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Archive for December, 2008

Via The New York Times:

option-armsAs shown by the graphic, Wachovia was one of the biggest players in Option-Adjustable Rate Mortage origination – mainly because they acquired several banks which specialized in this field.

The article itself contains a very thourough history of how “Option ARMs” came into existence, and how they are predatory by nature:

“I don’t think anyone thought a Pick-A-Pay product was a customer friendly product,” says a former Wachovia executive who requested anonymity to preserve professional relationships. “It is easy to mislead them.”

Nice.

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Paul Krugman, who won the Nobel Prize in economics this year, speaks about the state of our economy at the National Press Club.

Here’s the best part of his hour long speech:

Start around the 4 minute mark, and follow through until the end – this is the part of his speech where he breaks away from his notes and speaks about the practicality of a bailout package.

Some fun facts from the speech:

  • The Multiplier Effect of government spending is $1.50 for every dollar of fiscal stimulus; if we had a bailout package of $850 billion, the effect on the real economy would be $1.275 trillion.
  • GDP needs to grow by 2% in order to eliminate 1% of unemployment; the real effect of the stimulus package would be around 9% of our GDP (1.275/14), eliminating 4.5% unemployment…Krugman estimates that unemployment will be around 9-10% by year end. Therefore, on the surface, this stimulus would set the U.S. off into a world of full employment, but we must consider how quickly we can spend the money (which believe it or not, is the hard part).
  • Finally, we’ve  concluded that infrastructure would be one of the best targets of fiscal spending (besides technology). However, estimates show that there are only $150 billion worth of “shovel ready” jobs, or projects which can be started in 6 months (at the earliest). This means we will have to get creative in our methods of spending – green collar jobs, fix bridges, retrofit buildings, upgrade our electrical grid from AC to DC (which would allow our electrical lines to go under water, allowing us to build wind farms in the middle of the Atlantic Ocean).

Hat-tip to Paul for the video.

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From Tony Crescenzi’s blog, via CNBC:

In Friday’s release, cash balances held by commercial banks topped $1 trillion for the first time, reflecting cash balances held at the Fed. Pre-Lehman, cash balances tended to hover around $300 billion, with an annual growth rate of less than 1% per year. The Federal Reserve’s curse on cash, hexed as it was last week with the Federal Reserve’s Zero Interest Rate Policy (ZIRP), will eventually pressure banks to use the cash, as net interest margins on loans are far more attractive than the return on cash.

A good point. Banks won’t be earning there way out of this mess by having their money sit at the Federal Reserve, so one has to think that 2009 will be a big year for lending – albeit there is increasing risk of default – since that is the obvious way a commercial bank earns money (opening savings accounts and making loans). Of course some banks have investment arms, but we know what can happen if we rely too heavily on those for profits…

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From Bloomberg:

Credit Suisse Group AG’s investment bank has found a new way to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds: using them to pay employees’ year-end bonuses.

The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.

“While the solution we have come up with may not be ideal for everyone, we believe it strikes the appropriate balance among the interests of our employees, shareholders and regulators and helps position us well for 2009,” Chief Executive Officer Brady Dougan and Paul Calello, CEO of the investment bank, said in the memo.

The securities will be placed into a so-called Partner Asset Facility, and affected employees at the bank, Switzerland’s second biggest, will be given stakes in the facility as part of their pay. Bonuses will take the first hit should the securities decline further in value.

“It’s monstrously clever,” said Dirk Hoffman-Becking, an analyst at Sanford C. Bernstein Ltd. in London who has a “market perform” rating on Credit Suisse stock. “From a shareholders’ perspective it’s great because you’ve got rid of some of the assets and regulators will be pleased because you’ve organized a risk transfer.”

Interesting approach; stick the originators of toxic assets with the toxic assets as bonuses…Credit Suisse must subscribe to the phrase “What goes around comes around.”

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After a move from $40 to $50, it looked like oil may have bottomed. We now stand at $38, even after production cuts from OPEC.

Oil extended yesterday’s 8.1 percent decline after OPEC agreed the group’s 11 members with quotas will trim current production by 2.46 million barrels a day to 24.845 million barrels a day. U.S. fuel consumption in November declined 7.4 percent from a year earlier to the lowest for the month since 1998, the American Petroleum Institute said yesterday.

The media describes this as “traders thinking the cuts won’t be enough to eliminate a supply glut.” I don’t necessarily agree with that since it isn’t plausible to say that cutting aggregate output from 87.5 million barrels a day to 81.5 wouldn’t affect the price…there lies the issue. It’s not that the action won’t be enough to boost prices, its that OPEC can’t afford to/doesn’t have the discipline to cut output that drastically since they are having a credit crisis of their own, and oil is the only thing the middle east exports (How else will they finance all of these underground malls?)

Anyway, if you believe oil will sustain these lower price levels for the immediate future, there is no explanation for oil related companies to sustain the rallys they had when oil seemed to have bottomed at $40. The drillers (Schlumberger, Transocean, Haliburton) are still depressed, but the conglomerate companies like Exxon and Chevron are quite high.

xom-cvx-uso1

“USO” is an ETF which tracks the price of crude, “XOM” is Exxon, and “CVX” is Chevron (a company which does the same thing as Exxon). Notice that during the sell off in October, both of these companies dropped at faster rates than crude oil. We see the divergence since then,  however during the sell off in November, we saw the same behavior as the October sell off – the oil companies falling harder than oil itself. Given this increasingly large gap in the past month, I don’t think it’s unreasonable to conclude that Exxon and Chevron will be hit rather hard during the next sell off in the new year.

Therefore if you think this rally will end in January, consider buying “DUG” a 200% short ETF which targets oil companies like Chevron and Exxon, or “EEV” which shorts the MSCI emerging markets index. Emerging market economies rely heavily on oil prices, however the Obama infrastructure plan ignited a rally amongst the Iron-ore companies (iron-ore is the chief ingredient in making steel), which caused this ETF to go down substantially.

Or if you don’t like financials either, there is “SDS” which is the inverse of the S&P 500. Since the S&P is a weighted-average index, moves in Exxon and Chevron (in addition to financials) typically dictate how the S&P will close (since they have the most weight from their share price multiplied by outstanding shares – or market caps).

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fail-owned-stock-market-fortune-cookie-fail1

Courtesy of FAIL Blog, a pretty funny site.

I decided that this picture is relevant to Economicequities, since the satire happens to be educational.

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Some people have been making a big fuss about who exactly caused this deregulatory mess (Bush, Greenspan), and this topic has been a particularly prevalent theme over at The Big Picture:

Today’s New York Times has a damning article linking Senator Chuck Schumer to many of the radical deregulatory policies that underlie much of the current crisis.

I have assessed a lot of blame for the crisis on several people — Greenspan at the top of the list, followed by several others, including President Bush. Phil Gramm was a prime sponsor of all manners of ruinous legislation — which, I hasten to add, was signed into law by one President Clinton (he sure isn’t blameless in the mess).

I guess it’s fun to point fingers and try to single out a scapegoat, but we can’t go much deeper than recognizing our mistakes and trying to make sure they don’t happen again. In The Great Depression, for example, we learned that using the gold standard likely exacerbated a series of demand shocks which could have been averted if we had targeted the money supply using interest rates, like we do today (hence, learning from our mistakes).

That said, where are we in the process of identifying what is wrong with our current system, and what will it mean for the future? If we determine that the problem is 30-1 leverage ratios and easy access to money, we are going to accommodate their absence with a much slower rate of growth in our next expansion.

All of that said, I’d like to point fingers for a moment. Anyone think about blaming the SEC? The news of Bernard Madoff’s ponzi-scheme is especially sobering to the fact that no one was/is watching these guys.

From Bloomberg:

Dec. 14 (Bloomberg) — Bernard Madoff’s investment advisory business, alleged to be a Ponzi scheme that cost investors $50 billion, was never inspected by U.S. regulators after he subjected it to oversight two years ago, people familiar with the case said.

The Securities and Exchange Commission hasn’t examined Madoff’s books since he registered the unit with the agency in September 2006, two people said, declining to be identified because the reviews aren’t public. The SEC tries to inspect advisers at least every five years and to scrutinize newly registered firms in their first year, former agency officials and securities lawyers said.

Wait…this is the best part:

“Given what the SEC claims is the magnitude of the fraud, this is something you would hope an inspection would have uncovered,”

Hmm. Good point. Did they even check this Madoff guy out? As soon as the fraud was exposed, a series of reports came out (almost instantaneously) which identified how this was a blatant ponzi-scheme – here, here, here, and here. So how did the SEC not figure this out? Is our public sector really that far behind the curve, as not to identify a $50 billion scam?

Either way, I think there is no chance that the current SEC chairman, Christopher Cox, makes it into the Obama administration. None. Please read his Op-Ed in the WSJ to see how Bob Rubin-esque his analysis of this situation is. As many have pointed out, the SEC has utterly failed to carry out their explicit responsibility in regulating rating agencies, the same agencies which deemed Fannie Mae and Freddie Mac AAA caliber debt, just before they had to be nationalized. The SEC was also responsible for relinquishing the mandated debt-to-net capital ratio (read: leverage) from 12:1 to 40:1, by the way.

As much as I’m not a fan of Jim Cramer’s antics, he could do a better job than Cox – what more could he do worse? He’s talked about reinstating the uptick rule, banning these leveraged ETF’s (which would undoubtedly lower volatility), changing mark-to-market accounting principles for illiquid assets (think of any 3 letter acronym – CDO. CDS. MBS.) – All of which would have a positive influence on the markets, and ultimately our economy.

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