Getting to “Yes” in the Wild West December 28, 2008
Posted by wonderingin in Banking.add a comment
Washington Mutual (WaMu) was one of the parade marshals leading mortgage borrowers down the path to financial ruin for the bank, their borrowers, and ultimately the taxpayers who are footing the bill for the largest bank failure in history!
“At WaMu, getting the job done meant lending money to nearly anyone who asked for it — the force behind the bank’s meteoric rise and its precipitous collapse this year in the biggest bank failure in American history.
On a financial landscape littered with wreckage, WaMu, a Seattle-based bank that opened branches at a clip worthy of a fast-food chain, stands out as a singularly brazen case of lax lending. By the first half of this year, the value of its bad loans had reached $11.5 billion, nearly tripling from $4.2 billion a year earlier.”
Continue reading from the NYTimes…
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Many if not most spectacular bank failures involve aggressive bank executives pursuing aggressive growth, which ultimately requires lowering the bank’s lending standards and subsequently burying the bank under a mountain of bad loans.
For some strange reason, some people think that banks can and should be growth businesses. They are not.
Banks’ functions are more like those of a utility – enabling commerce for a fee. And they should be treated like utilities, which are allowed to earn a reasonable return on their capital but only under the aegis of tight regulatory supervision.
Stay tuned for big changes in the way banks operate and don’t buy any bank stocks just yet!
Option ARMs were candy-coated poison December 26, 2008
Posted by wonderingin in Personal Finance, The Economy.add a comment
“We have not been able to identify one delinquency, much less a foreclosure, that is due to the product,” Mr. Sandler said, adding that “if home prices had not dropped, you wouldn’t see” a single article.
- Herb Sandler, former owner of World Savings Bank & Golden West Financial
Option adjustable rate mortgages (option ARMs) allow borrowers to choose the amount of their initial monthly payment, which is generally less than the amount necessary to amortize the loan or even pay the full amount of interest due monthly. The most egregious loans allowed borrowers to make monthly payments based on a 1% interest rate while the loan accrued at a much higher rate.
The result is an increasing principal balance. After an initial period (often 3 to 5 years), the loan resets as a fixed rate loan with a much higher payment required to amortize the loan over its remaining term. In a rising housing market, the strategy was to re-finance at or before the mandatory reset since many if not most borrowers would not be able to afford the higher monthly payments after the reset.
The loans were especially attractive to borrowers who could not afford high cost housing with traditional mortgages or who had poor credit, and to unscrupulous mortgage brokers pushing loans for a fee.
Mr. Sandler’s option ARMs were a direct contributor to the housing bubble by allowing people to buy homes at higher prices than would have been possible previously. Historically, rising home prices would have been choked off earlier at lower levels by the limits of traditional mortgage affordability.
Mr. Sandler’s option ARMs were part of a self-fulfilling prophecy – the longer the period and the higher the prices at which people can buy unaffordable homes, the larger the bubble and the greater the pop when the bubble finally bursts, as surely it must.
Miracles in the middle of the night December 25, 2008
Posted by wonderingin in Uncategorized.add a comment
How we got hear and where we may be headed December 21, 2008
Posted by wonderingin in Banking, The Economy.add a comment
There have been numerous recent explanations for how we came to the current financial crisis and what might happen next. The following commentary is one of the better summaries.
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“Little by little, business is enlarged with easy money. With the exhaustless reservoir of the Government of the United States furnishing easy money, the sales increase, the businesses enlarge, more new enterprises are started, the spirit of optimism pervades the community.
“Bankers are not free from it… They are human. The members of the Federal Reserve board will not be free of it. They are human…. Everyone is making money. Everyone is growing rich. It goes up and up, the margin between costs and sales continually growing smaller as a result of the operation of inevitable laws, until finally someone whose judgment was bad, someone whose capacity for business was small, breaks; and as he falls he hits the next brick in the row, and then another, and then another, and down comes the whole structure.
“That, sir…is no dream. That is the history of every movement of inflation since the world’s business began, and it is the history of many a period in our own country.”
- Elihu Root opposing establishment of the Federal Reserve System in 1913, as quoted in Is the Medicine Worse Than the Illness?
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And lest we forget, while inflation is good for borrowers, it’s deadly for savers.
Keeping things in perspective December 20, 2008
Posted by wonderingin in Politics, The Economy.add a comment
In the midst of all the dreary economic news and tales of scandal, we should also remember that most things in America still work pretty well.
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“This is a good time to remember who we are…. We are the largest and most technologically powerful economy in the world, the leading industrial power of the world, and the wealthiest nation in the world…. We are the oldest continuing democracy in the world, operating, since March 4, 1789, under a vibrant and enduring constitution that was formed by geniuses and is revered, still, coast to coast. We don’t make refugees; we admit them. When the rich of the world get sick, they come here to be treated, and when their children come of age, they send them here to our universities. We have a supple political system open to reform, and a wildly diverse culture that has moments of stress but plenty of give.
…while terrible challenges face us—improving a sick public education system, ending the easy-money culture, rebuilding the economy—we are building from an extraordinary, brilliant and enduring base.”
- Peggy Noonan, Who We (Still) Are, WSJ, 12/20/08, p. A15
Throwing stones December 19, 2008
Posted by wonderingin in Accounting, Banking, The Economy.add a comment
The current credit and financial crises have produced more than their share of scapegoats – unreasonable politicians; greedy executives, mortgage brokers and investment bankers; lax regulators; tight-fisted accountants, etc., etc.
Now, the putative scapegoats are throwing stones at each other!
In a recent interview, Gerrit Zalm, former Dutch Minister of Finance and recently named CEO of the combined ABN Amro and Fortis operations in the Netherlands, claims that the credit crisis is a regulatory problem and not an accounting problem (referring to the furor over whether the new fair value accounting standard in the U.S. is a cause of the credit crisis).
Zalm says the accountants merely report what they see. Zalm also serves as a trustee of the IASC Foundation which oversees the work of the International Accounting Standards Board (IASB).
In reality, it’s more like an incestuous ecosystem – all are to blame or none are to blame. We’re all in it together.
Ring around the Rosie December 18, 2008
Posted by wonderingin in Accounting, Banking, Corporate Finance.add a comment
Modern financial reporting contains elements similar to the observer effect in physics where the act of observing the behavior of sub-atomic particles actually changes their behavior.
Investment banking and financial services have focused much of their energy on creating innovative (black box) financial instruments (e.g. derivatives, mortgage-backed securities, structured financial products) which generated wealth (for their creators) while often skirting existing capital, regulatory, or accounting requirements. SIVs (off balance sheet special purpose investment vehicles) were also involved in many instances.
Financial gurus create products designed to get around particular accounting or regulatory constraints for which their clients gladly pay. Something blows up, regulators clamp down and demand that the accountants write new (often heavy-handed) rules to limit or eliminate the offending practices or products and then the game starts all over again.
Chuck Prince of Citigroup said it best, “As long as the music is playing, you’ve got to get up and dance.” This time around, however, when the music stopped, all of the chairs were knocked over, some broken beyond recognition. It reminds me of the nursery rhyme Ring around the Rosie.
Let’s hope the credit crisis is not a financial version of the bubonic plague.
Asset allocations to sleep by December 17, 2008
Posted by wonderingin in Personal Finance.add a comment
With the stock market (as measured by the S&P 500) down 40% over the last year, we’ve all had a few roller coaster stomach-in-throat moments. Some investors are less ill than others especially those few savvy enough to convert everything to cash early in 2008.
Personally, I have a terrible record at calling the turns on anything in the markets. For me sleeping well at night is all about conservative asset allocations. While I use money managers and consultants for advice on occasion, I always work out my own asset allocations based on these principles:
- Invest only in things I understand
- All investment strategies must be transparent
- Own all investments directly
My investment goals are pretty simple: preservation of capital and long-term average returns of inflation + 3%. Here are my current asset allocation targets:
- Real estate (all direct) 20 – 25%
- Equities 10 – 15%
- Muni bonds 40 – 45%
- Cash 15 – 20%
While the stock market hit was significant, it was not a disaster and I still sleep well at night.
Everyone wants to be a bank (holding company) December 16, 2008
Posted by wonderingin in Banking.add a comment
It seems that everyone in the financial sector now wants to be a bank holding company. Earlier, it was Goldman Sachs (GS) and Morgan Stanley (MS) as they worked to stave off the market contagion hammering their stock prices.
More recently, other players are stepping up for some Fed love, notably GMAC the giant finance company owned by Cerberus Capital and General Motors.
There would seem to be some real opportunity here for better funding using bank deposits, in addition to access to various Fed borrowing programs and FDIC debt guarantees.
GS had total assets at the end of August of $1.081 trillion versus bank deposits of $29 billion (3% of assets). MS had assets at the end of August of $987 billion and deposits of $36.7 billion (4% of assets). Finally, GMAC had $211 billion of assets and $19.5 billion of deposits (9% of assets).
By contrast, JPMorgan Chase had $969 billion of deposits supporting $2.2 trillion of assets and Bank of America reported $874 billion of deposits against $1.8 trillion of total assets, both at September 30, for an average of 46% of deposits to assets.
For GS, MS and GMAC to achieve deposit levels equal to only 30% of their current total assets, they would collectively need to raise approximately $600 billion in new deposits.
I wonder where all that money is going to come from?
But, then again maybe some of them won’t need those deposits after all.
Elephants in the room December 15, 2008
Posted by wonderingin in Politics, The Economy.add a comment
President-elect Barack Obama has won praise for his economic and national security teams – both indications, some would argue, of an intent to govern from the center and with continuity during a time of war and economic crisis.
But now the new administration’s true color (green) is showing brightly in the naming of the energy and healthcare teams. Mr. Obama is smart, smooth and pragmatic. But he is not likely to let a little recession and financial crisis get in the way of his big plans.
Americans rarely accept big changes except during a crisis, and some have argued that the current crisis might actually make it easier to make big changes in areas such as business regulation, energy, and healthcare.
Some elephants stand in the way of rapid, large-scale change.
Healthcare – activists like to point to the insurance companies and the drug companies as the bad guys, but the real conflict will come between the already squeezed healthcare provider community (doctors and hospitals) and those seeking to contain costs (squeeze the docs some more) and those seeking to improve healthcare for the uninsured (squeeze the docs even more).
Affordable, universal healthcare and reducing healthcare costs are in direct conflict. They are in fact mutually exclusive without rationing. And rationing is the big elephant in the room which no one is talking about.
Read – Why Americans pay more for healthcare
Energy – the rapid decline in the price of oil has let much of the air out of this balloon. Yes, we need to find new sources of energy and reduce our reliance on foreign oil. Neither of those are likely to happen quickly with oil at less than $50 per barrel.
Wind and solar power were not economical without government subsidies with oil over $100 a barrel. How will that work at $50? Energy sensitivity only works in Europe because gasoline costs $9 a gallon. And no one is suggesting that Americans would tolerate a gas tax of even $1 or $2 dollars per gallon let alone $7.
The climate change and energy policy changes demanded by progressives could only happen quickly if Americans were willing to dial back their standard of living significantly – another big elephant in the room.
Making money in the ether December 14, 2008
Posted by wonderingin in Business, Finance.add a comment
For years, my children would ask me, “What exactly do you do [for work], Daddy?”
I never had a good answer for them because I worked in so-called knowledge worker service professions such as consulting and management – activities which provided services rather than making products. I did not make or sell anything which my children could see or touch.
There are services and then there are services. Service industries come in three varieties. There are the physical service industries such as retail workers, technicians, and janitors. These service workers earn poor to ok wages with no real opportunity for significant economic advancement. Then there are the professional service workers – doctors, lawyers, accountants, scientists, managers, etc. – who earn solid, even comfortable, middle and upper middle incomes but we are not talking about people getting rich doing this stuff.
Finally, there are the Wall Street types – investment bankers, traders, money managers – who have figured out a way to make money – gobs of money – by manipulating and multiplying the invisible computer bits which make up much of the wealth in the modern world. Expand the bits and trillions of dollars in new wealth is created. Let the bits contract and trillions of dollars in wealth disappear.
Making money in the ether* took on new meaning for me, however, when I recently realized that the financial sector (banks, brokers, money managers, etc) made up 40% of the total capitalization of the U.S. stock market!
Can any of this stuff be real?!
Apparently a lot of it was not – we were just fooling ourselves.
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UPDATE 12/19/08 – While I am not routinely a Paul Krugman fan, his column in today’s NYT – the Madoff Economy – does add more grist to this debate.
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* There is even a web site (http://www.ether.com) where you can sell what you know.
Prudence pays – most of the time December 13, 2008
Posted by wonderingin in Corporate Finance, Personal Finance.add a comment
A recent article in the Wall Street Journal (Americanus Prudens: In Search of an Endangered Species) lauded the return of thriftiness and prudence as virtues in America. Prudence requires patience and discipline – two more scarce virtues in our culture.
Prudence has not always been rewarded. Profligate borrowers benefited from cheap financing and rising asset values while savers received little return on their savings amid a growing risk of inflation. Shareholders and executives of highly leveraged businesses enjoyed phenomenal financial rewards – until the music stopped. And now, it is the prudent who will shoulder much of the cleanup burden.
At the same time, risk-taking is at the heart of the free enterprise system. Anyone should be free to take whatever business and financial risks they feel appropriate as long as they are risking solely their own money. When other people’s money is involved (owners, shareholders, lenders), the standard must be prudent risk taking.
What is prudent risk taking?
Prudent risk taking involves taking an action or actions which involve significant risks only after fully understanding those risks and clearly assessing the probability and cost of each signifcant risk, as well as what actions can be taken to mitigate those risks.
In the runup to the current credit and financial crisis, borrowers, lenders, investment banks, and investors all made the same mistakes:
- They assumed that markets and asset values would continue to rise (it’s different this time).
- They trusted without verification (ninja loans, credit ratings, investment bankers)
- They implicitly assumed modest downside cases based on recent economic history (how bad can it get?) while we now face a financial crisis and recession more severe than anything experienced by most people living today.
- Finally, in each case, the actors took great risks with other people’s money.
There are some very hard lessons here:
- We each need to learn to assess our own risks and make our own decisions.
- We should not trust the advice of others without independent verification.
- We will all sleep better if we are a bit less greedy – after all, you can’t take any of it with you when you leave!
Our standard of living is in jeopardy December 12, 2008
Posted by wonderingin in Finance, Politics, The Economy.add a comment
The American standard of living is in jeopardy as never before.
Our collective historical economic success has been built on the hard work and personal responsibility of the free enterprise system. Personal saving and investing were hallmarks of that success.
Now, however, we are a nation of debtors as well as a debtor nation. And the proceeds of that debt have been spent on consumption (by individuals) and transfer payments (more consumption) by government.
There is a limit to how much we can borrow. The Wall street investment banks have reached that limit and are contracting rapidly. Consumer borrowing and spending have also contracted sharply in recent months.
Only the Federal Government seems to have unlimited borrowing capacity as every economic sector queues up for its own rescue. But the government’s borrowing capacity is also finite, and we may in fact be approaching that limit faster than we think.
The Federal Government has committed approximately $1 trillion of borrowed money to various bailout and rescue schemes, and the federal budget deficit for fiscal 2009 may exceed $1 trillion in a total economy of less than $15 trillion.
And that’s before President-elect Obama’s administration tees up regulatory reform, energy reform and healthcare reform. Any time a Democratic administration legislates “reforms,” higher spending and taxes are usually involved.
How will we pay for all of it? More taxes on the rich will not cover the bill. Sounds like more borrowing.
And yet our principal lenders have increasing concerns at home. China’s $500 billion domestic stimulus package will reduce the amount of their foreign currency reserves available to buy our debt, and the rapid decline in oil prices below $50 will surely reduce Treasury purchases by the oil states.
Sooner or later, we must learn to live on what we earn. That time may be sooner than we think.
Long, dark night of the soul December 11, 2008
Posted by wonderingin in The Economy.add a comment
While it may be a bit extreme to characterize our current economic difficulty as a coming long, dark night of the soul, we do appear to be facing an extended period of economic disruption, decline and possibly even entropy.
Our present dilemma was a long time in coming, and it will require considerable time to unwind the excesses of: easy money, low investment risk premiums, excessive leverage, and asset bubbles, not to mention our national “have it all now” attitude.
The combination of frozen credit and declining consumer spending is now rippling through the economy like the aftershocks of an earthquake. While the severity of the damage will vary widely and seemingly unpredictably, no industry or economic sector is likely to be completely immune.
As we each take shelter as best we can, we should remember two things:
- The economic shaking will not cease until the dragon’s energy is spent.
- Nothing lasts forever – not even earthquakes.
in the middle of the night December 10, 2008
Posted by wonderingin in Our purpose.add a comment
In the middle of the night, many things come to us including fears, revelations, and sometimes inspiration. From whence they come, we do not know; but come they do.
Napoleon Hill believed that these sudden waves rolling over our consciousness resulted from mental signals received from other people or from brief connections to what he called infinite intelligence – that body of everything that is to be known in the universe.
The middle of the night is also that time when we lie awake wrestling with our personal demons or just the struggles, large and small, of our daily lives. It’s that time when we try to make sense of what is happening around us or to us, and, more importantly, what we should do in response.
