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
Do you believe the government accurately reports inflation numbers?
In the 1980’s the government decided to remove housing price increases from the inflation index. If the government were to accurately report housing prices and more accurate numbers of inflation, the government would have been reporting inflation numbers closer to 9% rather than the 2% they have been reporting over the last few years.
It does not take much to figure the price of everything has gone up over the last 10 years. Ask anybody who has a family, goes to a grocery store, send kids to school or buys a house and you would be hard pressed to find anybody who says that prices have either stayed the same or come down. How is it possible that the government continues on with the farce that they say that inflation is benign?
The dollar has roughly declined 40% over the last few years which coincides with the cumulative effect of the US understating inflation. So on average if the government has been understating inflation by 4% for the last 10 years that would equate to the 40% decline. Hence the market has been telling you what the government won’t. In addition with the continued easing policy- inflation will begin to heat up again.