woes continue I wouldn’t be surprised to see strong currency appreciation amongst countries that are rich in commodities; Canada’s commodities rich economy has helped their currency strengthen as well. Still, there is no such thing as a free lunch and currency appreciation often comes with costs, with respect to making it more difficult to sell one’s goods to other countries. Meaning, currency appreciation may be a moot point when you’re selling oil, but not when you’re selling manufactured goods. 

Continue reading "News & Notes - 3/5/08" »

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To follow along with the previous post, here are some graphics related to the SWFs:

The first focuses on which regions of the world are getting the most capital and which regions are making the investments, this image is interesting as China is both getting a lot of SWF investments and making a lot of them at the same time.

The graphics are part of a larger discussion on codes of conduct and ethical guidelines being proposed by the EU, the IMF and the United States.

Here is another graphic that’s part of an article discussing the amount of capital held by various funds and the investments they’re making into commodities; this one is interesting as many SWF are accumulating cash due their domestic commodities businesses and via investing in them. It creates an interesting dynamic as the funds will get richer via selling commodities, and then drive the prices of other commodities even higher due to amount of cash chasing investments in oil, steel, coal, etc.

Sources:

Graphics courtesy of the Wall St. Journal

Posted by M at 05:24 PM | Permalink | Comments (0) | TrackBacks (0)

In the wake of the various investments made by sovereign wealth funds (SWFs) into banks in Europe, various countries are looking into limiting the investments the funds can make and/or getting them to adopt a code of conduct. While I can understand why certain nations would want to curtail or at least regulate investments made by foreign nations, the other side is that investment stimulates business and SWFs did bail out many American and Western European banks. Cutting off a source of capital (especially now) based on protectionist fear is probably not the best idea; the worries over SWFs reminds of the late 80s when Americans we afraid that the Japanese were “buying the country”.

At a certain level this smells of certain nations wanting to have their globalization cake and eat it too, as many of the same nations have no problems with their domestic corporations purchasing companies in other countries, controlling resources, etc. IF globalization is truly going to work I think some countries need to be a bit more open minded, as opposed to only believing in globalization when it’s convenient. Governments need to be mindful of limiting investments into strategic assets and being unnecessarily protectionist.

Continue reading "Resistance to Sovereign Wealth Funds" »

Posted by M at 04:26 PM | Permalink | Comments (0) | TrackBacks (0)

The big news in the financial sector right now is the British Government’s decision to nationalize Northern Rock Bank, a move that was mostly symbolic in my opinion as the institution was effectively nationalized back in September. The Northern Rock situation is a symptom of the failure of “interventionist economic policy”, where governments and central banks try to protect companies, investors and even the public from the consequences of bad decisions, economic cycles, etc. While the goals are of “interventionist economic policy” are admirable the cost of these actions are often more detrimental than the disease; Northern Rock’s troubles are a result of the Fed’s cheap money policy designed to ward off recession in the U.S.

The British Government tried to save depositors, protect the larger economy and their banking system and have instead shackled the tax payer with a liability that stands at $50 Billion and counting. As this crisis unfolds, I suspect history will look back and determine that the cost of “saving” Northern Rock was actually greater than simply letting it fail.

Continue reading "The Failures of Interventionist Economic Policy" »

Posted by M at 04:46 PM | Permalink | Comments (0) | TrackBacks (0)

Interesting piece in the WSJ about the small handful of analysts who accurately predicted some of the fall-out from the credit crisis, more specifically they issued negative reports on stocks like E-Trade, Merrill Lynch and Citigroup. To be honest I found the article somewhat ironic since the “negative calls” came well after the credit crisis had already hit, and the article wasn’t about analysts making negative calls in ’06 or early ’07 – when they were MOST needed. If you think about the calls that were made, it’s more a study in speaking up than anything else.  

Continue reading "The Rogue Analysts who Dare to Say "Sell"" »

Posted by M at 06:22 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting blog post from the WSJ “Deals Blog” discussing seven “Private Equity Victims”, AKA PE owned companies that have had to declare bankruptcy in the past month due to un-serviceable debt loads. It’s an apropos companion to my earlier posts around the declining value of PE debt, and the implications as far as PE firms having potentially overpaid for various companies. If this situation goes from isolated incident to full-fledged problem with PE owned firms it won’t be a difficult problem to dissect: in overheated markets people often overpay for investments as they’re afraid of missing out. Furthermore it takes courage to only pair what you believe is fair-value, and/or to wait for an undervalued investment.

The "overpaying for investments" phenomenon happened during the tech bubble, it’s what happened during the housing bubble and it appears to be happening to PE. You can avoid a lot of trouble by just sticking to the adage of buy low (fair value or lower) and selling high, buying high in the hopes of selling even higher is just bad business.

Posted by M at 06:22 PM | Permalink | Comments (0) | TrackBacks (0)

The Financial Times has a page dedicated to examining the preparations various companies are making in case the U.S. goes into a recession; the page also provides analysis on the possibility of the recession, likely impact, etc. I think it’s a worthwhile add to your bookmarks folder, as what I’ve read so far has been fairly solid.

Posted by M at 07:11 AM | Permalink | Comments (0) | TrackBacks (0)

To go along with the story I pointed to in my “News & Notes” post from Saturday regarding the drop in the value of leveraged loans, here is an article on the situation from the WSJ along with a graphic depicting the drop in value.

Posted by M at 02:21 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a round-up of interesting stories related to the financial sector.

The Financial Times reports a sell-off of debt related assets this past Friday as investors are afraid that the credit crunch will get worse; of the asset types being sold off private equity loans led the way, including those that were used to finance the buyouts of First Data and TXU. The private equity debt is an interesting aspect of this story, as it suggests that many investors feel that PE firms overpaid for their acquisitions and that the purchased companies won’t be able to generate enough earnings to service the debt.

In a separate article from earlier last week, the FT reported that the value of buy-out loans have dropped tremendously as a result of various hedge fund and leverage credit mutual funds being forced into fire sales.

It’s also worth nothing that the last credit crunch lasted from 1989-1992, touching parts of four different calendar years.

Continue reading "News & Notes: Financial Sector 2/9/2008" »

Posted by M at 07:09 PM | Permalink | Comments (0) | TrackBacks (0)

There is a story in the Financial Times that is a prime example of the need to always look under the hood and consider the future, as opposed to assuming everything is okay based on what’s happening right now. This particular story discusses how if you look past default rates there are signs of trouble ahead in the corporate debt markets.

(From the Financial Times)  

“Sometimes a number can be misleading. Global default rates for heavily indebted companies are close to all-time lows, suggesting all is well with the corporate world in spite of a severe credit crunch and a looming US recession.

This was confirmed by the latest figures from Moody's on Wednesday, which showed the global default rate for high-yield companies is currently standing at 1.1 per cent - around 26-year lows. 

But take a closer look at other key statistics that measure the stresses in the financial system and a much more alarming story emerges. Credit default swaps, high-yield bond spreads and leveraged loan prices - key barometers for the credit markets - are all pointing to trouble ahead.

Continue reading "Yield Spreads Point to Rising Future Corporate Debt Defaults" »

Posted by M at 01:40 AM | Permalink | Comments (0) | TrackBacks (0)

In response to an article on the consumer credit bubble, several readers asked me about possible financial sector shorts. In response I wrote a post on evaluating potential shorts and provided two names: Washington Mutual (WM) and Capital One Financial (COF). I named these two stocks not just due to their mortgage crisis related woes, but because they didn’t seem (in my not so humble opinion) to have learned their lessons around bad lending standards. In the aftermath of the mortgage crisis both companies actually increased their pursuit of subprime customers for credit cards and auto loans, and some of the marketing language around their ARM loans seemed designed to entice potential homebuyers to overspend. In my opinion it really came down to how the companies approached the consumer credit markets, both seemed to be stuck in the fantasy world of 2005.

Let’s look at the performance of these stocks over the time period of my original blog post on 9/13/07 to market close this past Friday (2/1/08).

Continue reading "Checking the Performance of Past Short Recommendations" »

Posted by M at 05:30 PM | Permalink | Comments (1) | TrackBacks (0)

I wish I could say this is an exaggeration……

Comic Courtesy of the Pittsburgh Post-Gazette

Posted by M at 11:35 PM | Permalink | Comments (0) | TrackBacks (0)

As a companion to some of my earlier posts on Sovereign Wealth Funds (SWFs), here is an article from the WSJ discussing the collective strength of the funds and how they’re enabling ownership transfers of key economic assets away from the West and Japan. Whilst the worries about political influence persist, it’s said that many CEOs would rather raise capital from SWFs than from a domestic entity like a state’s pension fund. However, when looking at this situation its best not to extrapolate a long-term trend based on the events of the last quarter, let’s not forget when the Japanese were buying up American assets and people worried about the Japanese buying the country.

This is not to say that the SWFs, not to mention foreign companies and investors won’t rebalance the ownership of key assets away from the current major economic powers, just that it’s unknown how the long-term trend will play out.

Note: Morgan Stanley estimates that sovereign wealth funds currently hold $3 trillion in assets and may have $12 trillion by 2015.

Sources:

Graphic courtesy of the Wall St. Journal

Posted by M at 12:58 PM | Permalink | Comments (0) | TrackBacks (0)

Posted by M at 07:00 AM | Permalink | Comments (0) | TrackBacks (0)

Here is an article discussing a study by a HBS professor looking at the impact of Private Equity investment on the acquired companies, with respect to job creation, bankruptcy, etc. To be honest the numbers could be interpreted in both directions as far as PE firms creating or destroying jobs, but I think a more holistic view is required. PE firms usually purchase struggling companies that are poorly managed, and nothing destroys jobs like bad management. The only way you can really gauge the impact of PE firms on companies, is to estimate what would be the long-term impact of leaving the bad management firm in place and/or what would happen if PE didn’t get involved.

Continue reading "Private Equity: Plunderers or Saviors?" »

Posted by M at 06:30 AM | Permalink | Comments (0) | TrackBacks (0)

Following on my previous post on spotting buying opportunities during a bear market, here is an article from the Financial Times that discusses the trend of individual investors to “sell scared” their positions and/or snap up shares in companies they think will rebound. I think the problem here is that when a well known company falls on hard times, people rush to pick up the stock as it’s cheap and they expect a full recovery due the company’s size, past performance, brand recognition, etc. The problem here is that many investors are gauging cheap by absolute price, as opposed to trading at a significant discount to fair value. On the sell side, people are scared and run from the market at the very time they need to be searching for those truly discounted stocks.

Posted by M at 06:54 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a link to a WSJ article discussing the rapidly increasing size of sovereign wealth funds and the increasing number of deals they’ve done over the past couple of years. The most interesting aspect of this trend is that the funds are concentrated in the third world and/or emerging market economies, not the west. In a sense, these funds could constitute a “financial colonization” of the west and a significant redistribution of global financial power. While I suspect governmental intervention will limit their acquisition activities somewhat, it’s really a sign of a much greater trend as far as the growing wealth of their respective economies and the influence that comes with it.

Continue reading "Sovereign Wealth Funds" »

Posted by M at 06:31 AM | Permalink | Comments (0) | TrackBacks (0)

For some historical perspective here is a BBC News rundown of various financial crises going back to 1866, the similarities between them are probably the most interesting aspect:

1. Some sort of boom period, expectation, etc, leads to an abandonment of common sense.
2. Financial “innovations” carry consequences their designers did not foresee
3. Fear (justified or not)
4. Lack of regular intervention in spite of obvious abuses, stupidity, etc
5. Over-speculation (see #1)

The specifics may change, but the underlying core problems remain the same.

Posted by M at 01:49 PM | Permalink | Comments (0) | TrackBacks (0)

I revised the post from earlier this week on the possibility of a Global Bear Market, with more insights into how to spot a good buying opportunity.

According to a recent WSJ article discussing signs of a global bear market, $7 trillion in total shareholder value has been lost across major stock indices in the U.S, China, Japan, Russia and the U.K.

(From the Wall St. Journal)

“A classic bear market starts with a period of exuberance. Then a downturn hits one part of the market, and gradually, the losses spread even to strong companies. A prolonged grind begins…

… It happened in the 1970s, when an oil embargo helped puncture the "nifty fifty" big-company stocks, and again in 2001, when the bursting of the Internet bubble caused a broad decline. Now, investors shaken by two days of severe volatility fear another bear market -- only this time, it would fully span the globe.

Continue reading "Bear Market vs. Buying Opportunity Redux" »

Posted by M at 01:14 PM | Permalink | Comments (0) | TrackBacks (0)

Since the SocGen fraud is likely to a big story heading into the weekend and over the next week, here are some links/news items related to it.

First, a BBC news story discussing the state of the markets this past week and how it’s unlikely that that the SocGen fraud caused the global market collapse this past Monday, made a bad situation worse perhaps, but not a root cause. If you ask me, people trying to blame market performance on SocGen are looking for a convenient scapegoat instead of focusing on the world’s underlying economic issues. Not to mention the poor performance of the world’s major market indices so far this year.

Continue reading "SocGen Update" »

Posted by M at 12:24 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting post from the “Jeff Matthews is not making this up” Blog discussing a topic he calls the “The Great Private Equity Cash Robbery of 2007”. The basic premise is that companies used the depressed stock prices of the ’87 crash to buy back shares at cheap prices, this time around (granted we’re not in a crash) companies haven’t done that. The reason being that they’ve already spend a ton of cash buying back shares during the credit boom period, when stocks traded a premium.

Whoops.

Posted by M at 07:07 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a link to a blog written by John Gapper AKA the Financial Times’ chief business commentator; I only stumbled upon it today and found some of the quick blurbs posted from the Davos conference to be rather interesting. It’s a blog worth adding to your RSS reader, bookmarks, etc.

Here is a link to a recent blog post on the role of sovereign wealth funds in bailing out..err investing in U.S. banks. While the idea of foreign nations buying large stakes in our banks is troubling, it doesn’t change the fact that they’re in dire need of the cash. When the alternative is a deeper credit crunch on our shores and/or banks facing severe funding issues, I don’t think we have much choice but to allow the needed foreign investment.  

Posted by M at 04:16 AM | Permalink | Comments (0) | TrackBacks (0)

Graphic and link to a WSJ article discussing signs of a global bear market, as $7 trillion in total shareholder value has been lost across major stock indices in the U.S, China, Japan, Russia and the U.K. Here is an additional link to data looking at stock market valuations from 1999 to present.

Continue reading "A Global Bear Market or a Global Buying Opportunity?" »

Posted by M at 02:49 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting chart from BBC News depicting the rise and fall of the FTSE 100 in response to the various economic booms and crises of the last two decades. If you click over to the original article you can quick commentary and links to detailed news stories for each event. It’s a rather interesting look back at recent market history that is not only interesting, but may help put the current chaos into its proper historical perspective.

Sources:

Graphic courtesy of BBC News  

Posted by M at 10:14 AM | Permalink | Comments (0) | TrackBacks (0)

Here is a good run down from the WSJ on today’s rate cut and the impact it had on the markets, replete with videos around the trader reactions and commentator discussions on the selloffs within various emerging markets yesterday. The basic story is rate cut did help the shares of certain companies, but the overall picture of the market as a whole is still rather negative. In my opinion the movement of certain financial stocks has created some trading opportunities, as the lower interest rates are unlikely to help their circumstances over the next 6-12 months.

Posted by M at 01:57 PM | Permalink | Comments (0) | TrackBacks (0)

Here is a follow-up to yesterday’s post around the global market selloff: one graphic showing the performance of the world’s major indices yesterday and the year to date, and another comparing the performance of various indices in ’07 and ’08. The graphic is part of a larger article discussing the national and global implications of the credit crunch with respect to small business and commercial lending. The credit crunch impacting small businesses is a topic I want to provide with more detailed treatment (not to mention give it its own separate post), so look for something on that issue in the next day or so.

Posted by M at 01:39 PM | Permalink | Comments (0) | TrackBacks (0)

During times like these, the cool heads make money and the reactionary investors lose it.

You can read more about the Asian market selloff here, and the European one here.

Posted by M at 10:03 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting read from Tuesday’s WSJ, it discusses a hedge fund trader (John Paulson no relation to Hank) who made a killing last year betting against the housing market. For the year his funds are up $15 million, and his estimated $3-4 billion pay day for ’07 may be the largest one year haul in Wall St. history. The fact that he made the money isn’t the most interesting part; it’s the fact that few others made similar trades as they were caught up in the “housing never goes down” myth. Finally make note as far as the clever ways he came up with too short housing, and then put some thought towards the fact that auto lending and revolving debt (while weak) have yet to really crash like mortgages.

Continue reading "Trader Makes Billions off of Subprime Bet" »

Posted by M at 05:23 PM | Permalink | Comments (0) | TrackBacks (0)

Obviously the big financial news today is that Fed cut interest rates another 25 basis points, as a pundit of sorts I suppose I should write something detailing the impact of the decision, what I think of it, etc. Instead, I’ll simply write out the first things that came to mind when I read about it in the WSJ:

The fed cut interest rates? In word: “So what?” Low interest rates aren’t going to help the financial sector and certain homeowners from escaping the consequences of their bad decisions. At a certain level, rate cuts are just placebos if you look at the situations certain individuals and companies are in around simply losing money on their investments, having depreciating assets on their balance sheets, etc. Finally, you can’t fix a problem caused by cheap money with more cheap money; and the impact to the dollar isn’t exactly going to help the U.S. economy either.

Continue reading "The Fed Cuts Rates by 25bp, so....." »

Posted by M at 02:08 PM | Permalink | Comments (0) | TrackBacks (0)

If you were ever curious about the impact of the credit crunch on the Private Equity Boom, the chart below will provide you with some insight. In a short, the rise in PE was a bubble as well since it was powered by a credit bubble and cheap money; the sharp downturn in PE deals once the credit crunch hit is rather astounding.

Continue reading "Private Equity and the Credit Crunch" »

Posted by M at 04:56 PM | Permalink | Comments (0) | TrackBacks (0)