Monday, September 29, 2008

Confidence Game or Confidence Crisis?

The US House of Representatives just voted down the $700B “Wall Street” bailout bill. The US markets reacted in predictable fashion: the Dow Jones Industrials closed down -778, a drop of nearly -7%, while the S&P 500 index closed down -106, a drop of nearly -9%. Prices on US Treasuries soared as investors looked for a safe haven.

Even though the legislation had been hammered out between Dems and Repubs in marathon weekend sessions, enough of each party defected to the “nays” to defeat it. Predictably, there is predictable finger-pointing on both sides, each blaming the other for the failure.

My friends, though the bill was widely vilified as a bailout of Wall Street banks and bankers on the backs of US taxpayers, it could have gone a long way toward helping Main Street too. When Wall Street investors lose confidence in the game, they take their chips off the table. When Main Street investors lose confidence in the game, they line up at their local bank. The largest bank failure in US history occurred last week for that very reason – more than $16B of deposits had fled Washington Mutual in less than two weeks.

Now what?

Congress will try again, although at this point it is unclear if that will happen now, after the election, or be delayed until the next Congress. Someone has probably opened a book on this in Vegas already.

Until such time as this is addressed by our elected officials (as opposed to our selected officials – Paulson and Bernanke, et al), here is what I know:

· The FDIC still stands behind bank deposits up to $100,000 per depositer. Be sure you don’t have more than $100k in any one bank. You can view the rules at

· The Treasury put up $50B last week to insure money market fund assets for the next 12 months. The $1 net asset value is safe for the time being. If you are concerned about this, switch your money market fund to one that invests solely in US Treasury obligations.

· Markets do come back. If the Dow can plunge -778 points in one day, it can rise +778 points in one day. For all of the gyrations the week of September 15th when Lehman Brothers filed for bankruptcy, the markets actually finished up for the week. If you needed the money in the near future, it wouldn’t be in the markets anyway, right? Right?

· In the near term, markets are likely to be choppy.

· Neither of the Presidential election campaigns can be counted on to add any sanity, but are more likely to use events to try and score with voters.

· I’m keeping the sensitivity dial on my BS detector set on HIGH – I suggest you do the same.

· Stay invested, stay diversified.


Friday, September 19, 2008

Helter Skelter

“When I get to the bottom
I go back to the top of the slide
Where I stop and turn
and I go for a ride
Till I get to the bottom and I see you again”
- Helter Skelter (Lennon-McCartney)

One of my daughters just loves roller coasters, but I think even she would’ve been nauseous this past week. Some of us held our breath while the rest of us held our noses.

That smoke you smell is from the friction of the over-heated U.S. Treasury printing presses cranking at maximum capacity to keep up with the obligations assumed by our very own federal government.

Losses in private business are – once again – being socialized on the backs of the U.S. taxpayer. Remember the Savings and Loan disaster in the 80s? That was a mere pittance at $150B. This dwarfs that by a magnitude of oh, say, at least 10X. The Crowned Heads of Government Finance (Bernanke, Paulson et al) were – once again – check-mated into backing private business with taxpayer dollars. The U.S. financial markets had become so intertwined that “too big to fail” was quickly replaced with “too complex to fail”. They drew a line in the sand with Lehman Brothers, but the markets quickly erased it with the loss of confidence in insurer AIG whose participation in the unregulated market for Credit Default Swaps (CDS) threatened market stability all over the world. Even providing financing to AIG wasn’t enough and now they are trying a fire break to cleanse the banking system of bad debts in the hope that will stop the firestorm.

So now the U.S. Government owns (one way or another) Bear Stearns ($29B), Fannie Mae, Freddie Mac (combined $6T), AIG ($85B), ALL THE BAD MORTGAGE LOANS IN THE ENTIRE COUNTRY (“We’re talking hundreds of billions.” – Paulson) but wait, it gets better: ALL LOSSES IN MONEY MARKET FUNDS for the next 12 months ($50B to start).

My brain hurts. As Everett Dirksen is often quoted as saying: “A billion here, a billion there, pretty soon it adds up to real money.”

My 2 cents: They better well make damn sure the financial “institutions” share in the cost and they better make sure it hurts because I can tell you, our share is gonna hurt. WE CAN’T KEEP DOING THIS.

You can kiss any campaign promise tax decreases good bye and the hidden tax of rising inflation caused by printing money will only add to the pain.

In spite of the wild ride, the U.S. stock markets actually eked out a small gain for the week.

I repeat my mantra for investors: stay invested, stay diversified.


Monday, September 15, 2008

The Day the Earth Stood Still

"Klaatu barada nikto."
- Michael Rennie to Patricia Neal in The Day the Earth Stood Still

The Day the Earth Stood Still was a film released in 1951. Like many sci-fi films, on the surface it appears to be about space aliens and ray guns, but there is a deeper story with an anti-war message.

The line delivered in the film is intended as instructions to the alien robot Gort to stop its assault on the military units surrounding the spaceship and to resuscitate (resurrect?) the character played by Rennie (shot and apparently killed in another scene) so he can deliver his speech in the closing scene.

In spite of the Crowned Heads of Wall Street working all weekend though, there is no resurrection for Lehman Brothers. Lehman began operations before the Civil War and had survived many other crises, but not this time. The government drew a line in the sand. Finally. There would be no taxpayer money backing any takeover of Lehman. Merrill Lynch saw the writing on the wall and quickly arranged a “merger” with Bank of America. That pretty much leaves only Goldman Sachs and Morgan Stanley as the last of the large, independent investment banks and rumors about their viability as independent entities abound.

So, is the earth standing still today? I don’t think so. Capitalism is doing what it does best: rewarding the winners and punishing the losers. The punishment taking place is obvious, but knowing who the winners will be is not so obvious.

What I do know though, is that the markets will recover. They always do. Now is not the time to bail. Stay invested, stay diversified.


Thursday, September 11, 2008

Uh, Wait a Minute

“Wait, oh yes wait a minute mister postman
Wait, wait mister postman”
- Please Mister Postman (as performed by The Beatles)

Now that some of the dust has settled after the U.S. Government takeover of Fannie Mae and Freddie Mac, more details are coming to light.

In the most recent post on this blog, I stated that the implied U.S. guarantee of Fannie and Freddie obligations had become an explicit guarantee. Dumb ‘ol me: this is not the case.

In an article on published today (Sept 11th):

“The federal takeover of the government-sponsored enterprises, or GSEs, on Sept. 7 failed to address whether the debt of Fannie and Freddie should be included in the budget, or whether it carries an explicit government guarantee. In an interview this week, Treasury Secretary Henry Paulson cited the ``incongruities'' in the law and said ``we should be clear, is there a government guarantee or isn't there?''

Any decision to add Fannie and Freddie to the budget wouldn't automatically translate into an explicit government backing for the companies' combined $1.7 trillion in unsecured debt and $3.5 trillion of mortgage guarantees. Granting the full faith and credit of the U.S. would require an act of Congress to change the companies' legal status.”

As Emily Litella would’ve said “Ohhh, that’s very different!”

The perception in the market seems to be that the U.S. is on the hook for the obligations, no matter what might be said. Ever heard of “credit default swaps”? Commonly referred to as CDSs, credit default swaps are insurance for investors. If you own a bond say, and are concerned about getting your money back, you can buy an insurance policy in the form of a CDS. Like all insurance, the price is (for the most part) directly proportional to the likelihood of the insured event occurring during the time period covered, i.e., the more likely it is perceived the event will occur, the higher the price of the insurance.

You can buy CDSs on U.S. government debt. What you say? Someone out there thinks we might not pay? Yeah – someone out there thinks we might not pay and in fact, the cost of CDSs for U.S. Government debt has increased quite a bit this year. Ouch. If the U.S. is perceived as a lower quality borrower, that means lenders will require higher interest rates. Think of the implications of such a shift in perception for you and me as U.S. taxpayers: higher interest rates means higher federal outlays for debt servicing which translates into higher U.S. taxes.


Tuesday, September 9, 2008

The State of the Investment Markets

“There was an old lady who swallowed a fly.
I dunno why she swallowed that fly,
Perhaps she'll die.

There was an old lady who swallowed a spider,
That wriggled and jiggled and wiggled inside her.
She swallowed the spider to catch the fly.
But I dunno why she swallowed that fly -
Perhaps she'll die.”
- Folksong

I thought it would be a good time to offer some perspective on what we’re seeing in the investment markets.

It’s been a brutal year: the Standard & Poor’s 500 index is down -12.3% for the year – this after Monday’s (Sept 8th) increase of 2% (25.48 points). Markets in other countries have fared no better and many in fact are doing worse. A global economic slowdown seems to be underway.

By now, the story of the housing bubble fueled by easy credit should be familiar. Too much easy money ignited demand for houses (new and existing) and created an unsustainable rise in home prices. We are still dealing with the consequences. Home values are falling and borrowers who thought they would be able to re-finance their way out of trouble are finding they can’t and are abandoning their homes to the lender. Mortgage foreclosures are approaching numbers not seen in the U.S. since the Great Depression of the 1930s (9% of all residential mortgages in the U.S. are in late payment status or foreclosure proceedings). Lenders have tightened their credit requirements – which means they are making fewer loans – while their assets – mortgages and mortgage bonds – are declining in value. Banks large and small are finding themselves in the unenviable position of having to raise capital in this environment – sell stock or issue bonds – to shore up their balance sheets so they can remain in business. Many of the largest U.S. banks have turned to Sovereign Wealth Funds (SWF) for capital, effectively selling part of themselves to non-U.S. investors. Of course, the U.S. Government has been doing this for years for essentially the same reason.

Enter the U.S. Treasury (or “Treasure Island” as I’ve seen it referred to). The U.S. Government explicitly guarantees only certain debt issues: U.S. Treasury obligations (T-Bills, Notes and Bonds) and mortgage-backed bonds issued by the Government National Mortgage Association (Ginnie Mae) being prime examples. There are two major Government Sponsored Entities (GSE) that have enjoyed an implicit U.S. Treasury guarantee: Fannie Mae (FNMA - Federal National Mortgage Association) and Freddie Mac (FHLMC - Federal Home Loan Mortgage Corporation). Fannie and Freddie as they are known, provide about half of the financing for home mortgages in the U.S. and have used the implied government guarantee to finance their operations.

Monday’s takeover of Fannie and Freddie – changing the implied guarantee to an explicit guarantee - could go a long way in reducing mortgage interest rates for new borrowers, stabilizing U.S. housing prices, and perhaps help to free up the tight credit markets around the world. In fact, today (Sept 9th) 30 year mortgage rates are being quoted at a national average of ~5.9%, down 50 basis points (one-half of 1%) from levels one month ago. This is a huge drop. Lower rates may help stabilize housing prices and home buyers may decide to quit waiting for prices to fall further and return to the market. There is still a large housing inventory overhang, but reducing it to historical levels (about 6 months’ worth is considered “balanced”) would really help the current economic environment.

There is still a long way to go. One of the big questions concerns further write downs of bad loans by banks worldwide, recently passing $500 Billion. Many commentators expect bank losses to eventually exceed $1 TRILLION. Stabilized housing prices could help homeowners re-finance their mortgages to affordable loans and remain in their houses. This in turn could help “stop the bleeding” in the banking industry. This in turn could help loosen the tight credit markets. This in turn could help businesses expand, creating more jobs. All of this would be positive for stock markets around the world.

Hopefully, the takeover of Fannie and Freddie will be the action that stops the “old lady” from attempting to solve a series of problems with an action that creates a bigger problem:

“There was an old lady who swallowed a horse -
She's dead, of course.”


Wednesday, September 3, 2008

Getting Organized in the 21st Century

With the ever-increasing proliferation of web-based services, a large hole in many financial plans is growing larger.

You may have prepared a comprehensive list of all of your financial relationships and related contact information: accountant/tax preparer, bank/s, legal document location/s, mortgage holder, credit cards, financial advisor/s, attorney, safe deposit box location (and key!), etc. (Here’s your chance to say “Why, yes I have!”…)

This list should be kept up to date and copies kept in more than one location. (Here’s your first chance to say “Why, yes I will!”…)

But, you may not have included the “keys” to your web-based relationships on this list: those important website addresses (banking, bill-paying, e-mail, shopping) with your login ids and passwords.

Virtually all web-based relationships are governed by a legal document you agreed to when you first established the relationship, the Terms Of Service Agreement (TOSA). Like me, when presented with a “check here if you agree to our terms” check box, you probably checked “yes” and didn’t think about it.

Time to think again.

TOSAs commonly contain “use” clauses and privacy clauses. The use clauses often state that your account access – like an e-mail account – will be terminated and all data wiped out if you don’t use the service for a stipulated time period, sometimes as short as 30 days. The privacy clause prevents the service provider from giving anyone else access to the service – they will not give anyone else your login and password. These are good things, but what happens when someone dies or becomes unable to communicate (a stroke) and their family can’t find their login and password? Short of a court order – at the family’s expense – they are out of luck.

Here’s another one: do you protect your home computer with a password? If no one else knows it, your family may not be able to access it if you die or become unable to communicate. What if your list of important items is on your password-protected computer?

Your vital documents should contain a list of all of your on-line account relationships with their related login ids and passwords. Of course, this list needs to be kept up to date.

It goes without saying, but don’t keep the sole copy of this list on-line!

Here's a link to what looks like a great organizer for just this purpose: (currently in development - enter your contact info and they'll let you know when it's available).