Ratings Agency Rope-a-dope March 14, 2009
Posted by wonderingin in Banking, Financial Markets, Personal Finance.add a comment
The ratings agency downgrades of Warren Buffet’s Berkshire Hathaway after the company recently reported some large paper losses for 2008 remind me of the old joke about the job of an auditor -
he’s the guy who comes in after the battle to shoot the wounded.
Throughout the financial crisis, the ratings agencies (Fitch, S&P, Moody’s) have been more than a few days late and a lot of dollars short. They have been just one more cog in Wall Street’s investment banking black box.
That banking black box has worked much like the chicken pie machine in the children’s movie, Chicken Run (“chickens go in; pies come out”) until the machine broke down and its owners had no idea what to do to fix it.
Ratings and default insurance have allowed investors to avoid doing their own homework much to their current dismay. If you don’t know what you are buying and why, you are a chicken waiting to be plucked.
The new normal – like it or not March 12, 2009
Posted by wonderingin in Personal Finance, Regulation, The Economy.add a comment
“The business landscape has changed fundamentally; tomorrow’s environment will be different, but no less rich in possibilities for those who are prepared. … We are experiencing … a restructuring of the economic order” – Ian Davis, Managing Director at McKinsey
It’s time to fasten the safety belts (if you have not already been thrown from the roller coaster)!
Just as the current economic turmoil is unprecedented since the 1930’s, Davis anticipates major shifts in the structure of the U.S. economy:
- Less financial leverage – consumer and business
- More government involvement
- Lower levels of consumption resulting in lower economic growth
- Global economic growth increasingly centered in Asia
- Continuing technological innovation
While there will continue to be significant opportunities for individual economic advancement, the rising tide of overall economic growth has shifted to other shores.
The Great Consumer De-leveraging Picks Up Steam March 10, 2009
Posted by wonderingin in Personal Finance, The Economy.add a comment
The great de-leveraging of household balance sheets is in full swing according to Vince Farrell at Soleil Securities:
“Despite surging unemployment, the latest stats show the consumer re-liquefying his/her balance sheet at a rapid pace. The savings rate this time last year was essentially zero. In January it hit 5% which is the steepest rate of ascent since they started keeping records. Savings has averaged about 7% over the very long haul but in the 1970’s and 1980’s it averaged over 9%. It is probably a good bet it will move towards that level and very quickly. While that will impact GDP negatively (money saved is not money spent) it is a necessary part of the restructuring that the economic/financial landscape has to undergo.
“The savings rate is soaring and the consumer is paying down debt at the same time. The Globe and Mail reports that the number of people behind on their credit card (“behind” defined as 90 days past due) fell by 11% in the last quarter. Also, a category called “non-mortgage interest” paid by consumers fell 13% last quarter which is apparently the first time it has declined since 1948 when they started keeping track. Paying less interest indicates less debt outstanding.
“That idea is borne out by the stats on consumer credit which fell $20.6 billion in the fourth quarter. And that is the largest decline since 1943 when this particular item was first observed. The danger is the consumer retrenches too much or permanently and we get a stagnant economy even if we solve the toxic asset issue. I look forward to worrying about getting the consumer to spend after the savings rate reaches higher single digits and sanity returns to the consumer balance sheet.”
With consumers in full retreat, and the investment banks shrinking under regulatory pressure, Uncle Sam looks to be left holding the bag – he will be sending you a capital call for your share in the very near future.
Damming the flood of foreclosures March 7, 2009
Posted by wonderingin in Financial Markets, Personal Finance, The Economy.add a comment
Much is being written about slowing the mortgage foreclosure crisis and “keeping people in their homes.” According USA Today, 50% of the foreclosures in 2008 occurred in 35 counties (mostly in CA, AZ and FL), and just seven counties accounted for 25% of the foreclosures.
But many of the proposed government programs amount to little more than damming up the river after the flood has begun – the water still has to go somewhere.
“Why can’t the government find the right way to bail out the financial system and the housing market? Historian Tom Woods has a provocative answer: it’s a fruitless war against reality. No matter what steps we take, prices will fall to their market levels. What’s worse, all the attempts to prevent this are just making things worse by creating chaos in the markets,” writes John Carney at the Business Insider.
Maybe the better answer would be to let the flood wash through and then clean up the mess. Declare the worst counties disaster areas, focus the federal aid there, and let housing in the rest of the country proceed in the normal fashion.
What are they smoking? February 20, 2009
Posted by wonderingin in Business, Economics, Personal Finance.add a comment
“Launching ‘public works’ projects – putting people to work with shovels and jackhammers to put money into their pockets – is not the way to jump-start a 21st-century economy – or to build competitive advantage in the different world that is taking shape.” The Obama administration “understands that the US economy needs more than a relief package for troubled banks, asphalt for pot-holed streets and patches for schoolhouse roofs,” and is “proposing a higher-impact stimulus package that addresses future needs and national competitiveness.”
- Samuel Palmisano, CEO of IBM in the Financial Times
Read the article in the Financial Times
The real problem with both scenarios is that some people inside and outside the government actually think that government programs can solve our problems.
Only we can solve our problems. Government’s role is to provide businesses and individuals with:
- proper incentives to save and invest,
- reasonable tax rates such that all the work is worth the effort, and
- a moderate regulatory environment that attempts to corral the worst excesses without trying to micro-manage daily conduct.
I refer to this as the parenting model of oversight. Anyone who has been a parent of teenage children understands that you can work to instill values and good habits, but you cannot control all their actions. Sooner or later your children must make their own decisions and then take the consequences.
In economics, this is called the discipline of the markets.
Stimulus is a four-letter word February 19, 2009
Posted by wonderingin in Personal Finance, The Economy.add a comment
Much of the talk in political circles these days has been about the giant economic “stimulus” package which was just passed by the Democratic Congress and signed by President Obama.
Creating jobs, however, requires investment not just stimulating consumption. Our current economic mess was driven in large part by high levels of consumption based on excessive amounts of borrowed money.
The recent level of excess consumption is not likely to resume, and it should not. People need to be saving more for what will matter in the future rather than trying to buy everything in sight today.
Investing to sleep well – Part II January 8, 2009
Posted by wonderingin in Financial Markets, Personal Finance.add a comment
In an earlier post, we wrote about asset allocations to sleep by. Yesterday, John Bogle added his Six Lessons for Investors. With a few comments from us, they are:
1. Beware of market forecasts, even by experts – no one really ever gets this right. Even the prognosticators who hit on a big one, do not necessarily have good overall forecasting track records. We merely remember (they tout) the one time they got it right.
2. Never underrate the importance of asset allocation – To my way of thinking, asset allocation must go beyond stocks, bonds, emerging markets, etc. Proper asset allocations should include significant amounts of cash (for safety) and directly owned real estate (the value never goes to zero) without significant leverage.
3. Mutual funds with superior performance records often falter – I personally prefer to own stocks directly for transparency.
4. Owning the market remains the strategy of choice – This is a classic indexing strategy, Mr. Bogle’s favorite hobby horse and claim to fame, but it may not be sufficient, especially in times like now when the markets are swooning.
5. Look before you leap into alternative asset classes – This should be true for any investment decision. What are the risk and return profiles? How much can you lose? How much can you afford to lose?
6. Beware of financial innovation – Welcome to Wall Street where the pros get rich and investors may or may not make a nickel depending on the timing. On the flip side, the Wall Streeters would not have a chance to make money from new products unless at least some investors were clamoring for higher returns or a better deal.
Regardless of the asset class, no one should expect above market returns unless they know something that others don’t. Saving money with steady interest compounding often beats all the other options.
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.
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.
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!
