Published at November 5, 2008
in Money.
There has been a lot of talk in the papers recently about not paying bonuses to the employees of Wall Street firms.
The logic is as follows: Since most of the financial community has been devastated and have been forced to borrow money from the treasury, why should the banks pay out bonuses? The fact is that the money to be paid out in bonuses will be coming from tax payer money. On the surface, it looks like a logical argument.
However in most of these firms the employees of these investment houses didn’t lose money this year. The majority of the losses came from a few areas of the firms : mortgage department, loan market and similar areas. At any Wall Street firm the number of people in these areas is relatively small. There is only so many traders, research and salesman that you need in one product group. So just because the mortgage department wiped out the equity of the firm doesn’t mean the guy trading emerging markets isn’t owed a bonus.
In the case of Bear Stearns and Lehman Brothers, their employees will not be paid because they went bankrupt. In the case of other firms that were saved (AIG) the government decided to step in and honor the firms contracts, hence the bonuses must be paid.
Like any other industry in the U.S, on Wall Street, most of the employees are solid and honest working people. The reason that many of these firms went bankrupt is because the management of these firms decided to take massively large and levered bets on the real estate market and lost. The guys who made these bets were all multimillionaires and if they had won, they would have made even more money. Since the bets didn’t pay off most of these executives were fired but kept all their millions. They made the perfect bet-heads I win tails you lose. The trader on another desk in another area of the firm is now the guy losing his job, through no fault of his own. The sad thing is that he dos not have all the millions to fall back on and now is struggling to survive.
Many of these Wall Street executives ran these firms as private fiefdoms ( see Lehman Brothers) and because of their hubris, many people have lost their jobs, their life savings and their careers. For this reason alone, I don’t believe you can punish someone by not paying them a bonus. They were not the guys who lost the money in the first place.
Published at October 22, 2008
in Money.
While politicians have been adding more regulations and laws, the Treasury has continued to add liquidity to the system and yet the markets have continued to fall. It reminds me of the old Humpty Dumpty story ” All the kings horses and all the kings men could not put Humpty Dumpty back together again”.. The Treasury and the Congress seem a bit dumbfounded by this and wonder why the markets have not recouped their losses. Another analogy would be the case of the jilted wife who accepts her husband back after all his infidelities. She has taken him back but she has not forgotten.
The markets will remain stalled until trust comes back into the market, yes trust. The humanistic person always will seek to add another law and another regulation to solve the markets. However the markets don’t work that way because they realize you can not legislate away honesty. The markets are not working because of the tremendous leverage that exists in the system and the lack of forthrightness by many of the finance companies. The U.S system of commerce is based on credit. And by credit I mean the extension of credit by banks to fund small businesses. Once this dries up, the whole economy dries up.
The finance sector has taken the money provided by the Treasury and has been using it to shore up its own balance sheets-they have not been extending this credit to the small business owner. The finance system has been arguing all along that they are in good shape only to see one company after another go under. Over the last year we have all witnessed numerous CEO’s come out and say they are in a good financial shape only to see them go out of business ( Like Lehman). This lack of truthfulness by the CEO’s has undermined the market as the players doubt the truthfulness of theses companies and all others and begin to sell.
So I would argue , these little white lies are undermining the whole system. Over the last 20 years, teachers have cited that more and more students cheat more than ever. And, as these students in turn graduate and enter the workforce, these character defects have begun to show up. Who would have ever thought that “Thou Shall Not Lie” was actually pretty sound advise.
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Published at July 31, 2008
in Money.
Part of the reason we are having a melt down in the financials right now is that the market does not understand the position of the financials. For example in mid July of 08 Merrill wrote down 9.8 billon of assets only to be followed by another 5.7 billon on July 28th, 2008. As they say a billon here and a billon there and after a while it becomes real money. After the announcement, the CNBC pundits came out and openly questioned the honesty of Merrill Lynch’s CEO. I believe John Thain is an honest man who has been put in a horrendous position by his predecessors- as he has been hired to clean up the sub prime mess. The problem that Merrill faces is that if they were completely open with the public about the true nature of their losses, the market would be horrified and probably send the stock straight to zero. So hence, Merrill is forced to be discreet and hide their problems on their balance sheet and the whole market knows this.
The only reason why financial markets work is because the market has to believe in the audited financials. For the markets to work, people have to believe in their counterparts and the companies listed on the exchanges are being truthful, and to the extent they are not; why would anybody invest one cent in the markets? To be even more clear for the financial markets to work- there has to be a high degree of honesty and truthfulness. First and foremost for somebody to want to buy your stock the investors have to believe you are being truthful about what you are earning. So in reality- what is most important about the markets is not how much money a company can make but really how truthful they are in reporting those numbers. What the markets are suffering right now is a lack of credibility in what the financial houses are reporting and these have long term consequences.
After the Enron and Arthur Anderson debacle in 2001 the markets went into a free fall, partly because of the tech bubble and partly because people no longer had faith in what the companies were reporting. The congress passed the Sarbanes-Oxley Act which forced US listed companies to be more truthful in their reporting or face the consequences. Amazing as it seems, we are facing the same crisis for the same reason. What is different this time is that the financial houses are not stand alone companies, they are the engines that finance the growth of the U.S. and to the extent they can not manage to tell the truth about the nature of their losses, they have grave and serious consequences on each and every citizen.
Published at May 16, 2008
in Money.
Gresham’s Law states that whenever government overvalues one form of money and undervalues another, the undervalued money will leave the country or disappear into “hoarding,” while the overvalued money will flood into circulation. Hence the saying, “Bad money drives out the good.”
In the early 1960s U.S coins were made with real silver money but with price of silver rising the U.S. stopped minting coins with silver. It is hard to find any silver coins now unless you collect them. The fact is that these coins, because of their silver content, are now more worth than their face amount.
Instead of the US firming up the USD by buying and holding amounts of silver in the central banks, they decided to debase the currency. Silver coins still hold exceptional value. The old dime contains over $1.40 worth of silver at today’s silver price. The old quarter is worth nearly $3.60. A 50-cent piece contained about $8 of silver. And a good old silver dollar is now worth more than 16 times its face value. And these are just the silver values of the coins. The coins themselves might be worth far more, depending on condition and rarity. (source http://www.whiskeyandgunpowder.com/)
Don’t be surprised if the nickel and the penny disappear soon enough as they know cost more to produce than what their face states. In the old times, unethical traders would clip some of the silver content from the coins and then re-melt them. This was seen as an egregious offense, but today the government does it daily without a whimper from the masses.
I am a big proponent for lower taxes for a variety of reasons, but one of the main reasons I don’t like them is because taxes are inflationary. All of the current political candidates answer to our current problems is to raise taxes. The economy is going south, we have massive deficits and we have a large under funded social security program — and the proposed solution that we keep on getting from our current candidates is that they want to take out even more money out of our hands through taxes.
If this does not sound ludicrous to you, think of this analogy. If a parent gave his teenage child 100$ to last him for a week but came back with a credit card bill for 1,000$ one week later, would you be inclined to give that child more or less money? Pretty obvious answer isn’t it? So how is it any different from what we face with our government today?
If the government were run as a business: people would get fired, costs would get reduced, debts would get paid and fiscal sanity would become the norm but not so with these current candidates.Through higher taxes- the cost of producing things goes up. These year-to-year increase in taxes come in the form of excise duties and sales taxes, both of which add to the price of goods. On top of the federal taxes, states and cities also charge taxes. The main ones cities charge are property taxes which have been getting out of control even though real estate prices have been falling. In addition we are hit with hidden taxes everywhere we go for example we pay taxes on the following: airline travel, car rentals, housing, hotels, parking, water, etc, the list is endless.
These taxes feed inflation through government spending which than adds to deficit spending. Taxes are always passed on to the end user, so as we are taxed we also are getting higher inflation. So taxes are like double whammy: the individual is now paying more money out of pocket and on top of that the money that the taxpayer has left in his pocket buys less things.
The best advice I can give is to always vote with your wallet-it tends to keep the politicians more honest. They can’t get spend or steal what they don’t have. If you don’t believe me look at this latest stat: “The full tax burden of the American citizen including state, local, and sales tax as a percent of income, hit an all-time high of 32.69% in 2007.”
Published at March 11, 2008
in Money.
There was a brilliant article last Friday in the FT by Gillian Tett that bears worth reading. “The Vicious Spiral That Haunts the Debt Markets” “The western financial system is caught in a trap … on the one hand, there is an urgent need for clearing prices to be established for impaired assets to restore confidence; on the other hand, if this is done in a mark-to-market world, there is a risk that some banks will run out of capital. Policymakers are in the unenviable position of knowing almost any step they take risks denting sentiment further”.
“The risk now is that we will remain trapped in this climate of grinding fear for months – at best. Few institutions have much incentive to voluntarily create clearing prices. However, hedge funds are now being forced to make asset sales in an ad hoc, opaque manner that is adding to the sense of fear. This is forcing the banks to mark books lower and pull in their horns, sparking even more hedge fund sales and fuelling concern about banks. It is a viciously unpleasant spiral”.
In plain language this is what is happening. The banks lent too much money to the hedge funds. In some cases on a 30 to1 ratio. For every 1 dollar the hedge fund had in capital the hedge fund was able to purchase 30$ worth of goods. In a rising market this, amplified the funds returns. But now, in a declining market the hedge funds are going under along with the banks’ money they borrowed.
As the value of the assets in the hedge funds have been going down, the banks have been making margin calls. The hedge funds have been forced to sell those assets into the market. And as these funds have continued to liquidate its holdings, the hedge funds have been driving the value of its own assets down- thus incurring more margin calls. In turn this is forcing wide spread liquidations. This is why there does not appear to be an end in sight.
There is now talk of watering down capitalization regulations so as to minimize the massive liquidations. Gillian Tett concludes with this ominous note:
“We are now up to $188bln in terms of total write downs globally from the estimated credit losses. These mounting losses in turn make it more difficult for economic agents to secure funding. That then leads to more economic weakness, which then fuels the wave of delinquencies, defaults and foreclosures.”
Published at February 21, 2008
in Money.
If you have been following the financial markets for the last few months, you probably would have noticed that the market is being driven by credit fears. More simply put- people are not paying for the things that they bought which is pushing the equities market down. In particular it has pushed Real Estate prices down.
Here is a brief explanation on how we got into this mess: Average Joe bought a house and took out a mortgage. Mr. Banker sold the mortgage to a financial house. The financial house then took 100 mortgages and pooled them together and then sold them as a C.D.O (Collateral Debt Obligation). The C.D.O was then broken up into 3 pieces (A, B and C).
For simplicity sakes this is how it worked for an investor who bought a C.D.O. Investor A earned a 20% yield as long as there were less than 20 defaults, Investor B got 12% as long as there were less than 30 defaults and Investor C received 8% so long as there were less than 40 defaults. Well there have been more than 30 defaults, which have meant that investor A & B have been wiped out. Investor C is still standing, but barely.
This is where it gets complicated; in order for the financial houses to make even more money they did the following: They placed the A and B tranches into a new C.D.O- and called that C.D.O (squared). Then they resold the C.D.O (squared) to new investors with three new tranches (A, B and C). It gets worse… from the new CDO (squared product) they did it all over again and created a new C.D.O (cubed).
Because the investment houses placed so many of the same mortgages into the C.D.O’s, there was significant correlation risk. Because many of the C.D.O’s are tranches of one another- and as one defaults, it triggers another default which triggers another and so on. So if an investor wanted to value 1 CDO- more than likely he would have to know the value of over 10 tranches of other CDO’s. And in doing so would probably have to value another 10 tranches of more C.D.O’s. As you can see it becomes very hard to value- which is why the banks are struggling in telling the regulators how many losses they have on their books. Another way to look at is like pulling a thread on a sweater- once you begin to pull on one string, the whole thing begins to unravel.
If you find that all a bit confusing, don’t worry because it is. What is most disappointing is that the best and brightest minds of Wall Street managed to screw this up so badly.
Published at February 20, 2008
in Money.
Buying from outside the US:
Most people don’t think it’s a bad thing to buy from China. I tend to agree with that because most people would rather pay less for item than more. It only becomes a problem when as a country we don’t sell enough of our U.S goods overseas. The fact is the United States imports a lot more than it exports. The United States ranks as one of the world’s worst countries with a negative trade balance of over 800 billon. Simply said we are buying 800 billon more of goods than we are selling overseas.
Countries such as Germany, Japan, China all run positive trade balance well over 100 billon or so. If these numbers don’t impact you think about the following: when an individual buys a TV from Japan it implies the following; you are selling U.S dollars and are buying Japanese Yen to pay for that T.V. Not a big deal per transaction, but when you multiply that by the billons it becomes a very big deal. Because as we continue to buy more than we sell- we have to sell a lot of US dollars to buy these things.
So as long as these numbers remain out of whack- the value of the US dollar will continue to depreciate. In other words it will take ever increasing amounts of dollars to pay for things.
Last week we had Congress holding hearings on baseball with proposed plans to hold hearings on football. With our dollars being debased every day and inflation ramping up- our Congress has decided to focus on something as trivial as baseball. Instead of focusing on something substantive, they have decided to focus in on the trivial. The fact is the American public is getting what they deserved-we voted for this Congress. We all are responsible. What is hard for a Congressman to talk about is how taxes and regulations is strangling our economy and leading us to this mess.
Published at February 12, 2008
in Money.
It use to be on the old days that when you wanted to buy a house you had to talk to your local banker to get a loan. If the loan went bad and you did not pay the loan, you were forced out of our house and the banker had a whole lot of explaining to do to his bank. The banker had a vested interest in the buyer paying off his loan- if the borrower did not pay he was out of a job. Subsequently, bankers tracked all the loans they made, the conditions of the housing market and their customers.
However a few years ago it became much easier for banks to make loans and then resell those loans to other buyers. So the banker became a little more negligent in the loans he approved. Because the bankers incentives changed, he was no longer concerned about the qualifications of the buyers. The banker wanted to make as many as loans in order to sell them. The more loans the bank made, the more they could sell. The banks began to abandon their fiduciary responsibility of insuring the quality of the loans.
From a buyers point of view it was crazy to buy these loans. You were buying a loan from somebody else who did the credit work and from a banker who no longer had a care if the loan performed. So what the buyer did was package these loans and got an insurer to give it a AAA rating. With these AAA rated structures the buyer were then able to make fees by structuring and selling these loans to insurance companies, hedge funds, etc.
However the fact remained that the original borrower was shaky, the credit work was done by someone else and there was no real incentive for the buyer of the house to pay the loan as home prices began to decline. The market thought otherwise and as along as it had the pristine ratings-end buyers of these loans were abundant. Until the whole thing fell apart- and that is where we stand now. The values of all these loans and structures are falling in price as desperate sellers look to get out at any price. Some of the banks who sold these structures have been forced to buy back these loans- the balance sheets keep on taking more paper by the day as the balance sheets gets bloated with terrible loans. How are the banks expected to make any money as they assume more and more loans on their book? Stay away from the financials as there is still more trouble coming