tag:blogger.com,1999:blog-56159550929100601342024-02-02T08:01:59.100-08:00Adverse SelectionEconomic and Financial Commentary from America's leading mediocre mind.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.comBlogger37125tag:blogger.com,1999:blog-5615955092910060134.post-51258118095276156692009-07-17T09:48:00.000-07:002009-08-06T21:52:06.693-07:00The Arrogance of Wall St.<a class="zem_slink" href="http://www.gs.com" title="Goldman Sachs" rel="homepage">Goldman Sachs</a> is a smart firm...very smart. But their recent position on the re-purchase of warrants from the <a class="zem_slink" href="http://en.wikipedia.org/wiki/Treasury" title="Treasury" rel="wikipedia">Treasury</a> has me a little perplexed. Allow me to explain. Goldman took over $10 billion in <a class="zem_slink" href="http://en.wikipedia.org/wiki/Troubled_Assets_Relief_Program" title="Troubled Assets Relief Program" rel="wikipedia">TARP</a> money from the Treasury to insure against <a class="zem_slink" href="http://en.wikipedia.org/wiki/Insolvency" title="Insolvency" rel="wikipedia">insolvency</a>. In exchange for the $10 billion or so of cash from the Treasury Goldman issued warrants to the Treasury (read: taxpayers). Warrants give one the right, but not the obligation, to purchase shares of a company's stock at a certain price. It's very similar to an "option" with the key difference being the length of time one has to exercise the warrant (the life of a warrant is typically 5-10 years while an option is generally shorter than that, sometimes only months). Here's an example using the Goldman case (I'm too lazy to look up the exact numbers but I think an approximation will suffice). <br /><br />The treasury receives twelve(12) million warrants that allow them to buy Goldman stock at $122/share. Last I knew, Goldman was trading at $150 (or thereabouts). If the Treasury exercises its <a class="zem_slink" href="http://en.wikipedia.org/wiki/Right_to_buy_scheme" title="Right to buy scheme" rel="wikipedia">right to buy</a> the shares, it would buy them at $122/share and sell them for $150/share, making a tidy profit of $372,000,000. By my rough calculations, that's about a 5% internal <a class="zem_slink" href="http://en.wikipedia.org/wiki/Rate_of_return" title="Rate of return" rel="wikipedia">rate of return</a>. Not bad for 12 months. But, it's not quite that easy. The contract Goldman signed with the Treasury allowed them to buy these warrants back from the Treasury. But price is negotiable. So what should Goldman pay? Whatever the Treasury wants. I'm guessing the Treasury won't give up their warrants for the $372,000,000 because of the tremendous long-term potential they see in Goldman. Remember, as Goldman's stock increases, so does the Treasury's profit. Since Goldman is one of the first to pay pack their loan, I would bet the treasury is eager to show the taxpayer what a good deal the TARP is for them and is asking for a little premium on their warrants. In other words, more than $372,000,000 and more than Goldman is willing to pay. If I'm the Treasury (and it's a good thing I'm not), then I would NOT let go of those warrants for any less than $750,000,000, yielding an attractive 10% <a class="zem_slink" href="http://en.wikipedia.org/wiki/Internal_rate_of_return" title="Internal rate of return" rel="wikipedia">IRR</a>. That's a nice double digit number. It's O.K. for Goldman to 'stick it to the man' as long as the "man" is not the Treasury/tax payer/life saver.<br /><br />If somebody saves your life, you take what they give you. I'm firmly rooting for the Treasury on this one!<br /><br /><div style="margin-top: 10px; height: 15px;" class="zemanta-pixie"><a class="zemanta-pixie-a" href="http://reblog.zemanta.com/zemified/c79ab2f3-d290-4b4d-a341-813711ec8abd/" title="Reblog this post [with Zemanta]"><img style="border: medium none ; float: right;" class="zemanta-pixie-img" src="http://img.zemanta.com/reblog_e.png?x-id=c79ab2f3-d290-4b4d-a341-813711ec8abd" alt="Reblog this post [with Zemanta]"></a><span class="zem-script more-related pretty-attribution"><script type="text/javascript" src="http://static.zemanta.com/readside/loader.js" defer="defer"></script></span></div>Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com3tag:blogger.com,1999:blog-5615955092910060134.post-568774025887933962009-06-25T09:11:00.001-07:002009-06-25T09:57:43.178-07:00Thoughts on Obama's Plan for Restructuring Financial ServicesLast week, Tim Geitner laid out a plan to restructure regulation within the financial services industry. The net result was an additional three government regulatory agencies with clearly defined mandates, which, among other responsibilities include monitoring banks, hedge funds, and consumer protection. One can easily find Mr. Geitner's testimony online (which I will find and post) but, in essence, it boiled down to 1) require banks to hold more reserves and keeping a close eye on banks that are "too big to fail" 2) require certain private investment vehicles to register with the SEC and 3) create a new division whose sole responsibility is to protect consumers. Here are a couple of thoughts. But before I share those, I should disclose (lest there be some agregious misconception that I know what I'm talking about) that I have no idea how to fix the problem. If I did, I would be there...fixing it (and making a lot more money). While I'm generally opposed to creating more governement agencies, I'm sure Mr. Geitner and the entire administration were thoughtful in their proposal, and it is certianly better than anything I would have come up with.<br /><br />1) I don't think more "regulation" is THE solution, nor was lack of regulation the problem. On the face of it, it would seem Mr. Geitner does think regulation was the problem. I get it, that's what he does, he exchanged a multi-million dollar private contract for a multi-million dollar public contract and his party line is, by necessity, "Re-establish confidence in the banking sector via broader regulation." But this is a faux-solution that is only optical in nature. Nope, more regulators won't work because employees working at Hedge Funds, Investment Banks, and other Financial Institutions are smarter than regulators. These firms made billions of dollars maneuvering through the OTC, FDIC, SEC, Treasury, FED, and the office of Thrift Supervision (just to name a few).<br /><br />2) I think there is a misalignment of interest between banks that are too big to fail, the shareholders, and the public. If a bank is too big to fail, then the purpose of that bank should NOT be to maximize shareholder wealth. Since maximizing shareholder wealth requires banks (because it is economically rational) to circumvent regulation and shoot for the moon. In other words, pushing the price of the stock higher and higher sometimes means you take more "risks" (that, in theory, you are compensated for). In the end, you have a limited liability since many of your liabilities (deposits) are insured by the state. However, if you are deemed systemically relevant (a very slippery definition) then you should have the public interest as a primary objective with shareholder value subordinate to that of the public. So this position, I think, creates a lot of philisophical problems for capitalism.<br /><br />Regulation may not be THE solution, but PART of the solution. What I believe we are grappling with are the incentives of capitalism. One tenent of capitalism is constant innovation and efficiency which result from risk taking at some level. Unfortunately, the higher the climb, the steeper the fall.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-48102719039269399882009-06-15T10:01:00.000-07:002009-06-16T09:01:56.122-07:00Investing in the New Economic Paradigm<p class="zemanta-img" style="margin: 1em; float: right; display: block;"><a href="http://www.flickr.com/photos/89488115@N00/2426434212"><img src="http://farm3.static.flickr.com/2231/2426434212_83d95ed5f5_m.jpg" alt="Bull Wrestling Bear Markets: Testosterone-driven" style="border: medium none ; display: block;"></a><span class="zemanta-img-attribution">Image by <a href="http://www.flickr.com/photos/89488115@N00/2426434212">ocean.flynn</a> via Flickr</span></p>I'll continue with the sparse summer posting. It seems these days my time is spent passed out on the couch from overconsumption of otter-pops. <br /><br />There's little doubt the last two years have changed the rules for investing and managing risk. Constructing your investments based on historical information worked as long as financial markets dealt the same types of risks (though the timing around the manifestations of those risks were completely random). In short, we all learned that when dealing with models, garbage in equals garbage out. Yes, models are helpful and they help crystallize your thinking, but it should not be a substitute for a good deal of independent critical thinking. So with all the uncertainty surrounding where the market is headed over the next 1,3,5, or 10 years I thought I would share a couple of thoughts. Perhaps they will be of some benefit (but probably not).<br /><br />1) The current recovery may be little more than a "Dead Cat Bounce". Perception is reality. Based solely on the number of editorials, articles, and reports I've seen over the last few weeks, I conclude the majority of US citizens assume the worst is behind us. Which is extremely curious. Based on fundamental information only, there is no justification of a recovery. In fact, less than 15% of all the stimulus has been deployed. Although this is curious, its not surprising. In a previous post I noted Mordecai Kurtz's (Stanford) research on behavioral economics. Kurtz concludes fully four-fifths (80%)of the movement of a stock price is based on behavioral factors, not technical. Markets move up when the majority of investors hold optimistic expectations of the economy and down when the collective view is pessimistic. To me, this conclusion means the American psyche could be in for a huge disappointment. Banks and Insurance companies still have a tremendous amount of exposure to commercial mortgage backed securities, which, by the way, have yet to correct for pricing. If this happens, unemployment could easily reach 15% which, I imagine, will have a devastating affect on investors who assumed the worst was behind us.<br /><br />2) If traditional asset allocation, modern portfolio theory doesn't work, what does? Perhaps a prudent way to evaluate investments is with three scenarios in mind; growth, depression, inflation. This allows one to be less rigid in their approach and forces investors to consider the macro environment before making a decision, instead of blindly following an allocation model. How much you allocate to each is based on your personal macroeconomic perspective. True diversification is a moving target. Writing in broad generalities, in the growth bucket you would target public stock, high-yield bonds, Real Estate, and avoid T-bills and some commodities. In the Depression bucket you would focus on holding T-bills, Gold, Foreign Reserve Currencies, and short duration government bonds but avoid exposure in US stocks or high-yield bonds. Inflation warrants investment in Commodities, Infrastructure (like toll roads, power, hospitals, etc.)and international markets. You might allocate a third of your resources to each bucket (growth, depression, and inflation) and tilt the allocation one way or the other based on your outlook. One note, exercise prudence when purchasing or selling securities to avoid buying at the height of the market. You could either dollar-cost average (purchase $200 of XYZ security every month/week/etc.) or use some light market timing. An example of "light" market timing would be waiting to buy gold. Gold is trading at historically high levels. Rather than wait for it to return to "normal prices", which may not happen for a few years, you would wait for it to come down, say 10%, and then make your purchase. In other words, you're simply being more opportunistic when you make your purchases. Unless you have a good understanding of a sector, its probably best to dollar-cost average.<br /><br />Anyway, I'm not providing specific advice, nor am I providing any advice for a fee (now you can't sue me). Rather, I'm simply introducing a couple of ideas that readers might find helpful and would like to study in more detail (on their own).<br /><br /><div style="margin-top: 10px; height: 15px;" class="zemanta-pixie"><a class="zemanta-pixie-a" href="http://reblog.zemanta.com/zemified/6570f257-174f-4d78-ba9d-b9c24b095485/" title="Reblog this post [with Zemanta]"><img style="border: medium none ; float: right;" class="zemanta-pixie-img" src="http://img.zemanta.com/reblog_e.png?x-id=6570f257-174f-4d78-ba9d-b9c24b095485" alt="Reblog this post [with Zemanta]"></a><span class="zem-script more-related pretty-attribution"><script type="text/javascript" src="http://static.zemanta.com/readside/loader.js" defer="defer"></script></span></div>Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-51015110626438095622009-05-10T20:04:00.000-07:002009-05-10T20:36:08.710-07:00The New York Common Fund ScandalThanks for bearing with me throughout the hiatus. Truthfully, aside from the Chrysler bankruptcy, there wasn't a whole lot going on. However, if you've been reading the financial times or the wall street journal you'll have come across several stories regarding Cuomo's latest smackdown involving one of New York's largest pension plans. Why should you care about this? Because some of the underlying details actually get to the problem with decision making in the institutional world that is equally applicable at the individual level.<br /><br />Here's what happened. The New York Common Fund is a public pension fund, one of the largest in the world. The fund is being investigated for allocating funds to money managers who made political/personal contributions. That's basically it. Most public pension funds have a Board of Directors acting as a check and balance on what the internal investment team is doing to avoid conflicts such as these. However, at the New York Common fund, they have a sole decision maker, the Comptroller. This Comptroller allegedly allocated money to several external money managers who investigators say also contributed heavily to the local political party. These "contributions", ahem...bribes were made by investment managers directly (think hedge funds and private equity funds) and also by placement agents. Placement agents are basically hired by hedge/private equity funds to help them raise money. They are paid a commission on any money they bring in. Cuomo says these placement agents paid fees to the comptroller, or his party, in exchange for several millions of dollars worth of commitments. Also, the NY Common fund hired consultants that almost had discretionary authority and approved several of these allocations. It's messy. Of course now it's turned into a massive witch hunt that will ripple across the institutional universe. I'm not to naive to think this doesn't go on elsewhere. <br /><br />There are obvious lessons here, but a couple I think we can apply personally. The first mistake is having a sole decision maker. It's a stupid idea for institutional investors and it's a stupid idea for individuals. You should never make a major money decision without a second opinion. You need someone else to help you think through the idea and help you discover if perhaps you are seeing something that simply isn't there. Second, many pension funds rely on consultants for opinions. This might seem like a good idea. But not taking any action unless a consultant approves such action is essentially giving de facto discretionary authority. This can be equally damaging. So if you don't want to make decisions on your own, and you don't want to rely too heavily on a consultant (or perceived "expert"), what do you do? Something in the middle. Make sure you listen to others but use some good judgment. Ask yourself, why would this individual be considered an expert in a certain field? What are his motives? Are they aware of other opportunities? Are they on the hook for the decision? Do they have money at stake (in other words, if I lose, do they lose?)?<br /><br />Being honest of ones intellectual and behavioral limitations could save thousands of dollars. It's not enough to be right or wrong, but to be right or wrong for the right reasons (or something like that). Good luck.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-88091799832051582582009-03-31T17:43:00.000-07:002009-03-31T21:02:49.035-07:00Double Standard for Auto IndustryI'm going to field this question as I walk out the door because I don't think it's too difficult. Many are wondering why the Obama administration is taking such a hard line with the auto manufacturers while being so tolerant to the banks. Here are five reasons, in no particular order.<br /><br />1. Banks pose greater systemic risks than the auto manufacturers. Although the effects of auto manufacturers going bankrupt would be immense, it would be worse to let the banks fail.<br />2. Banks are operationally solvent. Meaning, they have enough money to pay their bills and have only taken money from the Government to comply with regulation. Auto manufacturers can't even pay their bills, which is mostly due to their high labor costs.<br />3. Auto makers have been losing market share for the last ten years or so. Up until last year, banks have made money every year.<br />4. The White House is teaming with former Wall Street executives, which may account for why they understand the wall street funk.<br />5. The automobile industry has a lot more long-term uncertainty surrounding their business model (i.e. cars that run on alternative fuels, etc.). On the other hand, the low interest rate environment has actually helped banks this year as the spread between what they pay the depositors and what they lend is relatively wide. The majority of banks will be profitable this year (by profitable, I mean in a healthy way).Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com2tag:blogger.com,1999:blog-5615955092910060134.post-58928871515208189282009-03-30T09:47:00.000-07:002009-03-30T10:04:59.337-07:00Insights from PE Conference Part IIMore of the same doom and gloom scenarios with some interesting comments from the former head of the EBRD (European Bank for Reconstruction and Development).<br /><br />-There are major issues with banks in Europe since it is not uncommon for a bank's subsidiary, which functions entirely separately from its parent, to need additional capital to prevent a failure. Here's the problem, the parent bank is located in a different country. So XYZ bank is headquartered in Poland and has an Italian subsidiary that needs additional capital. Taxpayers in Poland have to put up the money to save an ostensibly Italian bank. That's caused some contention. <br /><br />-Eastern and Central European consumers are more reselient than U.S. consumers because they are not as demanding. Most Europeans in the developing regions are more resourceful and use to living on meager incomes. So it's unlikely the consumer will be as distressed in those areas as they are in other developing regions.<br /><br />-Lots of talk regarding the deleveraging of the U.S. consumer. That's a fancy way of saying americans are going to save more. According to a brand new study by McKinsey, every percentage point gained in the personal savings rate translates into $100 Billion of decreased spending, which can be a major drag on the economy. This of course, assumes income growth remains stagnate (which it has since 2000). If incomes increase, then spending can increase and savings can grow.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-20476012828960570052009-03-26T14:21:00.000-07:002009-03-26T14:31:15.343-07:00InsightsFor the next two days I'll be at the Thunderbird Global Private Equity Conference. The first couple of presentations have been interesting. Here are some tidbits.<br /><br /><br />Regarding TARP Money. An executive from a large bank that took money from the TARP had to rescind job offers to several candidates because he was informed that banks who recieve money from TARP can't hire non-U.S. citizens. Ouch. Can you say talent flight?<br /><br />On the Treasury's new plan. Seems like consensus is that the new proposed partnerships (I know, I promised a post on this and will complete it soon) between the governement, banks, and private money, is a logistical nightmare. I can't say I'm surprised. You have three separate parties trying to establish a "fair" price. And everyone has a different agenda.<br /><br />More shoes to drop. Not to go into detail, but bond spreads are predicting defaults to go from approximately 5% to 15%. That's not great news for employment, and, by extension, GDP.<br /><br />China's political backlash. Earlier this week China said it was worried about the solvency of the U.S. That should scare most people. China is the largest holder of U.S. treasuries. If China decides to dump them for a safer investment, we would have massive hyperinlation (I know, that's redundant). I don't think that will happen for two reasons. First, there really aren't any other currencies I can think of that are safer and second, they'd be shooting themselves in the foot. China's GDP is like 50% exported and the U.S. is the largest net buyer. Guess what happens if we can't afford their goods due to our hyperinflation?<br /><br />More to come.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-48825139046959496872009-03-22T21:27:00.000-07:002009-03-23T11:13:10.664-07:00Summing up the AIG bonus debateHard to watch/listen to any news without hearing about AIG's $165 million dollar bonus payout. I guess I was a little surprised how quickly the story spiraled out of control. My blood started to boil when I heard a prominent democrat (I won't mention HER name but will only say that it rhymes with "smelosi") illustrate what could generously be referred to as a complete lack of insight, knowledge or even a general awareness of the circumstances and points of debate regarding the bonuses AIG paid out to their employees. I'm not making a political statement. This is not a political blog. Many members of congress, on both sides of the aisle, misunderstand the situation but I only heard her comments due to her public profile. <br /><br /><span style="font-weight:bold;">What Happened</span><br />AIG received $170 billion from TARP and posted a 4th quarter loss of ~$60 billion. A week ago AIG announced it was paying out $165 million in bonuses to various employees. Total payouts by AIG could reach over $1.2 billion. The difference accounts for additional performance and retention bonuses. Can't wait for that to happen. And you think $165 million is bad?<br /><br />So here's a smattering from around the web. I tried to find arguements on both sides, but gave up after discovering there really isn't a logical contra-arguement against the paying of the bonuses, mostly just populist rage. Here what strikes me as funny, everybody hates these guys are getting paid, but no one knows for what or for when and everybody hates the 90% tax. Tell me again why we're having this arguement? Is it even productive?<br /><br />As you can expect, comments range all over, from very sophisticated "These bonuses are terrible but must be paid as a matter of contract" to "Hey, Pa, come n' see what those @#$%* from AIG that knocked up Jenny done did!" Alas, the apparent risks of a computer in every home.<br /><br />First....<br /><br /><strong>Rick Newman U.S. News</strong> explains why we are so outraged.<br />Myriad experiments in behavioral economics have found that people are willing to pay to punish members of a group whom they believe to be shirkers or free-riders. In other words, people are willing to make themselves worse off (they have to pay their own money) in order to insure that others don’t get undeserved rewards. But when it comes to the A.I.G. bonuses, the costs of clawing them back are trivial at best, while the public satisfaction at seeing what feels like justice being served will be great. Getting all worked up about this money may not, strictly speaking, be rational, but I think that paradoxically, if some of this money is clawed back, it’ll increase the chances that we’ll be able to keep dealing with the ongoing crisis in a rational way in the future.<br /><br /><strong>On to the rational minds...</strong><br /><strong>Andrew Ross Sorkin (Editor, NY Times). </strong><br />The fundamental value here is the sanctity of contracts. Imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right. A.I.G. built this bomb, and it may be the only outfit that really knows how to defuse it. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it. Let them leave, you say. Where would they go, given the troubles in the financial industry? But the fact is, the real moneymakers in finance always have a place to go. You can bet that someone would scoop up the talent from A.I.G. and, quite possibly, put it to work — against taxpayers’ interests. <br /><br /><strong>SmartMoney</strong><br />For the stock market, this is a rally-killer. Or worse. No one seems to want to determine whether the people getting this money deserve it or not. Maybe some of them don't—maybe some of them are even the bad people who got AIG into trouble in the first place. But maybe some of them do deserve it. Maybe there's one guy or gal who has just done some brilliant trade that has made taxpayers billions, at least offsetting some of the billions in losses. Should that trader not get a bonus? No one seems to care that the 90% tax will apply to all banks that have accepted federal money, not just to AIG. That includes banks like Wells Fargo, who told Treasury secretary Henry Paulson that they didn't even want the money when the Troubled Asset Relief Program (TARP) was enacted last October. Reluctantly, Wells took the money at Paulson's urging, as did other healthy banks such as JPMorgan. Now virtually every employee of every one of them faces a 90% tax on their bonuses. No one seems to care that the Internal Revenue Code is designed to collect federal revenue, not to punish particular classes of people. These employees will simply leave. Or they will turn their brains off. Either way, the taxpayers whose money is at stake in these companies will be hurt—because these companies will crash and burn.A successful economy depends more than anything else on the rule of law. There has to be a stable set of rules governing the interactions between economic players, and between players and the government. <br /><br /><strong>From the Wall Street Journal</strong><br />If the A.I.G. bonuses looked were the quintessential example of Wall Street self-dealing, the House’s bill looks like a quintessential example of blunt and ill-considered political policymaking. On top of that, one logical consequence of this bill would be that companies will simply pay people much higher base salaries, which takes us in the wrong direction. <br /><br /><strong>Henry Blogett at Clustershock</strong><br />Today’s frantic passage of the Populist Rage Tax was a new low in the US government’s response to this crisis. It shows just how likely we are to doom ourselves to a decade or more of misery — by choking our markets, closing our borders, turning our banks into tools of social policy, and wrecking what’s left of our economy. If the “TARP bonus” bill the House passed today becomes law, any of the hundreds of thousands of people who work for Citigroup, Bank of America, AIG, and nine other major US corporations will have to fork over 90 cents of every dollar they make that puts their household income over $250,000. That’s household income, not individual income. If you’re married and filing singly, you’ll have to surrender anything over $125,000. Indefinitely.<br /><br /><strong>Eric Etheridge, NYTimes</strong><br />As the financial crisis has evolved its moral has been simplified, grotesquely. In the beginning this crisis was messy. Wall Street financiers behaved horribly but so did ordinary Americans. Millions of people borrowed money they shouldn’t have borrowed and, not, typically, because they were duped or defrauded but because they were covetous and greedy: they wanted to own stuff they hadn’t earned the right to buy. But now that taxpayer money is on the line the story has changed: innocent taxpayers are now being exploited by horrible Wall Street financiers. The guy who defaulted on mortgages on his six spec houses in the Nevada desert has turned himself into the citizen enraged by the bonuses paid to the AIG employees trying to sort out the mess caused by his defaults. <br /><br /><strong>David Harsanyi at DenverPost</strong><br /><br />Here's an idea: If you stop nationalizing banks, there will be no need to engage in phony-baloney indignation over bonus payments anymore. Don't we want AIG to succeed and get off the government dole? What sort of employee would work for an entity that doesn't honor its contractual obligations? How many valuable employees will walk away from such a company? <br /><br /><br /><strong>Chris Bowers at OpenLeft </strong>describes why the tax needs to be broad<br /><br />1. Passing Constitutional Muster: Lawrence Tribe has written that, in order for a bonus tax to be constitutional, it must be "sufficiently general to avoid classification as a measure targeting solely a closed class of identified and named individuals." The more narrow the bonus tax legislation, the less likely it will be ruled constitutional. As such, making the bonus tax as broad as possible is necessary to the survival of the legislation.<br /><br />2. Weeding out thieves from the bailout program: The bonus tax must apply to all participants in the bailout program, so as to guarantee that only those firms and people interested in helping the economy participate. Anyone who considers their personal compensation to be more important than helping the economy needs to be kept as far away from the bailout program as possible.<br /><br />3. Addressing a broad culture of greed and excessive executive compensation: I agree with President Obama that the bonus scandal is a "a symptom of a larger problem," based on a broader "culture of greed.". As such, if the bonus tax that is aimed only at AIG, then it simply is not good enough legislation. The bonus tax has to make a broad dent in broader problem of excessive financial services industry employee compensation, which is directly connected to our ever widening income inequality. This is one of the best opportunities I can ever remember to pass such a law.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com3tag:blogger.com,1999:blog-5615955092910060134.post-60181211971947947662009-03-14T14:19:00.000-07:002009-03-14T16:36:58.348-07:00Banking ParalysisSome of you could probably tell I've been intentionally avoiding posting on the economy specifically for a few weeks as I was waiting for the stimulus mess to sort itself out. I hoped to post something about President Obama's stimulus package in more detail, but, after following several publications over the last couple of months on the matter, determined there are enough sites out there to explain what the stimulus means to the "average Joe." But I would like to address a couple of items that have come up in conversations/emails. They are 1) <span style="font-weight:bold;">What is taking the Banks so long to get their act together</span> and 2) <span style="font-weight:bold;">What does a Bank "Recap" mean?</span>. So there's still lots of discussion around financial services. This discussion however, is different than the commentary six months ago. I'm not going to answer these questions in order, or even in one post, but instead lay out, basically, how banks work. Doing this, I think, will help give perspective to the ongoing financial paralysis. I apologize if this sound condescending, but I have no idea who is reading this blog so I will write to the least common denominator.<br /><br /><span style="font-weight:bold;">How Do Banks Make Money</span><br />You open a checking and/or savings account with the Bank and they pay you little to no interest. Then, they take your money and lend it out at say 6%. If the Bank pays you 2% on your savings account, they are making 4% on your money. More specifically, they pay you 2% on your savings account and lend your money to home buyers (in the form of a mortgage) for 6%. <br /><br /><span style="font-weight:bold;">What does it mean to "Securitize" a mortgage?</span><br />I wrote about this in an earlier post but will briefly summarize here. Let's say your mortgage is with Bank A for $200,000. You pay the bank say $1,500/mo for 30 years in exchange for the $200,000 up front (you're total payment is $540,000 over 30 years). But perhaps Bank B wants to buy your mortgage from Bank A. So Bank A sells the mortgage, for about $200,000. In this role, Bank A acts as an intermediary and only makes money off of closing fees. Your mortgage is now with Bank B, and they have claim to all future payments. Over the last several years Bank B would typically be an investment bank. Not only would they buy Bank A's mortgages, but they would buy mortgages from thousands of banks. Bank B bundles 1,000 (for example) mortgages together and divvies them out in slices of 10 (each slice has payments from 100 mortgages). This slice can now be called a security, or, a CDO (Collateralized Debt Obligation). The price that another bank would pay for this security is based on the perceived riskiness of the underlying payments, or, the credit worthiness of the borrower. At the time, none of the Banks anticipated the steep decline in housing prices. <br /><br /><span style="font-weight:bold;">Bank Capital</span><br />When borrowers began to default because they couldn't refinance their homes the Bank holding the CDO had to write the value of that CDO down accordingly based on mark-to-market (or fair value) accounting. The CDO is an asset to the bank that owns it. Future payment streams from mortgages are assets to banks. However, if the value of the Bank's investment was $10 million a year ago, it's now worth $2 million and they must take a $8 million dollar loss. That's what has been going on over the last year. Let's look at how that affects the Bank by providing an example.<br /><br />Say you wanted to start a Bank and you were able to come up with $20 million dollars in cash from investors in exchange for equity (i.e. stock) in the bank. Then, you went and borrowed money in the form of Bonds for another $80 million. Now you have $100 million to "invest". Remember, with a bond, you pay the bondholder a set percentage each month, say 4%, of the face value of the bond and at the end of ten years you have to make a lump sum payment to the bondholder for the face amount of the bond (you would have thousands of Bondholders with individual bonds for $1,000 each paying 4%/yr). From the Bank's perspective, Bonds are liabilities. They represent a future obligation the Bank has to someone else. Then, with your $100 million, you go out and buy some CDO's that are paying you 6%. That's a great business model. Your CDO's are paying 2% more than you have to pay your bondholders. But if CDO's fall in value by 80% due to defaulting borrowers in the underlying mortgages, your $100 million of CDO's is now worth $20 million. Keep in mind, you still have to pay your bond holders. Now, your assets are less than your liabilities. Meaning, you don't have enough money coming in from your CDO's to pay your bondholders. The Bank is insolvent. I'm over-simplifying here, but you get the picture. This gets us to about Q3 of last year.<br /><br /><span style="font-weight:bold;">One Thing Exacerbates the Problem</span> <br />There's a timing issue. You may have noticed at the onset that Banks borrow short and lend long (to use standard industry vernacular). A deposit is a short term liability to the bank, whereas a mortgage is a long term asset. At any point in time a Bank may only have 15-20% of all their deposits on hand in cash. Should depositors want to withdraw all their money at the same time the Bank would not be able to liquidate enough assets to pay their liabilities. This is one sort of "Bank Run." We know from the IndyMac fiasco last year, that all deposits are guaranteed by the FDIC up to $100,000. The problem lies in the fact that most Bank's short-term liabilities are not deposit accounts, and are not insured. To meet these obligations, Banks will typically borrow from other banks. But today, Banks are unwilling to lend to eachother because 1) they are worried the bank won't be solvent based on their exposure to CDO's and 2) they want to hang on to their own cash in case they have the same problem. So banks are just staring at eachother. Finally, a derivative product is to blame for the most recent stagnation--the dreaded Credit Default Swap.<br /><br /><span style="font-weight:bold;">Credit Default Swaps Explained</span><br />Back to bonds for a minute. If you want to buy a $100 Bond from JPMorgan you would pay JPM $100 (usually) and they would pay you a set interest rate, say 6% for 10 years, at which point they will pay you $100. You make $6/yr for 10 years and get your $100 dollars back, for a total of $160. Not bad, better than a 2% savings account. But there are two big risks. What if JPMorgan can't pay you back? What if interest rates go up and you're stuck at 6%? You could buy a Credit Default Swap for a few hundredths of a percentage point from an insurer to hedge the default risk (but you can't do much about interest rate risk). The insurer would step in and pay you off in the event the company you bought the bond from defaulted. Simply, they are insurance policies. But, since they're derivatives, the swap itself could be sold for a specific value. Let's make it a little more palpable.<br /><br />Merrill Lynch owns a bond OR a CDO from Lehman Brothers. They do the sensible thing to protect themselves and buy a CDS to insure against a Lehman default. Since Lehman is a huge company, they go to AIG for the insurance and pay AIG .5%/mo in exchange for the coverage. See the problem? CDO's default, Lehman is insolvent, AIG can't make everyone whole (CDS' aren't regulated so "sellers" of the insurance don't have to have reserves). ML is stuck holding the bag. Whereas ML thought they would be made whole via AIG they are now stuck with major losses on their own assets and are themselves, insolvent Now holders of ML bonds or CDO's must mark down their assets and they are insolvent, triggering another payout by insurers of ML to those that had CDS on ML. And by the way, ML sold their own CDS to other Banks, which they will no longer be able to honor. This massive chain reaction is still playing out across the financial sector. A bank may look healthy but they may be depending on an insurance payment from an insolvent bank.<br /><br /><br />Hopefully I've been able to elucidate the current financial faceoff in a little more detail. AIG was bailed out because they were the largest sellers of CDS in the world. The government is still trying to figure out ways to either get these toxic CDO's and other mortgage backed securities off the Banks balance sheet, or provide additional capital to "Recap" the bank. Both of which I will treat in the next post.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-84420157253295138902009-03-02T18:47:00.001-08:002009-03-02T19:44:10.403-08:00We interrupt your program to...<p class="zemanta-img" style="margin: 1em; float: right; display: block; width: 212px;"><a href="http://commons.wikipedia.org/wiki/Image:Steve_Jurvetson.jpg"><img src="http://upload.wikimedia.org/wikipedia/commons/thumb/2/22/Steve_Jurvetson.jpg/202px-Steve_Jurvetson.jpg" alt="Steve Jurvetson" style="border: medium none ; display: block;" width="202" height="243"></a><span class="zemanta-img-attribution">Image via <a href="http://commons.wikipedia.org/wiki/Image:Steve_Jurvetson.jpg">Wikipedia</a></span></p>...bring you a message of hope! GEEZE! I have to say it's getting a little annoying how CNN is reporting on the stock market. <br /><br />"DOW reaches a new twelve year low today. Wait...nope, now is its lowest in twelve years, wait, NOW...now...now...no, NOW."<br /><br />I get it, it's low. Fortunately, this market has done wonderful things for my popularity at social functions. Although I am getting a little cynical. Conversation:<br /><br />Partygoer: "What do you do for work?" <br />Me: "I'm a greedy bonus-mongering private equity investment guy."<br />PG: <span style="font-style: italic;">Blank stare </span> <br />PG: "Um, how would YOU fix this mess."<br />Me: "The way I figure it, the wealthiest people in the world right now are the Somali pirates. I think they should apply for Bank Holding Status and expand operations with money they receive from TARP. Since the government isn't asking any questions, I figure they could get to $20 billion or so with TARP money, plus whatever they get through routine plundering. At traditional 30:1 ratios, they could lend up to $600 billion (USD) to help stimulate the economy. The pirates that get sea-sick can go work on Wall St."<br />PG: <span style="font-style: italic;">Silence.</span> "Did you see how low the DOW was today?"<br /><br />On a different matter, I love talking to venture capitalists. They are the only ones that aren't afraid to say they are going to "change the world." I grin like a giddy school boy when they say it and I can never figure out why. Maybe it's because, subconsciously, I know some have actually already done it. Venture capitalists are behind some of the biggest game changing technologies like, Apple, Google, Yahoo, eBay, Amazon, Skype, Twitter, Cisco, MySpace, and Facebook. That's not even including the VC's who are working on advanced biotechnology and Life Science projects that will synthetically replicate human organs without the chance of rejection. I suppose I like talking to them because they're not depressed like the rest of us--they still dream. Here's one of the premier VC's in the world, Steve Jurvetson, of Draper, Fisher, Jurvetson, talking about his love of rockets. Incidentally, my son loves this clip.<br /><br />http://www.ted.com/index.php/talks/steve_jurvetson_on_model_rocketry.htmlJengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-11927046806711503012009-02-18T08:21:00.000-08:002009-02-18T12:13:09.017-08:00A Bong, an IOU, a FavorWhile I was stopped unnecessarily on the freeway this morning for President Obama's speech that was less than 15 minutes from my home, I recalled one of my favorite scenes from Dumb and Dumber. It's where the evil kidnapper finally tracks down Lloyd (Jim Carrey), grabs the briefcase and opens it while pointing a gun at Lloyd's head. Instead of finding a suitcase full of ransom money, he finds a bunch of I.O.U's, meticulously accounting for every dollar Harry and Lloyd spent upon learning there was actual money in the briefcase. Lloyd, apparently recognizing the kidnapper's distress, gently picks one of the pieces of paper off the ground and says, in a gentle voice, "Those are I.O.U's, that's a good as money. Look, this one for $250,000 (for a Lambourghini), you might want to hang on to that one..." So classic. <br /><br />My amusement quickly diminished as I replayed the scene in my head. In the replay, I played the role of Lloyd, my son played the one opening the briefcase (only he wasn't an evil kidnapper), and instead of $250,000 the price tag was $1.5 trillion, and instead of a lambourghini, it was social security. Yep, you can obviously tell that I'm worried about our future generations and the obligations they'll have to face, or not. Todays economic climate is in many ways primal and its given me reason to pause and consider a few random thoughts.<br /><br /><strong>Impact of Today on Future Generations:</strong> Economists and politicians have said very little regarding the impact of todays decisions on our children. To what extent are we mortgaging the future? At what point does someone (meaning someone in Washington) stand up and excersise some monetary and fiscal discipline now so that we pay for our decisions, and not our kids? We need to take action and solve the entitlement problem in the U.S., meaning health care and social security. In investing, you are taught to always look at a companys unfunded liabilities (i.e. pensions that are underwater or other obligations they can't meet) and run the other way if they have any. Then that begs the question, why would anyone want to invest in the U.S. with our underfunded pensions, broken social security and medicare programs? Could the U.S. default on its national debt? It's possible, but not probable. I think it would be more politically expedient to pick hyperinflation over default, but I'm not an economist. Time will tell what "kind" of Obama emerges. Will he step up and demand that deficits created from todays debacle be payed back with future suprluses, similar to the EU? Or will he continue to allow politicians make decisions based on the short-term and stick our children with the bill? I'm not saying that's irrational, as the current incentive program enduces such behavior, but we shouldn't expect legislators to act altruistically, better to make it law, which I don't think is probable. But that all leads me to my original soap-box that the problem with politics started when we made it a career.<br /><br /><strong>And another thing</strong>. Much has been written about Michael Phelps' bong debacle. Phelps was pictured smoking some herb at the University of South Carolina a week ago. I believe he should definately be more careful as he is a role model but, the amount of outrage over this matter is completely unnecessary. I mean really, even if it is deplorable, is that what we need to be focused on? A swimmer smoking a drug, which to my knowledge, has killed zero people? This seems to be a recent development in America--we're captivated by "breaking" yet useless news which only serves to distract us from other problems we should be dealing with. What's ironic about America's "outrage" is its generally directed toward people engaged in an action that the majority of american's have also participated in, but have not been caught. I love how the news anchors shake their heads in disgust when reporting stories about marijuana use, teen sex, or drunken icons, as if THEY have acted any better (see youtube "newscaster bloopers" if you don't believe me). Anyway, I'm not saying that such actions like those of Michael Phelps or others are acceptable, but I am asking that 1) is that really the most pressing news? Doesn't it just cheapen American intellect? I know that's what sells, but is that the point? To report only what sells? How about what's important? and 2) why should we be accusatory for something the majority of american's have engaged in? C'mon, FOCUS AMERICA! We're too distracted by shiny things--like clearance tags. We love to point the finger and blame other people for their "mistakes". <em></em>Rhetorical question.<em></em> Are you saying we are to blame for this mess and not Wall St. executives? I'm choosing not to answer that. But let's scream and throw chairs when discussing their bonuses. Is anyone else concerned that we are outraged at the bonuses of professionals who work in banking (a necessary industry) and not the compensation of professional athletes? Wait, wait, before you respond with "Professioal atheletes haven't caused any harm", I would like you to think about that question (since the two fundamental assumptions can be debated 1) did bankers actually cause today's issues? or did debt hungry Americans and 2) professional atheletes haven't caused any social or economic problems. To which I would say "really?")Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com3tag:blogger.com,1999:blog-5615955092910060134.post-17003184964201746112009-02-16T08:07:00.000-08:002009-02-16T08:56:54.457-08:00A Note About "Interesting Websites"Some of you may have noticed that I have a list of interesting websites to the right. Every so often I add a site to the list but I have never introduced them as I've posted them. So, since I have some spare time on President's day, I thought I would write a sentence or two on each of them. There is one commonality--all are backed by well known venture capitalists.
<br />
<br /><ol><li><span style="font-weight: bold;"><span class="blsp-spelling-error" id="SPELLING_ERROR_0">Zemanta</span></span>. Contextually relevant <span class="blsp-spelling-corrected" id="SPELLING_ERROR_1">pictures</span>, links, and suggestions for email and blogs. Ba<p class="zemanta-img zemanta-action-dragged" style="margin: 1em; float: right; display: block;"><a href="http://www.flickr.com/photos/79989800@N00/2516113621"><img src="http://farm3.static.flickr.com/2354/2516113621_7b86f4fc75_m.jpg" alt="Blog better using Zemanta" style="border: medium none ; display: block;" /></a><span class="zemanta-img-attribution">Image by <a href="http://www.flickr.com/photos/79989800@N00/2516113621">chucks</a> via Flickr</span></p>sically, you download <span class="blsp-spelling-error" id="SPELLING_ERROR_2">Zemanta</span> to your browser and while you are typing an email or blog post, <span class="blsp-spelling-error" id="SPELLING_ERROR_3">Zema</span><span class="blsp-spelling-error" id="SPELLING_ERROR_6">nta</span> suggests pictures, links, or tags you may want to add. You can even easily pull a quote from another blog and include it on your blog. Even as I type this, my <span class="blsp-spelling-error" id="SPELLING_ERROR_7">Zemanta</span> tool bar to the right suggests several pictures for "President's Day" as well as links to useful trivia and blog posts. See the image to the right.</li><li><span style="font-weight: bold;"><span class="blsp-spelling-error" id="SPELLING_ERROR_8">BillShrink</span>. </span>Checks credit cards and cell phone offers to ensure you are getting the best deal possible. You enter your balance/monthly fee, your interest rate (for <span class="blsp-spelling-error" id="SPELLING_ERROR_9">CCd's</span>), zip code, usage, etc. and <span class="blsp-spelling-error" id="SPELLING_ERROR_10">BillShrink</span> will come back to you with the best result. In the case of cell phones, it list alternatives by signal strength.</li><li><span style="font-weight: bold;"><span class="blsp-spelling-error" id="SPELLING_ERROR_11">ScrapBlog</span>. </span>You can create stunning <span class="blsp-spelling-corrected" id="SPELLING_ERROR_12">multimedia</span> scrapbooks online for free! Rather than simply send your friends sterile pictures, you can personalize your vacation, first day of school, with one of <span class="blsp-spelling-error" id="SPELLING_ERROR_13">Scrapblog's</span> <span class="blsp-spelling-corrected" id="SPELLING_ERROR_14">templates</span> or create one of your own. It is free to register, create and share your <span class="blsp-spelling-corrected" id="SPELLING_ERROR_15">multimedia</span> scrapbook online, but if you want to print it out, that will cost you. Not a bad business model.</li><li><span style="font-weight: bold;"><span class="blsp-spelling-error" id="SPELLING_ERROR_16">SearchMe</span>. </span>This is a new way to search the web. <span class="blsp-spelling-error" id="SPELLING_ERROR_17">SearchMe</span> lets you see what your looking for. Choose your category and you'll see pictures of web pages that contain your answer. This way, you can scan the web page for the necessary information before clicking through. It uses "stacks", which, if you've cycled through the top-movies section on <span class="blsp-spelling-error" id="SPELLING_ERROR_18">iTunes</span>, it has a similar feel--web pages cycle through your view as you move the toolbar from left to right, or right to left.</li><li><span style="font-weight: bold;">Yelp. </span>No rocket science here. Yelp is an easy way to find what's good, or not so good, in your area. You type what your looking for in the search bar and then your zip code and a list will populate with user reviews.</li><li><span style="font-weight: bold;"><span class="blsp-spelling-error" id="SPELLING_ERROR_19">Wetpaint</span>. </span>A <span class="blsp-spelling-error" id="SPELLING_ERROR_20">Wetpaint</span> website is built on the power of collaborative thinking. Here, you can create websites that mix all the best features of <span class="blsp-spelling-error" id="SPELLING_ERROR_21">wikis</span>, blogs, forums and social networks into a rich, user-generated community based around the whatever-it-is that rocks your socks. A social website that’s so easy to use, anyone can participate.</li><li><span style="font-weight: bold;"><span class="blsp-spelling-error" id="SPELLING_ERROR_22">Widgenie</span>. </span>If you're one to include polls or other types of tables in your blogs or just want a sharp looking graphic then <span class="blsp-spelling-error" id="SPELLING_ERROR_23">Widgenie</span> is for you. You can register for free, customize data and create a graphic to post to your blog, <span class="blsp-spelling-error" id="SPELLING_ERROR_24">facebook</span>, or <span class="blsp-spelling-error" id="SPELLING_ERROR_25">igoogle</span> account.</li><li><span style="font-weight: bold;">Prosper. </span>Looking for extra money? Prosper creates an online meeting place for those seeking money and those that have money but want a higher yield on their investment. It's a social lending site. You can apply for a loan or make a loan. Only there aren't any banks involved directly here. If you're looking for a loan, then you enter your information and those willing to make loans, will bid on your loan. Prosper asks for a lot of information on the borrower and will pull a credit score to show to potential lenders. Lenders can slice the data any way they want and bid for high or low-risk loans. What if you don't want to expose all your money to one person? You can spread your money around. If you have $1,000 to lend, you can parcel that out between different borrowers. </li></ol>
<br />There you have it. Some creative sites all aimed at making the universe more efficient. Also, since these are all venture backed companies they are all in the early stages of creation and I know <span class="blsp-spelling-error" id="SPELLING_ERROR_26">CEO's</span> are open and anxiously awaiting feedback from interested users. So take a look and don't be afraid to drop them a note via their "feedback" links if you don't like something. They will welcome your input with open arms.
<br /> <div style="margin-top: 10px; height: 15px;" class="zemanta-pixie"><a class="zemanta-pixie-a" href="http://reblog.zemanta.com/zemified/da4721bd-ef27-4477-a820-2e5de2be7ef8/" title="Zemified by Zemanta"><img style="border: medium none ; float: right;" class="zemanta-pixie-img" src="http://img.zemanta.com/reblog_e.png?x-id=da4721bd-ef27-4477-a820-2e5de2be7ef8" alt="<span class=" error="" id="SPELLING_ERROR_27" />Reblog this post [with <span class="blsp-spelling-error" id="SPELLING_ERROR_28">Zemanta</span>]"></a></div>Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com4tag:blogger.com,1999:blog-5615955092910060134.post-65772185638611674722009-02-03T20:16:00.000-08:002009-02-03T21:47:32.564-08:00Why Not Give Bailout Money to Taxpayers?In keeping with the theme of shedding a little light on financial topics you may be forced to discuss or have an opinion on at parties, funerals and baptisms, I would like to highlight a common question. It generally sounds something like this...<br /><br />"Why not give the bailout money to the taxpayers? We'll spend it. If they want to help us, just give us the money? How come the government is still giving it to irresponsible Wall St. companies? Bailing out Wall St. creates a moral hazard."<br /><br />Those who hold this view are assuming that 1) all bailouts create a moral hazard, 2) giving money to taxpayers in lump sums is preferred and 3) taxpayers will spend the "stimulus" money. I'd like to present a few alternatives to each of the three basic assumptions. And since the party you are speaking with will probably hold the "pro" side, it will be your job to introduce an alternate view (unless you don't care for confrontation, in which case you can smile and nod, or make a trip to the bathroom).<br /><br />1) Moral Hazards. This is the idea that if people are insulated from their bad decisions, they are more likely to act irresponsibly. Therefore, if Wall St. knows it's going to get bailed out in a pinch it will continue to act recklessly, or so the argument goes. If I have fire insurance then, according to the argument, I would be less vigilant about having fires in my home. But let me assure you, I would be equally concerned about a fire in my home with or without insurance. Likewise, we would expect banks that have received bailout money to continue in rash behavior. But we haven't seen that. In fact, they've pulled back too much and no lending is going on. Perhaps one solution to the moral hazard issue lies in the perceived outcome. For example, most people are ambivalent towards which banks hold their deposits because of FDIC insurance. That's because FDIC insurance offers a quantifiable solution, a known outcome. But a bailout or a house fire creates uncertainty and potentially complex and messy situations. I think the less certain the outcome, the less impact the moral hazard argument holds. As I stated in an earlier post, I don't think shareholders in Bear <span class="blsp-spelling-error" id="SPELLING_ERROR_0">Stearns</span>, who lost 100% of the value of their shares, or unemployed <span class="blsp-spelling-error" id="SPELLING_ERROR_1">CEO's</span>, are still running around like <span class="blsp-spelling-error" id="SPELLING_ERROR_2">druken</span> frat boys looking for more mischief.<br /><br />2) Giving money to taxpayers in lump sums. I've heard ridiculous numbers running around the <span class="blsp-spelling-error" id="SPELLING_ERROR_3">internet</span> about how much we'd all get if the government were to cut us a check. I think CNN ran an article today or yesterday showing the number to only be $9,500 (far below some claims of $100k). There is a psychological difference between a windfall (such as a stimulus check) and increased monthly wealth. Americans tend to save windfalls and spend when long-term prospects for personal wealth increase. Which is why...<br /><br />3) I don't think consumers will spend like we say we will. I'm not going to spend anything extra this month if I think my income will be zero next month. I believe the issue here is perceived job security. Stimulus from 2002 wasn't very helpful, nor was the stimulus from last year (so far). In environments of financial turmoil and uncertainty Americans save bonus money. However, this is why I think President <span class="blsp-spelling-error" id="SPELLING_ERROR_4">Obama's</span> taxpayer stimulus might actually work. His idea is to give taxpayers a credit by decreasing the withholding amount. Pretty clever. For most, it will amount to an extra $50/mo. in our paychecks for one year. Some economists think that this will help Americans spend money because we see a long term, fixed increase in our take home pay.<br /><br />To conclude, I'm saying the moral hazard argument should not be overstated, that if the <span class="blsp-spelling-error" id="SPELLING_ERROR_5">governemenet</span> wants us to spend, then they should attack the heart of the uncertainty--the job market, and that Pres. <span class="blsp-spelling-error" id="SPELLING_ERROR_6">Obama's</span> proposed stimulus is fairly astute.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com3tag:blogger.com,1999:blog-5615955092910060134.post-64622758664306510222009-01-25T13:39:00.000-08:002009-01-25T19:17:38.475-08:00No, wait, DON'T GO!This is still the blog for the infamous Toad Musings. Only, I think I've grown out of my wife's pet nickname for me. I also thought Adverse Selection was more appropriate. In economics, adverse selection is what you call it when you do business with someone/thing that you should not have only because the other party had information you didn't (what many call informational asymmetry). Confused about the parallels? Excellent. Feel free to tell me if you don't like the new layout.<br /><br />This will be a big week for the markets. There are a lot of earnings reports coming out this week and if the DOW can stay above its psychological floor of 8,000 that will be a good sign that maybe we've reached the bottom. Notables announcing earnings this week include McDonalds and Wells Fargo. Both may act as the proverbial canary-in-the-cole-mine. McDonalds historically has done very well in recessionary environments and Wells Fargo will provide a proxy for financial services in general. My prediction is that it will not be pretty. I think most firms announcing are going to take a big bath in order to lower expectations going in to the next quarter. Losses will be greater than what most analysts predict and I think its highly probable the DOW will slip below 8,000.<br /><br />Oh yeah, I haven't said happy New Year yet.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com1tag:blogger.com,1999:blog-5615955092910060134.post-12785241394334312582009-01-13T19:46:00.000-08:002009-01-14T08:51:35.543-08:00A Laughable YearSo I've been patiently waiting for an interesting financial news story to write about, although I have no idea how any could top what we saw in '08. 2008 was the year we saw the average Joe become a genius. Any schmuck could complain about any industry/politician/policy and be right. It was all a mess. From a rogue trader taking <span class="blsp-spelling-error" id="SPELLING_ERROR_0">Societe</span> <span class="blsp-spelling-error" id="SPELLING_ERROR_1">Generale</span> (a HUGE French bank) for $7 Billion, to bank runs, bailouts, and oil frenzies. Whew! What a year. It had all the hallmarks of a good action movie--non-stop explosions, car chases, and blatant disregard for extras. And like a good action flick, just when you think the action is over there is a dramatic outburst of unexpected last-minute action. Like last December where we were supposed to all hold hands and sing like the Who's in <span class="blsp-spelling-error" id="SPELLING_ERROR_2">Whoville</span> (much to the chagrin of the Grinch) on Christmas Eve--<span class="blsp-spelling-error" id="SPELLING_ERROR_3">BAM</span>! The grand finale featured Bernie <span class="blsp-spelling-error" id="SPELLING_ERROR_4">Madoff</span> wowing the audience by taking $50 Billion from savvy investors. In the words of Syndrome (from the <span class="blsp-spelling-error" id="SPELLING_ERROR_5">Incredibles</span>), "I'm still <span class="blsp-spelling-error" id="SPELLING_ERROR_6">geekin</span>' out about that!" I got back to my office after the holidays, sat back in my chair, took a deep breath and thought, "What next?" That's when my eyes wandered through the days headlines and saw.....<br /><br />A Porn industry BAILOUT? Excuse me? Yep, turns out the CEO of Hustler and the CEO of Girls Gone Wild paid a visit (no pun intended) to capital hill for a piece of the stimulus action (no pun intended), approximately $5 Billion. Where did THEIR money go?! America wastes money on boos, cigarettes, gambling, and porn. What's Hustler's excuse? They don't get any love from <span class="blsp-spelling-error" id="SPELLING_ERROR_7">Jenga</span> (and if the CEO of Hustler is reading, "<span class="blsp-spelling-error" id="SPELLING_ERROR_8">Jenga</span>" is just my stage name). Hilarious.<br /><br />Changing gears, my vote for "<span style="FONT-WEIGHT: bold">Best Decision nobody knows/cares about</span>": How about the GAO (government accountability office) refusing to opine on the Governments financial statements for the 11<span class="blsp-spelling-error" id="SPELLING_ERROR_9">th</span> consecutive year. They claim the government misdirected $55 billion, meaning, it went missing, in 2007. That's up from $41 billion the year before. How about Obama focuses on mowing his own lawn first this year. I'd start with the Defense department, where the GAO sites "accounting chaos." Good call GAO for not <span class="blsp-spelling-corrected" id="SPELLING_ERROR_10">putting</span> your name on THAT.<br /><br /><span style="FONT-WEIGHT: bold">I got a good chuckle out of these cheeky headlines from 2008</span> <span style="FONT-WEIGHT: bold">from about.com</span><br /><br /><strong style="FONT-WEIGHT: normal"><br /></strong>1. <a href="http://www.nytms-se.com/">Iraq War Ends; Bush Indicted For Treason</a> (NY Times Spoof Edition)<br />2. <a href="http://www.borowitzreport.com/article.aspx?ID=6961" target="_new637"><span class="blsp-spelling-error" id="SPELLING_ERROR_11">Obama's</span> Use of Complete Sentences Stirs Controversy</a> (<span class="blsp-spelling-error" id="SPELLING_ERROR_12">Borowitz</span> Report)<br />3. <a href="http://www.theonion.com/content/news_briefs/black_man_given_nations?utm_source=slate_rss_1">Black Man Given Nation's Worst Job</a> (The Onion)<br />4. <a href="http://borowitzreport.com/article.aspx?ID=6957">Failure to Blow Election Stuns Democrats</a> (<span class="blsp-spelling-error" id="SPELLING_ERROR_13">Borowitz</span> Report)<br />5. <a href="http://www.236.com/news/2008/11/05/american_voters_were_not_retar_10076.php" target="_new137">America to World: "We're Not Retarded!"</a> (23/6)<br />6. <a href="http://borowitzreport.com/article.aspx?ID=6960" target="_new246">Bush in Race Against Time to Wreck Country</a> (<span class="blsp-spelling-error" id="SPELLING_ERROR_14">Borowitz</span> Report)<br />7. <a href="http://tomburka.com/archives2/2008/10/mccain-to-suspe.php">McCain To Suspend Campaign In Order to Rescue Campaign</a> (Opinions You Should Have)<br />8. <a href="http://www.theonion.com/content/node/82168">Bill Clinton Sadly Folds First Lady Dress Back Into Box</a> (The Onion)<br />9. <a href="http://www.theonion.com/content/news/nation_finally_shitty_enough_to">Nation Finally Sh*<span class="blsp-spelling-error" id="SPELLING_ERROR_15">tty</span> Enough To Make Social Progress</a> (The Onion)<br />10. <a href="http://tomburka.com/archives2/2008_09.php#001120">Bush To Put <span class="blsp-spelling-error" id="SPELLING_ERROR_16">FEMA</span> in Charge of Wall Street Rescue</a> (Opinions You Should Have)<br /><br />Honorable Mention:<br /><br />11. <a href="http://borowitzreport.com/article.aspx?ID=6940" target="_new5">McCain Replaces Palin with Startled Deer</a><br />12. <a href="http://steveyoungonpolitics.com/ponzi-estate-sues-federal-prosecutors-for-slander/" target="_new682">Ponzi Estate Sues Madoff Federal Prosecutors For Slander</a><br /><br />2008 set the bar pretty high.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com1tag:blogger.com,1999:blog-5615955092910060134.post-84337072740823782042008-12-10T10:35:00.000-08:002008-12-10T11:02:30.184-08:00What are some unintended consequences of the auto bailout?Okay, I'll let the deep philosophical discussions (or lack thereof) on the new altruistic <span class="blsp-spelling-corrected" id="SPELLING_ERROR_0">American</span> business model rest for a second to discuss the bailout for the automotive industry (which will no doubt change in the coming days/weeks).<br /><br />I thought the comment below, from the Cato Institute, provides a nice context for discussion.<br /><br /><br /><span style="font-family:times new roman;">"Surprise! President Bush is willing to spend taxpayers money and inject the federal government into the economy – yet again. The financial bailout might have been justified on the grounds that finance is the lifeblood of the entire economy, and a frozen credit system brings every industry to a halt. But a bailout for a specific manufacturing industry has all the hallmarks of lemon socialism. It puts the federal government in the business of picking winners and losers, reduces the incentive of other industries to avoid excessive risk, creates a lobbying frenzy, and brings the inefficiency of the government sector to the normally more efficient private sector, which under free enterprise must stay in the black or go out of business. But I want to focus on a particularly scary part of this bailout bill.</span><br /><br /><span style="font-family:times new roman;">The bill provides that if the government gives companies money, the government will make some of their decisions: limit executive compensation, ban dividends, review large contracts, get rid of their executive jets (certainly a reduction in corporate efficiency, where the time of their top executives is the most valuable resource), make “green” cars rather than the cars consumers want, and so on. But it adds a new twist: The bill currently bars the car companies from pursuing lawsuits against California and other states trying to implement tougher tailpipe emissions standards. Jonathan <span class="blsp-spelling-error" id="SPELLING_ERROR_1">Cohn</span> of the New Republic suggests taking that concept further and requiring General Motors to fire a vice chairman who has expressed skepticism about the catastrophic effects of global warming.</span><br /><br /><span style="font-family:times new roman;">This ought to scare any genuine liberal. Congress is going to use our money to censor political dissent? Usually libertarians warn that if you take government money, you’ll eventually find yourself subject to government restrictions on your freedoms. In this case, there’s no phase-in, no “eventually.” Congress wants to tell private companies, private individuals, that once they take government money, they will shut up and toe the government’s line.<br /></span><br /><span style="font-family:arial;"><span style="font-family:times new roman;">If economics <span class="blsp-spelling-error" id="SPELLING_ERROR_2">isn</span>’t a good enough reason to oppose this bailout, preserving independent thought ought to be</span>."</span><br /><span style="font-family:Arial;"></span><br />I think the author's point regarding political expression is valid, while at the same time <span class="blsp-spelling-corrected" id="SPELLING_ERROR_3">recognizing</span> this also creates a material disincentive to take government money, which I think should be the point. Make no mistakes, the deal will be very good for government, but can you also say the deal will then be good for taxpayers? <span class="blsp-spelling-error" id="SPELLING_ERROR_4">Hmm</span>. I get a little uncomfortable when I see media sources interviewing GM or Chrysler workers/suppliers who talk about how much they hope the government goes through with the bailout so they can keep their jobs. Does anyone see <span class="blsp-spelling-corrected" id="SPELLING_ERROR_5">fallacious</span> logic here? Whether or not the government grants the support, the big three will still have to drastically reduce excess and change business models, which means layoffs, plant closings, and breached contracts. Although staying in business is better, I think it might create a false sense of security for workers and suppliers.<br /><br />Then there's this little gem of a comment I read in the NY Times:<br /><span style="font-family:Arial;"></span><br /><span style="font-family:times new roman;">"Basically what we have here is the corporate equivalent of AA meetings. “My name is General Motors and I’m a <span class="blsp-spelling-error" id="SPELLING_ERROR_6">financaholic</span>.” (Applause please!) His long suffering mother, aka the United States government, attends <span class="blsp-spelling-error" id="SPELLING_ERROR_7">Alanon</span> meetings where she justifies giving junior a large enough allowance so he <span class="blsp-spelling-error" id="SPELLING_ERROR_8">needn</span>’t work enabling him to stay drunk 24/7." </span><br /><span style="font-family:Times New Roman;"></span><br />Where will the government draw the line? How many industries will/can we bail out? Is this the last one? Or are we just being taken for a ride (pun intended)?<br /><span style="font-size:0;"></span>Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com10tag:blogger.com,1999:blog-5615955092910060134.post-34532441212103369632008-12-02T11:37:00.000-08:002008-12-02T15:06:18.904-08:00Creative CapitalismWith an Recession officially under our belts, massive global uncertainty, and volatile capital markets, perhaps now is as good a time as any to revisit the traditional capitalistic model of making money. Earlier this year, Bill Gates delivered a speech at the World Economic Forum in <span class="blsp-spelling-error" id="SPELLING_ERROR_0">Davos</span>, Switzerland, entitled "Creative Capitalism." You can view his speech, which is about 20 minutes with an additional 10 minute Q & A, by clicking on the link below.<br /><br /><a href="http://www.youtube.com/watch?v=Ql-Mtlx31e8">http://www.youtube.com/watch?v=Ql-Mtlx31e8</a><br /><br />In his speech, Gates calls for a new form of capitalism whereby businesses focus some of it's efforts and resources towards eradicating the world's largest inequalities (i.e. Malaria, AIDS, Education, etc.). His speech <span class="blsp-spelling-corrected" id="SPELLING_ERROR_1">received</span> a warm response from the forum but was largely ignored by the global community (except for Warren Buffet and U2's <span class="blsp-spelling-error" id="SPELLING_ERROR_2">Bono</span>). However, yesterday on the Diane <span class="blsp-spelling-error" id="SPELLING_ERROR_3">Rehm</span> show, NPR featured a book called "Creative Capitalism" which is a <span class="blsp-spelling-corrected" id="SPELLING_ERROR_4">compilation</span> of essays and responses by some of the World's leading economists, <span class="blsp-spelling-corrected" id="SPELLING_ERROR_5">legislators</span>, and business executives on whether Gates' new business model, focusing on the global poor, could succeed. I looked through the table of contents and couldn't wait to read it. It takes a very "Hey, this is what he said to what you wrote, do you want to respond?" mentality which makes for some very passionate writing.<br /><br />Gates' speech is worth listening to, if for no other reason than the fact that the majority of the fortunes of the two wealthiest men on the globe will be deployed to combat or solve some of these maladies. But what do you all think? Who is responsible for solving some of these problems? If it adversely effects shareholders, should businesses be required to direct valuable time and money to <span class="blsp-spelling-corrected" id="SPELLING_ERROR_6">alleviate</span> the spread of malaria in Africa? Is there a problem with how "shareholder value" is defined and should it attempt to quantify the value of a company's social impact? And what about Gates himself, he made his billions thanks to the current free market system. Over the last 20 years, he spent his valuable time working on building a global giant, watching every penny to get <span class="blsp-spelling-corrected" id="SPELLING_ERROR_7">Microsoft</span> to where it is today.<br /><br />But what does everyone think? I would like to get your feedback.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com0tag:blogger.com,1999:blog-5615955092910060134.post-45925071582346519882008-11-24T15:56:00.000-08:002008-11-26T11:39:15.638-08:00A REAL Rich Man's OpinionThe last time I met with somebody who made Forbes' list of 500 Wealthiest Americans, the individual walked away with my pen. I was somewhat agitated since my pen cost about $6.00 (which I would usually have to disclose to my wife) and he probably has a dozen pens each worth ten-times the value of mine. Granted, this '<span class="blsp-spelling-error" id="SPELLING_ERROR_0">perp</span>' was number 200something on the list, you know, not THAT wealthy, only worth a few hundred million--so I should expect him to be fairly thrifty.<br /><br />Last week I had to meet with another one, this time higher on the list (I didn't bring a pen to the appointment). He handed me his card and I noticed he had one of those nifty nicknames people make up and put on their cards that have nothing to do with their real name. Like Larry "Buck" Smith, or Fernando "Hank" Velazquez. But, in this case, I thought it was deserved since he was probably beat up time and again on the playground because of his first name. Good call.<br /><br />I won't disclose his name since I didn't inform him that potentially up to TEN people might read about his comments on my blog, so it will have to suffice to say he is the CEO of a publicly traded company. He graduated from Harvard <em><span class="blsp-spelling-error" id="SPELLING_ERROR_1">Magna</span> Cum <span class="blsp-spelling-error" id="SPELLING_ERROR_2">Laude</span></em> with multiple honors (no "gentleman's" C here), which means he's a <span class="blsp-spelling-corrected" id="SPELLING_ERROR_3">legitimate</span> smarty-pants.<br /><br />Here's what HE thinks (emphasis here on his THOUGHTS <strong>not</strong> the fact that the individual is a MALE)<br /><br /><strong>Q</strong>: Why has your stock price gone from $36/share to $4/share in just a few months?<br /><strong>A</strong>: I'm not entirely sure, when we went public I put on the cover of our shareholder report that our daily stock price would not be an accurate reflection on the underlying, long-term economic value of the firm. So we don't manage around our stock price. Also, I don't think the majority of the public understands what we do. Believe me, I watch the stock price but there is little more I can do other than provide some level of comfort to investors.<br /><br /><strong>Q</strong>: How do you think the government is handling the current crisis?<br /><strong>A</strong>: On the whole, doing a good job. They've obviously made some mistakes. For example they tried too hard to help individual companies without figuring out how to help the broader economy at first. It's like a pack of wolves attacking Caribou and once a Caribou is injured and goes down, the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_4">government</span> tries to revive it, while they're doing that, another one goes down and they have to run over and help that one. But what they didn't do, is stop and figure out how to get the wolves from attacking the heard. I think now they're on the right track. But they blew it when they let Lehman go under. In my opinion, Lehman posed a greater risk than <span class="blsp-spelling-error" id="SPELLING_ERROR_5">AIG</span>. In fact, the organization that stood to lose the most amount of money from Lehman's bankruptcy was the government. Now, <span class="blsp-spelling-error" id="SPELLING_ERROR_6">AIG's</span> biggest counter-party (in other words, the biggest loser if <span class="blsp-spelling-error" id="SPELLING_ERROR_7">AIG</span> goes under) is Goldman Sachs. And by the way, Hank <span class="blsp-spelling-error" id="SPELLING_ERROR_8">Paulson</span> is an ex-Goldman banker and the Treasury is swarming with ex-Goldman employees who still probably own a good <span class="blsp-spelling-corrected" id="SPELLING_ERROR_9">chunk</span> of Goldman stock. But, that book hasn't been written. I'm only speculating here.<br /><br /><strong>Q</strong>: So you think what they're doing with the TARP, in all it's variety, is the right thing?<br /><strong>A</strong>: For the most part. Buying the troubled loans never made any sense to me. Here's why. If you buy something from the Bank for one dollar (as an example), all that bank gets is one dollar. If however, you provide them with one dollar of equity (which is now the goal of the TARP) they can turn around and get 15 dollars of additional capital since banks are leveraged 15:1. This is how credit and lending resumes. Without that outside capital, banks will not be able to lend.<br /><br /><strong>Q</strong>: So are you saying we should see liquidity and lending start to come back in the next few months?<br /><strong>A</strong>: No. That's what the treasury screwed up. We should have followed Europe. In Europe, when central banks had to step in they provided not only equity but added that the new capital had to be tied to increased levels of lending. We didn't ask for that in the U.S. The treasury should tie the equity infusion to resumption of lending, but either we won't, or have not to this point but may in the future.<br /><br /><strong>Q</strong>: What opportunities do you see over the next year?<br /><strong>A</strong>: Bonds! Debt! That's where the money will be made. I have no idea why anyone would want to take equity, or stock, in any company when the bonds will get you 20%. From a geographic perspective, we really like China because they have a very robust national balance sheet and there is a lot of organic growth. GDP estimates over the next year put China at 7 or 8%, which is huge given what's going on in the world today.<br /><br /><strong>Q</strong>: Where do you see our economy in three years?<br /><strong>A</strong>: Dealing with inflation. I think the government will continue to pour billions of dollars in new stimulus packages and will continue to do so until they overshoot. Since there is a lag, it will be impossible for the government to see the benefits of their stimulus packages and that will create inflation which will be <span class="blsp-spelling-corrected" id="SPELLING_ERROR_10">exacerbated</span> by high commodity prices, especially oil.<br /><br /><strong>Q</strong>: The latest question on <span class="blsp-spelling-error" id="SPELLING_ERROR_11">everyone's</span> mind is what to do with Detroit. Why are automakers being asked to come back with a plan when the Treasury is giving money away to institutions without any plan?<br /><strong>A</strong>: Automakers are further down in the food chain. They benefit from increased credit access. Although it wouldn't be pretty, we could do without automakers, we can't do without banks.<br /><br /><br />So there you have it. The pride of Harvard. Any thoughts?Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com4tag:blogger.com,1999:blog-5615955092910060134.post-70230743131881478562008-11-11T08:04:00.000-08:002008-11-12T10:15:06.477-08:00My Economic Agenda for President-Elect ObamaThe other day someone asked me, half <span class="blsp-spelling-corrected" id="SPELLING_ERROR_0">jokingly</span>, what I would do to fix the economy. I blurted something incoherent because I'm not very good on my feet and went back to work. Then I started thinking a little bit more and decided I would share my conclusions with the ten people that read my blog. I've given it a good day's worth of pondering, so, clearly, my opinions are very broad. Here are three thoughts, in no particular order.<br /><br /><strong>1. Create a principles-based rather than rules-based economy</strong>. This is no surprise to accountants. Most of them have had long philosophical discussions late into the night regarding the benefits and drawbacks of principles-based accounting (remember I spent a summer with a bunch of them). I'll share an example from the accounting world that will help illustrate my point. International accounting standards have a principles-based rule for the accounting of leases while the U.S. standards (according to <span class="blsp-spelling-error" id="SPELLING_ERROR_1">GAAP</span>) favor a rules-based standard. According to international accounting, leases must be booked as capital leases (<span class="blsp-spelling-error" id="SPELLING_ERROR_2">nevermind</span> the terminology here, that's not the point) <strong>"</strong><span style="FONT-WEIGHT: bold">if </span><strong>it transfers substantially all the risks and rewards incident to ownership."</strong> However, U.S. accounting standards lay out four different criteria for differentiating the different types of leases. If the lease meets one of the four criteria, it must be classified as a capital lease. The international standard is based on a principle, while the U.S. standard is based on several rules. There are obvious advantages and disadvantages to both. We generally like rules because they're easier to communicate and understand. They also create standardization. Conversely, while rules are better for <strong>communicating</strong>, we generally see that principles are better for <strong>compliance </strong>and forces one to use judgment. Broad principles avoid the pitfall of creating specific requirements that allow contracts to manipulate their intent. It's emphasizing form over substance. I'm not arguing we shouldn't have any rules, just that it currently seems a bit excessive and most savvy individuals and firms are quite good at finding ways around the rules.<br /><br /><strong>2. Lower Corporate Tax Rates.</strong> Currently the U.S. has the second highest corporate tax-rate (behind Japan) for developed nations. The tax rate, combined with the increasingly onerous regulatory environment (i.e. <span class="blsp-spelling-error" id="SPELLING_ERROR_3">Sarbanes</span>-<span class="blsp-spelling-error" id="SPELLING_ERROR_4">Oxley</span>) decreases the relative attraction of establishing businesses in the U.S. It also <span class="blsp-spelling-error" id="SPELLING_ERROR_5">de</span>-<span class="blsp-spelling-error" id="SPELLING_ERROR_6">incentivizes</span> companies currently headquartered in the U.S. to maintain operations, or a public listing. So this repels business investment, and creates both <span class="blsp-spelling-error" id="SPELLING_ERROR_7">un</span>- and under-<span class="blsp-spelling-corrected" id="SPELLING_ERROR_8">employment</span>. But there is yet another disadvantage of high corporate tax rates. Interest from debt is tax-deductible. The higher the tax rate, the greater the savings from the interest write-off (which eventually increases your firm's value, and, thus, share price). Therefore, <span class="blsp-spelling-corrected" id="SPELLING_ERROR_9">elevated</span> tax rates create an economic incentive to obtain leverage. This will come as no surprise to anyone in finance familiar with the "optimal capital structure." At it's core is a <span class="blsp-spelling-corrected" id="SPELLING_ERROR_10">theorem</span> which basically states in a world with no taxes, the amount of debt you have is irrelevant (from the standpoint of the value of your business and shareholder <span class="blsp-spelling-error" id="SPELLING_ERROR_11">wealth</span>, although it does increase risk) but as rates increase, so does the corresponding incentive to obtain debt since the tax savings from the interest write-off will be greater than the cost of the debt. The <span class="blsp-spelling-corrected" id="SPELLING_ERROR_12">theorem</span> states that there is an optimal amount of debt a company should have where it maximizes the risk adjusted return to shareholders. So decreasing tax rates will correspondingly decrease the economic incentive to lever a business. As a nation I think it's fair to say we are over-levered.<br /><br /><strong>3. Boost Government Spending in Infrastructure, Health Care, and Education.</strong> It may be good to introduce how GDP is calculated. GDP = C + I + (G-T) + X where GDP equals the sum of consumer spending C, Private Sector Investment (corporate spending) I, fiscal stimulus (netting government spending G minus what they bring in taxes T) and net exports X.<br /><br />How can GDP increase when consumer spending is down C, businesses are investing less I, and exports are decreasing because of the global recession X? That leaves fiscal stimulus. And, according to our equation above, if GDP is to remain constant, the fiscal stimulus (G-T) must be great enough to offset the losses in the other three categories. So we focus on G and T. Certainly decreasing taxes, both consumer and business, or creating tax credits will increase aggregate consumption in both (C and I). But many overlook the importance of government spending. Whatever the government spends will obviously increase the overall deficit. But the deficit will be a smaller problem if the money is spent on infrastructure rather than fettered away into adult film consumption (which, by the way, is very resilient in a recession). Instead of sending out more stimulus checks to Joe the Plumber (I'm referring here to the average <span class="blsp-spelling-corrected" id="SPELLING_ERROR_13">American</span>, not the actual guy that's been identified) the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_14">government</span> should think longer term and invest to decrease the cost of education, increase access to Health Care, and update our ailing 30-year old infrastructure (highways, roads, and utilities). If my children are going to be responsible for the deficit the government creates, then I want them to benefit.<br /><br />As I said at the onset, I haven't given this a great deal of thought, but enough to perhaps elucidate where I think our economy should look over the next ten to fifteen years. I'm sure I've left some vital piece of information out, but blogs are obviously imperfect (<span class="blsp-spelling-error" id="SPELLING_ERROR_15">afterall</span>, you get what you pay for). I think some of these changes will create a more intelligent, agile, and sustainable economy. And one last suggestion, I don't think Obama should run for re-election. He needs to be able to make decisions without the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_16">subconscious</span> desire to please potential supporters in 2012 .Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com4tag:blogger.com,1999:blog-5615955092910060134.post-81248469114241655002008-10-28T20:58:00.000-07:002008-10-29T10:41:56.733-07:00Looters after the HurricaneI thought I was the first to use the term "Financial Terrorism" in the context of today's financial crisis, until I saw Jim <span class="blsp-spelling-error" id="SPELLING_ERROR_0">Cramer</span> on <span class="blsp-spelling-error" id="SPELLING_ERROR_1">CNBC's</span> Mad Money going crazy about it a few weeks ago. Seems like the idea that 9/11 type terrorists are going after our pocket books is gaining some ground on Wall Street. Although many banks feel like they've been victimized by motivational short-selling, I don't think we can call this one the result of "nefarious" international investors...yet.<br /><br />The most popular purported "tool" of these economic pirates is called short-selling. Short-selling is the art of selling something you don't own. Until relatively recently, you could only be rewarded in the market if you correctly <span class="blsp-spelling-error" id="SPELLING_ERROR_2">forecasted</span> the company whose stock price would increase, but there wasn't a way you could benefit from your ablity to forecast a <span style="FONT-WEIGHT: bold">decrease</span> in the stock price if you didn't own any shares.<br /><br /><span style="FONT-WEIGHT: bold">Here's an example</span><br /><br /><span class="blsp-spelling-error" id="SPELLING_ERROR_3">XYZ</span> stock price is currently $100/share - I think the stock price of <span class="blsp-spelling-error" id="SPELLING_ERROR_4">XYZ</span> will go down tomorrow - I don't own any shares of <span class="blsp-spelling-error" id="SPELLING_ERROR_5">XYZ</span> - I borrow 100 shares of <span class="blsp-spelling-error" id="SPELLING_ERROR_6">XYZ</span> from a bank for 24hrs and pay $5/share (total cost = $500) - Same day I sell my borrowed shares for $100/share (total proceeds = $10,000) - Next day stock price of <span class="blsp-spelling-error" id="SPELLING_ERROR_7">XYZ</span> falls to $85/share - I owe bank 100 shares - Purchase 100 shares for $85/share (total coast = $8,500) - I make $1,000 (10,000-500 cost of borrowing - $8,500) and 24 hrs earlier I didn't own any shares and only had a guess.<br /><br />Short-selling is a popular practice of Hedge Funds. What's a Hedge Fund? The name is somewhat misleading and mostly historical. A Hedge Fund is nothing more than an investment vehicle open to a limited range of investors (either institutions or very wealthy individuals) and, because of the sophistication of their investors, is permitted to engage in a much wider range of investment strategies. It may be helpful for a moment to compare them to mutual funds. A mutual fund is nothing but a "shell", just like a Hedge fund. In other words, saying you own mutual funds doesn't tell us in any detail about your investment strategy. You can have mutual funds that invest in international stocks, in Tech stocks, in large or small companies, or in bonds. So we care more about whats IN the mutual funds. And they are heavily regulated and must stick to the disclosed strategy because they are open to the public. More bluntly, Mutual Funds serve the 80% of the population that make up 20% of the money. And because "Joe the Plumber" can own them, they must be simple (according to the SEC).<br /><br />Conversely, Hedge Funds cater to the 20% of the population that control 80% of the global wealth. They escape regulations, in most jurisdictions, governing short-selling, the use of debt, and derivatives (options, etc.) contracts. To qualify for these exemptions, you must have fewer than 100 investors AND your investors must be "accredited," meaning an individual must have more than $5,000,000 in <span class="blsp-spelling-error" id="SPELLING_ERROR_8">investable</span> assets. ALSO, they do not have to disclose their activities to third parties. Approximately 75% of Hedge Funds are registered off-shore, usually in the Cayman Islands. Lastly, Hedge Funds control roughly $2.6 <strong>TRILLION</strong> dollars, and are attracting approximately $200 <strong>BILLION</strong> a quarter. Those are scary numbers. If you participate in a Hedge Fund, you are essentially giving your money to a manger with almost full discretion. For all of the reasons listed above, the government is taking a closer look at tighter control.<br /><br /><strong>The SEC Hammer</strong><br /><br />Last month, the SEC banned short-selling of 799 financial institutions and issued this statement:<br /><br />"We are concerned about the possible <strong>unnecessary or artificial</strong> price movements based on unfounded rumors regarding the stability of financial institutions and other issuers, exacerbated by naked short selling. Our concerns, however, are no longer limited to just financial institutions."<br /><br />Just before 9/11 several Hedge Funds, primarily using the Toronto and Frankfurt stock exchanges shorted the stocks of several airlines and financial companies housed in the Trade towers. Obviously, after the attack stock prices tumbled. Their profits were thought to be huge, and virtually untraceable. This time, the majority of short-selling is being done from London and Dubai. There are literally hundreds of Hedge Funds with murky ownership structures, investors, and strategies. If even a handful of them act in concert and begin active short-selling to "artificially" push the price down it would have a massive impact on the economy and they would be making millions of dollars. Where is that profit going? Who knows. But one thing I do know; <span class="blsp-spelling-corrected" id="SPELLING_ERROR_9">because</span> of all the words I've used in this post, I'm sure the CIA has at least read it.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com3tag:blogger.com,1999:blog-5615955092910060134.post-74767161665757110582008-10-09T21:16:00.000-07:002008-10-09T22:15:03.824-07:00...And the Kitchen Sink. Part IIWhy am I reminded of the movie "The Money Pit" as I watch our economy fall apart piece by piece? Probably because what looked good from the outside was really rotten to the core. It's clear now that what is moving the market is sheer contagion. The DOW is down around 20+% over the last month, with no signs of slowing down. The other day I was speaking with an older economist who felt the need to help me understand that I will never see this type of environment again in my lifetime. I wasn't sure what to make of that.<br /><br />So I have just a few random thoughts to share, nothing too heavy.<br /><br />1. I expect to turn out like my Grandpa. Those of us who had Grandparents that grew up in the depression are very familiar with the tireless rantings where our Grandpa/Grandma would espouse the virtues of savings accounts, <span class="blsp-spelling-error" id="SPELLING_ERROR_0">CD's</span>, no debt, and hiding money under the mattress. Now, I don't think that's such a bad way to go. Although, some savings accounts aren't even THAT safe these days. I truly believe this crisis will have a profound effect on the younger generation in respect to how they view long-term savings and their appetite for risk.<br /><br />2. The most troubling statistic of the week. Earlier this week <span class="blsp-spelling-error" id="SPELLING_ERROR_1">MSN</span> reported that 1 in 6 Homeowners owe more than their house is worth. That's almost 20 million homes. If 25% walk away (likely to be much higher) then that means banks will own 5 million homes. That means more fire sales which will decrease the value of existing homes even further. And don't forget about the already existing inventory sitting on the market. Indeed, it is difficult to believe housing will recover anytime soon. Think at least five years out. My solution? Burn the home. This accomplishes two things. First, it decreases the supply of homes for sale, thus bringing the demand/supply curve into closer equilibrium. Second, it prevents a fire (no pun intended) sale from bringing down housing prices even further, preserving the current value for existing homeowners. Or you could donate it to Habitat for Humanity (I think they could use a solid <span class="blsp-spelling-error" id="SPELLING_ERROR_2">pre</span>-built home).<br /><br />3. Regarding the recent rate cut by the Fed and European Central Banks. This was a fascinating development. On Monday the Fed decreased the federal funds rate another half-a-percent. At the same time, Central Banks in Europe also decreased their interbank lending rates. Why did they do it together? I think there are two reasons. First, I believe they want to demonstrate a very united front. European Banks started to slide and at least a dozen had to be bailed out. The message is SUPPOSED to be "Hey, we are serious about taking action and will do so on a global scale." However, I think it had the opposite effect. Most <span class="blsp-spelling-corrected" id="SPELLING_ERROR_3">Americans</span>, and, from the reaction of the market, most people worldwide, took the Central Bank's action as meaning "Yep, it's much worse than we thought and we don't know what else to do," which in turn <span class="blsp-spelling-corrected" id="SPELLING_ERROR_4">served</span> to confirm <span class="blsp-spelling-error" id="SPELLING_ERROR_5">everyone's</span> fears. Perhaps in this case, inaction is the best solution. But there is a more technical reason why the Central Banks cut rates in concert. They are worried about capital flight out of their countries. If interest rates in the U.S. drop, then, if I'm China, I pull my money out of the U.S. and invest it in another country that is paying higher interest. But if all major central banks cut rates together, and maintain the same relative relationship, then the economic incentive to pull your money is <span class="blsp-spelling-corrected" id="SPELLING_ERROR_6">severely</span> diminished.<br /><br />4. The importance of <span class="blsp-spelling-error" id="SPELLING_ERROR_7">Commercial</span> Paper. The Fed also announced this week that they would begin to buy <span class="blsp-spelling-error" id="SPELLING_ERROR_8">Commercial</span> paper. Why is that significant? Commercial paper is short-term debt (usually with a maturity anywhere from 1 to 270 days) that a corporation will issue to fund operating cash flow. Think of it as a very short term loan. For example, if I'm Microsoft I issue <span class="blsp-spelling-error" id="SPELLING_ERROR_9">commercial</span> paper for $1 million dollars at 4% interest with a 30 day maturity. A money market fund will buy it from Microsoft because, after all, Microsoft is highly rated and the Money Market Fund can earn 4% interest over 30 days rather than 3% in the bank. At the same time, Microsoft can use the money to pay salaries or fund other assets. Now the problem is no one is buying this <span class="blsp-spelling-error" id="SPELLING_ERROR_10">Commercial</span> Paper from Microsoft because they don't trust them. Only highly rated companies are allowed to issue <span class="blsp-spelling-error" id="SPELLING_ERROR_11">commercial</span> paper. The fact that Money Market funds in particular don't trust them, even over a very short period of time, speaks volumes regarding the uncertainty in the market. The Fed stepped in because they recognize businesses depend on this financing to operate on a daily basis.<br /><br />Hot Investment Tip of the Week. Residential homes in Houston, Texas. Some rather astute real estate investors have indicated that Houston has a bright future as a place to invest in a home. These professionals cite the low cost of living, and favorable population demographics based, in part, on the growth of the Energy sector which is getting ready to boom with the energy demands of the global middle class.<br /><br />On the bright side, Alan Greenspan did say he thought the economy would turn around in the first quarter of next year. I think that sounds about right. I'm not sure though, I think I'll go ask my Grandpa.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com6tag:blogger.com,1999:blog-5615955092910060134.post-70978247091571347862008-09-28T21:29:00.000-07:002008-09-30T09:02:29.954-07:00$700 Billion Don't Buy What it Used to. Part I.This will probably be my most ambitious post. In what could be termed the greatest triumph of mediocrity, I'm going to try and explain the mechanisms by which we find ourselves in this current economic state of affairs with Uncle Sam pumping $700 Billion into the economy and explain how the plan (TARP, Troubled Asset Relief Program) will work. My analysis will be, at best, imperfect in predicting its long term impact (and anyone else who professes to know anything should probably confess the same) on the U.S. and global economies, and, at the very worst, a disturbing reminder of the agony of a mediocre mind. This is part I.<br /><br /><br /><span style="FONT-WEIGHT: bold">First, A Quick Review of the Mortgage Mess<br /><br /></span>I'll refer everyone to my prior two posts, found below, on the "credit crunch" and birth of the mortgage back security.<span style="FONT-WEIGHT: bold"> </span>As a quick reminder, <span class="blsp-spelling-error" id="SPELLING_ERROR_0"><span class="blsp-spelling-error" id="SPELLING_ERROR_0">subprime</span></span> mortgages were packaged into portfolios of Prime and Alt-A (between prime and <span class="blsp-spelling-error" id="SPELLING_ERROR_1"><span class="blsp-spelling-error" id="SPELLING_ERROR_1">subprime</span></span>) mortgages and inappropriately rated 'AAA'. These portfolios were sold to other financial institutions (both public and private). Since there was no historical mechanism by which to price these assets (I'm referring here to the "<span class="blsp-spelling-error" id="SPELLING_ERROR_2"><span class="blsp-spelling-error" id="SPELLING_ERROR_2">securitized</span></span>", or packaged product, obviously not mortgages themselves) it should come as no surprise that they were <span class="blsp-spelling-error" id="SPELLING_ERROR_3"><span class="blsp-spelling-error" id="SPELLING_ERROR_3">mis</span>-priced</span>. Now, hold that thought. Here, one needs to understand a basic accounting principle called mark-to-market.<br /><br /><span style="FONT-WEIGHT: bold">What is all this Mark-to-Market and Fair Market Value jazz?</span><br /><br /><span class="blsp-spelling-error" id="SPELLING_ERROR_4"><span class="blsp-spelling-error" id="SPELLING_ERROR_4">GAAP</span></span> (Generally Accepted Accounting Principles) requires that assets (including portfolios of mortgages) should be reviewed (usually quarterly, or earlier if necessary) and priced at Fair Market Value. <span class="blsp-spelling-error" id="SPELLING_ERROR_5"><span class="blsp-spelling-error" id="SPELLING_ERROR_5">FMV</span></span> requires you to 'mark' the asset as if you had to sell it in the market today, so you 'mark' your asset according to the 'market' price (mark-to-market). This is all in the name of greater transparency for the shareholder so that any quarterly statement accurately reflects the economic viability of that institution at that point in time. So we have hundreds of financial institutions that are having to mark-to-market their portfolios of troubled mortgages. Okay, let me address the "market" and why I don't think it's efficient (meaning, it can not be relied on to deliver accurate pricing).<br /><br /><span style="FONT-WEIGHT: bold">Efficient Market Theory</span><br /><br />Efficient Market Theory was the product of Harry <span class="blsp-spelling-error" id="SPELLING_ERROR_6"><span class="blsp-spelling-error" id="SPELLING_ERROR_6">Markowitz</span></span> in 1952 and is widely held today as the paradigm explaining market prices. I've already written about EMT as well in a previous post on investing, but I will revisit it here.<br /><br />Basically, EMT claims that markets are able to correctly price any asset at any point in time. In other words, markets are completely 'rational.' When news regarding a certain company or event is 'known' the market automatically correctly, and 'efficiently', prices the news. However, this assumption has been tested. In fact, a <span class="blsp-spelling-corrected" id="SPELLING_ERROR_7">theorem</span> coming out of Stanford asserts that technical fundamentals, based on EMT, only account for about 20% of stock price volatility. Investors as a whole are simply incorrect in their assumptions of future events. This is the classic difference between "Experience" and "Exposure." Where <span style="FONT-STYLE: italic">experience</span> looks to the past, <span style="FONT-STYLE: italic">exposure</span> considers the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_8">likelihood</span>, and risk, of an event that history may not reveal. I think most investors are currently wrong about 1) their ability to forecast future events and 2) their ability to correctly price the news. And those are two fundamental assumptions one needs if EMT is to hold true.<br /><br /><span style="FONT-WEIGHT: bold">Is There Any Pride in Being the Last Lemming off the Cliff? The Wisdom of Crowds.</span><br /><br />What we're seeing is a fundamental shift in belief-structures. Mordecai <span class="blsp-spelling-error" id="SPELLING_ERROR_7">Kurz's</span> theorem on belief structures indicates that the other 80% of stock price volatility is the result of shifting belief structures. Again, this is a theorem, not an opinion. Belief Structures represent the proportion of all investors at a given point in time that hold below average/above average expectations of returns. Logically, a constant, or diminishing rate of good or bad news, can create a growing proportion of optimists or pessimists. EMT holds true, most of the time, in a <span class="blsp-spelling-corrected" id="SPELLING_ERROR_9">heterogeneous</span> population. However, when <span class="blsp-spelling-corrected" id="SPELLING_ERROR_10">heterogeneity</span> (or diversity) is lost, markets perform poorly as herding sets in and <span class="blsp-spelling-error" id="SPELLING_ERROR_8">immitation</span> becomes a substitute for reason. I think this accurately describes today's environment. Belief Structures work <span class="blsp-spelling-error" id="SPELLING_ERROR_9">independant</span> of fundamentals. Many economists think that, based on fundamentals, we should only see a 30% drop in these mortgage backed securities and we've seen 80% decreases. As I mentioned in my previous post, the presence of severe uncertainty exacerbates the problem. For nobody knows how high-is-high or how low-is-low. Last year, Alan Greenspan stood up at a conference, and, holding a mortgage back security, waved it around and said, 'Can anybody tell me what this thing is worth?" Note, this was <span style="FONT-STYLE: italic">after </span>the news about <span class="blsp-spelling-error" id="SPELLING_ERROR_10">subprime</span> mortgages hit the fan. This alone should severely question <span class="blsp-spelling-error" id="SPELLING_ERROR_11">anyone's</span> <span class="blsp-spelling-error" id="SPELLING_ERROR_12">allegience</span> to EMT and rational markets.<br /><br /><span style="FONT-WEIGHT: bold">Back to Fair Market Value<br /><br /></span>So I ask, "Why are companies forced to price their securities according to market prices when the market is probably not accurate?"<span style="FONT-WEIGHT: bold"> </span>It's this inaccuracy that is creating the balance of the economic crisis. Follow the logic below:<br /><br /><span style="FONT-STYLE: italic">Institution 'A' must write value of security down (based on markets pessimistic belief structure and mass uncertainty) - Institution becomes insolvent (more liabilities than assets as a result of the new asset "price") - Institution must sell asset quickly or risk <span class="blsp-spelling-error" id="SPELLING_ERROR_13">bankrupcy</span> - Institution sells assets at fire sale price (<span style="FONT-WEIGHT: bold">thus setting the new "market price"</span>)</span> - <span style="FONT-STYLE: italic">Institution B must write down value of security based on 'A's' price - Cycle Repeated<br /><br /></span>What results is a self perpetuating downward spiral<span style="FONT-STYLE: italic"> </span>that can only be stopped by external influences (unless you allow for widespread systematic failure).<span style="FONT-STYLE: italic"><span style="FONT-STYLE: italic"><br /><br /><span style="FONT-WEIGHT: bold"></span></span></span><span style="FONT-WEIGHT: bold">The Fed's Bailout<br /><br /></span>Is it a good idea or not? Time will tell.<em> </em>But I have to <strong>strongly disagree with the position of many politicians and friends who assume that Wall Street gets all the upside while the tax-payer is stuck with the bill. This opinion incorrectly assumes Wall Street and Main Street operate on separate planes, which couldn't be further from the truth. </strong>Anyone who has ever <span class="blsp-spelling-corrected" id="SPELLING_ERROR_14">received</span> a business loan, or a mortgage, or purchased stocks, mutual funds, or <span class="blsp-spelling-error" id="SPELLING_ERROR_15">ETF's</span> illustrates that Wall Street and Main Street are unseperable. At the same time, there are bad actors on both sides. We should not only be pointing fingers at Wall Street. Clearly, there were nefarious actors who made a ton of money and disreputable credit agencies that acted out of greed. But, at the same time, there were thousands of consumers who lied on mortgage applications (granted, some were tricked) and that bought more house than they knew they could afford. I think blame should go both ways and that politicians should quit pandering to us like we're Harry Potter's fat spoiled cousin Dudley <span class="blsp-spelling-error" id="SPELLING_ERROR_16">Dursley</span> (although that may not be too far from the truth).<br /><br />Anyway, if you would like to read the entire 110pg bill that's being debated this week, you can do so by <a href="http://i.cdn.turner.com/cnn/2008/images/09/28/ayo08c04_xml.pdf">clicking here:</a><br /><br />I would simply like to make a few points about the proposed plan.<br /><br />1) The Fed will be buying direct mortgages and mortgage portfolios from institutions requesting aid.<br /><br />2) It's a "principles" based bill as opposed to "rules" based. In other words, Hank <span class="blsp-spelling-error" id="SPELLING_ERROR_17">Paulson's</span> mandate is to act in a manner that is in the best interest of the country and the tax-payer, maximizing profits and reducing costs. Granted, there are plenty of rules, but <span class="blsp-spelling-error" id="SPELLING_ERROR_18">Paulson's</span> authority is fairly broad in the bill.<br /><br />3) Executive aren't making out like bandits. First, all the executives are getting canned, and, according to the bill, if any institution wishes to participate in the $700 billion, the <span style="FONT-WEIGHT: bold">executive </span>must reimburse the company any bonus <span class="blsp-spelling-corrected" id="SPELLING_ERROR_19">received</span> which is deemed to have been previously paid for inappropriate self-enrichment. Also, they are doing away with any 'golden' parachutes. And no investor that watched their stock go from $70/share to .20 cents/share is going to think they are getting bailed out. And what about tax-payers? I think we already made our money. Most of us wouldn't be in our houses if not for Wall Street's innovation. Not to mention Real GDP grew to almost 4% (historical average of 3.5%) which translates in to trillions of dollars that came to most of us in the form of rental homes, new tools, <span class="blsp-spelling-error" id="SPELLING_ERROR_20">xbox</span> 360's, cars, and flat screen T.V.'s.<br /><br />4) The Fed is buying these mortgages using Net Present Value. Essentially that is above market price (putting the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_21">cab-bosh</span> on the downward spiral) but below what the company paid for them. They will buy most of the mortgages in a reverse auction, where banks basically compete for the Fed (lowest price wins). The fed will then service the loans and cut deals with individual borrowers by extending terms, reducing principle amounts, or deferring payments.<br /><br />5) Some of the money will come back. The Government isn't going to simply spend the money. As I stated above, many, if not the majority, of the mortgages will get worked out and the Fed will make money (For example, your loan is for 100k, the Fed buys it from <span class="blsp-spelling-error" id="SPELLING_ERROR_22">XYZ</span> corp for 10k, turn around and cut a deal with you, the borrower, for 70k). Win-Win-Win. And the Fed is able to take equity (but non voting) stakes in a company that is a participant in the program, thus giving the tax-payer potential upside.<br /><br />6) The language is interesting on the total amount borrowed. The program allows for more than $700 billion. It simply says the Fed cannot have more than $700 billion outstanding at any one time. In other words, it will function like a line of credit in that they could have $300 billion, sell it, buy $400 billion, sell it, buy $250 billion, sell it, buy $400 billion, etc. etc.<br /><br />Although I support the plan, the touted ramifications should Congress not act sounds <span class="blsp-spelling-corrected" id="SPELLING_ERROR_23">eerily like George Bush's threats of Armageddon should we not invade Iraq. </span>Anyway, that's it for now. I'm going to follow up in a couple of days after I get some sleep and do more research.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com2tag:blogger.com,1999:blog-5615955092910060134.post-63822656959823043662008-09-19T09:45:00.000-07:002008-09-19T09:56:38.675-07:00Useful SitesYou'll notice to the right that I posted some of the financial websites I check on a regular basis. I clearly did not list all of them, but most of the ones I thought were helpful. In addition to the ones posted, I would also like to recommend reading commentaries and whitepapers posted on the sites of the various Federal Reserve Banks across the country. I didn't list their links because there are 12 of them, but you can get to them from here:<br /><br /><a href="http://www.federalreserve.gov/OTHERFRB.HTM">http://www.federalreserve.gov/OTHERFRB.HTM</a><br /><br />You'll also notice underneath the "Useful Websites" list that I have a short list of "Interesting" websites. These sites are owned by prominent venture firms (the same ones that started Google, Yahoo, Amazon, eBay, Apple, 3Com, etc.). There's no shared theme, other than they are all owned by venture capitalists and could be the next big thing.<br /><br />You can also click on the map to the right for local news on any country in the world.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com1tag:blogger.com,1999:blog-5615955092910060134.post-13009122464786546412008-09-17T09:02:00.000-07:002008-09-17T10:59:59.126-07:00Indeed, the other shoe has droppedThe current environment demands and explanation. So let me first reiterate the impact of uncertainty and then share one perspective on the recent news of Merrill, Lehman, and <span class="blsp-spelling-error" id="SPELLING_ERROR_0">AIG</span>.<br /><br />"Uncertainty" is different than "Risk." In risk, the underlying probabilities of a certain event are known, as well as the effects (i.e. you are able to quantify the payoff) those events will have. Thus, roulette is a game of risk (all probabilities and payoffs are known). War is an uncertainty, in that the effects of the same can't be accurately quantified. As I stated in a previous post, when you are unable to quantify the problem, the more likely you are to follow the herd. And the herd will <span class="blsp-spelling-corrected" id="SPELLING_ERROR_1">demonstrate</span> a tremendous amount of overshoot (up, if the news is good, down, if the news is bad). And the less one is able to identify the "high" and the "low," the less likely the trend will end anytime soon. The presence of magnificent leverage, or debt, exposes both institutions AND individuals to <span class="blsp-spelling-corrected" id="SPELLING_ERROR_2">extraordinary</span> financial risk amidst uncertainty. So I think we're in for a long ride. Unfortunately, the overshoot and uncertainty is so great, and the leverage all too common, that it has produced multiple victims (seen in high profile bankruptcies on the corporate side, and massive foreclosures on the consumer side).<br /><br />Now, on to the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_3">hemorrhaging</span> on Wall St. Merrill was sold to Bank of America (not a big deal, although alarming), Lehman declared bankruptcy and will sell off various divisions, and <span class="blsp-spelling-error" id="SPELLING_ERROR_4">AIG</span> was bailed out by the <span class="blsp-spelling-corrected" id="SPELLING_ERROR_5">government</span>. I don't think I will address the actual remedies of Merrill Lynch, Lehman Brothers, and <span class="blsp-spelling-error" id="SPELLING_ERROR_6">AIG</span>. Those have been treated in great detail by others more qualified than me. Perhaps the question you may be asking is, "Why was one sold, one bailed out, and one not? And what does that say about our financial system?"<br /><br />Merrill Lynch was wise and found a potential buyer before things got really ugly. They realized they were going to run out of money. But unlike many of their competitors that kept the news quiet until the last moments, Merrill's CEO was forthright and honest about the current state (probably because he was only hired in <span class="blsp-spelling-corrected" id="SPELLING_ERROR_7">November</span> and is still in the honeymoon stage with the Board). In the words of beloved <span class="blsp-spelling-error" id="SPELLING_ERROR_8">JPMorgan</span> CEO Jamie <span class="blsp-spelling-error" id="SPELLING_ERROR_9">Dimon</span>, "It's one thing to buy a house (referring to <span class="blsp-spelling-error" id="SPELLING_ERROR_10">BoA's</span> acquisition of Merrill), it's an entirely different matter to buy a house on fire." Merrill bailed while the flames were beginning to torch the grass but have not yet reached the home.<br /><br />Before discussing <span class="blsp-spelling-error" id="SPELLING_ERROR_11">AIG</span> and Lehman, let me interject here that I've been pleased with the coordination between <span class="blsp-spelling-error" id="SPELLING_ERROR_12">Bernake's</span> Fed and <span class="blsp-spelling-error" id="SPELLING_ERROR_13">Paulson's</span> Treasury (the Fed is responsible for monetary policy while the Treasury is responsible for fiscal policy, or, how the government spends money). They've both <span class="blsp-spelling-corrected" id="SPELLING_ERROR_14">approached</span> this disaster with very innovative ideas, which I think are in the best long term interest of the U.S. economy. The biggest problem most people have, rather, what I hear people complain about most frequently is the doctrine that government should not undertake bailouts because it creates a type of "moral hazard." Although the government is stepping in to help <span class="blsp-spelling-error" id="SPELLING_ERROR_15">AIG</span>, <strong>average taxpayers face a higher standard of living over the long run from utilizing a taxpayer-funded "bailout" to re-establish growth than they do by permitting a collapse of the global financial system.</strong> Furthermore, management and shareholders often pay a heavy price under such circumstances (which is not the case in other countries where governments have stepped in and protected shareholders).<br /><br />So why save <span class="blsp-spelling-error" id="SPELLING_ERROR_16">AIG</span> and not Lehman (who filed for chapter 11)? Although Lehman is huge, <span class="blsp-spelling-error" id="SPELLING_ERROR_17">AIG</span> is the hub of a spoke and wheel network whose wheel is the global economy. Their integrity must be protected. One economist we work with said, "what we are seeing is a certain level of experimentation and sampling. The financial system has never really been stress-tested and is evolving." No one really knows how it will end up. That makes it difficult to say "bailouts" are either good or bad. <span class="blsp-spelling-corrected" id="SPELLING_ERROR_18">Apparently</span>, the risks of testing the system by letting a huge global giant like <span class="blsp-spelling-error" id="SPELLING_ERROR_19">AIG</span> go bankrupt are too high to assume until we have experimented with smaller companies, like Lehman. I believe we are seeing a testing-while-protecting strategy from the Treasury and the Fed, and, I think on the balance, they are doing a good job.<br /><br />Again I'll end with an ominous prediction. Whose next? Wall Street seems to think Morgan Stanley and Goldman Sachs are next (based on credit default spreads, which gauge risk). I would not be surprised to see a partnership between the two. I would be surprised, if twelve months from now, those two organizations still stand independant.Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com11tag:blogger.com,1999:blog-5615955092910060134.post-87552831248128926762008-08-20T11:43:00.000-07:002008-08-21T11:16:39.306-07:00Did $100Billion of Stimulus Checks Help?Somebody at worked asked me if I thought the stimulus checks sent out in May and June of this year have helped prop up the economy. The short answer is that it's too early to tell. But, doing some preliminary math will add at least some transparency. The federal reserve shows that the household savings rate spiked in May and June to 4.9% and 2.5% respectively (compared to .61% over the last three years). In order for those numbers to hold true, then Americans recieving rebate checks would have had to save 80% of May rebates and 60% of June rebates. This isn't exactly what the Fed was hoping for. The goal was to either boost spending or extinguish debt, and, so far, none of that seems to be happening. Although the rebates do seem to be supporting consumer durables (necessities) the general impact on spending does not seem to be proportionate to the size of the rebates. But, most experts agree that we need to see data from the third and fourth quarters to be more definite. And then you have to ask yourself, "was this even the best way to spend $100 Billion dollars?"Jengahttp://www.blogger.com/profile/05154364198602107346noreply@blogger.com1