Financial mayhem

[Michael Stuart Kelly]

Holy Moly!

I just looked at a newpaper article about The Paulson Plan. They want to centralize the whole kit and kaboodle of America's finances. I don't think Bush understands that while multiple regulatory agencies are a pain in the ass, at least they have checks and balances built in to contain abuse of power (to some extent).

If this plan takes off and comes to pass, there will only be one real way of assuring financial security. You will have to be good at sucking up to the Paulson Plan people. Maybe not so much at first, but after the change settles and the power goes to their head, it will be pure hell on earth for anyone on the outside.

Michael

[sjw]

Holy Moly!

I just looked at a newpaper article about The Paulson Plan. They want to centralize the whole kit and kaboodle of America's finances. I don't think Bush understands that while multiple regulatory agencies are a pain in the ass, at least they have checks and balances built in to contain abuse of power (to some extent).

If this plan takes off and comes to pass, there will only be one real way of assuring financial security. You will have to be good at sucking up to the Paulson Plan people. Maybe not so much at first, but after the change settles and the power goes to their head, it will be pure hell on earth for anyone on the outside.

Michael

Same old story: Statist interventions cause a mess, then statists use the mess as an excuse to call for increased interventions.

There is only one possible long-term outcome for this. It is a scary situation: the more the world population grows, the more the complexity of the economic interactions, the more precarious the non-objectivity of state controls make things. Long-term economic decisions will become hopelessly distorted. So far these controls have managed to squelch economic growth over almost the past 10 years (look at the DOW). First progress slows--the next step is a reversal of progress. I fear it won't take much for things to start sliding backwards at an accelerating rate, a rate fed by statist premises being enacted as alleged solutions which in reality just keep making things worse.

Shayne

[Wolf DeVoon]

Heads up. Paulson Plan handing out free money to 'prime broker' pals:

Since debt can substitute for equity, killing common stockholders while making whole even junior creditors amounts to a loophole by which lazy investors can shirk their duty of market discipline. It's not easy to learn which firms are genuinely worthy of ones trust, but that work is precisely what investors get paid for when they earn better-than-risk-free returns. Bondholders, counterparties in derivatives transactions, and other creditors are supposed to assess the credit risk of the firms with whom they entrust money, just as stockholders evaluate business risks. Letting bank creditors enjoy high-returns effectively risk-free creates an obvious arbitrage: short Treasuries and lend as much as you can to any firm that is too big to fail!

Interfluidity blog: 'The Moral Hazard of Creditors'

http://www.interfluidity.com/posts/1207025118.shtml

Meanwhile...

BROCKTON, Massachusetts (Reuters) - Thieves smashed the window to break in and then gutted the property for its copper pipes -- a crime that has spread across the United States as the economy slows and foreclosed homes stand empty and vulnerable. "They cut it here and then pulled it right out of the wall," real estate broker Marc Charney said, pointing to broken plaster near a wrecked baseboard heating system in the 2,774-sq-ft home in Brockton, Massachusetts, a working-class city of 94,304 people.

Similar stories are unfolding nationwide as a glut of home foreclosures coincides with record highs in the price of copper and other metals. Real estate brokers and local authorities say once-proud homes coast-to-coast are being stripped for copper, aluminum, and brass by thieves. Much of it ends up with scrap metal traders who say nearly all copper gets shipped overseas, much of it to China and India.

In areas hit hardest by foreclosures, such as the Slavic Village neighborhood of Cleveland, Ohio, copper and other metals used in plumbing, heating systems and telephone lines are now more valuable than some homes. "We're in an incredibly unfortunate time where the nonferrous metals commodities market for scrap is at an all-time high. Houses are getting stripped pretty quickly once they go through the foreclosure process," Cleveland city councilor Tony Brancatelli said.

Edited April 1, 2008 by Wolf DeVoon

[Brant Gaede]

How does one invest in equities?

Buy selected equities using dollar-cost averaging. Use diversification. Consider low cost index funds. Regularly take delivery of the stock certificates (say when one has 100 shares) and put them in a bank's safe deposit box. Keep an inventory of those separately and in the box. Keep excess cash in FDIC protected accounts, not brokerages. (Avoid commodities.) Don't worry about day to day fluctuations in markets, for when there is a general contraction one's money simply buys more of one's favorite companies. When the markets go up (and if your stocks do) your money buys less. The natural thing to do when markets or one's stocks go down is to sell them. When they go up is to buy as much as one can. Dollar-cost averaging keeps one from doing that. This advice is not for the retired, it is for working people who need to save.

I think we are going to see a contraction in the major stock indexes over the next year, but there is so much scared money on the sidelines I could be wrong if it floods back into equities. Just ignore me and gurus generally. If one is scared buy a case of tuna fish and put it under the bed and fill up the gas tank. I am as much a speculator and trader as an investor. For an investor diversification and dollar-cost averaging are the only things that really make sense.

This is my last post on this thread. OL is not an appropriate place for financial pontification that one acts on so much as that pontification gives one another perspective on the world. While the negativity I have expressed here has been born out by the results of the first quarter this year, the next quarter may witness a classic snap-back.

--Brant

Edited April 1, 2008 by Brant Gaede

[Wolf DeVoon]

"We haven't seen anything as bad as this in the 30-year period we looked at," said James Davis at consultants Oliver Wyman, who recently conducted a review of investment banking with Nick Studer at Wyman and Huw van Steenis at Morgan Stanley. "You'd probably have to go back to the 1930s to get something quite as bad."

(Reuters)

[syrakusos]

... Regularly take delivery of the stock certificates (say when one has 100 shares) and put them ...

You may know of firms that still use paper, but basically, it is a thing of the past. There is a surcharge for these things now, some times quite hefty,About ten years ago, when everything went electronic, brokerages paid people to empty their safes of useless paper. Some coin dealers bought huge amounts -- one rumor was a million dollars worth -- to empty out these vaults. Now, classic airline certificates or automotives go for $20 to $100 or more each, but the commons, you can buy from specialty dealers at 100 certificates for $50. I know one dealer who puts these in picture frames and sells them for $10. Basically, he is retailing picture frames.

Anyway, no one holds stock certificates any more, though, yes, there are "bearer bonds" and other kinds of fiduciary paper.

... except me, of course... I collect stuff like that, you know, history capitalism and all that...

[Wolf DeVoon]

U.S. Personal Saving Ratio as Percentage of Disposable After-Tax Income

Negative saving since mid-2007 and trend will likely continue downward

Edited April 6, 2008 by Wolf DeVoon

[sjw]

U.S. Personal Saving Ratio as Percentage of Disposable After-Tax Income

Negative saving since mid-2007 and trend will likely continue downward

Wolf does this graph take into account those who save in assets like real-estate and the stock market?

In this world net worth is a more important measure than savings accounts.

[Wolf DeVoon]

Wolf does this graph take into account those who save in assets like real-estate and the stock market?

Paul Murphy at the Financial Times explains:

Between 1947 and 1997, real GDP increased by around 455%, while real consumer spending rose 476%. Consumer spending increased slightly faster than total output but the difference was marginal ( 2.9%). But since 1997, real GDP has increased 32.1%, while real consumer spending has risen by a massive 40.8%. Consumer spending outstripped GDP growth most noticeably during the pre-millennial boom and into the early part of this decade. Since then the gap has been narrower. But previous consumer spending booms were followed by an offsettting period in which household spending grew more slowly than the economy. There was no similar period of retrenchment after the last boom. Household spending continued to grow at least as fast and often faster than GDP throughout most of the recession and into the 2005-2007 boom.

Consumer spending grew unsustainably fast during the late 1990s and early 2000s. But the usual correction has been postponed as a result of the low interest rate policy pursued by the Federal Reserve System between 2001 and 2006 and the resulting housing and credit boom. The result was a gaping trade gap and a huge rise in household debt levels. It is that overdue adjustment which is now coming as consumer spending has to fall below growth in the economy as a whole, freeing up capacity to boost exports and to some extent business investment.

It will take time for these (large) adjustments to play out. The likelihood is that the United States faces a period of noticeably slower growth over at least the next two years, with very slow growth in consumption offset in part by strong growth in exports. It also implies that the USD will need to remain weak to incentivise the necessary shift from domestic consumption to export-led growth. Hopes for a modest slowdown during H1 followed by a surging rebound in H2 seem misplaced.

[Wolf DeVoon]

Nouriel Roubini yesterday:

"This will turn out to be the most severe recession and financial crisis that the US has experienced for decades. Thus, the current conditions and valuations in US equity and financial markets – that currently price a mild and shallow recession – will be proven wrong as the bottom of the real economic contraction and the bottom of the financial and credit losses are ahead of us rather than behind us. The sense of complacency in financial markets – especially equity markets – following the Bear Stearns rescue will be dashed in the next few months as an onslaught of poor macro and financial news will lead to further realization that aggressive monetary policy easing by the Fed will not prevent a severe recession and the ensuing financial losses."

And then there's Pope Innocent the Last:

April 8 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said the current credit crisis is the worst in at least 50 years. "The current credit crisis is the most wrenching in the last half century and possibly more,'' Greenspan told a conference in Tokyo today via satellite from Washington. Greenspan's remarks echo the assessments of economists including those at the International Monetary Fund, and may add to pressure on policy makers to strengthen their response to the credit crunch. Federal Reserve officials last week acknowledged that capital markets remain distressed even after the fastest interest-rate cuts in two decades.

Edited April 8, 2008 by Wolf DeVoon

[Wolf DeVoon]

WASHINGTON (Reuters) - Members of the Federal Reserve's policy-setting committee worried at their most recent meeting that housing and financial market stress could trigger a nasty slide in the economy, even as inflation pushed higher, minutes of the meeting released on Tuesday show.

"Some believed that a prolonged and severe economic downturn could not be ruled out given the further restriction of credit availability and ongoing weakness in the housing market," minutes of the March 18 meeting said.

---

April 8 (Bloomberg) -- Bank holding companies including Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. have the thinnest safety cushion against losses in seven years. The margin may erode further in coming weeks. Credit ratings on $704 billion of bonds have been cut this year following the collapse of the U.S. housing market. Sheila Bair, chairman of the Federal Deposit Insurance Corp., said last week that downgrades may compromise bank capital ratios enough that some of the largest institutions will no longer be considered well capitalized.

Falling below a regulatory benchmark that is intended to maintain a minimum level of capital to protect depositors against losses would subject banks to more scrutiny from regulators than they have ever experienced. "This is a nightmare for the country,'' said William Isaac, who was chairman of the FDIC from 1981 to 1985. Banks will "raise what capital they can, then they'll slow down their growth and stop lending, and what should be a mild recession becomes a much more serious one.''

The biggest danger to the economy is that to preserve their ratios, banks will cut off the flow of credit, causing a decline in loans to companies and consumers. Banks have already raised $136 billion in capital, based on data compiled by Bloomberg, and cut dividends. More stock sales and payout reductions are likely to follow, says analyst Meredith Whitney at Oppenheimer & Co.

-----

Clear, brief discussion of recession at Accrued Interest blog.

Obviously, this recession, if we have one, is consumer and not inventory driven. As such, unemployment will switch from effect to cause.

Lastly, Toro notes that "over the last 13 quarters, since the [share] buyback boom started in the fourth quarter of 2004, the companies in the [s&P 500] index reported net earnings of $2.1 trillion. They paid out $721 billion in dividends and spent $1.4 trillion in buybacks. Their total capital spending came to $1.6 trillion. In other words, over the past three years, all profits have been returned to shareholders while all capital expenditures have been funded by debt. Given the problems in the credit markets, this is unlikely to continue over an extended period of time."

Edited April 9, 2008 by Wolf DeVoon

[Wolf DeVoon]

Hat tip: Toro's Running of the Bulls/UK Market Oracle

[Wolf DeVoon]

(Bloomberg, April 21) Corporations in the U.S. and Europe must repay $1 trillion in debt maturing this year, the most since 2000, data compiled by New York-based Citigroup Inc. show. As the cost of borrowing for investment-grade companies climbed to 2.35 percentage points above government debt in the past year, firms such as Wachovia Corp., Wesfarmers Ltd. and Imperial Energy Plc are selling shares for an average 14.7 times profit, Bloomberg data show. That's the lowest since at least 1995.

"Companies won't be getting for their shares what they would have expected months ago,'' said Sandro Baechli, a Zurich-based equity strategist at Clariden Leu, which oversees $128 billion. "Debt markets are not welcoming. Companies that desperately need the cash will have to undergo a fire sale.''

[Wolf DeVoon]

Shortages of rice, cooking oil, and flour reported in California and New York.

Shortfalls in crude oil production starting to snowball. Venezuela falling apart. Labor union refinery strike knocks North Sea offline; sabotage k.o.'s Nigeria and Shell declares force majeur (again). Meanwhile in Russia: "The latest data on Russian oil production showed that for the first time in a decade, output fell in the first three months of this year. Merrill Lynch analyst Francisco Blanch said in a recent report to investors that Russia surpassed Saudi Arabia as the world's largest oil producer in 2007 with an average daily output of 9.84 million barrels. But first-quarter production this year fell to an average 9.75 million barrels per day. 'Mature fields, exploding costs, a heavy tax burden, infrastructure constraints and market-unfriendly government policies have led to stagnation in oil exploration and production,' Blanch wrote." (Houston Chronicle)

Higher oil prices are feeding into agriculture costs. This looks really bad, folks.

W.

[Wolf DeVoon]

[Wolf DeVoon]

From a comment at Accrued Interest blog:

Anonymous said...

AI: A better explanation is that the market is struggling to price a world where liquidity is improving but real economics are deteriorating.

As you pointed out, the "fast" money (trading CDS) was doing entirely different things than the "real" money.

People who work on Wall Street may or may not be corrupt, depending who you ask, but as a group they aren't stupid. They all know two indisputable truths about their employers:

1) A good many of them have Level 3 assets (the unpricable garbage) that is several multiples of share holder equity. And this is before one subtracts "good will" from the assets column (which represents how much excess banks paid in their acquisition binges). In short, a good many of the big banks are insolvent. Having access to funding from the Fed does not change this

2) Many banks' business models can be boiled down to this: enter into a negative gamma trade (mortgages, credit, whatever), and lever the living crap out of it. Most of the time, things work out and you collect your little spread (multiplied by your leverage) and life is good. But a couple times per decade, you get one of these extreme events (call them Black Swans if you insist) and the options you are short take you to the cleaners.

Many banks have lost more money in the last 9 MONTHS than they made in the last 7-8 YEARS. If your business is not profitable through a full business cycle -- then its not really a business. It means your "profits" in the early years failed to include sufficient charges for future write-offs.

Bernanke can pretend like banking is still a business, but in the wise words of Watergate's Deepthroat: follow the money. Consider Citibank. The Latin America debt crisis. Bad loans in the oil patch (that took down Continental Illinois). Bad LBO debt. Real estate problems in the early 1990s (remember the prince of Saudi Arabia had to bail them out?). Then they had all the legal / investment banking issues that led Sandy Weill to leave. And of course: this latest mortgage snafu.

These "unprecedented" disasters keep happening every 7-8 years.

Going forward, its something of a foregone conclusion that the Fed will not allow anywhere near the same amount of leverage that was used in the past. Even 20-1 leverage is just a problem waiting to happen.

So what exactly is Wall Street's business model now? The short gamma trade is over-subscribed. The really narrow spreads offered by spread products won't float Wall Street unless they are levered a lot.

Even if they won't say so out loud, everyone knows there is a big problem.

BTW - Warren Buffet has been sitting on something close to $40 billion in cash for some time now. The major banks are trading at less than half what they were a year ago. If banking's future was bright, you would think the world's smartest long term investor would snap this stuff up and then wait for the dust to settle.

Well, he bought a bubble gum company instead.

[Wolf DeVoon]

quoted on FT Alphaville Markets Live:

The financial debauchery in this decade is on a scale that even a Marx or Castro would find improbable.

- Donald G. M. Coxe

Global Portfolio Strategist, BMO Financial

[Wolf DeVoon]

[Wolf DeVoon]

James Hamilton on Ben Bernanke's latest warble (via Seeking Alpha):

If anything like a reasonable margin requirement had been in effect, Bear Stearns could not possibly have gotten into contracts totaling $13.4 trillion notional. But these weren't traded on a regular exchange, so there was no margin requirement, and apparently no real limit on the size of the exposures that Bear Stearns could take on, or the size of what they could bring down with them if they fell.

And that raises the question, Why were counterparties willing to accept these trades with no margin to guarantee payment? To this I'm afraid the answer is, they figured Bear was too big for the Fed to allow it to fail. And on this, I'm afraid they proved to be exactly correct.

I would feel better if Bernanke were less focused on how to "provide liquidity" and more focused on how to get the system deleveraged and more transparent.

Right on.

[Wolf DeVoon]

Foreclosure flood: 1,000 auctions a day in California

WSJ: April foreclosures hit an all time high: 243,000

Meanwhile:

(Reuters) General Motors will need to refinance close to $8.7 billion of debt due between now and January 2010, as well as absorb additional cash burn of close to $11 billion, Lehman Brothers analyst Brian Johnson said. Last week, Fitch Ratings said both GM and Ford will continue to face heavy cash drains in 2008 and are likely to burn cash through 2009 unless industry sales rebound. GM lost $51 billion over the past three years.

Edited May 14, 2008 by Wolf DeVoon

[Brant Gaede]

I said on April 1 I was no longer going to post on this thread, but I've changed my mind. For one thing the thread died when Wolf left. For another I wish to make some comments from time to time.

The drop in real estate prices and the damage to financial institutions is now going to accelerate with the coming home to roost of Pay Option Adjustable Rate Mortgages (ARMS) defaults.

For information simply Google "Pay Option ARM."

This is a massive problem that will likely destroy the presidency of the next President who will be elected in November. The economy is inexorably going into the wood-chipper of a giant recession. This recession will be world-wide. That's the negative side of "globalization." This is like 1929 in some serious respects.

--Brant

[tjohnson]

Wow, bad shit!

[Brant Gaede]

Why is the stock market going down? I suspect the massive liquidity the Federal Reserve has been pumping out has generally been going into financials to buck up reserves--not equities. Bank of America now pays a 9% dividend. This means investors have no faith in its ability to maintain its dividend. It's twice as high as it was a year ago. GM is slowly descending into bankruptcy. People don't have to buy new cars and trucks. The quality has improved so much cars and trucks last a lot longer making it more of an option. The choice is to avoid new debt, especially real estate and vehicles. Inflation is underlying everything. Fighting the business cycle has become futile. A world-wide recession could easily result in a backlash against "globalization"--protectionism, which would make it all much worse. In the meantime the dollar is being destroyed and the consumer based economy is being revealed as destructive of capital. The United States is going to become a substantially poorer, weaker country.

--Brant

[Brant Gaede]

How to invest in oil:

Never, ever, short oil unless your position is hedged. (This is not a reference to oil companies.)

An event in the Middle East could cause the price of oil to as much as double over night.

There is a very good chance, for instance, that Israel will take out--or try to take out--Iran's nuclear capability between now and the swearing in of a new President, especially after the election if McCain loses to Obama.

Such a spike up in prices can be immediately shorted. The fear factor in the price will soon collapse and you can cover and bank.

If you are long oil at the time of the great event, sell immediately. Shorting will be optional.

--Brant

[Brant Gaede]

How to invest in gold:

Investing in gold is savings and a dollar hedge. Dollar savings is nonsensical in the reality of inflation, bad now, worse probably to come. (Never mind the CPI; it's understated. That's why TIPS are a bad investment.) In the present environment the max percent of gold in a portfolio should be 10-20.

Buy GLD on the NYSE using dollar-cost averaging. Never mind the price of gold, just buy some every month, two months, or quarter. Be consistent. Don't sell it. You can also buy physical gold directly from a reputable dealer in bullion coins with a modest markup. Avoid sales taxes. (Put them in a safe deposit box.)

Buying gold company shares is more problematic; they are much more volatile up and down than the underlying commodity. They can go out of business.

--Brant