Hedge Funds: The Quiet Epidemic
We haven’t been hearing too much about hedge funds lately. But I suspect that there will be some news about them fairly soon, as they become the next group to wash out from today’s financial crisis.
The typical hedge fund raises money from “accredited investors” through private placements that allow them to operation outside the scrutiny of the Securities Exchange Commission.
We will soon be finding that many hedge investors consisted of corporations, pension plans and college endowments.
Hedge funds started becoming popular in the 1990s. Among the very wealthy, investing in hedge funds became a kind of status symbol. Waiters at cocktail parties and charity banquets regularly overheard such statements as, “Yes, buy my hedge fund returned 89% last year.”
Some of the nation’s top money managers gravitated to this environment because, being unregulated, hedge managers can actually take a share of investor profits. Managers are also (virtually) unrestrained in the leverage they can use.
Hedge managers borrowed large sums of money and placed big bets on things like currencies, stocks and commodities. Hedge funds have been blamed for driving the price of oil futures to astronomical levels. They have been blamed for driving stocks down by taking huge short positions (selling shares you do not own, with the expectation of buying them after prices fall), particularly in financial services companies. They have been charged with collusion and market manipulation. But, because they are unregulated, there is little documentation about how they have invested or what they own—until the roof caves in.
Popular Hedging Strategy
For years, one of the biggest hedging strategies was borrowing money in the U.S. or Japan, because interest rates were low. This cash is then converted into Icelandic krona and used to purchase Icelandic government bonds. http://www.nysun.com/business/low-us-interest-rates-mean-dollar-is-used/73644/
It has not been unusual for there to be a spread of 10% or more between the borrowing cost and the Icelandic bond yield. The spread detailed in March, 2008 (hyperlink above), showed a 2.25% U.S. interest rate and a 15% Icelandic yield, a difference of 12.75%. Let’s say I have $1 billion in investor money. I then go out and borrow $10 billion at 2.25% interest. I pay $225 million in interest to a U.S. bank. I earn 15% on my bonds, which is $1.5 billion. This gives me a net profit of $1.275 billion. This is a 127% return on my invested capital. Let’s say the hedge manager takes its share of the profits. This still leaves 100% to the investors in one year.
This would seem like a slam dunk. And it has been, for a good while. During the past year, there has been a huge swing in the exchange rate between the krona and the dollar. On September 8, 2008, it took 86.1 krona to purchase $1. On October 6, 2008 it took 127.8 krona to buy $1. This is a 48% drop in value in one month. My $10 billion in Icelandic bonds is now worth just $5.2 billion. This is a $4.8 billion loss on the original hedge fund investment amount of $1 billion. In other words, on paper, the investors in this fund have lost 480%.
http://www.exchange-rates.org/history/ISK/USD/G/30
http://www.spiegel.de/international/business/0,1518,582487,00.html
Now, don’t quibble with me that there would be interest on the bonds (about 1.25%) during the month. Yes, I understand that there is a chance that the bonds will return to their original value. There is also a chance that things will get worse.
Here’s the big problem. Investors in hedge funds typically have to wait at least 90 days before withdrawing cash from the fund. They issue a call on their cash, and the manager has 90 days to unwind his investments and send the money. We know that many big investors are running short of cash. They are doing everything they can to get out of a sinking ship before losing everything. In our example, lets assume that half of our investors ask for their money back. This leaves about $200 million in bonds and a $5 billion note to some U.S. bank. Do we really think this loan will be repaid?
This same sort of thing has been going on with investments in CDOs (mortgage backed securities). This time our hedge manager borrows $10 billion in Japan at 1%. The manager turns around and buys CDOs yielding 6%. We have a neat little profit of 50% on our invested cash. After splits with the manager, investors earn a solid 40%. Not bad, until these CDOs prove to be worthless.
And entire unregulated industry has been feeding on these types of investments for years. And there are going to be many wealthy people selling their McMansions in Beverly Hills and Westport because of this collapse. We haven’t read too much about this yet. But we will.
www.lumbert.com
www.shaksperbooks.com
Thursday, October 9, 2008
Tuesday, October 7, 2008
The Anatomy of a Financial Crisis
6o Minutes and Half the Truth
When I watched the 60 Minutes piece on television the other night, I was impressed at how they were able to boil down a very complicated, global financial meltdown and break it into two easy-to-understand pieces. According to 60 minutes, it was a case of greed and planned ignorance among the Wall Street crowd.
Our investment banks up risky mortgages, packaged them without regulation and sold them (using huge offering memorandums detailing mathematical models designed by physics experts and cosmologists) to an unwary public as investment-grade debt. Then they “insured” the payment of these securities (CDOs) through something called “Credit Swaps.” Of course, it wasn’t called insurance. That would have meant regulation, and the setting aside of reserves to meet this liability. Ultimately, (according to the show) it was the credit swaps that caused many large financial institutions (Lehman, Bear Stearns, AIG, etc.) to teeter on (or over) the edge of bankruptcy.
I give CBS credit for explaining the nub of the issue in a way that hockey moms and Joe six-pack can understand. Unfortunately, CBS only addressed half of the cause. They were correct in describing Wall Street execs as greedy, amoral souls (my words) intent on reaping huge profits, regardless of risk, at any cost. But CBS completely ignored the role that Congress should (could) have played in preventing this global crisis.
According to CBS, Congress allowed $50,000,000,000,000-$60,000,000,000,000 ($50-$60 trillion for those of you who get a brain freeze with so many zeros.) to go unregulated. This is as much as the total U.S. net worth, of $55 trillion. http://www.fxstreet.com/news/forex-news/article.aspx?StoryId=cb82625a-a1a5-4760-a1a5-0a3b82f53c79
Much of the money used to purchase these securities has been borrowed, perhaps 90% or more. To put this in perspective, debt currently held by the U.S. public is about $5 trillion. Total U.S. government debt is about $10 trillion. The U.S. Treasury puts this at $4.2 trillion. But they have not added the $700 billion bailout or the $ 5 trillion of debt assumed in the takeover of Fannie Mae and Freddie Mac.
http://www.treasurydirect.gov/NP/BPDLogin?application=np http://www.federalreserve.gov/releases/g19/Current/
So, somewhere out there in the ether, financial institutions have borrowed three times as much as every American and the U.S. government combined. And these are the people that are lending money to us?
How did this happen? I have explained the mechanisms in prior blogs, so I won’t go into that here in detail. Simply put: Financial institutions (for themselves and for their clients) purchased these things (CDOs, mortgage-backed securities, toxic debt) with the expectation that there were assets backing them.
The rating agencies relied upon a twenty-year bull market in real estate (brought on by duel working families, the lowering interest rates enhanced by a generous Fed policy), complex algorithms developed by geeks trained at Harvard, Stanford, Cal Tech and MIT who had chased the big bucks on Wall Street. They also relied upon the word (and the historical practices) of Fannie Mae and Freddie Mac.
In the 60 Minutes piece, one of the “experts” stated (I am paraphrasing) that math cannot predict human behavior. That is not a correct statement. Math can predict human behavior, but not with certainty. With investments, math can predict behavior (of which a large part is irrational emotion), but only to a point within ranges and probabilities. For example, math can predict that a certain investment’s return will fall between a range of returns with a given probability. Below I give a simple illustration.
Example: A basket of stocks might be expected to return 10% per year over time. There will be a “standard deviation” or volatility to this return. Let’s say that the standard deviation is 10. Our math tells us that two thirds of the time, in a one year span of time, our return will fall within our expected return (10%), plus or minus one standard deviation (10%). This means that our investment return will fall between zero (10% minus 10%) and 20% (10% plus 10%). Ninety-five percent of the time, our return will land within our expected return plus or minus two standard deviations. This gives us a range of -10% to 30% return, 95% of the time. If we go to three standard deviations, our expected return is predicted to fall within our expected return plus or minus three standard deviations. (-20% and 40%) http://en.wikipedia.org/wiki/Standard_deviation
In summary, our math tells us that we can determine the probability of a range of returns given our expected return, plus or minus our standard deviations.
Percentage Probability Range of Return
1 Year Low High
67% 0% +20%
95% -10% +30%
99% -30% +40%
The expected return range expands as our certainty increases. In other words, most of the time, the return will fall somewhat close to what we suspect. However, some of the time, unusual things will happen (war, terrorism, financial collapse) that will cause an unexpected return. The greater the certainty, the greater the range of returns.
The longer the time frame grows, the smaller our range becomes. Over time, investments tend to repeat the returns of the past. For example, when our time frame moves to ten years, our standard deviation may narrow to 5%. In this case, our ranges would be as follows:
Percentage Probability Range of Return
10 Year Low High
67% 5% +15%
95% 0% +20%
99% -5% +25%
The Wall Street firms all had mathematical models that predicted the performance of mortgage securities, depending upon quality, initial equity, time duration, property location, etc. These models took such statistics as a borrower’s credit ratings, their occupation, their documentation, length of employment and used them to come up with the probabilities of ongoing payments the probabilities of complete repayment in any given time frame, the probabilities of interest rate resets and what they might be. There were hundreds of variables that went into these calculations.
Obviously, some of the important factors were not included in the calculations, or they were minimized.
Here’s what happened:
When determining their capital base, financial institutions are required to “mark to the market” with securities they hold. They are not allowed to say that investments in their portfolio are worth their purchase price, which may have been far in the past. They are required to assess the current value of the securities on their balance sheets.
For years, there was no actual “market” for these securities. They were not traded on exchanges, they were simply held. Investment banking firms simply assigned values to these securities, since there was no market. Many firms chose to value these securities higher than initial cost. This allowed them to book higher profits (which triggered lucrative stock options) and increase their capital base so they could buy more.
When Countrywide failed, the world (or at least regulators) suddenly realized that these CDOs were worth far less than expected. This forced financial institutions to revalue portfolio securities, dramatically reducing their capital.
Capital is needed by banks before they can issue loans. They must maintain certain capital to loan ratios. So, when capital decreases, loans to business and individuals must also decrease. This causes business to slow, jobs to be lost, etc.
While balance sheets were being redrafted to reflect the current (and rapidly falling) value of mortgage backed securities, another nasty thing was happening to the investment banks. They were being asked to make good on their credit swaps (unregulated insurance).
Companies like Bear Stearns, AIG, Lehman Brothers and Citi had profited greatly by selling “guarantees” on mortgage backed securities they thought would never lose value. They were forced to pay the interest (and principal) on mortgages when homeowners began defaulting. This hampered cash flow. It also dramatically increased liabilities as it decreased capital. This is the equivalent of bank hari kari.
Do not underestimate the function of these credit swaps. This “insurance” was purchased by investors, because they often borrowed the money to buy these investments in the first place. These securities were purchased with enormous leverage, so even a small drop in value would be devastating to a bank’s (investor’s or pension’s) capital base.
Enter the Perfect Financial Storm
As it became apparent that these CDOs were worth nowhere near the values on bank balance sheets, banks (I use this term broadly) were forced to readjust their capital base. Many of the investment banks (Lehman, Bear Stearns, Citi) also faced mounting liabilities from their credit swaps. Within a few short months, enormously profitable, asset rich companies became completely insolvent. If allowed to continue, this insolvency would have blown through our society like a hurricane. In fact, this has already started, nearly pulling the world beyond a global recession into a depression.
Banks cannot lend money when they have no capital. This is a simple fact, but an awesome, bitter truth.
Wall Street firms must take much of the blame for this problem. Their mathematical algorithms predicted this. Nothing is certain. But the probability of this happening was slight, and considered an “acceptable risk” of business. Big mistake.
One of the main problems for this statistical breakdown was that Fannie Mae and Freddie Mac dramatically relaxed their underwriting standards, without really telling anyone. These two organizations purchase about half of all mortgage loans in the country. Their purchase is generally considered to be a kind of “seal of approval” with regard to quality.
These two organizations allowed mortgage companies to send increasingly inferior loans, purchased them and sold them off for profit. Appraisal standards deteriorated. Documentation standards grew lax. Borrowers became a commodity, not a banking decision.
This strategy allowed men like Fannie CEO, Franklin Raines, to make hundreds of millions of dollars while they cooked the books and destabilized our economy. Wall Street banks, hedge funds and pension plans were willing buyers. But Fannie and Freddie flat out lied about what they were selling.
What Was The Government’s Contribution?
Our government must shoulder a good portion of the blame for this. This crisis was caused by too little regulation and too much regulation. It was caused by corporate greed, but also by political ambition and greed. This helped cause and then magnify the problem.
1992:
It began in 1992 when Clinton vowed to end “corporate greed.” He demanded, and got, legislation that limited the tax deduction on corporate salaries to $1 million. Congress didn’t realize that corporate executives are like highly paid athletes (except that many of them actually produce something). They are free agents, able to go to the team that will pay them the most.
These executives are worth far more to companies than $1 million. However, it is not good business practice to pay taxes on compensation, since it leaves less for shareholders. Corporations used the complex tax laws to find a way around the 1992 law limiting corporate deductions. They replaced large corporate salaries with smaller salaries combined with incentives. Many of these incentives were based upon stock performance. This caused executives (including those at Fannie Mae and Freddie Mac) to drive stock performance, even if it meant breaking the law and committing fraud.
This is a classic case of unintended consequences. The president and Congress thought they were addressing corporate “greed.” Instead, they created a way to make it worse.
This law change was one of the main culprits in the “tech bubble” of the 1990s. Company executives forced their stock prices upward in order to trigger stock options. This caused businesses to lose much of their long-term focus, in favor of questionable accounting practices and short-term thinking.
The ensuing stock market collapse (of 2000) helped create a ready market for mortgage backed securities. Pension plans grew underfunded, and they needed securities with low risk and high returns. Wall Street filled the enormous demand with mortgage backed securities. A crisis was incubated.
Hedge funds caught on to this game. They used a common exclusion (Regulation D) to the Securities Act of 1933 to create large pools of investments outside the regulation of the SEC. They raised billions of dollars, borrowed trillions and invested in mortgage backed securities. If they could borrow at 3% and earn 6%, they profited greatly from the spread. Big time.
Investment banks used the liberal Fed window to borrow funds to purchase (hedge) mortgage backed securities. This was almost a license to print money and profits skyrocketed.
Fannie and Freddie were seen as golden boys, manufacturing the geese that laid these golden eggs.
No Regulation
Republican leaders pushed for fewer regulations of the securities markets. Their mantra was that regulation inhibits productivity. But both parties stood by and allowed a shadow market to grow far too large with little regulation.
Mortgage Fairness
For years, Fannie Mae was not buying loans issued to low income, low credit borrowers. Democratic leaders called this discriminatory and pushed for mortgage “fairness.” This caused Fannie to buy mortgages they would not normally even consider. With little government oversight, they were able to almost do this at will.
Poor loans received the Fannie “stamp of approval” and sold along with the rest, as quasi-investment grade.
The Fed
The tech bubble (partly caused by tax legislation) caused our stock markets to become highly overvalued. P/E ratios were twice their traditional multiples. At the end of the boom, business had to digest a spending binge, so it was up to the American consumer to pull our economy along and prevent a big recession. Enter the Fed.
Alan Greenspan quietly engineered a housing boom to create equity and consumer spending. He did this by consistently lowering interest rates (among other things). As home equity rose, consumers refinanced their homes. They used refinancing proceeds to purchase goods and services and drive the economy.
Political Games
As early as 2002, Congressmen began calling for an investigation into the practices of Fannie Mae and Freddie Mac. Fannie and Freddie were quasi-government organizations. They were independent, publicly traded companies, but their debt was guaranteed by the Federal Government. As a result of this crisis, they are now, technically, owned by Uncle Sam. So is their debt.
Fannie was being run by Clinton appointee and adviser, Franklin Raines. When it became apparent that Fannie was abusing the system, Republicans began calling for an investigation. (Raines has since been assessed a fine of more than $23 million) The Democrats saw this as a political problem, not an economic one, so they blocked meaningful oversight.
Democrats control Congress, so they chair the banking committees of the Senate and the House. Christopher Dodd and Barney Frank simply refused to investigate any wrongdoings by Fannie and Freddie. So, the problem grew greater, until everything collapsed.
The Fed Bailout
Enter the Fed rescue plan, or “bailout.” This will help stabilize markets and keep some liquidity in our banking system. But it will not replace the trillions in capital that have been lost by the world’s financial system, and by investors. It will not make this problem go away; it just softens the blow. We will face lower stock market returns for a good decade because of this. Inflation will be greater because of the massive infusion of money by the Fed. Our children and grandchildren will pay the ultimate price, because they will have to pay on this debt for decades.
The Final Result – A Perfect Financial Storm
As you can see, this problem was caused by a confluence of seemingly unrelated factors, all converging to create the perfect financial storm. We had the law change that helped create the tech bubble. The stock market collapse caused Greenspan to help create the housing boom. Pension plans cried for higher yielding, low risk securities. Wall Street built computer models that convinced the rating agencies to consider mortgage backed securities as investment grade debt. Low interest rates allowed unregulated hedge funds to join the investment banks and pension plans. Together, they bought as much as could be created. Congress forced a lowering of underwriting standards. Fannie Mae (and Freddie Mac) executives cooked the books and lowered quality to drive their stock prices higher to trigger stock options. Democratic leaders refused to investigate. Republican leaders pushed for deregulation and allowed a huge piece of the financial world to go unregulated. Insurance companies and investment banks borrowed huge sums of money to purchase these securities. Then they “insured” them to add to their profits. Wall Street ignored the bottom end of the mathematical return range, seeing it as acceptable risk. When mortgage holders began defaulting, investment banks were forced to “mark to the market.” This caused a dramatic fall in capital, and instant insolvency. The credit markets seized and the world economy ground to a halt. Investment banks and insurance companies were asked to make good on their guarantees and couldn’t deliver. World stock market values plummet and the capital base grew even weaker. The U.S. Government more than doubled our national debt (when we add the assumption of Fannie Mae and Freddie Mac debt).
This reminds me of hurricane Katrina and New Orleans. It has been three years, and New Orleans is still not the same. Areas of the city remain blighted. The local economy still suffers. And the danger still remains.
The same thing goes for our nation and the world. The United States will feel the effects of this for years. We will have lower corporate earnings than we might have enjoyed. Inflation will be greater than it would have been. We will create new regulations. Those regulations will have their own unintended consequences. And someday, hopefully not too soon, we will probably do it all over again.
www.lumbert.com
www.shaksperbooks.com
When I watched the 60 Minutes piece on television the other night, I was impressed at how they were able to boil down a very complicated, global financial meltdown and break it into two easy-to-understand pieces. According to 60 minutes, it was a case of greed and planned ignorance among the Wall Street crowd.
Our investment banks up risky mortgages, packaged them without regulation and sold them (using huge offering memorandums detailing mathematical models designed by physics experts and cosmologists) to an unwary public as investment-grade debt. Then they “insured” the payment of these securities (CDOs) through something called “Credit Swaps.” Of course, it wasn’t called insurance. That would have meant regulation, and the setting aside of reserves to meet this liability. Ultimately, (according to the show) it was the credit swaps that caused many large financial institutions (Lehman, Bear Stearns, AIG, etc.) to teeter on (or over) the edge of bankruptcy.
I give CBS credit for explaining the nub of the issue in a way that hockey moms and Joe six-pack can understand. Unfortunately, CBS only addressed half of the cause. They were correct in describing Wall Street execs as greedy, amoral souls (my words) intent on reaping huge profits, regardless of risk, at any cost. But CBS completely ignored the role that Congress should (could) have played in preventing this global crisis.
According to CBS, Congress allowed $50,000,000,000,000-$60,000,000,000,000 ($50-$60 trillion for those of you who get a brain freeze with so many zeros.) to go unregulated. This is as much as the total U.S. net worth, of $55 trillion. http://www.fxstreet.com/news/forex-news/article.aspx?StoryId=cb82625a-a1a5-4760-a1a5-0a3b82f53c79
Much of the money used to purchase these securities has been borrowed, perhaps 90% or more. To put this in perspective, debt currently held by the U.S. public is about $5 trillion. Total U.S. government debt is about $10 trillion. The U.S. Treasury puts this at $4.2 trillion. But they have not added the $700 billion bailout or the $ 5 trillion of debt assumed in the takeover of Fannie Mae and Freddie Mac.
http://www.treasurydirect.gov/NP/BPDLogin?application=np http://www.federalreserve.gov/releases/g19/Current/
So, somewhere out there in the ether, financial institutions have borrowed three times as much as every American and the U.S. government combined. And these are the people that are lending money to us?
How did this happen? I have explained the mechanisms in prior blogs, so I won’t go into that here in detail. Simply put: Financial institutions (for themselves and for their clients) purchased these things (CDOs, mortgage-backed securities, toxic debt) with the expectation that there were assets backing them.
The rating agencies relied upon a twenty-year bull market in real estate (brought on by duel working families, the lowering interest rates enhanced by a generous Fed policy), complex algorithms developed by geeks trained at Harvard, Stanford, Cal Tech and MIT who had chased the big bucks on Wall Street. They also relied upon the word (and the historical practices) of Fannie Mae and Freddie Mac.
In the 60 Minutes piece, one of the “experts” stated (I am paraphrasing) that math cannot predict human behavior. That is not a correct statement. Math can predict human behavior, but not with certainty. With investments, math can predict behavior (of which a large part is irrational emotion), but only to a point within ranges and probabilities. For example, math can predict that a certain investment’s return will fall between a range of returns with a given probability. Below I give a simple illustration.
Example: A basket of stocks might be expected to return 10% per year over time. There will be a “standard deviation” or volatility to this return. Let’s say that the standard deviation is 10. Our math tells us that two thirds of the time, in a one year span of time, our return will fall within our expected return (10%), plus or minus one standard deviation (10%). This means that our investment return will fall between zero (10% minus 10%) and 20% (10% plus 10%). Ninety-five percent of the time, our return will land within our expected return plus or minus two standard deviations. This gives us a range of -10% to 30% return, 95% of the time. If we go to three standard deviations, our expected return is predicted to fall within our expected return plus or minus three standard deviations. (-20% and 40%) http://en.wikipedia.org/wiki/Standard_deviation
In summary, our math tells us that we can determine the probability of a range of returns given our expected return, plus or minus our standard deviations.
Percentage Probability Range of Return
1 Year Low High
67% 0% +20%
95% -10% +30%
99% -30% +40%
The expected return range expands as our certainty increases. In other words, most of the time, the return will fall somewhat close to what we suspect. However, some of the time, unusual things will happen (war, terrorism, financial collapse) that will cause an unexpected return. The greater the certainty, the greater the range of returns.
The longer the time frame grows, the smaller our range becomes. Over time, investments tend to repeat the returns of the past. For example, when our time frame moves to ten years, our standard deviation may narrow to 5%. In this case, our ranges would be as follows:
Percentage Probability Range of Return
10 Year Low High
67% 5% +15%
95% 0% +20%
99% -5% +25%
The Wall Street firms all had mathematical models that predicted the performance of mortgage securities, depending upon quality, initial equity, time duration, property location, etc. These models took such statistics as a borrower’s credit ratings, their occupation, their documentation, length of employment and used them to come up with the probabilities of ongoing payments the probabilities of complete repayment in any given time frame, the probabilities of interest rate resets and what they might be. There were hundreds of variables that went into these calculations.
Obviously, some of the important factors were not included in the calculations, or they were minimized.
Here’s what happened:
When determining their capital base, financial institutions are required to “mark to the market” with securities they hold. They are not allowed to say that investments in their portfolio are worth their purchase price, which may have been far in the past. They are required to assess the current value of the securities on their balance sheets.
For years, there was no actual “market” for these securities. They were not traded on exchanges, they were simply held. Investment banking firms simply assigned values to these securities, since there was no market. Many firms chose to value these securities higher than initial cost. This allowed them to book higher profits (which triggered lucrative stock options) and increase their capital base so they could buy more.
When Countrywide failed, the world (or at least regulators) suddenly realized that these CDOs were worth far less than expected. This forced financial institutions to revalue portfolio securities, dramatically reducing their capital.
Capital is needed by banks before they can issue loans. They must maintain certain capital to loan ratios. So, when capital decreases, loans to business and individuals must also decrease. This causes business to slow, jobs to be lost, etc.
While balance sheets were being redrafted to reflect the current (and rapidly falling) value of mortgage backed securities, another nasty thing was happening to the investment banks. They were being asked to make good on their credit swaps (unregulated insurance).
Companies like Bear Stearns, AIG, Lehman Brothers and Citi had profited greatly by selling “guarantees” on mortgage backed securities they thought would never lose value. They were forced to pay the interest (and principal) on mortgages when homeowners began defaulting. This hampered cash flow. It also dramatically increased liabilities as it decreased capital. This is the equivalent of bank hari kari.
Do not underestimate the function of these credit swaps. This “insurance” was purchased by investors, because they often borrowed the money to buy these investments in the first place. These securities were purchased with enormous leverage, so even a small drop in value would be devastating to a bank’s (investor’s or pension’s) capital base.
Enter the Perfect Financial Storm
As it became apparent that these CDOs were worth nowhere near the values on bank balance sheets, banks (I use this term broadly) were forced to readjust their capital base. Many of the investment banks (Lehman, Bear Stearns, Citi) also faced mounting liabilities from their credit swaps. Within a few short months, enormously profitable, asset rich companies became completely insolvent. If allowed to continue, this insolvency would have blown through our society like a hurricane. In fact, this has already started, nearly pulling the world beyond a global recession into a depression.
Banks cannot lend money when they have no capital. This is a simple fact, but an awesome, bitter truth.
Wall Street firms must take much of the blame for this problem. Their mathematical algorithms predicted this. Nothing is certain. But the probability of this happening was slight, and considered an “acceptable risk” of business. Big mistake.
One of the main problems for this statistical breakdown was that Fannie Mae and Freddie Mac dramatically relaxed their underwriting standards, without really telling anyone. These two organizations purchase about half of all mortgage loans in the country. Their purchase is generally considered to be a kind of “seal of approval” with regard to quality.
These two organizations allowed mortgage companies to send increasingly inferior loans, purchased them and sold them off for profit. Appraisal standards deteriorated. Documentation standards grew lax. Borrowers became a commodity, not a banking decision.
This strategy allowed men like Fannie CEO, Franklin Raines, to make hundreds of millions of dollars while they cooked the books and destabilized our economy. Wall Street banks, hedge funds and pension plans were willing buyers. But Fannie and Freddie flat out lied about what they were selling.
What Was The Government’s Contribution?
Our government must shoulder a good portion of the blame for this. This crisis was caused by too little regulation and too much regulation. It was caused by corporate greed, but also by political ambition and greed. This helped cause and then magnify the problem.
1992:
It began in 1992 when Clinton vowed to end “corporate greed.” He demanded, and got, legislation that limited the tax deduction on corporate salaries to $1 million. Congress didn’t realize that corporate executives are like highly paid athletes (except that many of them actually produce something). They are free agents, able to go to the team that will pay them the most.
These executives are worth far more to companies than $1 million. However, it is not good business practice to pay taxes on compensation, since it leaves less for shareholders. Corporations used the complex tax laws to find a way around the 1992 law limiting corporate deductions. They replaced large corporate salaries with smaller salaries combined with incentives. Many of these incentives were based upon stock performance. This caused executives (including those at Fannie Mae and Freddie Mac) to drive stock performance, even if it meant breaking the law and committing fraud.
This is a classic case of unintended consequences. The president and Congress thought they were addressing corporate “greed.” Instead, they created a way to make it worse.
This law change was one of the main culprits in the “tech bubble” of the 1990s. Company executives forced their stock prices upward in order to trigger stock options. This caused businesses to lose much of their long-term focus, in favor of questionable accounting practices and short-term thinking.
The ensuing stock market collapse (of 2000) helped create a ready market for mortgage backed securities. Pension plans grew underfunded, and they needed securities with low risk and high returns. Wall Street filled the enormous demand with mortgage backed securities. A crisis was incubated.
Hedge funds caught on to this game. They used a common exclusion (Regulation D) to the Securities Act of 1933 to create large pools of investments outside the regulation of the SEC. They raised billions of dollars, borrowed trillions and invested in mortgage backed securities. If they could borrow at 3% and earn 6%, they profited greatly from the spread. Big time.
Investment banks used the liberal Fed window to borrow funds to purchase (hedge) mortgage backed securities. This was almost a license to print money and profits skyrocketed.
Fannie and Freddie were seen as golden boys, manufacturing the geese that laid these golden eggs.
No Regulation
Republican leaders pushed for fewer regulations of the securities markets. Their mantra was that regulation inhibits productivity. But both parties stood by and allowed a shadow market to grow far too large with little regulation.
Mortgage Fairness
For years, Fannie Mae was not buying loans issued to low income, low credit borrowers. Democratic leaders called this discriminatory and pushed for mortgage “fairness.” This caused Fannie to buy mortgages they would not normally even consider. With little government oversight, they were able to almost do this at will.
Poor loans received the Fannie “stamp of approval” and sold along with the rest, as quasi-investment grade.
The Fed
The tech bubble (partly caused by tax legislation) caused our stock markets to become highly overvalued. P/E ratios were twice their traditional multiples. At the end of the boom, business had to digest a spending binge, so it was up to the American consumer to pull our economy along and prevent a big recession. Enter the Fed.
Alan Greenspan quietly engineered a housing boom to create equity and consumer spending. He did this by consistently lowering interest rates (among other things). As home equity rose, consumers refinanced their homes. They used refinancing proceeds to purchase goods and services and drive the economy.
Political Games
As early as 2002, Congressmen began calling for an investigation into the practices of Fannie Mae and Freddie Mac. Fannie and Freddie were quasi-government organizations. They were independent, publicly traded companies, but their debt was guaranteed by the Federal Government. As a result of this crisis, they are now, technically, owned by Uncle Sam. So is their debt.
Fannie was being run by Clinton appointee and adviser, Franklin Raines. When it became apparent that Fannie was abusing the system, Republicans began calling for an investigation. (Raines has since been assessed a fine of more than $23 million) The Democrats saw this as a political problem, not an economic one, so they blocked meaningful oversight.
Democrats control Congress, so they chair the banking committees of the Senate and the House. Christopher Dodd and Barney Frank simply refused to investigate any wrongdoings by Fannie and Freddie. So, the problem grew greater, until everything collapsed.
The Fed Bailout
Enter the Fed rescue plan, or “bailout.” This will help stabilize markets and keep some liquidity in our banking system. But it will not replace the trillions in capital that have been lost by the world’s financial system, and by investors. It will not make this problem go away; it just softens the blow. We will face lower stock market returns for a good decade because of this. Inflation will be greater because of the massive infusion of money by the Fed. Our children and grandchildren will pay the ultimate price, because they will have to pay on this debt for decades.
The Final Result – A Perfect Financial Storm
As you can see, this problem was caused by a confluence of seemingly unrelated factors, all converging to create the perfect financial storm. We had the law change that helped create the tech bubble. The stock market collapse caused Greenspan to help create the housing boom. Pension plans cried for higher yielding, low risk securities. Wall Street built computer models that convinced the rating agencies to consider mortgage backed securities as investment grade debt. Low interest rates allowed unregulated hedge funds to join the investment banks and pension plans. Together, they bought as much as could be created. Congress forced a lowering of underwriting standards. Fannie Mae (and Freddie Mac) executives cooked the books and lowered quality to drive their stock prices higher to trigger stock options. Democratic leaders refused to investigate. Republican leaders pushed for deregulation and allowed a huge piece of the financial world to go unregulated. Insurance companies and investment banks borrowed huge sums of money to purchase these securities. Then they “insured” them to add to their profits. Wall Street ignored the bottom end of the mathematical return range, seeing it as acceptable risk. When mortgage holders began defaulting, investment banks were forced to “mark to the market.” This caused a dramatic fall in capital, and instant insolvency. The credit markets seized and the world economy ground to a halt. Investment banks and insurance companies were asked to make good on their guarantees and couldn’t deliver. World stock market values plummet and the capital base grew even weaker. The U.S. Government more than doubled our national debt (when we add the assumption of Fannie Mae and Freddie Mac debt).
This reminds me of hurricane Katrina and New Orleans. It has been three years, and New Orleans is still not the same. Areas of the city remain blighted. The local economy still suffers. And the danger still remains.
The same thing goes for our nation and the world. The United States will feel the effects of this for years. We will have lower corporate earnings than we might have enjoyed. Inflation will be greater than it would have been. We will create new regulations. Those regulations will have their own unintended consequences. And someday, hopefully not too soon, we will probably do it all over again.
www.lumbert.com
www.shaksperbooks.com
Wednesday, October 1, 2008
Financial Healing Underway
As bad as things may seem in the world of finance, I believe that the healing is now underway.
Congress now has no choice but to pass the emergency legislation that will allow an injection of liquidity and the cleaning of balance sheets. While there is no easy solution, a solution is at hand.
The world economy is fundamentally sound. Yes, we are probably in the midst of a mild recession. This recession will probably get worse before it gets better. This is not an unusual thing for the stock market to endure; it is normal. However, the stock market typically looks into the future a good six months. The market will often rise before a recession is over, as it sees that the end is drawing near.
I have a strong belief in the fundamental greatness of our nation’s people and in our economy. Yes, things have happened recently that will make it more challenging to prosper in the future. So, maybe our financial candle won’t burn quite as bright as it might have. We have greater debt issues to deal with. We will have greater “safeguards” (i.e. Regulations) for the economy. But our economy will burn brightly, and our nation will prosper.
Now is not a time to look back and cry about the spilled milk or the opportunities we have lost. It is time to clean up the mess and leave it behind. Congress will pass a big spill cleanup bill this week. We must now look forward and embrace our great way of life.
There are many “bargains” out there for those investors with a long-term time horizon. There are many money managers with very long “buy lists,” praying for an influx of capital to invest. Twenty years from now, we may look back to these days as an extraordinary buying opportunity in U.S. equities. This may be seen as a time when the U.S. economy roared out of the financial ashes and surprised us all with its resilience and strength. That’s what I am betting on. America has suffered an injury. But like with any great athlete (and our economy is like a financial superstar) an injury just strengthens the inner fire to succeed. That is where I think we are today. Our nation is in physical therapy for a severe, but treatable injury. We can handle it, so let the games begin again.
Congress now has no choice but to pass the emergency legislation that will allow an injection of liquidity and the cleaning of balance sheets. While there is no easy solution, a solution is at hand.
The world economy is fundamentally sound. Yes, we are probably in the midst of a mild recession. This recession will probably get worse before it gets better. This is not an unusual thing for the stock market to endure; it is normal. However, the stock market typically looks into the future a good six months. The market will often rise before a recession is over, as it sees that the end is drawing near.
I have a strong belief in the fundamental greatness of our nation’s people and in our economy. Yes, things have happened recently that will make it more challenging to prosper in the future. So, maybe our financial candle won’t burn quite as bright as it might have. We have greater debt issues to deal with. We will have greater “safeguards” (i.e. Regulations) for the economy. But our economy will burn brightly, and our nation will prosper.
Now is not a time to look back and cry about the spilled milk or the opportunities we have lost. It is time to clean up the mess and leave it behind. Congress will pass a big spill cleanup bill this week. We must now look forward and embrace our great way of life.
There are many “bargains” out there for those investors with a long-term time horizon. There are many money managers with very long “buy lists,” praying for an influx of capital to invest. Twenty years from now, we may look back to these days as an extraordinary buying opportunity in U.S. equities. This may be seen as a time when the U.S. economy roared out of the financial ashes and surprised us all with its resilience and strength. That’s what I am betting on. America has suffered an injury. But like with any great athlete (and our economy is like a financial superstar) an injury just strengthens the inner fire to succeed. That is where I think we are today. Our nation is in physical therapy for a severe, but treatable injury. We can handle it, so let the games begin again.
Tuesday, September 30, 2008
We Have Lost Our Human Center
We Have Lost Our Human Center
As I watched the stock market plunge this afternoon I though of the Wizard of Oz. I feel like I have been transported to some foreign country, where good and evil do battle before my eyes. Where life is magnified, and the colors of our lives are intensified beyond reason.
There’s the Good Wall Street and the Evil Wall Street. It’s the grease that lubricates the world’s financial engine, but also the thief that steals your life’s savings.
There’s the Good Congressman and the Bad Congressman, and they can be one in the same. Barney Frank, Christopher Dodd and Nancy Pelosi are working yeoman’s hours trying to hammer out a deal. But it was Dodd and Frank that blocked an investigation in Fannie Mae back as far as 2002, when it became apparent that our government oversight wasn’t strong enough. Dodd has received the greatest payoffs from Fannie Mae, totaling more than $100,000. Now he’s helping to lead the charge in the solution. Something is strangely warped here.
Republicans have to shoulder a big chunk of the blame on this one, too. They have been champions of fewer regulations in the financial world. In theory, less regulation means more efficiency. I have been in the financial services industry, and I know this to be true. Advisors can spend (literally) half their time filling out forms. Greater regulations mean greater inefficiencies and less profitability. Less profitability means fewer jobs and less tax revenue.
The problem is this: Crooks always find a way around regulations. And when you make it as easy as we did, they have a license to steal. Yes, we made if far too easy this time. And we allowed a single “product” to permeate the entire fabric of our economy, seeping into it like blood. It is like we went on vacation and left the door wide open.
As the man opens up the door to his house, he says, “Damn, Martha, I thought I might have left that back door ajar when we went away on that hard-earned vacation. Someone’s done backed up a U-Haul to our place and stolen every damn thing we had.”
Martha looks inside and says, “At least they cleaned up and closed the door behind them, George. And we got off easy. I hear that the Stewarts had their whole house stolen.”
“Their whole house?”
“From the foundation up.”
“That sucks.”
“Uh, huh.”
“And they are good people, too.”
Well-mannered crooks are crooks will take anything and everything they can. Including your house.
I have always been a champion of Wall Street and of business. Business provides jobs and produces the things that improve our lives. Wall Street helps provide the capital needed for businesses to grow and thrive. My experience (in business and in economics) has led me to believe that a dollar in the hands of a productive person produces far more than a dollar in someone’s mattress.
This time though, the “big game” wasn’t producing much beyond phantom profits. It was a shell game. Now, I don’t blame Wall Street for playing the game; that’s their job. They are in business to make money, for themselves and their clients.
But this whole shell game trickled from Wall Street to Main Street, becoming so large that it spread like the Asian flu. Wall Street got greedy. And they allowed themselves to become ignorant to reality. They refused to look beyond the money machine to its inner workings.
AIG (among others) marketed their services to unsophisticated bankers who thought that the word “guarantee” actually meant something. They showed bankers how they could borrow from others (depositors and the Fed) and invest in CDOs (mortgage backed securities), with AIG guaranteeing the interest and make a “guaranteed” profit. That is, until the mortgage holders default.
All of this mess might have been manageable, except that it became like a drug habit. Everyone needed more and more. Underwriting standards grew lax. And FRAUD prevailed.
Wall Street quants had created beautiful (and complicated) algorithms that dealt with every conceivable market scenario, showing that these things were “rock solid.” The thing that the quants couldn’t predict was true human behavior.
Humans are a complex animal. Our emotions have not been able to keep up with our intellectual development. So, while our intellect is in the 21st century, our emotions are barely out of the Middle Ages.
Look at the world and try to tell me that we aren’t in some emotional time warp. We’ve got suicide bombers igniting themselves every day, with thoughts of 70 virgins. We’ve got genocide occurring in dozens of countries today, as I write this. We’ve got a Congress that is playing politics as our economy bleeds to death.
I have watched our great nation take several steps toward becoming a second-tier nation in the past few weeks. Our national debt has nearly doubled. We are preparing a $700 billion bailout package that will be only a band-aid that might stop some of the bleeding. Healing will take far more. Far more.
I am beginning to wonder if we are reaching the limits of our emotional capacity to handle the complexity and change in our lives.
I am beginning to wonder if we must develop some new paradigm for living, something that will allow us to cope with the multiple facets of government, of business and of juggling far too many things in our personal lives.
For example: Texting while driving is becoming a hot topic. People are crashing trains and cars because they are texting friends while they steer. While driving in cars, people are texting while listening to the radio, taking drags of the morning cigarette, drinking coffee and reading the paper in stop and go traffic. We talk on the phone while cooking. We text on the PDA while talking on the phone. We jab at our Blackberry’s between quarters at our kid’s football games. We never stop.
Maybe we need a new law from Congress, one that mandates solitude and rest.
If our government can start nationalizing businesses…If they can create new regulations that make it more and more impossible to succeed…If they can tax business so much that a national treasure like Budweiser (the Great American Beer) is better off being foreign owned because taxes are far lower overseas…If they can halt the sale of junk food…If they can ban smoking in privately-owned condos (I am not a smoker, but smokers have rights, too)…If they can force us to drive certain cars…Or carry our own bags into the supermarket…Then, certainly government can come up with a law that makes us better and better adjusted people.
I say that we have a mandated day where we have to do little, except spend time with our families. It should be a time for reflection, a time without multi-tasking and stretching our limits of sleep. We used to have this day. Sunday. It was a day of rest and reflection. But that was before the days of multi-tasking, playdates and soccer moms.
Religion is a flash topic, and this is not about religion. It is about the human condition.
Let’s make our day Thursday. I’m always a little tired by Thursday, so that would be good. Maybe business can’t start until after two p.m. Families must eat breakfast together and then have quiet time for an hour. Maybe take a walk, and think about the great things we have in life, not all the things we don’t have. Then they should sit down for lunch, and talk, air thing out, laugh a bit. That sure would be nice. Fat chance.
Maybe all of these global problems we are facing should be seen as a wakeup call. Maybe we need to slow things down. I’m going to think about this tonight after dinner is over and homework is under control. I will sit down in my living room, with Monday Night Football on softly, my next novel on my lap for editing, my PDA on my belt and a family member or two sitting close by. Or, maybe I’ll try just one thing. Probably not. I’ve got too many things to do, can’t just do one thing at a time. Won’t work anymore. Unless it was law…I don’t like to break the law. If there was this law that said I had to relax and reflect…Would that be Utopia?
I better go back and read Utopia. I’ll put it next to “The Rise and Fall of the Roman Empire.” Somewhere in there I might find an answer to this mess, where we are heading in this chaos we call life.
As I watched the stock market plunge this afternoon I though of the Wizard of Oz. I feel like I have been transported to some foreign country, where good and evil do battle before my eyes. Where life is magnified, and the colors of our lives are intensified beyond reason.
There’s the Good Wall Street and the Evil Wall Street. It’s the grease that lubricates the world’s financial engine, but also the thief that steals your life’s savings.
There’s the Good Congressman and the Bad Congressman, and they can be one in the same. Barney Frank, Christopher Dodd and Nancy Pelosi are working yeoman’s hours trying to hammer out a deal. But it was Dodd and Frank that blocked an investigation in Fannie Mae back as far as 2002, when it became apparent that our government oversight wasn’t strong enough. Dodd has received the greatest payoffs from Fannie Mae, totaling more than $100,000. Now he’s helping to lead the charge in the solution. Something is strangely warped here.
Republicans have to shoulder a big chunk of the blame on this one, too. They have been champions of fewer regulations in the financial world. In theory, less regulation means more efficiency. I have been in the financial services industry, and I know this to be true. Advisors can spend (literally) half their time filling out forms. Greater regulations mean greater inefficiencies and less profitability. Less profitability means fewer jobs and less tax revenue.
The problem is this: Crooks always find a way around regulations. And when you make it as easy as we did, they have a license to steal. Yes, we made if far too easy this time. And we allowed a single “product” to permeate the entire fabric of our economy, seeping into it like blood. It is like we went on vacation and left the door wide open.
As the man opens up the door to his house, he says, “Damn, Martha, I thought I might have left that back door ajar when we went away on that hard-earned vacation. Someone’s done backed up a U-Haul to our place and stolen every damn thing we had.”
Martha looks inside and says, “At least they cleaned up and closed the door behind them, George. And we got off easy. I hear that the Stewarts had their whole house stolen.”
“Their whole house?”
“From the foundation up.”
“That sucks.”
“Uh, huh.”
“And they are good people, too.”
Well-mannered crooks are crooks will take anything and everything they can. Including your house.
I have always been a champion of Wall Street and of business. Business provides jobs and produces the things that improve our lives. Wall Street helps provide the capital needed for businesses to grow and thrive. My experience (in business and in economics) has led me to believe that a dollar in the hands of a productive person produces far more than a dollar in someone’s mattress.
This time though, the “big game” wasn’t producing much beyond phantom profits. It was a shell game. Now, I don’t blame Wall Street for playing the game; that’s their job. They are in business to make money, for themselves and their clients.
But this whole shell game trickled from Wall Street to Main Street, becoming so large that it spread like the Asian flu. Wall Street got greedy. And they allowed themselves to become ignorant to reality. They refused to look beyond the money machine to its inner workings.
AIG (among others) marketed their services to unsophisticated bankers who thought that the word “guarantee” actually meant something. They showed bankers how they could borrow from others (depositors and the Fed) and invest in CDOs (mortgage backed securities), with AIG guaranteeing the interest and make a “guaranteed” profit. That is, until the mortgage holders default.
All of this mess might have been manageable, except that it became like a drug habit. Everyone needed more and more. Underwriting standards grew lax. And FRAUD prevailed.
Wall Street quants had created beautiful (and complicated) algorithms that dealt with every conceivable market scenario, showing that these things were “rock solid.” The thing that the quants couldn’t predict was true human behavior.
Humans are a complex animal. Our emotions have not been able to keep up with our intellectual development. So, while our intellect is in the 21st century, our emotions are barely out of the Middle Ages.
Look at the world and try to tell me that we aren’t in some emotional time warp. We’ve got suicide bombers igniting themselves every day, with thoughts of 70 virgins. We’ve got genocide occurring in dozens of countries today, as I write this. We’ve got a Congress that is playing politics as our economy bleeds to death.
I have watched our great nation take several steps toward becoming a second-tier nation in the past few weeks. Our national debt has nearly doubled. We are preparing a $700 billion bailout package that will be only a band-aid that might stop some of the bleeding. Healing will take far more. Far more.
I am beginning to wonder if we are reaching the limits of our emotional capacity to handle the complexity and change in our lives.
I am beginning to wonder if we must develop some new paradigm for living, something that will allow us to cope with the multiple facets of government, of business and of juggling far too many things in our personal lives.
For example: Texting while driving is becoming a hot topic. People are crashing trains and cars because they are texting friends while they steer. While driving in cars, people are texting while listening to the radio, taking drags of the morning cigarette, drinking coffee and reading the paper in stop and go traffic. We talk on the phone while cooking. We text on the PDA while talking on the phone. We jab at our Blackberry’s between quarters at our kid’s football games. We never stop.
Maybe we need a new law from Congress, one that mandates solitude and rest.
If our government can start nationalizing businesses…If they can create new regulations that make it more and more impossible to succeed…If they can tax business so much that a national treasure like Budweiser (the Great American Beer) is better off being foreign owned because taxes are far lower overseas…If they can halt the sale of junk food…If they can ban smoking in privately-owned condos (I am not a smoker, but smokers have rights, too)…If they can force us to drive certain cars…Or carry our own bags into the supermarket…Then, certainly government can come up with a law that makes us better and better adjusted people.
I say that we have a mandated day where we have to do little, except spend time with our families. It should be a time for reflection, a time without multi-tasking and stretching our limits of sleep. We used to have this day. Sunday. It was a day of rest and reflection. But that was before the days of multi-tasking, playdates and soccer moms.
Religion is a flash topic, and this is not about religion. It is about the human condition.
Let’s make our day Thursday. I’m always a little tired by Thursday, so that would be good. Maybe business can’t start until after two p.m. Families must eat breakfast together and then have quiet time for an hour. Maybe take a walk, and think about the great things we have in life, not all the things we don’t have. Then they should sit down for lunch, and talk, air thing out, laugh a bit. That sure would be nice. Fat chance.
Maybe all of these global problems we are facing should be seen as a wakeup call. Maybe we need to slow things down. I’m going to think about this tonight after dinner is over and homework is under control. I will sit down in my living room, with Monday Night Football on softly, my next novel on my lap for editing, my PDA on my belt and a family member or two sitting close by. Or, maybe I’ll try just one thing. Probably not. I’ve got too many things to do, can’t just do one thing at a time. Won’t work anymore. Unless it was law…I don’t like to break the law. If there was this law that said I had to relax and reflect…Would that be Utopia?
I better go back and read Utopia. I’ll put it next to “The Rise and Fall of the Roman Empire.” Somewhere in there I might find an answer to this mess, where we are heading in this chaos we call life.
Friday, September 26, 2008
Are Politicians a Different Species?
I am beginning to think that politicians are an entirely different species than the average American. There is some genetic misprint in their DNA, something that causes them to create chaos out of order. Something beyond the natural order (or disorder).
Simplified, the second law of thermodynamics is that “Entropy Increases.” Nothing takes place with 100% efficiency, causing disorder in the universe to increase. When a china cup falls to the floor, it breaks into disordered pieces. Disordered pieces do not drop to the floor and emerge as a whole cup. Increasing disorder is natural and normal.
In Congress, we’ve got hundreds of men and women bouncing around like excited molecules inside a glass of water, all waiting to spill out and create CHAOS. They are not satisfied by making simple choices and creating simple solutions to problems we face. It’s like they have some genetic predisposition for making things so convoluted that Einstein would be no match.
Right now, our nation is facing a financial crisis. The availability of credit has vanished, just like it did before the Great Depression. If something isn’t done immediately, and I mean now, we will be facing much the same problem. Just today, Washington Mutual went into receivership, a $300 billion behemoth bank. It had been teetering, waiting for the “bailout” to occur. But it took longer than it should have for Congress to act, so the plug was pulled. This will be happening daily until something is done.
I know that Congress does not always attract our best and brightest. Some might even say that they lack the required alphas to lead the pack. But they are people who (usually) care about their constituents. They just have this genetic defect (maybe it is just that this gene is more dominant) that causes them to make trapezoids and mazes out of circles.
I am not normally a bail-out kind of guy. If you screw up, you pay the consequences, learn from your mistakes and do it better next time. This time it is different. The level of fraud and greed has taken everyone by surprise. If we had endured just fraud or just greed, the nation would have been okay. But when the greed is based upon fraud (like Fannie Mae dramatically relaxing its standards without telling anyone and cooking its books for stock bonuses and option conversions), and excessive leverage is used, we have a calamity in waiting.
The proposed government bailout was not the Fed’s (or the administration’s) first choice. It is a last-ditch effort to put on a tourniquet before death occurs. Unfortunately, its passage is put into the hands of a breed of human that can do nothing but complicate things. Our leaders are manipulating the agreement to score political points and point fingers.
I assure you, for most members of Congress, actually understanding this bailout plan would be like understanding Chinese the first time you look at it. It cannot be done by the normal human brain, let alone one of a politician. So, Congress retreats to a place where it is comfortable, making everything so complicated that no one understands it.
Restricting golden parachutes was a good addition to this plan. But adding condition after condition, and setting limits upon when cash can be made available, is like telling a Triage Nurse that a patient cannot have a new IV bag, or a blood transfusion until a week has passed. The patient needs it now. The doctor agrees. But the kitchen workers have decided that it isn’t fair for someone to get care that fast and efficiently.
What does a kitchen worker know about trauma? What does a member of Congress know about finance? I would say that they are relatively equivalent. Congress needs to let experts do their jobs, and go complicate something else, like health care. (Just joking, but that is next.)
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Simplified, the second law of thermodynamics is that “Entropy Increases.” Nothing takes place with 100% efficiency, causing disorder in the universe to increase. When a china cup falls to the floor, it breaks into disordered pieces. Disordered pieces do not drop to the floor and emerge as a whole cup. Increasing disorder is natural and normal.
In Congress, we’ve got hundreds of men and women bouncing around like excited molecules inside a glass of water, all waiting to spill out and create CHAOS. They are not satisfied by making simple choices and creating simple solutions to problems we face. It’s like they have some genetic predisposition for making things so convoluted that Einstein would be no match.
Right now, our nation is facing a financial crisis. The availability of credit has vanished, just like it did before the Great Depression. If something isn’t done immediately, and I mean now, we will be facing much the same problem. Just today, Washington Mutual went into receivership, a $300 billion behemoth bank. It had been teetering, waiting for the “bailout” to occur. But it took longer than it should have for Congress to act, so the plug was pulled. This will be happening daily until something is done.
I know that Congress does not always attract our best and brightest. Some might even say that they lack the required alphas to lead the pack. But they are people who (usually) care about their constituents. They just have this genetic defect (maybe it is just that this gene is more dominant) that causes them to make trapezoids and mazes out of circles.
I am not normally a bail-out kind of guy. If you screw up, you pay the consequences, learn from your mistakes and do it better next time. This time it is different. The level of fraud and greed has taken everyone by surprise. If we had endured just fraud or just greed, the nation would have been okay. But when the greed is based upon fraud (like Fannie Mae dramatically relaxing its standards without telling anyone and cooking its books for stock bonuses and option conversions), and excessive leverage is used, we have a calamity in waiting.
The proposed government bailout was not the Fed’s (or the administration’s) first choice. It is a last-ditch effort to put on a tourniquet before death occurs. Unfortunately, its passage is put into the hands of a breed of human that can do nothing but complicate things. Our leaders are manipulating the agreement to score political points and point fingers.
I assure you, for most members of Congress, actually understanding this bailout plan would be like understanding Chinese the first time you look at it. It cannot be done by the normal human brain, let alone one of a politician. So, Congress retreats to a place where it is comfortable, making everything so complicated that no one understands it.
Restricting golden parachutes was a good addition to this plan. But adding condition after condition, and setting limits upon when cash can be made available, is like telling a Triage Nurse that a patient cannot have a new IV bag, or a blood transfusion until a week has passed. The patient needs it now. The doctor agrees. But the kitchen workers have decided that it isn’t fair for someone to get care that fast and efficiently.
What does a kitchen worker know about trauma? What does a member of Congress know about finance? I would say that they are relatively equivalent. Congress needs to let experts do their jobs, and go complicate something else, like health care. (Just joking, but that is next.)
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Thursday, September 25, 2008
This Crisis Beyond Politics
This is not a “Political” Crisis. It is very real, and it is at your back door.
When the president of the United States goes on national television to talk about a financial crisis, we should pay attention. Rather than seeing it as just another “political” move with no more sincerity than Cruella DeVil petting a Dalmatian puppy, we should see it for what it is: a desperate cry of “Look out!” before we drive over a cliff.
I know that Congress is not filled with leaders that can process information quickly and then make rational, informed decisions. No, politics tends to attract a different kind of human (some might call them subhuman) who often sees life as a series of maneuvers and negotiations. For them, nothing is black and white, good or bad, but different shades of gray that spill across the aisles in the form of legislation.
This is a time when politicians must shed their skin and, for once, do something that is not politically motivated, but people motivated, nation motivated. Millions of human lives are teetering on the brink of ruin, unless Congress takes swift and decisive action. A small or “gradual” fix will do nothing but delay disaster. Doing nothing will send the planet into an economic freeze that could cure global warming. It is this bad.
Our banking system works on money (financial ratios) and faith. A banker must have faith that the money they loan will be repaid. Otherwise, the bank goes out of business. Depositors must have faith that a bank will survive, and that their money is safe. Otherwise they withdraw their money. If depositors withdraw their money, the bank must call in loans immediately (remember those ratios). In a time of crisis, there is often no other place that businesses or individuals can replace their loans, so they default. This causes a further erosion in capital and the cycle continues.
There are organizations whose job is to audit and regulate financial institutions. The Federal Reserve is one of these, so I will use them in my example. The Fed regularly goes into banks and looks at their books. They make sure that the bank has the assets they claim to. They make sure that they remain financially strong, so that a business downturn, or a small crisis in confidence won’t put the bank out of business, or lose depositors’ money.
For years, many banks have been purchasing CDO’s (mortgage backed securities) as a way to invest, hedge and bring profits. Until recently, these CDOs were considered valuable, and were seen by regulators (hence the general public) as being safe. Now that many of these securities have proven to be worthless, banks must assign them a much smaller value.
Banks are allowed to lend money based upon their asset (and deposit) base. The more money they have in reserve, the more they can lend. They must adhere to certain “ratios.” For example, let’s assume for every dollar of deposits, I can lend out fifteen. Using this example, if I have $1 million on deposit, I can lend out $15 million. If these assets (deposits plus securities) decrease in value, a bank must reduce its loan portfolio to stay within the financial regulations (laws). If one of my depositors withdraws $500,000, this means that my bank must either replace that money, or call in $7.5 million in loans.
If I am a bank that owns $1 billion in mortgage backed securities, I might have lent out $15 billion using them as security. If these securities drop in value to $500 million, my bank must either replace it, or call in $7.5 billion in loans. This would cause big problems in the business community and many jobs would be lost.
By my math, our nation’s banks (both commercial and investment) own trillions of dollars worth of CDOs (mortgage backed securities). Until recently, the Federal Reserve has been lending money against these securities at something approaching (if not meeting) their face value. This has allowed the financial system to proceed as usual. The problem is, the Fed is not allowed to do this forever. At some point (that means now) the Fed (and other regulators) have to recognize the true value of a bank’s deposits and securities, and force them to adhere to the lending ratios that will keep them solvent.
Here is the problem: our financial institutions are holding hundreds of billions in worthless “assets” that must be accounted for. These securities must be assigned their true value, and loans must be reduced to reflect this capital base. If this happens, businesses and individuals with the highest credit ratings will have loans called in. New loans will virtually cease, and our economy will drive off that cliff, or come to a grinding halt. This is monumental.
The president is proposing a bridge that will allow the Federal Government to purchase these deflated securities at full or near-full value. This will allow banks to avoid calling in trillions of dollars in loans. It might help avoid putting millions of people out of work. I might help us avoid a global recession, or worse.
If this plan does not get passed, look for a friendly call from your banker explaining that, despite your AAA credit, despite your 780 FICO score, you can’t buy that home or finance that business, because the money just isn’t there.
This is not a cry of Wolf. It is not a political ploy. This is the guillotine resting above our nation’s neck, preparing to fall. Congress can stop it, or they can stand idly by as millions of Americans get the “axe,” through no fault of their own.
If banks begin to fail, depositors will grow scared and lose faith in the banking system. We have already seen this, where three month T-Bills were purchased last week with a negative return. Investors accepted a guaranteed loss for the safety of T-Bills. Imagine what might happen when banks begin to fail and depositors begin withdrawing money from banks. This would exacerbate the problem. Bank reserves are being artificially propped by the Fed. This can't go on forever unless the law is changed. This is the task our Congress faces this week. I believe they must fix this. They must fix this fast. They must fix this decisively. If they don't, it will be hard for us to say, "Forgive them, for they know not what they do." Congress has been educated. They have been warned. If they put politics above our nation's safety and survival, they are doing it with full knowledge of the possible consequences.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
When the president of the United States goes on national television to talk about a financial crisis, we should pay attention. Rather than seeing it as just another “political” move with no more sincerity than Cruella DeVil petting a Dalmatian puppy, we should see it for what it is: a desperate cry of “Look out!” before we drive over a cliff.
I know that Congress is not filled with leaders that can process information quickly and then make rational, informed decisions. No, politics tends to attract a different kind of human (some might call them subhuman) who often sees life as a series of maneuvers and negotiations. For them, nothing is black and white, good or bad, but different shades of gray that spill across the aisles in the form of legislation.
This is a time when politicians must shed their skin and, for once, do something that is not politically motivated, but people motivated, nation motivated. Millions of human lives are teetering on the brink of ruin, unless Congress takes swift and decisive action. A small or “gradual” fix will do nothing but delay disaster. Doing nothing will send the planet into an economic freeze that could cure global warming. It is this bad.
Our banking system works on money (financial ratios) and faith. A banker must have faith that the money they loan will be repaid. Otherwise, the bank goes out of business. Depositors must have faith that a bank will survive, and that their money is safe. Otherwise they withdraw their money. If depositors withdraw their money, the bank must call in loans immediately (remember those ratios). In a time of crisis, there is often no other place that businesses or individuals can replace their loans, so they default. This causes a further erosion in capital and the cycle continues.
There are organizations whose job is to audit and regulate financial institutions. The Federal Reserve is one of these, so I will use them in my example. The Fed regularly goes into banks and looks at their books. They make sure that the bank has the assets they claim to. They make sure that they remain financially strong, so that a business downturn, or a small crisis in confidence won’t put the bank out of business, or lose depositors’ money.
For years, many banks have been purchasing CDO’s (mortgage backed securities) as a way to invest, hedge and bring profits. Until recently, these CDOs were considered valuable, and were seen by regulators (hence the general public) as being safe. Now that many of these securities have proven to be worthless, banks must assign them a much smaller value.
Banks are allowed to lend money based upon their asset (and deposit) base. The more money they have in reserve, the more they can lend. They must adhere to certain “ratios.” For example, let’s assume for every dollar of deposits, I can lend out fifteen. Using this example, if I have $1 million on deposit, I can lend out $15 million. If these assets (deposits plus securities) decrease in value, a bank must reduce its loan portfolio to stay within the financial regulations (laws). If one of my depositors withdraws $500,000, this means that my bank must either replace that money, or call in $7.5 million in loans.
If I am a bank that owns $1 billion in mortgage backed securities, I might have lent out $15 billion using them as security. If these securities drop in value to $500 million, my bank must either replace it, or call in $7.5 billion in loans. This would cause big problems in the business community and many jobs would be lost.
By my math, our nation’s banks (both commercial and investment) own trillions of dollars worth of CDOs (mortgage backed securities). Until recently, the Federal Reserve has been lending money against these securities at something approaching (if not meeting) their face value. This has allowed the financial system to proceed as usual. The problem is, the Fed is not allowed to do this forever. At some point (that means now) the Fed (and other regulators) have to recognize the true value of a bank’s deposits and securities, and force them to adhere to the lending ratios that will keep them solvent.
Here is the problem: our financial institutions are holding hundreds of billions in worthless “assets” that must be accounted for. These securities must be assigned their true value, and loans must be reduced to reflect this capital base. If this happens, businesses and individuals with the highest credit ratings will have loans called in. New loans will virtually cease, and our economy will drive off that cliff, or come to a grinding halt. This is monumental.
The president is proposing a bridge that will allow the Federal Government to purchase these deflated securities at full or near-full value. This will allow banks to avoid calling in trillions of dollars in loans. It might help avoid putting millions of people out of work. I might help us avoid a global recession, or worse.
If this plan does not get passed, look for a friendly call from your banker explaining that, despite your AAA credit, despite your 780 FICO score, you can’t buy that home or finance that business, because the money just isn’t there.
This is not a cry of Wolf. It is not a political ploy. This is the guillotine resting above our nation’s neck, preparing to fall. Congress can stop it, or they can stand idly by as millions of Americans get the “axe,” through no fault of their own.
If banks begin to fail, depositors will grow scared and lose faith in the banking system. We have already seen this, where three month T-Bills were purchased last week with a negative return. Investors accepted a guaranteed loss for the safety of T-Bills. Imagine what might happen when banks begin to fail and depositors begin withdrawing money from banks. This would exacerbate the problem. Bank reserves are being artificially propped by the Fed. This can't go on forever unless the law is changed. This is the task our Congress faces this week. I believe they must fix this. They must fix this fast. They must fix this decisively. If they don't, it will be hard for us to say, "Forgive them, for they know not what they do." Congress has been educated. They have been warned. If they put politics above our nation's safety and survival, they are doing it with full knowledge of the possible consequences.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Wednesday, September 24, 2008
Bernanke Translation
As Bernanke briefs Congress for a second day, it is obvious that Congress speaks a different language than the Fed Chairman. They simply do not appear to hear what he is saying, so I will translate.
“The intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant drag on growth.”
Translation: The economy will come to a screeching halt within days if you don’t do something NOW. Banks will hoard their cash, because they can see that businesses everywhere might start to fail like Wall Street giants. People could begin losing jobs in a manner approaching the Great Depression, unless you guys act NOW. People will stop spending and the situation will get worse and worse, until we are in a major recession. This will spread across the globe like a financial red tide. People will line the streets like a lynch mob, calling for the people responsible to be punished. Eventually, the punishment will spread to the members of Congress who blocked government oversight into Fannie Mae and Freddie Mac. This will spill over to the heads of financial committees, such as the ones that are hearing me now, and I will not lift a finger to save your sorry asses if we all go down. You need to act NOW.
“The downside risks to the outlook thus remain a significant concern.”
Translation: We are standing on the brink of a financial disaster unless you mover your butts to quell the liquidity crunch. I have done all I can to fix this thing, but I am hampered by laws that only you can fix. You need to fix this NOW.
“Economic activity appears to have decelerated broadly.”
Translation: We are in deep crap and it is going to pile so high that we might all get smothered. Recession is the least of my worries. I worry that this thing will snowball so out of control that our nation will look like an old Steel Mill or Dustbowl town. We need to act NOW.
“Stabilization of our financial system is an essential precondition for economic recovery.”
Translation: Until Congress does something to break the credit gridlock, our economy will sink deeper and deeper into a recession, until this Congress will go down as the most inept in history. People in your hometown will be using newspapers with your face on dartboards and to wipe their butts. The only monument to your handling of this situation will be a Great Wall of Shame, written in textbooks saying that “you had the chance to fix this,” but you tried to swing it to your advantage, forsaking the nation in favor of your own political and personal EGO. You need to fix this NOW.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
“The intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant drag on growth.”
Translation: The economy will come to a screeching halt within days if you don’t do something NOW. Banks will hoard their cash, because they can see that businesses everywhere might start to fail like Wall Street giants. People could begin losing jobs in a manner approaching the Great Depression, unless you guys act NOW. People will stop spending and the situation will get worse and worse, until we are in a major recession. This will spread across the globe like a financial red tide. People will line the streets like a lynch mob, calling for the people responsible to be punished. Eventually, the punishment will spread to the members of Congress who blocked government oversight into Fannie Mae and Freddie Mac. This will spill over to the heads of financial committees, such as the ones that are hearing me now, and I will not lift a finger to save your sorry asses if we all go down. You need to act NOW.
“The downside risks to the outlook thus remain a significant concern.”
Translation: We are standing on the brink of a financial disaster unless you mover your butts to quell the liquidity crunch. I have done all I can to fix this thing, but I am hampered by laws that only you can fix. You need to fix this NOW.
“Economic activity appears to have decelerated broadly.”
Translation: We are in deep crap and it is going to pile so high that we might all get smothered. Recession is the least of my worries. I worry that this thing will snowball so out of control that our nation will look like an old Steel Mill or Dustbowl town. We need to act NOW.
“Stabilization of our financial system is an essential precondition for economic recovery.”
Translation: Until Congress does something to break the credit gridlock, our economy will sink deeper and deeper into a recession, until this Congress will go down as the most inept in history. People in your hometown will be using newspapers with your face on dartboards and to wipe their butts. The only monument to your handling of this situation will be a Great Wall of Shame, written in textbooks saying that “you had the chance to fix this,” but you tried to swing it to your advantage, forsaking the nation in favor of your own political and personal EGO. You need to fix this NOW.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Tuesday, September 23, 2008
"Quite Fragile" means Crashing
The Federal Reserve Chairman must always try to stay above politics. They must be careful in what they say, so that they don’t spook the markets needlessly. A misplaced word can (literally) move markets.
Although his words will sail harmlessly over most people’s heads, today’s words by Ben Bernanke were astounding.
I quote: “The financial markets are in quite fragile condition and I think absent a plan they will get worse…I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.”
“Quite fragile.” Quite fragile? We are talking about the most powerful nation on earth, with (by far) the largest GDP, a nation that is often accused of bullying our way around the globe.
When the Fed Chairman says “quite fragile,” what he is doing is this: He is standing on the top of the Empire State Building with a megaphone more powerful than speakers at a ZZ Top concert. He is yelling at the top of his lungs, “Look Out Below! Our entire country is about to fall on your sorry asses! If you thought 9/11 brought you pain, just wait until you see what this one brings you. If your stupid Congress doesn’t act within the next few days, all hell is going to break loose! Can you hear me? Can you hear me! I am talking to you. I am screaming in your frigging ears! Will you listen?”
That’s what Bernanke said today. Nothing less. Congress better listen, and listen fast.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Although his words will sail harmlessly over most people’s heads, today’s words by Ben Bernanke were astounding.
I quote: “The financial markets are in quite fragile condition and I think absent a plan they will get worse…I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.”
“Quite fragile.” Quite fragile? We are talking about the most powerful nation on earth, with (by far) the largest GDP, a nation that is often accused of bullying our way around the globe.
When the Fed Chairman says “quite fragile,” what he is doing is this: He is standing on the top of the Empire State Building with a megaphone more powerful than speakers at a ZZ Top concert. He is yelling at the top of his lungs, “Look Out Below! Our entire country is about to fall on your sorry asses! If you thought 9/11 brought you pain, just wait until you see what this one brings you. If your stupid Congress doesn’t act within the next few days, all hell is going to break loose! Can you hear me? Can you hear me! I am talking to you. I am screaming in your frigging ears! Will you listen?”
That’s what Bernanke said today. Nothing less. Congress better listen, and listen fast.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
One Third Rule
While watching our local July 4th parade, I began to think about the dreamers who convinced our nation to fight for its freedom.
Before the Revolution, we really didn’t have it so bad. Yeah, we had a little tax on tea. But, other than that, we were pretty much free to go our own ways. We could own property and companies. We had some religious freedom. No, life was pretty good. And we were taxed a heck of a lot less than we are today.
Back then, about a third of our population was firmly in the Tory camp. They supported the monarchy and favored British rule and protection. One third of our population was firmly against British rule. And the middle third? They didn’t really care.
Government is still that way today. On one side, we have conservatives, primarily by the (right wing) Republican Party. Liberals tend to rule the Democratic Party (left wing). Caught in the middle, we find those with no strong ideology that gravitates them to one side or the other. Whichever side (right or left) is able to convince more of the middle to come there way, will generally win an election.
Prior to the convention, John McCain’s campaign was floundering, as those who would normally be solidly in his camp (the conservatives) were not excited by his candidacy. It was only after he chose Sarah Palin (a classic conservative) that he energized his party and pulled up in the polls.
Barack Obama is squarely entrenched with liberals (with one of the most liberal voting records in the Senate) and he has truly energized his third of the populace.
As we close in on election day, it will be curious to see how both candidates maneuver to the center. McCain appears more main stream than Obama, as he is to the left center of his party. So he might normally have an easier time appealing to the middle. But Obama’s followers are so enthusiastic in their support that they may be powerful persuaders toward his cause.
Such was the case during the American Revolution. The revolutionists were far more passionate and more vocal than their counterparts. In this manner, they were able to sway the middle toward their side, and launch the country into war. Will Obama’s champions be as successful? Or, will McCain’s natural inclination to the middle win him the day?
Only time will tell.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Before the Revolution, we really didn’t have it so bad. Yeah, we had a little tax on tea. But, other than that, we were pretty much free to go our own ways. We could own property and companies. We had some religious freedom. No, life was pretty good. And we were taxed a heck of a lot less than we are today.
Back then, about a third of our population was firmly in the Tory camp. They supported the monarchy and favored British rule and protection. One third of our population was firmly against British rule. And the middle third? They didn’t really care.
Government is still that way today. On one side, we have conservatives, primarily by the (right wing) Republican Party. Liberals tend to rule the Democratic Party (left wing). Caught in the middle, we find those with no strong ideology that gravitates them to one side or the other. Whichever side (right or left) is able to convince more of the middle to come there way, will generally win an election.
Prior to the convention, John McCain’s campaign was floundering, as those who would normally be solidly in his camp (the conservatives) were not excited by his candidacy. It was only after he chose Sarah Palin (a classic conservative) that he energized his party and pulled up in the polls.
Barack Obama is squarely entrenched with liberals (with one of the most liberal voting records in the Senate) and he has truly energized his third of the populace.
As we close in on election day, it will be curious to see how both candidates maneuver to the center. McCain appears more main stream than Obama, as he is to the left center of his party. So he might normally have an easier time appealing to the middle. But Obama’s followers are so enthusiastic in their support that they may be powerful persuaders toward his cause.
Such was the case during the American Revolution. The revolutionists were far more passionate and more vocal than their counterparts. In this manner, they were able to sway the middle toward their side, and launch the country into war. Will Obama’s champions be as successful? Or, will McCain’s natural inclination to the middle win him the day?
Only time will tell.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Monday, September 22, 2008
Back To The Future Financial System
For the past few months, the world’s financial system has been (literally) teetering on the brink of collapse.
This weekend the Fed took a final step in bringing this crisis off the cliff. The Fed allowed the two remaining investment banks (Morgan Stanley and Goldman Sachs) to become holding companies, effectively eliminating this separation, and returning us to the pre-1929 banking rules. This is being allowed so Morgan and Goldman will have better access to Fed bailout money. This will help keep them afloat, so that the crisis in the confidence continues its abatement.
The U.S. Congress passed the Glass-Steagall Act to create separation between commercial and investment banks. The 1929 Stock Market Crash, and the ensuing Great Depression, were largely attributed to banks that created stock pools, used excessive leverage, participated in “insider trading” and drove investor savings into their own shaky banking institution.
I find it curious that the issues that created our current financial crisis are virtually the same ones that this law was designed to guard against. Investment Banks moved in lock-step (along with commercial banks) to create a demand for certain financial products, they used leverage of 30-1 (the 1920s leverage was capped at 10-1), they traded algorithms like insiders and they allowed investors to keep on buying overvalued stock and securities until the very end.
The real culprit here was not under-regulation. It was politicians (so, what’s new?) who refused to heed the warning cries and allow regulators to do their jobs. It was politicians that created a law in 1993 that eliminated the tax deduction for corporate salaries in excess of $1 million. This forced companies to pay executives through such means as stock options, thereby changing business focus from long-term to short-term. It was also greedy financiers who cooked their books as long as they could, despite the risks, knowing that that the Fed would bail them out if they failed. Fannie Mae was ordered, by Congress, to buy mortgages from low-credit areas, where few mortgage bankers feared to tread.
This problem will continue until Congress acts vigorously to prevent it. This does not mean more regulations (except for hedge funds, who should have oversight with the rest of the financial system). It means consequences. There should be consequences for fraud.
Recently, Franklin Raines, former head of Fannie Mae, was ordered to pay more than $20 million in penalties and fines. This resulted from an investigation by the Office of Federal Housing Enterprise Oversight, known as OFHEO. OFHEO found that Raines and Fannie Mae had overstated company earnings by more than $9 billion from 2001-2004. (About 40%). This overstatement allowed Raines and others to earn more than $100 million in bonus money.
These fines are a start, but they will do little to discourage future financial atrocities. A fine of just 20% of illegal and immoral bonus money is nothing. It will take jail time to drive the point home.
It appears that Fannie Mae and Freddie Mac relaxed their lending standards far more than the public was led to believe. This “public” includes the financial institutions that hold this (now worthless) paper, the hedge funds, the money market funds, the pension managers and the mutual fund managers. All of these groups were led to believe that these mortgages were solid, adhering to long-held safety standards. Financial institutions were gorging on a feast of tainted food. Now they are all kneeling by the toilet.
In their haste to point fingers and punish culprits, I do hope that Congress looks to the root of the problem before issuing a new spate of government regulations that will do little to solve the problem.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
This weekend the Fed took a final step in bringing this crisis off the cliff. The Fed allowed the two remaining investment banks (Morgan Stanley and Goldman Sachs) to become holding companies, effectively eliminating this separation, and returning us to the pre-1929 banking rules. This is being allowed so Morgan and Goldman will have better access to Fed bailout money. This will help keep them afloat, so that the crisis in the confidence continues its abatement.
The U.S. Congress passed the Glass-Steagall Act to create separation between commercial and investment banks. The 1929 Stock Market Crash, and the ensuing Great Depression, were largely attributed to banks that created stock pools, used excessive leverage, participated in “insider trading” and drove investor savings into their own shaky banking institution.
I find it curious that the issues that created our current financial crisis are virtually the same ones that this law was designed to guard against. Investment Banks moved in lock-step (along with commercial banks) to create a demand for certain financial products, they used leverage of 30-1 (the 1920s leverage was capped at 10-1), they traded algorithms like insiders and they allowed investors to keep on buying overvalued stock and securities until the very end.
The real culprit here was not under-regulation. It was politicians (so, what’s new?) who refused to heed the warning cries and allow regulators to do their jobs. It was politicians that created a law in 1993 that eliminated the tax deduction for corporate salaries in excess of $1 million. This forced companies to pay executives through such means as stock options, thereby changing business focus from long-term to short-term. It was also greedy financiers who cooked their books as long as they could, despite the risks, knowing that that the Fed would bail them out if they failed. Fannie Mae was ordered, by Congress, to buy mortgages from low-credit areas, where few mortgage bankers feared to tread.
This problem will continue until Congress acts vigorously to prevent it. This does not mean more regulations (except for hedge funds, who should have oversight with the rest of the financial system). It means consequences. There should be consequences for fraud.
Recently, Franklin Raines, former head of Fannie Mae, was ordered to pay more than $20 million in penalties and fines. This resulted from an investigation by the Office of Federal Housing Enterprise Oversight, known as OFHEO. OFHEO found that Raines and Fannie Mae had overstated company earnings by more than $9 billion from 2001-2004. (About 40%). This overstatement allowed Raines and others to earn more than $100 million in bonus money.
These fines are a start, but they will do little to discourage future financial atrocities. A fine of just 20% of illegal and immoral bonus money is nothing. It will take jail time to drive the point home.
It appears that Fannie Mae and Freddie Mac relaxed their lending standards far more than the public was led to believe. This “public” includes the financial institutions that hold this (now worthless) paper, the hedge funds, the money market funds, the pension managers and the mutual fund managers. All of these groups were led to believe that these mortgages were solid, adhering to long-held safety standards. Financial institutions were gorging on a feast of tainted food. Now they are all kneeling by the toilet.
In their haste to point fingers and punish culprits, I do hope that Congress looks to the root of the problem before issuing a new spate of government regulations that will do little to solve the problem.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Wednesday, September 17, 2008
Politics - A Deceptive Beast
As I watch the political ads that are pasting my television, I have noticed a very curious thing. Candidates are being blamed for voting against (or for) something that is entirely against their character.
Upon closer inspection, I have found this: Every bill has a laundry list of other bills that are attached to it. Politicians do this for several reasons. Fist, it is a way to add unpopular pork to a popular bill. Since politicians tend to get re-elected when they get more pork for their own district, members will trade off their pork in a “you scratch my back and I’ll scratch yours” manner.
Let’s say that there is a new bill proposed to raise taxes. Attached to that bill is a bill to provide more soup to soup kitchens in Detroit. If I vote against higher taxes, I am also voting against sending more soup to the soup kitchens. Come election time, my opponent will say in his ads that I voted against sending more soup to the soup kitchens.
Let’s say that there is a bill to lower taxes. Attached to that bill is a bill to provide more soup to soup kitchens in Detroit. If I vote against lower taxes, I am also voting against sending more soup to the soup kitchens. Come election time, my opponent will say in his ads that I voted against sending more soup to the soup kitchens.
I really haven’t voted against more soup, I have voted on taxes. But, come election time, my opponent will drag out a host of things I didn’t know that I had even voted on.
Congress plays this big game of “Gotcha” all the time. This leads to a real distortion of a candidate’s views and it causes a lot of confusion and wrong choices to be made.
Upon closer inspection, I have found this: Every bill has a laundry list of other bills that are attached to it. Politicians do this for several reasons. Fist, it is a way to add unpopular pork to a popular bill. Since politicians tend to get re-elected when they get more pork for their own district, members will trade off their pork in a “you scratch my back and I’ll scratch yours” manner.
Let’s say that there is a new bill proposed to raise taxes. Attached to that bill is a bill to provide more soup to soup kitchens in Detroit. If I vote against higher taxes, I am also voting against sending more soup to the soup kitchens. Come election time, my opponent will say in his ads that I voted against sending more soup to the soup kitchens.
Let’s say that there is a bill to lower taxes. Attached to that bill is a bill to provide more soup to soup kitchens in Detroit. If I vote against lower taxes, I am also voting against sending more soup to the soup kitchens. Come election time, my opponent will say in his ads that I voted against sending more soup to the soup kitchens.
I really haven’t voted against more soup, I have voted on taxes. But, come election time, my opponent will drag out a host of things I didn’t know that I had even voted on.
Congress plays this big game of “Gotcha” all the time. This leads to a real distortion of a candidate’s views and it causes a lot of confusion and wrong choices to be made.
AIG Saved - Now What?
The Fed got smart and saved AIG. At one point this company was one of the ten largest in the world, with assets over $1 trillion, worth more than $200 billion, with more than 100,000 employees. Now it is 80% owned by the U.S. government. Ouch.
AIG, however, insures millions of people, and has made billions in guarantees to other financial institutions. It is not that they were too big to fail,; they were too critical to fail. Where do we go from here?
I am not a huge fan of stifling government regulations. Having toiled in the securities industry for many years, I can’t tell you how onerous these regulations can be. However, using a loophole called Regulation D, hedge funds have been able to conduct their business virtually uncontrolled by any government regulations at all. This free-for-all fueled much of what we are enduring today.
Reg D allows organizations who are comprised of “sophisticated investors” to conduct their affairs outside of the traditional regulations that were put in place to protect the “little guy.” Unfortunately, this exception allowed the unregulated, hedge fund industry to grow so large that it could not help but whipsaw the entire economy. Oil prices were artificially raised, commodities and currencies were manipulated, and the stock market’s risks were exacerbated beyond reason. New industries were spawned that were more like the Robber Baron days than today’s traditional financial markets.
As we emerge from this turmoil, you can expect to see the hedge fund industry fall under much greater scrutiny than ever before. Because, like it or not, it is often the little guy that pays for their mistakes, not just their investors.
AIG, however, insures millions of people, and has made billions in guarantees to other financial institutions. It is not that they were too big to fail,; they were too critical to fail. Where do we go from here?
I am not a huge fan of stifling government regulations. Having toiled in the securities industry for many years, I can’t tell you how onerous these regulations can be. However, using a loophole called Regulation D, hedge funds have been able to conduct their business virtually uncontrolled by any government regulations at all. This free-for-all fueled much of what we are enduring today.
Reg D allows organizations who are comprised of “sophisticated investors” to conduct their affairs outside of the traditional regulations that were put in place to protect the “little guy.” Unfortunately, this exception allowed the unregulated, hedge fund industry to grow so large that it could not help but whipsaw the entire economy. Oil prices were artificially raised, commodities and currencies were manipulated, and the stock market’s risks were exacerbated beyond reason. New industries were spawned that were more like the Robber Baron days than today’s traditional financial markets.
As we emerge from this turmoil, you can expect to see the hedge fund industry fall under much greater scrutiny than ever before. Because, like it or not, it is often the little guy that pays for their mistakes, not just their investors.
Tuesday, September 16, 2008
Why AIG Scares Me
The demise of Lehman Brothers and Bear Stearns hurts, but the demise of AIG could be devastating to the world’s financial structure.
While AIG provides traditional insurance products, such as life insurance through American General Life, it is active in many non-traditional areas that have far-reaching effects throughout the economy.
AIG has been active in creating profitable niche areas of insurance that would befuddle the normal human brain. It has taken insurance practices that were only undertaken by private insurers like Lloyds of London, and brought them mainstream. One of these areas is what is known as Credit Default Swaps (on mortgage backed securities). In a credit swap, a company would pay AIG to guarantee the income stream of their mortgage portfolio. There are other things to guarantee, but let’s use this for our example.
AIG’s financial strength has allowed them to provide income guarantees effectively and profitably. AIG had the resources to make these guarantees, as well as the credit ratings to make their guarantees matter. This all works well until there are radical changes in the nature of the investments that AIG guaranteed.
Let’s say that a mortgage pool is owned by a bank. The bank has contracted with AIG (hedged) to guarantee the income stream of the mortgage portfolio. If the mortgage pool defaults, AIG has to come up with cash to make up the shortfall. AIG has reserved liquid assets against this risk, so everyone is happy. The bank manager feels secure, because his return is “guaranteed” and his profits have skyrocketed. AIG feels good, because they have earned money insuring a risk they don’t expect to incur.
Let’s continue this hypothetical scenario:
Let’s assume that large pools of these mortgages have defaulted. AIG has been forced to make payments. As the defaults grow, AIG uses more of its reserve. It becomes apparent that the initial reserve was not enough, so AIG scrambles to come up with more liquid assets. At the same time, the financial rating organizations, such as Standard & Poor’s, Moody’s. Fitch and A.M. Best all figure out that AIG has problems. They recognize that AIG has not set aside sufficient assets to cover their shortfall. In addition, it appears that defaults will continue to occur, causing a need for even greater capital. This causes AIG’s financial stability to suffer. So, the rating agencies downgrade the financial ratings of AIG. Big problem for an insurance company.
The new downgrades do many things. They cause AIG to need even more liquid capital, as their long-term profit outlook has soured. If this capital is not available (as it may not be) it could force AIG to become insolvent, and unable to meet its contractual financial obligations. They also have to pull assets away from more profitable activities and make them safer.
The downgrade in AIG's financial rating also causes a similar downgrade for other companies. If AIG’s guarantee is meaningless, other companies must then reflect this on their own balance sheets. Let’s say that I am this bank who has borrowed lots of money to purchase mortgage securities. I feel okay about this, because I have borrowed at 3% and I am earning 6% on my mortgage portfolio. For the sake of simplicity, let’s assume that I pay AIG 1% per year to guarantee my cash flow. I still net 2% on money I have borrowed. I have borrowed a mere $1 billion, but I make $20 million in enhanced profits, on top of my normal banking profits. If my mortgage portfolio stops paying interest, and AIG cannot make up the difference, I now have a worthless security as my collateral for my bank’s loans. My creditors get nervous, so they call in their loans. Now my bank is in trouble. To raise cash, my bank must now call in its business loans or sell assets. Good companies are forced out of business. Stocks get cheaper because of selling pressure. Investors lose money. My own stock plummets. Etcetera, etcetera.
The failure of AIG could cause many strongly capitalized, “conservative” companies to face financial difficulties, even collapse. It could cause many well-run companies to have liquidity crunches, not because of business mistakes they have made, but because of a credit swap negotiated in the Isle of Man, Paris or the Cayman Islands has gone sour.
AIG has insured hundreds of billions, if not more. So, if they collapse, expect this to reverberate through the markets like a California brush fire, with no end in sight except for some Pacific cliffs. Let’s hope that our economy (or Federal Reserve) doesn’t have to jump off.
While AIG provides traditional insurance products, such as life insurance through American General Life, it is active in many non-traditional areas that have far-reaching effects throughout the economy.
AIG has been active in creating profitable niche areas of insurance that would befuddle the normal human brain. It has taken insurance practices that were only undertaken by private insurers like Lloyds of London, and brought them mainstream. One of these areas is what is known as Credit Default Swaps (on mortgage backed securities). In a credit swap, a company would pay AIG to guarantee the income stream of their mortgage portfolio. There are other things to guarantee, but let’s use this for our example.
AIG’s financial strength has allowed them to provide income guarantees effectively and profitably. AIG had the resources to make these guarantees, as well as the credit ratings to make their guarantees matter. This all works well until there are radical changes in the nature of the investments that AIG guaranteed.
Let’s say that a mortgage pool is owned by a bank. The bank has contracted with AIG (hedged) to guarantee the income stream of the mortgage portfolio. If the mortgage pool defaults, AIG has to come up with cash to make up the shortfall. AIG has reserved liquid assets against this risk, so everyone is happy. The bank manager feels secure, because his return is “guaranteed” and his profits have skyrocketed. AIG feels good, because they have earned money insuring a risk they don’t expect to incur.
Let’s continue this hypothetical scenario:
Let’s assume that large pools of these mortgages have defaulted. AIG has been forced to make payments. As the defaults grow, AIG uses more of its reserve. It becomes apparent that the initial reserve was not enough, so AIG scrambles to come up with more liquid assets. At the same time, the financial rating organizations, such as Standard & Poor’s, Moody’s. Fitch and A.M. Best all figure out that AIG has problems. They recognize that AIG has not set aside sufficient assets to cover their shortfall. In addition, it appears that defaults will continue to occur, causing a need for even greater capital. This causes AIG’s financial stability to suffer. So, the rating agencies downgrade the financial ratings of AIG. Big problem for an insurance company.
The new downgrades do many things. They cause AIG to need even more liquid capital, as their long-term profit outlook has soured. If this capital is not available (as it may not be) it could force AIG to become insolvent, and unable to meet its contractual financial obligations. They also have to pull assets away from more profitable activities and make them safer.
The downgrade in AIG's financial rating also causes a similar downgrade for other companies. If AIG’s guarantee is meaningless, other companies must then reflect this on their own balance sheets. Let’s say that I am this bank who has borrowed lots of money to purchase mortgage securities. I feel okay about this, because I have borrowed at 3% and I am earning 6% on my mortgage portfolio. For the sake of simplicity, let’s assume that I pay AIG 1% per year to guarantee my cash flow. I still net 2% on money I have borrowed. I have borrowed a mere $1 billion, but I make $20 million in enhanced profits, on top of my normal banking profits. If my mortgage portfolio stops paying interest, and AIG cannot make up the difference, I now have a worthless security as my collateral for my bank’s loans. My creditors get nervous, so they call in their loans. Now my bank is in trouble. To raise cash, my bank must now call in its business loans or sell assets. Good companies are forced out of business. Stocks get cheaper because of selling pressure. Investors lose money. My own stock plummets. Etcetera, etcetera.
The failure of AIG could cause many strongly capitalized, “conservative” companies to face financial difficulties, even collapse. It could cause many well-run companies to have liquidity crunches, not because of business mistakes they have made, but because of a credit swap negotiated in the Isle of Man, Paris or the Cayman Islands has gone sour.
AIG has insured hundreds of billions, if not more. So, if they collapse, expect this to reverberate through the markets like a California brush fire, with no end in sight except for some Pacific cliffs. Let’s hope that our economy (or Federal Reserve) doesn’t have to jump off.
Is This What A Stock Market Bottom Feels Like?
The world’s largest insurance company is on the ropes. Blue chip investment firms are closing shop. Banks are lying in financial ruin. The world is on the brink of a global depression.
There is bad news everywhere, and not a lot of light in this tunnel. This is beginning to look like a stock market bottom to me.
The stock market is a reflection of the human condition. Humans have lots of great qualities and many flaws. We are a noble and complex creature.
So, too, is the market. The stock market reacts in the same erratic, irrational and nonsensical way that we all do. It goes up when things seem bleak. It falls when all the news is rosy.
I am not saying that the stock market is at its bottom. No one can know for sure until it has already occurred. I do know this. Global market capitalization has fallen by about $15 trillion dollars. Yes. Trillion. Global wealth has fallen by much more, as real estate values have plummeted around the globe.
From what I can discern, there was something like $30 trillion borrowed against $1 trillion in mortgage assets. I have always suspected that the stated values of the mortgage pieces sold into the market, when aggregated, overstated values by about 100%. So, a $15 trillion loss, just about brings us to ground zero. I know, the value of GE stock has little to do with a CDO held by AIG or the Chinese government. But, in a way, it does.
Stock market values became overinflated because earnings became overinflated. Wall street firms, banks and hedge funds were showing paper profits based on theoretical value increases in “now-worthless” securities. They were also showing up on company balance sheets as appreciating assets. We are no longer seeing these earnings. Companies are writing down the value of these securities on their balance sheets. Things are getting back to normal.
A 30% decline in global market capitalization has historically proven to be a good time to buy, rather than a good time to sell. Investors who have been able to hold their breath, close their eyes and jump, have historically been rewarded for such intrepidness.
I do not know if the stock market has hit bottom. Maybe we are heading toward a global depression that will take a decade to fix. All I can say is, in my 30+ years of following the stock market, this feels a heck of a lot more like a buying opportunity than a selling one.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
There is bad news everywhere, and not a lot of light in this tunnel. This is beginning to look like a stock market bottom to me.
The stock market is a reflection of the human condition. Humans have lots of great qualities and many flaws. We are a noble and complex creature.
So, too, is the market. The stock market reacts in the same erratic, irrational and nonsensical way that we all do. It goes up when things seem bleak. It falls when all the news is rosy.
I am not saying that the stock market is at its bottom. No one can know for sure until it has already occurred. I do know this. Global market capitalization has fallen by about $15 trillion dollars. Yes. Trillion. Global wealth has fallen by much more, as real estate values have plummeted around the globe.
From what I can discern, there was something like $30 trillion borrowed against $1 trillion in mortgage assets. I have always suspected that the stated values of the mortgage pieces sold into the market, when aggregated, overstated values by about 100%. So, a $15 trillion loss, just about brings us to ground zero. I know, the value of GE stock has little to do with a CDO held by AIG or the Chinese government. But, in a way, it does.
Stock market values became overinflated because earnings became overinflated. Wall street firms, banks and hedge funds were showing paper profits based on theoretical value increases in “now-worthless” securities. They were also showing up on company balance sheets as appreciating assets. We are no longer seeing these earnings. Companies are writing down the value of these securities on their balance sheets. Things are getting back to normal.
A 30% decline in global market capitalization has historically proven to be a good time to buy, rather than a good time to sell. Investors who have been able to hold their breath, close their eyes and jump, have historically been rewarded for such intrepidness.
I do not know if the stock market has hit bottom. Maybe we are heading toward a global depression that will take a decade to fix. All I can say is, in my 30+ years of following the stock market, this feels a heck of a lot more like a buying opportunity than a selling one.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Monday, September 15, 2008
The Good Wall Street
I know that I have been going a little hard on Wall Street lately. With trillions of dollars of wealth being lost, it is easy to lose sight of the important function that Wall Street, and the investment community provide. Without our investment community, we would not be a strong and prosperous nation. It is not Wall Street’s essential function that I criticize; it is the abuse of trust that has occurred in some parts of “The Street,” by a relatively small (but powerful) number of people.
I have been a member of the investment and brokerage community for more than two decades. I have started two broker/dealer (brokerage) firms. I have sat at the feet of some of the masters. I have raised capital and I have worked with investors. So, when I criticize, I am not criticizing everyone, because there are many good advisors out there. I criticize those who put their own good ahead of their clients’ good.
There are many of us who were trained to “serve first,” putting the needs of our clients ahead those of ourselves. There is a great body of very good people who adhere to this philosophy. What bothers me is when a few tarnish the reputation of our entire profession.
Without the investment/financial community, there would be no ready access by business to essential capital. There would be no liquidity. Whether it is a firm on Wall Street, your insurance company, or you local bank, each of them plays an integral role in keeping America strong.
Investment banks often put their own capital on the line. They do this to help others, as well as earn profits. It often takes enormous risk to bring about innovation and financial growth. Someone had to put up the cash to build the garage businesses of Apple and Google. Someone had to look beyond the “kids” to see their ideas. They had to risk their capital and reputation on complex ideas that had every opportunity to fail. And for every Google, there are many companies you will never hear of.
I do not begrudge enormous profits to Wall Street. They deserved them for themselves and their clients, because it is their risk capital that fuels our nation’s financial engine. I just want them to do it honestly and ethically.
What bothers me is when smart people do dumb things, in the name of short-term profits. When people stop producing in favor of churning for profit, I get angry. This makes life difficult for all of us. It also stops future capital from being invested, which lowers the standard of living for everyone.
As a result of the current financial mess, there are (literally) trillions of dollars that are no longer available to invest. This will slow future economic growth. Our country has increased its national debt by more than 50%. This will drive up long-term interest rates. Finally, there will be a spate of new government regulations that will make it harder for honest, hard-working investment advisors and brokers to do business. We all lose.
The people who do things right, will have to pay for the sins of those who don’t. Yet, many of the people that brought us this ugly mess, will walk away with fat wallets and reputations intact.
Do not lose faith in the system. It is the best one we have. And be kind to your investment advisor, because the vast majority of them had no way of knowing that this was coming. Most of them do really want to see you prosper.
Be careful how you invest your money. Analyze carefully. Remember that long-term return is earned by taking calculated risks and staying the course through the ups and downs over time. Even well-conceived long-term investments can show substantial losses in the short run. You should take great care in understanding this, and do not panic when volatility occurs. Higher returns can only come with greater risk. Uneducated or inappropriate risks can lead to the erosion of capital. That is what happened to many people, even the most sophisticated, during this latest “crisis.” A long line of people decided to put their own benefits ahead of others. Unfortunately, we all must pay the price.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
I have been a member of the investment and brokerage community for more than two decades. I have started two broker/dealer (brokerage) firms. I have sat at the feet of some of the masters. I have raised capital and I have worked with investors. So, when I criticize, I am not criticizing everyone, because there are many good advisors out there. I criticize those who put their own good ahead of their clients’ good.
There are many of us who were trained to “serve first,” putting the needs of our clients ahead those of ourselves. There is a great body of very good people who adhere to this philosophy. What bothers me is when a few tarnish the reputation of our entire profession.
Without the investment/financial community, there would be no ready access by business to essential capital. There would be no liquidity. Whether it is a firm on Wall Street, your insurance company, or you local bank, each of them plays an integral role in keeping America strong.
Investment banks often put their own capital on the line. They do this to help others, as well as earn profits. It often takes enormous risk to bring about innovation and financial growth. Someone had to put up the cash to build the garage businesses of Apple and Google. Someone had to look beyond the “kids” to see their ideas. They had to risk their capital and reputation on complex ideas that had every opportunity to fail. And for every Google, there are many companies you will never hear of.
I do not begrudge enormous profits to Wall Street. They deserved them for themselves and their clients, because it is their risk capital that fuels our nation’s financial engine. I just want them to do it honestly and ethically.
What bothers me is when smart people do dumb things, in the name of short-term profits. When people stop producing in favor of churning for profit, I get angry. This makes life difficult for all of us. It also stops future capital from being invested, which lowers the standard of living for everyone.
As a result of the current financial mess, there are (literally) trillions of dollars that are no longer available to invest. This will slow future economic growth. Our country has increased its national debt by more than 50%. This will drive up long-term interest rates. Finally, there will be a spate of new government regulations that will make it harder for honest, hard-working investment advisors and brokers to do business. We all lose.
The people who do things right, will have to pay for the sins of those who don’t. Yet, many of the people that brought us this ugly mess, will walk away with fat wallets and reputations intact.
Do not lose faith in the system. It is the best one we have. And be kind to your investment advisor, because the vast majority of them had no way of knowing that this was coming. Most of them do really want to see you prosper.
Be careful how you invest your money. Analyze carefully. Remember that long-term return is earned by taking calculated risks and staying the course through the ups and downs over time. Even well-conceived long-term investments can show substantial losses in the short run. You should take great care in understanding this, and do not panic when volatility occurs. Higher returns can only come with greater risk. Uneducated or inappropriate risks can lead to the erosion of capital. That is what happened to many people, even the most sophisticated, during this latest “crisis.” A long line of people decided to put their own benefits ahead of others. Unfortunately, we all must pay the price.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Financial Roulette
Yesterday, Lehman Brothers declared bankruptcy. If you haven’t been in the securities business, it will be hard for you to understand the significance of this action.
Lehman, along with just a few other investment banking firms, has ruled Wall Street for decades. Lehman has always been seen as a blue blood, filled with more intellectual capital and refinement than many of its “boorish” counterparts. They have been able to snub their nose at lesser firms, and walk along Wall Street with its head held high. No more.
The Federal Reserve refused to bail out Lehman, as it has Bear Stearns, Fannie Mae and Freddie Mac. I am sure this sent shivers through the investment community. AIG and Merrill Lynch stood next in line with their hands out. Sorry fellas. This is bleak.
When Merrill realized that the Federal pockets were empty, they quickly sought a new partner, Bank of America, selling for a total price that would have been laughable just one year ago. I’m not sure what will happen to AIG. I was trying to ferret out their financials during the past couple of weeks, and I came to the conclusion that they have so much hidden that it is impossible to predict what will happen. But it would not surprise me if the world’s largest insurance company is the next to fall.
Bank of America has become the quintessential “value investor,” picking up gems like Countrywide and Merrill Lynch at the bargain table. It may well emerge as a global financial behemoth before this all shakes out, provided they have not bitten off more than even they can chew.
Getting your hands around the “dark matter” of mortgage backed securities is like trying to catch fog. You know it is there, but, damn, it is hard to hold. For the country’s sake, I hope BOA thrives. If they don’t, we are in for some very rough sledding.
As of this date, I see a world sitting on the brink of global collapse. No one really knows how close the financial dominoes lie. Will the $150 billion that Lehman owes cause other institutions to collapse? Will the $1 trillion in treasuries that they own be dumped upon a market that no longer wants them?
The U.S. government has emptied the bank of all of its cash. It has taken on trillions of dollars in new liabilities, and it can’t produce more without seriously undermining world faith in our nation’s financial strength. We are perilously close to that point.
So, who is going to pay for all this? You are. Look at your shrinking 401(k) balance and give thanks to Wall Street greed. Big homes were built in Westport and Greenwich on your dime. Lavish parties were thrown at your expense.
Don’t get me wrong. We need a strong Wall Street. But there has always been a sense of entitlement in the financial district, the feeling that the spoils of success were due, even if earned by slight of hand. You will never convince me that no one knew what was really going on for the past half decade or so. Why shoot the golden goose? Just sock away a personal nest full of golden eggs and let the peons pay the bill. The days of living like the 1920s have got to stop. Wall Street should not be the home of Robber Barons. Hopefully, this weekend’s Fed actions will bring this toga party to a close for good.
Greed on Wall Street is not necessarily a bad thing. Greed begets motivation, which gets things done. Without big financial incentives, no one will take the big financial risks that are to create wealth for us all.
But the days of taking unconscionable risks with the little guy’s money do have to stop. Maybe today is the day.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Lehman, along with just a few other investment banking firms, has ruled Wall Street for decades. Lehman has always been seen as a blue blood, filled with more intellectual capital and refinement than many of its “boorish” counterparts. They have been able to snub their nose at lesser firms, and walk along Wall Street with its head held high. No more.
The Federal Reserve refused to bail out Lehman, as it has Bear Stearns, Fannie Mae and Freddie Mac. I am sure this sent shivers through the investment community. AIG and Merrill Lynch stood next in line with their hands out. Sorry fellas. This is bleak.
When Merrill realized that the Federal pockets were empty, they quickly sought a new partner, Bank of America, selling for a total price that would have been laughable just one year ago. I’m not sure what will happen to AIG. I was trying to ferret out their financials during the past couple of weeks, and I came to the conclusion that they have so much hidden that it is impossible to predict what will happen. But it would not surprise me if the world’s largest insurance company is the next to fall.
Bank of America has become the quintessential “value investor,” picking up gems like Countrywide and Merrill Lynch at the bargain table. It may well emerge as a global financial behemoth before this all shakes out, provided they have not bitten off more than even they can chew.
Getting your hands around the “dark matter” of mortgage backed securities is like trying to catch fog. You know it is there, but, damn, it is hard to hold. For the country’s sake, I hope BOA thrives. If they don’t, we are in for some very rough sledding.
As of this date, I see a world sitting on the brink of global collapse. No one really knows how close the financial dominoes lie. Will the $150 billion that Lehman owes cause other institutions to collapse? Will the $1 trillion in treasuries that they own be dumped upon a market that no longer wants them?
The U.S. government has emptied the bank of all of its cash. It has taken on trillions of dollars in new liabilities, and it can’t produce more without seriously undermining world faith in our nation’s financial strength. We are perilously close to that point.
So, who is going to pay for all this? You are. Look at your shrinking 401(k) balance and give thanks to Wall Street greed. Big homes were built in Westport and Greenwich on your dime. Lavish parties were thrown at your expense.
Don’t get me wrong. We need a strong Wall Street. But there has always been a sense of entitlement in the financial district, the feeling that the spoils of success were due, even if earned by slight of hand. You will never convince me that no one knew what was really going on for the past half decade or so. Why shoot the golden goose? Just sock away a personal nest full of golden eggs and let the peons pay the bill. The days of living like the 1920s have got to stop. Wall Street should not be the home of Robber Barons. Hopefully, this weekend’s Fed actions will bring this toga party to a close for good.
Greed on Wall Street is not necessarily a bad thing. Greed begets motivation, which gets things done. Without big financial incentives, no one will take the big financial risks that are to create wealth for us all.
But the days of taking unconscionable risks with the little guy’s money do have to stop. Maybe today is the day.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Our Morality Is Shaped By Politics
Every four years we get to witness, first hand, how politics shapes personal morality. Americans from both political parties take each candidate’s words and actions and shape them into the proper mold as friend or foe, good or bad, right or wrong. As this year’s political wind rages stronger than hurricane Ike, I feel compelled to comment.
I receive comments, from normally sane and reasonable readers, that are so emotionally charged in one direction as to defy sensibility This reflects our society as a whole. We tend to choose one political side and deify that candidate, while we demonize the other.
I have played devil’s advocate with some of you, trying to see how deep your feelings sit, whether they ride close to the surface, or whether they are so deeply rooted as to be virtually unchangeable. What I find is this, no matter how great the evidence, it usually takes something akin to the Second Coming to change our deeply held political and social beliefs. My research leads me to believe that one third of us lean to the left, one third to the right, while the other third sits in the middle, blowing with the wind. This has been pretty much true throughout political history. One third rules. One of these days I will elaborate on this.
McCain had his fingers deep into the savings and loan debacle of the 1980s. His campaign finance reform exempted Indian Casinos, his greatest source of campaign donors. His supporters brush this off like there was no moral or political failure. His detractors choose this as the only litmus test of his character.
Obama profited immensely from a shady real estate deal with Tony Rezko. His political career was turbocharged by Bill Ayers, a proud former terrorist. His minister of twenty years spouted hate-filled, anti-white rhetoric from the pulpit to raucous cheers of “Amen.” Obama’s supporters see this as politics as usual. His detractors see this as a glimpse into a sinister inner man.
Joe Biden is a plagiarist, whose son and brother have been accused of fraud. His champions shrug this off, while his challengers use this to show the hypocrisy they see in the national media, particularly with their attacks of Sarah Palin.
The alleged misdeeds of the Clintons are legendary. Accusations of fraud, murder, viciousness and self-dealing pale to those of any third world dictator. Her supporters view this as right-wing rhetoric, while her detractors see it as evidence that she should be in jail.
Many of Sarah Palin’s detractors accuse her of having a Down Syndrome child just to prove a point. They see it as child abuse. Her daughter’s pregnancy is seen as a moral failure. Her supporters point to her strong religious beliefs and her impressive (albeit short) political track record as signs of her strength as a candidate.
No amount of evidence can shake the deep seated convictions of political ideologues. It is viewed as “circumstantial,” even when it comes from court records or first hand accounts. It is viewed as meaningless, when compared to the much-more-important issues in the election.
What divides us?
God: What role should God play in politics?
· Conservatives tend to want God as part of the political equation. They want God influencing schools and the government. They want religious morality as part of the governing process. They feel that we cannot separate ourselves from the most important issues of religious morality.
· Liberals tend to want to keep God out of government. They don’t want religion taught in school, or the Ten Commandments in our courthouses.
Abortion: Should abortion be legal or not?
· Religious conservatives believe that life is sacred. An abortion to them is a choice to end a life, not far removed from murder.
· Many liberals (particularly feminists) see abortion almost like a Sacrament, or Inalienable Right. No one should be able to legislate a woman’s right to choose what to do with her body, or any childe within it.
Role of Government: Should the government be large or small. Should the government decide where to spend our money, or should it be left up to individual choice?
· Conservatives tend to want to keep their money and spend it how they see fit.
· Liberals want to tax (particularly the rich) and spend it as they see fit.
Taxes: Should we have high taxes or low taxes? (See role of government.)
· Liberals tend to want higher taxes and more government control over where the money is spent.
· Conservatives want less taxes and more personal choice.
International Policy: What role should we play in the world?
· Liberals tend to abhor war and anything to do with it. They want to spend as little as possible (without sacrificing personal safety) and spend the money here at home. Liberals would rather get along with their enemies than fight with them.
· Conservatives see the world as a dangerous place. They feel that there are enemies that we can’t be friends with, and that we should do all we can to defend against them, even if it means going to war.
These are the central issues that often frame the political beliefs of the one third on each side of the political aisle. Whichever candidate aligns most closely with our feelings on these central issues, we will back with blind faith. We will ignore any personal weaknesses or failures. We sweep away any indiscretions or abuse of the law. Our candidate can do no wrong, and we do all we can to destroy the other.
Politics is blood sport. No, politics is a battle to the death and it takes no prisoners. Something is terribly wrong here. Those that seek political office are often not the best our nation can produce. I am not sure if they simply represent America, with all its flaws, or if they represent some lesser class of human, drawn to politics like a neurotic to Hollywood. (I could have been drawn to Hollywood, to make films of my books. So, don’t take this as a knock on character, just an observation.) Are we electing the best we can produce, or are we elevating the most flawed as our leaders?
There is a German word, called schadenfreude, the guilty pleasure we feel at someone else’s misery. Is this similar to what we feel about politicians? Are we happy to elect people that are more flawed than we? And, do we lower our own moral standards to support these candidates? Sadly, this may just be the case.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
I receive comments, from normally sane and reasonable readers, that are so emotionally charged in one direction as to defy sensibility This reflects our society as a whole. We tend to choose one political side and deify that candidate, while we demonize the other.
I have played devil’s advocate with some of you, trying to see how deep your feelings sit, whether they ride close to the surface, or whether they are so deeply rooted as to be virtually unchangeable. What I find is this, no matter how great the evidence, it usually takes something akin to the Second Coming to change our deeply held political and social beliefs. My research leads me to believe that one third of us lean to the left, one third to the right, while the other third sits in the middle, blowing with the wind. This has been pretty much true throughout political history. One third rules. One of these days I will elaborate on this.
McCain had his fingers deep into the savings and loan debacle of the 1980s. His campaign finance reform exempted Indian Casinos, his greatest source of campaign donors. His supporters brush this off like there was no moral or political failure. His detractors choose this as the only litmus test of his character.
Obama profited immensely from a shady real estate deal with Tony Rezko. His political career was turbocharged by Bill Ayers, a proud former terrorist. His minister of twenty years spouted hate-filled, anti-white rhetoric from the pulpit to raucous cheers of “Amen.” Obama’s supporters see this as politics as usual. His detractors see this as a glimpse into a sinister inner man.
Joe Biden is a plagiarist, whose son and brother have been accused of fraud. His champions shrug this off, while his challengers use this to show the hypocrisy they see in the national media, particularly with their attacks of Sarah Palin.
The alleged misdeeds of the Clintons are legendary. Accusations of fraud, murder, viciousness and self-dealing pale to those of any third world dictator. Her supporters view this as right-wing rhetoric, while her detractors see it as evidence that she should be in jail.
Many of Sarah Palin’s detractors accuse her of having a Down Syndrome child just to prove a point. They see it as child abuse. Her daughter’s pregnancy is seen as a moral failure. Her supporters point to her strong religious beliefs and her impressive (albeit short) political track record as signs of her strength as a candidate.
No amount of evidence can shake the deep seated convictions of political ideologues. It is viewed as “circumstantial,” even when it comes from court records or first hand accounts. It is viewed as meaningless, when compared to the much-more-important issues in the election.
What divides us?
God: What role should God play in politics?
· Conservatives tend to want God as part of the political equation. They want God influencing schools and the government. They want religious morality as part of the governing process. They feel that we cannot separate ourselves from the most important issues of religious morality.
· Liberals tend to want to keep God out of government. They don’t want religion taught in school, or the Ten Commandments in our courthouses.
Abortion: Should abortion be legal or not?
· Religious conservatives believe that life is sacred. An abortion to them is a choice to end a life, not far removed from murder.
· Many liberals (particularly feminists) see abortion almost like a Sacrament, or Inalienable Right. No one should be able to legislate a woman’s right to choose what to do with her body, or any childe within it.
Role of Government: Should the government be large or small. Should the government decide where to spend our money, or should it be left up to individual choice?
· Conservatives tend to want to keep their money and spend it how they see fit.
· Liberals want to tax (particularly the rich) and spend it as they see fit.
Taxes: Should we have high taxes or low taxes? (See role of government.)
· Liberals tend to want higher taxes and more government control over where the money is spent.
· Conservatives want less taxes and more personal choice.
International Policy: What role should we play in the world?
· Liberals tend to abhor war and anything to do with it. They want to spend as little as possible (without sacrificing personal safety) and spend the money here at home. Liberals would rather get along with their enemies than fight with them.
· Conservatives see the world as a dangerous place. They feel that there are enemies that we can’t be friends with, and that we should do all we can to defend against them, even if it means going to war.
These are the central issues that often frame the political beliefs of the one third on each side of the political aisle. Whichever candidate aligns most closely with our feelings on these central issues, we will back with blind faith. We will ignore any personal weaknesses or failures. We sweep away any indiscretions or abuse of the law. Our candidate can do no wrong, and we do all we can to destroy the other.
Politics is blood sport. No, politics is a battle to the death and it takes no prisoners. Something is terribly wrong here. Those that seek political office are often not the best our nation can produce. I am not sure if they simply represent America, with all its flaws, or if they represent some lesser class of human, drawn to politics like a neurotic to Hollywood. (I could have been drawn to Hollywood, to make films of my books. So, don’t take this as a knock on character, just an observation.) Are we electing the best we can produce, or are we elevating the most flawed as our leaders?
There is a German word, called schadenfreude, the guilty pleasure we feel at someone else’s misery. Is this similar to what we feel about politicians? Are we happy to elect people that are more flawed than we? And, do we lower our own moral standards to support these candidates? Sadly, this may just be the case.
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
Friday, September 12, 2008
Financial Misfortune - Your Call To Opportunity?
Last year at this time I voiced my grave concern for the U.S. economy. At the time, the stock market was climbing to all time highs. Optimism ruled Wall Street and “experts” everywhere touted the great global economy. Financial crooks and buffoons were making off with hundreds of billions, while our most sophisticated financial institutions were loading up on debt to purchase shady mortgage backed securities.
I took some heat when I issued my warning, as Wall Street marched upward toward the cliff like a pack of lemmings. Today I stand at the edge of that cliff, looking down at the debris scattered at the bottom of that cliff. Man, there’s a lot of detritus down there.
What a difference a year can make. Don’t say you weren’t warned. The mortgage derivative market has been revealed for what it was—a global shell game that was based upon slight of hand. Now, the American Taxpayer must pay the price. And it is steep. I was predicting $1 trillion. Now it looks like that sum might be double that amount.
To put this into perspective, this has added more than 20% to our national debt in a single year. Granted, much of this has been financed by federal slight of hand. Although it might not show up on the books, it will rear its ugly head as inflation. The simple fact is: when you lose money, it’s gone. When you print it, things go up in price. Inflation is coming.
When I was a kid, there was a TV commercial that said, “You can’t fool mother nature.” Ain’t that the truth. Our economy is Mother Nature. Let me explain.
The stock market is little more than the expression of the human condition. As humans, we strive to fulfill our needs. Maslow did a good job in explaining this, and I will give a quick summary here.
1. Our first and primary need is existential. We need to survive. That means we need such things as food, clothes and sleep. If these needs are not met, we die.
2. If we live, our next need is for safety. We feel the desire for protection from the risks to life. We seek to avoid war, sickness, accidents, environmental catastrophes. That sort of thing.
3. Once we feel safe, we strive for something else, socialization. We want to be with like-minded others. We want to be loved and accepted by others.
4. When we are part of a culture and family, we begin to search for higher things, like confidence, recognition and self-esteem. We seek to be seen by others as worthy of something more than basic acceptance or familial love.
5. Finally, once we earn the trophies and have that house and the car, once we have a family to care for and love, we seek to achieve the ultimate human achievement, self-realization: We look for inner peace, happiness and harmony with others and our world.
Here is how this all affects the stock market. We always seek to make our lives better. This leads us to search for new ways to be more comfortable, to make more money, to have more respect from our peers. This leads to
PRODUCTIVITY. Traditionally, our productivity growth ranges between 1% and 4% per year. Things like fire, electricity, the internal combustion engine, the assembly line, computers, the Internet and medicines are all examples of human achievements that have increased productivity and makes our economy grow. For the sake of my example, let’s assume average productivity growth of 2%. This means that the companies that make up our national economy on average would produce about 2% more goods and services each year over and above inflation.
Next, we have
RETURN ON INVESTMENT. Traditionally, the stock market trades as a Price/Earnings ratio of something between 14 and 20. (I know, you are saying, “Jay, what the heck does that mean?) If a company is earning $1,000,000 after taxes, a stock market P/E of 20 would mean that the company “value,” as it relates to the stock market would be $20 million. If there are 1 million shares outstanding, we would have a share price of $20.
i. With an average P/E for the market of about 18, the underlying companies would be earning a 5.5 % after tax return on our investment.
Finally, we have inflation
Inflation typically ranges from zero to 8%. There have been times when inflation has been negative. There have been times when it has been much higher than 8%. For the past century, the long-term inflation rate is about 3 %. It has been slightly higher than that since World War II.
THE STOCK MARKET
If we add up productivity growth, plus current earnings and inflation, we come up with a long-term return of the stock market of 10.5%. It is not quite as simple as this, but I hope it illustrates the point, that until human nature or the human condition changes radically, the stock market will continue to act as it always has.
This is why I say that the stock market is a reflection of the human condition.
While we have many ups and downs in the stock market, over long periods of time, it has always gone up a rate in the neighborhood of 10%. There have been decades when the stock market returns have been negative. There have been decades when returns have been extraordinary. But the returns always seem to gravitate to a mean return in the neighborhood of 10%. Positive stock market returns are never guaranteed. But as our time frame lengthens, particularly when it is more than 20 years, the chances get better and better that human nature wins out over short-term blips, like war, hyper-inflation, mortgage crises and Internet busts.
The after-market for mortgages (Collateralized Debt Obligations) has grown so large and complex that it has baffled the “experts” and blown away the computer models that predicted the safety of these investments.
We are a long way before computer neural networks can fully understand the range of human emotions. We, as humans cannot, and our computer models are only as good as the programmers.
This said: There is an old investment adage that says, “Buy low and sell high.” With most global markets down well over 20%, and the U.S. market faring little better, it is beginning to look more like a time to buy than a time to sell. Does this mean that there is little risk? Heck no. There is still a lot of risk in the stock market. There is still a lot of risk in the global economy.
Studies show that a good deal of the gain after a bear market occurs in a very brief period of time. We are talking weeks to a few months. For those who have a long-term perspective to their investments, it may be a time to begin to accumulate stocks again.
Do I think the stock market has seen its low point? No, I don’t. I still think that we haven’t seen the worst of the news. It is getting bad. This week, Lehman Brothers cried “No Más.” To have a blue chip investment banking firm (the fourth largest) go under (on the heels of Bear Stearns’s even bigger collapse) is monumental.
This is “blood on the streets,” guys. When we look back to these days twenty years from now, we just might be saying “What a great time to buy that was.”
Please do not take this as an investment recommendation. Talk to your fianancial advisor before making any investment decisions, particularly those that involve the stock market.
http://www.lumbert.com/
http://www.shaksperbooks.com/
http://www.jaylumbert.com/
I took some heat when I issued my warning, as Wall Street marched upward toward the cliff like a pack of lemmings. Today I stand at the edge of that cliff, looking down at the debris scattered at the bottom of that cliff. Man, there’s a lot of detritus down there.
What a difference a year can make. Don’t say you weren’t warned. The mortgage derivative market has been revealed for what it was—a global shell game that was based upon slight of hand. Now, the American Taxpayer must pay the price. And it is steep. I was predicting $1 trillion. Now it looks like that sum might be double that amount.
To put this into perspective, this has added more than 20% to our national debt in a single year. Granted, much of this has been financed by federal slight of hand. Although it might not show up on the books, it will rear its ugly head as inflation. The simple fact is: when you lose money, it’s gone. When you print it, things go up in price. Inflation is coming.
When I was a kid, there was a TV commercial that said, “You can’t fool mother nature.” Ain’t that the truth. Our economy is Mother Nature. Let me explain.
The stock market is little more than the expression of the human condition. As humans, we strive to fulfill our needs. Maslow did a good job in explaining this, and I will give a quick summary here.
1. Our first and primary need is existential. We need to survive. That means we need such things as food, clothes and sleep. If these needs are not met, we die.
2. If we live, our next need is for safety. We feel the desire for protection from the risks to life. We seek to avoid war, sickness, accidents, environmental catastrophes. That sort of thing.
3. Once we feel safe, we strive for something else, socialization. We want to be with like-minded others. We want to be loved and accepted by others.
4. When we are part of a culture and family, we begin to search for higher things, like confidence, recognition and self-esteem. We seek to be seen by others as worthy of something more than basic acceptance or familial love.
5. Finally, once we earn the trophies and have that house and the car, once we have a family to care for and love, we seek to achieve the ultimate human achievement, self-realization: We look for inner peace, happiness and harmony with others and our world.
Here is how this all affects the stock market. We always seek to make our lives better. This leads us to search for new ways to be more comfortable, to make more money, to have more respect from our peers. This leads to
PRODUCTIVITY. Traditionally, our productivity growth ranges between 1% and 4% per year. Things like fire, electricity, the internal combustion engine, the assembly line, computers, the Internet and medicines are all examples of human achievements that have increased productivity and makes our economy grow. For the sake of my example, let’s assume average productivity growth of 2%. This means that the companies that make up our national economy on average would produce about 2% more goods and services each year over and above inflation.
Next, we have
RETURN ON INVESTMENT. Traditionally, the stock market trades as a Price/Earnings ratio of something between 14 and 20. (I know, you are saying, “Jay, what the heck does that mean?) If a company is earning $1,000,000 after taxes, a stock market P/E of 20 would mean that the company “value,” as it relates to the stock market would be $20 million. If there are 1 million shares outstanding, we would have a share price of $20.
i. With an average P/E for the market of about 18, the underlying companies would be earning a 5.5 % after tax return on our investment.
Finally, we have inflation
Inflation typically ranges from zero to 8%. There have been times when inflation has been negative. There have been times when it has been much higher than 8%. For the past century, the long-term inflation rate is about 3 %. It has been slightly higher than that since World War II.
THE STOCK MARKET
If we add up productivity growth, plus current earnings and inflation, we come up with a long-term return of the stock market of 10.5%. It is not quite as simple as this, but I hope it illustrates the point, that until human nature or the human condition changes radically, the stock market will continue to act as it always has.
This is why I say that the stock market is a reflection of the human condition.
While we have many ups and downs in the stock market, over long periods of time, it has always gone up a rate in the neighborhood of 10%. There have been decades when the stock market returns have been negative. There have been decades when returns have been extraordinary. But the returns always seem to gravitate to a mean return in the neighborhood of 10%. Positive stock market returns are never guaranteed. But as our time frame lengthens, particularly when it is more than 20 years, the chances get better and better that human nature wins out over short-term blips, like war, hyper-inflation, mortgage crises and Internet busts.
The after-market for mortgages (Collateralized Debt Obligations) has grown so large and complex that it has baffled the “experts” and blown away the computer models that predicted the safety of these investments.
We are a long way before computer neural networks can fully understand the range of human emotions. We, as humans cannot, and our computer models are only as good as the programmers.
This said: There is an old investment adage that says, “Buy low and sell high.” With most global markets down well over 20%, and the U.S. market faring little better, it is beginning to look more like a time to buy than a time to sell. Does this mean that there is little risk? Heck no. There is still a lot of risk in the stock market. There is still a lot of risk in the global economy.
Studies show that a good deal of the gain after a bear market occurs in a very brief period of time. We are talking weeks to a few months. For those who have a long-term perspective to their investments, it may be a time to begin to accumulate stocks again.
Do I think the stock market has seen its low point? No, I don’t. I still think that we haven’t seen the worst of the news. It is getting bad. This week, Lehman Brothers cried “No Más.” To have a blue chip investment banking firm (the fourth largest) go under (on the heels of Bear Stearns’s even bigger collapse) is monumental.
This is “blood on the streets,” guys. When we look back to these days twenty years from now, we just might be saying “What a great time to buy that was.”
Please do not take this as an investment recommendation. Talk to your fianancial advisor before making any investment decisions, particularly those that involve the stock market.
http://www.lumbert.com/
http://www.shaksperbooks.com/
http://www.jaylumbert.com/
Friday, August 1, 2008
Goodness Is Local
Do you ever feel like there is a deep chasm between the reality that you experience and the one that you see on the news? I do.
When I read the news on paper or on the Web, or watch the nightly news, or peruse white papers on the state of world affairs I see a world so enmeshed in conflict it makes my head spin. It is hard to feel hope, when you read about global terrorism, genocide and impending war. It seems like every nation is in conflict with itself and with others. Religions pit themselves against one another, with victory only to one—the conqueror.
When I view mankind on a local level I see a far different picture, so different that it defies description. I see parents loving their children, people caring for the old and infirm, others giving a handout to people in need. I see backyard barbeques, baseball games and walks in the park. I see music concerts, dogs fetching tennis balls and people walking hand-in-hand. I see people waiting in line to donate clothing to the local Goodwill Store.
This is a far different world than the one that many non-Americans perceive. Some see us as immoral, baby-killing demons that are intent upon destroying their cultures. They view America as something that must be destroyed, not embraced as an ally. They don’t see the doting parents rushing in three directions to deliver their kids to soccer, dance and school play rehearsal. They don’t see the volunteers serving at soup kitchens or the minister preaching love and tolerance. They see Madonna promoting Sex, Cobain dead from drugs and the innocent casualties of war.
Our nature is to put things into categories—friend or foe, good or bad, worthy or unworthy. For thousands of years, this instinctual reaction served to protect us from our enemies and from nature. Fire burns, lions eat people, snakes bite. And it is always better to be safe than sorry. That is how we survived. The survival instinct can overpower all others.
Today, when we view others on a macro level, our instinctual nature is to put people into categories. Friend or foe. Partner or competitor. This is our survival instinct hard at work. Unchecked by reason, this instinct can create the perception that entire cultures are monolithic in belief and practice. America becomes a “satanic” enemy. Islam becomes a “terrorist” religion. And civil wars erupt within nations.
Our destructive tendencies will not stop until we educate everyone to the real truths about mankind. We love our children. We care for others. We want peace in the world. This is the true essence of every culture.
We must work to eliminate the threats to each other’s lives and cultures. Because once we feel threatened, the old instinct takes over. A parent will rarely hesitate from killing another if it is to protect a child, or himself. A nation attacked will rarely hesitate before defending itself. Nor should they. Until we realize this and fix it, we will never act globally as we do with each other in our own small worlds.
www.lumbert.com
www.shaksperbooks.com
When I read the news on paper or on the Web, or watch the nightly news, or peruse white papers on the state of world affairs I see a world so enmeshed in conflict it makes my head spin. It is hard to feel hope, when you read about global terrorism, genocide and impending war. It seems like every nation is in conflict with itself and with others. Religions pit themselves against one another, with victory only to one—the conqueror.
When I view mankind on a local level I see a far different picture, so different that it defies description. I see parents loving their children, people caring for the old and infirm, others giving a handout to people in need. I see backyard barbeques, baseball games and walks in the park. I see music concerts, dogs fetching tennis balls and people walking hand-in-hand. I see people waiting in line to donate clothing to the local Goodwill Store.
This is a far different world than the one that many non-Americans perceive. Some see us as immoral, baby-killing demons that are intent upon destroying their cultures. They view America as something that must be destroyed, not embraced as an ally. They don’t see the doting parents rushing in three directions to deliver their kids to soccer, dance and school play rehearsal. They don’t see the volunteers serving at soup kitchens or the minister preaching love and tolerance. They see Madonna promoting Sex, Cobain dead from drugs and the innocent casualties of war.
Our nature is to put things into categories—friend or foe, good or bad, worthy or unworthy. For thousands of years, this instinctual reaction served to protect us from our enemies and from nature. Fire burns, lions eat people, snakes bite. And it is always better to be safe than sorry. That is how we survived. The survival instinct can overpower all others.
Today, when we view others on a macro level, our instinctual nature is to put people into categories. Friend or foe. Partner or competitor. This is our survival instinct hard at work. Unchecked by reason, this instinct can create the perception that entire cultures are monolithic in belief and practice. America becomes a “satanic” enemy. Islam becomes a “terrorist” religion. And civil wars erupt within nations.
Our destructive tendencies will not stop until we educate everyone to the real truths about mankind. We love our children. We care for others. We want peace in the world. This is the true essence of every culture.
We must work to eliminate the threats to each other’s lives and cultures. Because once we feel threatened, the old instinct takes over. A parent will rarely hesitate from killing another if it is to protect a child, or himself. A nation attacked will rarely hesitate before defending itself. Nor should they. Until we realize this and fix it, we will never act globally as we do with each other in our own small worlds.
www.lumbert.com
www.shaksperbooks.com
Saturday, July 26, 2008
Greg Norman: One for the Aged
Greg Norman: One for the Aged
Don’t know if you caught the British Open this month, but it certainly was one for the ages (and aged). The “ancient” Greg Norman (53) battled men twenty and thirty years younger through driving rain, and persistent winds gusting over forty miles per hour. He showed the same grit he did when he was dominating world golf for over half a decade. All of this while he was on his honeymoon!
I am nominating Greg Norman as a guest member of the Varicose Vigilantes.
Sport is one of our nation’s most uplifting and enjoyable passions. We pit ourselves against others, the elements, and ultimately ourselves, stretching ourselves like thoroughbreds to beat everyone else to the pole. If we don’t compete ourselves, we watch others do it for us, and revel in the “thrill of victory and the agony of defeat.” An athlete’s body gives out long before the will to compete is gone. For a runner or a tennis player, this is sometime around the age of 30. Ouch. The “senior” tour for these athletes begins around the age of 35. Golfers can go on into their 40s. Their senior tour doesn’t begin until the age of 50. A top football running back is wasted by the age of 32. But a quarterback can play at a high level until the age of 40, since one of the key ingredients to quarterbacking success is experience and mental acuity.
Greg Norman’s success was due to his extraordinary skill and muscle memory. But a good deal of it was due to his mental toughness. His creativity. His ability to weather the elements. Ultimately, Norman fell short of winning. But that is not unusual for a golfer, or Greg himself.
Older folks can take heart in Norman’s brilliant accomplishment, knowing that we are never too old to compete, particularly where experience is a factor. And who has more experience than seniors? Nobody. Seniors have the experience factor locked up. It just isn’t fair.
So, remember to take all of your experience and bring it to YOUR game, every time you get ready to compete in life.
www.lumbert.com
www.shaksperbooks.com
Don’t know if you caught the British Open this month, but it certainly was one for the ages (and aged). The “ancient” Greg Norman (53) battled men twenty and thirty years younger through driving rain, and persistent winds gusting over forty miles per hour. He showed the same grit he did when he was dominating world golf for over half a decade. All of this while he was on his honeymoon!
I am nominating Greg Norman as a guest member of the Varicose Vigilantes.
Sport is one of our nation’s most uplifting and enjoyable passions. We pit ourselves against others, the elements, and ultimately ourselves, stretching ourselves like thoroughbreds to beat everyone else to the pole. If we don’t compete ourselves, we watch others do it for us, and revel in the “thrill of victory and the agony of defeat.” An athlete’s body gives out long before the will to compete is gone. For a runner or a tennis player, this is sometime around the age of 30. Ouch. The “senior” tour for these athletes begins around the age of 35. Golfers can go on into their 40s. Their senior tour doesn’t begin until the age of 50. A top football running back is wasted by the age of 32. But a quarterback can play at a high level until the age of 40, since one of the key ingredients to quarterbacking success is experience and mental acuity.
Greg Norman’s success was due to his extraordinary skill and muscle memory. But a good deal of it was due to his mental toughness. His creativity. His ability to weather the elements. Ultimately, Norman fell short of winning. But that is not unusual for a golfer, or Greg himself.
Older folks can take heart in Norman’s brilliant accomplishment, knowing that we are never too old to compete, particularly where experience is a factor. And who has more experience than seniors? Nobody. Seniors have the experience factor locked up. It just isn’t fair.
So, remember to take all of your experience and bring it to YOUR game, every time you get ready to compete in life.
www.lumbert.com
www.shaksperbooks.com
Friday, July 25, 2008
The Varicose Vigilantes: On Aging and Driving
As I was driving the other day I came upon a police speed trap. Out of reflex I looked down to my speedometer, silently saying “Oh, *#+*.” Strangely, I saw that I was actually driving UNDER the speed limit.
How did this happen? Did I suddenly grow old?
You know what I mean. We spend our youth pushing the limits. We see elderly drivers moving at snail-speed and want to shake our fists and say, “Get off the road, Gramps!” Life is always up ahead of us, something to be chased and embraced, if we can ever catch it.
Inside I still feel the same “me” as I did when I was 18. I can strut my stuff with the best of them. Robert Redford’s got nothing on me. But, damn, Robert Redford looks OLD!
How did this happen? Am I like some old air mattress that has sprung a slow leak, until it lies limp on the floor, all hardness and usefulness gone? Hell, no. I’m still the same me. Yeah, I’ve got some wear on my tires. I might squeak and squeal a little as I round the corners. But I can still hold the road and there’s some wear left in these old wheels. I can see Robert Redford up ahead of me. From the back he looks okay, except for that little bald spot on the top of his head that he hides as best he can. And that little sag in the jeans, and that hitch in his step.
I remember when 40 was OLD. Now 40 is prime. 80 looks old, but not like it used to. In fact, 80 doesn’t seem so bad. I hope to get there some day. I suppose it is inevitable that someday, hopefully not too soon, some young kid is going to shake his fist as he drives past, saying, “Get off the road, Gramps!” Will that suck, or what?
Actually, I don’t think so. I think that I will have earned such praise. I will have passed beyond always looking ahead and never seeing the NOW. I’ll be driving to BE there, not GET there. I’ll be smelling the roses and relaxing back in my seat enjoying the ride. No, aging isn’t so bad, as long as we keep a young mind and don’t get stuck in place. They even have a lane on the highway just for us. We used to call it the “slow lane.” I think it should be called the “experienced lane,” or the “wise lane.” That’s what I think. Because I’ve got a lot of experience in this old body. It might take me a bit longer to get this old thing rolling. But once I am moving, look out ‘cause my foot is still pressed down. It just won’t reach the floor like it used to.
www.lumbert.com
www.shaksperbooks.com
How did this happen? Did I suddenly grow old?
You know what I mean. We spend our youth pushing the limits. We see elderly drivers moving at snail-speed and want to shake our fists and say, “Get off the road, Gramps!” Life is always up ahead of us, something to be chased and embraced, if we can ever catch it.
Inside I still feel the same “me” as I did when I was 18. I can strut my stuff with the best of them. Robert Redford’s got nothing on me. But, damn, Robert Redford looks OLD!
How did this happen? Am I like some old air mattress that has sprung a slow leak, until it lies limp on the floor, all hardness and usefulness gone? Hell, no. I’m still the same me. Yeah, I’ve got some wear on my tires. I might squeak and squeal a little as I round the corners. But I can still hold the road and there’s some wear left in these old wheels. I can see Robert Redford up ahead of me. From the back he looks okay, except for that little bald spot on the top of his head that he hides as best he can. And that little sag in the jeans, and that hitch in his step.
I remember when 40 was OLD. Now 40 is prime. 80 looks old, but not like it used to. In fact, 80 doesn’t seem so bad. I hope to get there some day. I suppose it is inevitable that someday, hopefully not too soon, some young kid is going to shake his fist as he drives past, saying, “Get off the road, Gramps!” Will that suck, or what?
Actually, I don’t think so. I think that I will have earned such praise. I will have passed beyond always looking ahead and never seeing the NOW. I’ll be driving to BE there, not GET there. I’ll be smelling the roses and relaxing back in my seat enjoying the ride. No, aging isn’t so bad, as long as we keep a young mind and don’t get stuck in place. They even have a lane on the highway just for us. We used to call it the “slow lane.” I think it should be called the “experienced lane,” or the “wise lane.” That’s what I think. Because I’ve got a lot of experience in this old body. It might take me a bit longer to get this old thing rolling. But once I am moving, look out ‘cause my foot is still pressed down. It just won’t reach the floor like it used to.
www.lumbert.com
www.shaksperbooks.com
Thursday, July 24, 2008
Now For The Financial Hangover
Ready For The Financial Hangover?
I wish I had better news. But the economy shows no signs of getting better, and the worst pain is yet to come. This is the last time I am going to write about his for a while, because it is so damn depressing! However, since I am working on a series of financial books, I need to write something about what is going on.
Those of you who know me understand that I am a pretty optimistic fellow. I’m always doing something fun and creative, and see the world as a glass that’s half full. But a good deal of my training is in economics and investing, and what I see is truly ugly.
This all began more than a decade ago. Alan Greenspan was at the help of the Federal Reserve. Al Gore had just “invented” the Internet, the “Information Superhighway,” that was supposed to make us all rich and cure cancer.
The stock market took off like the proverbial rocket. I could use a more graphic image here, but I refrain. Bill Clinton was in the Presidency and it was a “feel good” time, where America was king and the world was laying at our feet. I could get graphic here, too, but that is not my intention.
What we saw was an “irrational exuberance” (Greenspan’s word) that defied reality. People were thinking that the Internet was going to lead to enormous profits, while forgetting the fact that it would lead to cutthroat competition.
I realized this in 1999 when I decided to buy a high-end video camera. The Canon recorder that I wanted cost $3,800 at local retailers. This included the big box stores that usually sell things at reasonable prices. The list price was over $5,000. Being the hip consumer that I am, I logged onto the Internet and shopped at hundreds of stores with the click of my mouse. I was able to find the same recorder listed in Texas for $2,100. I could have bought it in Singapore for $30 more. But I was able to check the Houston store out in the online yellow pages and the BBB, so I was reasonably sure that my money was good if I sent it there (again over the Web).
A couple days later I had my super dandy, movie quality recorder. I had also learned a powerful lesson, that the stock market was in deep doo doo. With the S&P selling at more than 36 times earnings, more than twice its usual P/E ratio, all based upon the assumption that the Internet would lead to greater profits, I had learned the opposite, that it would lead to a consumer revolution of lower prices and greater competition among businesses.
In late 1999, I told any client that would listen that it would be a good thing to move a good deal of assets to cash. I did the same thing last September, when I issued my first blog warning on the impending bear market.
How are the two related?
In the year 2000, when reality set in, the market was more than 100% overvalued. A “normal” market would have been about 50% lower. Now, if the stock market drops 50%, we have another word for that. Depression. Maybe not a full-blown depression, but a severe recession that would cause a great deal of problems.
Alan Greenspan decided to soften this blow by creating the housing boom. American business had just gone through an enormous spending binge, updating to the new world of the Internet. So, the economy would have to be driven by consumers. This is usually the case, as about 70% of our economy is consumer driven. As business spending went into shut-down mode, it was up to you and me to keep the economy afloat. And we did. Each new interest rate drop brought greater real estate values. We took out new mortgages and spent our equity like never before. We bought new cars and new homes. We went on vacations. We had fun.
Well, all good parties come to an end. And this one was a grand party, one worthy of John Belushi and Jamie Widdoes. A real toga. Now the hangover begins.
While consumers had their mortgage party, Wall Street did the same. Few of you have (probably) ever been to a Wall Street party. Suffice it to say, the old adage that the “rich” don’t think like you and me is magnified on Wall Street. Guys were spending $100,000 per seat for the Victoria’s Secret show. They were spending millions of dollars on new cars and their weddings, and tens of millions on their homes. All of this was fueled with equity out of your home and mine, courtesy of big Al.
While this was going on, Wall Street got fooled again. They started to believe that all of the mortgages were real. I know that they believed this somehow, because so many of them got caught with their pants down on stage. They lost billions. No, hundreds of billions. No, maybe trillions. Most of the people that created this mess are still living in their Westport homes and driving their Porches. They may have sold their Ferraris and their third vacation homes, but they are still living well.
It is the American taxpayer that will pay for this toga party. We are going to have to clean the puke off the floor and pick up all the ash trays. That’s a nasty thought, hey?
The latest shoe to drop in this whole mess is the fact that Fannie Mae and Freddy Mac are in trouble. (Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation). Well, duh. These names may or may not be familiar to you, but you better learn their names. Because you may own them soon.
Fannie Mae and Freddie Mac are quasi-government organizations that are publicly traded, like IBM and Microsoft. They exist to provide mortgage liquidity to the U.S. homeowner machine. They raise money by selling stock and bonds to the public. They also borrow money from the Federal Reserve. Remember big Al and his Internet party? These companies use their capital to buy mortgages from your local broker or bank. They package these mortgages and sell them to the public through agencies like the Government National Mortgage Association. If you own any “Ginnie Mae” securities, you own some of these. Many mutual funds own these as well, as do foreign investors and foreign governments. In order to keep mortgages competitive, and mortgage rates low, the U.S. government provides a guarantee on the securities issued by these public companies. Oh, oh.
These companies have issued more than $5 trillion in securities that have the backing of the U.S. government. So, when these things go in the “tank” it is the American taxpayer that will provide the mouth to mouth. Our nation currently has about $9 trillion in debt. We may be about to increase it by 50% through the mortgage crisis.
Hundreds of billions have been “lost” due to the ignorant and unscrupulous practices of the financial industry. In the end, I expect that the losses will total more than $1 trillion.
The Federal Reserve has been creating liquidity as fast as it can, by lending money against worthless securities, and giving it to foreign governments and companies by the boatload. They have dropped interest rates to Japan-like levels. This has caused the Dollar to continue its freefall against the world’s currencies. This week Saudi Arabia ended its long-standing link between its currency, the Riyal, and the dollar. They pegged it 30% higher. Does that mean that the U.S. has lost 30% of its value?
Consider this—if you add up the oil reserves of Saudi Arabia and Iran, they could buy the entire U.S. economy. Ouch.
Be prepared for more bad news as all of the Wall Street “dark matter” comes to light. Be prepared to face higher inflation in the upcoming years, as we pay the price for fixing this mess, again without a depression.
Our government is being run by taking out new credit cards to pay off the old ones. At some point, we are going to have to become responsible with America’s money. Otherwise, today’s youth will never hope to be able to achieve the kind of financial well-being we enjoy today. Their taxes will weigh them down like Marley’s chains.
Our Congress needs to restructure itself, so that spending more government money for the constituents at home is no longer the way to get re-elected. We need term limits and we need them soon.
We also need an energy policy that works. We need a Manhattan Project for clean energy. Windmills are fine. Solar is okay, if you like global warming. Ethanol is a cruel joke. Drilling offshore and in Alaska could help in the short run. I have faith that our oil companies will be cleaner in the Gulf of Mexico than the foreign oil companies that have been drilling there for the past 30 years. I really don’t think that the 2,000 acres of mosquitoes in Anwar will be disturbed much by the time drilling is completed up there. If you have ever seen how environmentally friendly major oil can be, (as I have) you know that the population of Alaskan wildlife, particularly the caribou, will only increase rather than decrease. This is no longer an issue of preserving the mosquito population of Alaska, it is a way of life issue for the American people. If you disagree with me here, let me know. I invite the discussion.
What we really need is to perfect the capacitor. (Remember the “Flux Capacitor” in “Back to the Future?”) The capacitor stores energy at virtually 100%. Energy in equals energy out. Compare this to the energy that is lost (about 70%) through batteries. We also need to pursue nuclear fusion on a massive scale. This is not dirty nuclear fission that leaves us with a thousand-year toxic storage problem. This is clean fuel that will last us for the next thousand years. Nuclear fusion occurs naturally in stars. We can do it on earth using heavy water as a main fuel. We can’t expect the oil companies to develop this kind of energy, as it would be 20 years away under the best of circumstances. It will take massive colliders and energy sources that will take hundreds of billions of dollars, perhaps even as much as the government has spent on the Iraq war or on the mortgage crisis.
I digress here from the purpose of this rant. I think my blood sugar has dropped.
When you see the media begin to panic and tell us that the financial world is about to come to an end, that is a sure sign that things are about to get better. I haven’t seen that yet, but I’ll watch for it.
Jay
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
I wish I had better news. But the economy shows no signs of getting better, and the worst pain is yet to come. This is the last time I am going to write about his for a while, because it is so damn depressing! However, since I am working on a series of financial books, I need to write something about what is going on.
Those of you who know me understand that I am a pretty optimistic fellow. I’m always doing something fun and creative, and see the world as a glass that’s half full. But a good deal of my training is in economics and investing, and what I see is truly ugly.
This all began more than a decade ago. Alan Greenspan was at the help of the Federal Reserve. Al Gore had just “invented” the Internet, the “Information Superhighway,” that was supposed to make us all rich and cure cancer.
The stock market took off like the proverbial rocket. I could use a more graphic image here, but I refrain. Bill Clinton was in the Presidency and it was a “feel good” time, where America was king and the world was laying at our feet. I could get graphic here, too, but that is not my intention.
What we saw was an “irrational exuberance” (Greenspan’s word) that defied reality. People were thinking that the Internet was going to lead to enormous profits, while forgetting the fact that it would lead to cutthroat competition.
I realized this in 1999 when I decided to buy a high-end video camera. The Canon recorder that I wanted cost $3,800 at local retailers. This included the big box stores that usually sell things at reasonable prices. The list price was over $5,000. Being the hip consumer that I am, I logged onto the Internet and shopped at hundreds of stores with the click of my mouse. I was able to find the same recorder listed in Texas for $2,100. I could have bought it in Singapore for $30 more. But I was able to check the Houston store out in the online yellow pages and the BBB, so I was reasonably sure that my money was good if I sent it there (again over the Web).
A couple days later I had my super dandy, movie quality recorder. I had also learned a powerful lesson, that the stock market was in deep doo doo. With the S&P selling at more than 36 times earnings, more than twice its usual P/E ratio, all based upon the assumption that the Internet would lead to greater profits, I had learned the opposite, that it would lead to a consumer revolution of lower prices and greater competition among businesses.
In late 1999, I told any client that would listen that it would be a good thing to move a good deal of assets to cash. I did the same thing last September, when I issued my first blog warning on the impending bear market.
How are the two related?
In the year 2000, when reality set in, the market was more than 100% overvalued. A “normal” market would have been about 50% lower. Now, if the stock market drops 50%, we have another word for that. Depression. Maybe not a full-blown depression, but a severe recession that would cause a great deal of problems.
Alan Greenspan decided to soften this blow by creating the housing boom. American business had just gone through an enormous spending binge, updating to the new world of the Internet. So, the economy would have to be driven by consumers. This is usually the case, as about 70% of our economy is consumer driven. As business spending went into shut-down mode, it was up to you and me to keep the economy afloat. And we did. Each new interest rate drop brought greater real estate values. We took out new mortgages and spent our equity like never before. We bought new cars and new homes. We went on vacations. We had fun.
Well, all good parties come to an end. And this one was a grand party, one worthy of John Belushi and Jamie Widdoes. A real toga. Now the hangover begins.
While consumers had their mortgage party, Wall Street did the same. Few of you have (probably) ever been to a Wall Street party. Suffice it to say, the old adage that the “rich” don’t think like you and me is magnified on Wall Street. Guys were spending $100,000 per seat for the Victoria’s Secret show. They were spending millions of dollars on new cars and their weddings, and tens of millions on their homes. All of this was fueled with equity out of your home and mine, courtesy of big Al.
While this was going on, Wall Street got fooled again. They started to believe that all of the mortgages were real. I know that they believed this somehow, because so many of them got caught with their pants down on stage. They lost billions. No, hundreds of billions. No, maybe trillions. Most of the people that created this mess are still living in their Westport homes and driving their Porches. They may have sold their Ferraris and their third vacation homes, but they are still living well.
It is the American taxpayer that will pay for this toga party. We are going to have to clean the puke off the floor and pick up all the ash trays. That’s a nasty thought, hey?
The latest shoe to drop in this whole mess is the fact that Fannie Mae and Freddy Mac are in trouble. (Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation). Well, duh. These names may or may not be familiar to you, but you better learn their names. Because you may own them soon.
Fannie Mae and Freddie Mac are quasi-government organizations that are publicly traded, like IBM and Microsoft. They exist to provide mortgage liquidity to the U.S. homeowner machine. They raise money by selling stock and bonds to the public. They also borrow money from the Federal Reserve. Remember big Al and his Internet party? These companies use their capital to buy mortgages from your local broker or bank. They package these mortgages and sell them to the public through agencies like the Government National Mortgage Association. If you own any “Ginnie Mae” securities, you own some of these. Many mutual funds own these as well, as do foreign investors and foreign governments. In order to keep mortgages competitive, and mortgage rates low, the U.S. government provides a guarantee on the securities issued by these public companies. Oh, oh.
These companies have issued more than $5 trillion in securities that have the backing of the U.S. government. So, when these things go in the “tank” it is the American taxpayer that will provide the mouth to mouth. Our nation currently has about $9 trillion in debt. We may be about to increase it by 50% through the mortgage crisis.
Hundreds of billions have been “lost” due to the ignorant and unscrupulous practices of the financial industry. In the end, I expect that the losses will total more than $1 trillion.
The Federal Reserve has been creating liquidity as fast as it can, by lending money against worthless securities, and giving it to foreign governments and companies by the boatload. They have dropped interest rates to Japan-like levels. This has caused the Dollar to continue its freefall against the world’s currencies. This week Saudi Arabia ended its long-standing link between its currency, the Riyal, and the dollar. They pegged it 30% higher. Does that mean that the U.S. has lost 30% of its value?
Consider this—if you add up the oil reserves of Saudi Arabia and Iran, they could buy the entire U.S. economy. Ouch.
Be prepared for more bad news as all of the Wall Street “dark matter” comes to light. Be prepared to face higher inflation in the upcoming years, as we pay the price for fixing this mess, again without a depression.
Our government is being run by taking out new credit cards to pay off the old ones. At some point, we are going to have to become responsible with America’s money. Otherwise, today’s youth will never hope to be able to achieve the kind of financial well-being we enjoy today. Their taxes will weigh them down like Marley’s chains.
Our Congress needs to restructure itself, so that spending more government money for the constituents at home is no longer the way to get re-elected. We need term limits and we need them soon.
We also need an energy policy that works. We need a Manhattan Project for clean energy. Windmills are fine. Solar is okay, if you like global warming. Ethanol is a cruel joke. Drilling offshore and in Alaska could help in the short run. I have faith that our oil companies will be cleaner in the Gulf of Mexico than the foreign oil companies that have been drilling there for the past 30 years. I really don’t think that the 2,000 acres of mosquitoes in Anwar will be disturbed much by the time drilling is completed up there. If you have ever seen how environmentally friendly major oil can be, (as I have) you know that the population of Alaskan wildlife, particularly the caribou, will only increase rather than decrease. This is no longer an issue of preserving the mosquito population of Alaska, it is a way of life issue for the American people. If you disagree with me here, let me know. I invite the discussion.
What we really need is to perfect the capacitor. (Remember the “Flux Capacitor” in “Back to the Future?”) The capacitor stores energy at virtually 100%. Energy in equals energy out. Compare this to the energy that is lost (about 70%) through batteries. We also need to pursue nuclear fusion on a massive scale. This is not dirty nuclear fission that leaves us with a thousand-year toxic storage problem. This is clean fuel that will last us for the next thousand years. Nuclear fusion occurs naturally in stars. We can do it on earth using heavy water as a main fuel. We can’t expect the oil companies to develop this kind of energy, as it would be 20 years away under the best of circumstances. It will take massive colliders and energy sources that will take hundreds of billions of dollars, perhaps even as much as the government has spent on the Iraq war or on the mortgage crisis.
I digress here from the purpose of this rant. I think my blood sugar has dropped.
When you see the media begin to panic and tell us that the financial world is about to come to an end, that is a sure sign that things are about to get better. I haven’t seen that yet, but I’ll watch for it.
Jay
www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com
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