Archive for October, 2008

Dag? Nab it! …

Just wanted to write a quick post to tout another pet project I’ve been working on with a couple of friends called dagblog.com, which just celebrated it’s one-month anniversary and is doing pretty well for such a new site. Right now, the blog is heavy into politics and business, not a surprise given current events,  but over time, we hope the scope of the content expands into entertainment, business, sports, satire and other areas of interest.

Most of what I write there is cross-posted here, but you really should read some of the other stuff on dagblog if you get a chance. If I may say so myself, I’ve been really impressed by the content so far.

And if you’re in the NYC area, dagblog plans on having a little election-night party, so stop by if you can – details to come.

The unspoken fear …

Take a step back from the day-to-day machinations and minutiae of the campaign for a moment. Put aside thoughts about the final stretch of polls and stump speeches and negative advertising and robo-calls and ground games and electoral map hypotheticals, and consider the enormity of what this country appears to be on the brink of doing one week from now: Electing an African-American to the highest office in the land.

Given the history of this nation, it is a remarkable prospect. It is exhilarating. It is almost unbelievable.

And that is why it is also very frightening.

Frightening because as the prospect of an Obama presidency becomes more real, I believe there are many in this country who are so sick and deranged that they would risk their own lives to make sure that doesn’t happen. Even with the best and most comprehensive security force, you cannot convince me that an assassination isn’t a very real possibility. Obama is attracting enormous crowds of tens of thousands of people, which are nearly impossible to totally manage. All it takes is one nut with a semiautomatic to be successful.

I now believe that an assassination is the only thing that will prevent Obama from being inaugurated as President of the United States come next January.

I hope I’m just being overly cautious or neurotic – with my personality, that would be within the realm of possibility – but I think a lot of people are wondering the same thing and just don’t want to express the unmentionable.

Am I wrong to worry??

ENOUGH!!! …

I’ve had it.

This country has been on engorging on a cheap credit binge for the last decade, stuffing itself on the sugar highs and empty calories provided by ultra-low interest rates and fancy derivatives and zero-down mortgages. Now the chickens are coming home to roost, and everyone is looking for a way to get their butt saved.

It’s bad enough that Congress already spent $150 billion earlier this year on a fiscal stimulus plan that did nothing but allow us to buy IPhones and XBoxes for a few more months. The American people now want more, and it looks like Congress is going to give it to us with another huge stimulus package. It’s money we can’t afford right now and which won’t do anything but provide another very temporary boost to an economy and consumer that needs to retrench for an extended period of time before they can begin to reflate.

But spending money one doesn’t have is the American way. Just ask the country’s beleaguered homeowners now drowning under onerous interest payments, the folks who were too busy picking out Ikea furniture to read the fine print of those adjustable-rate, no-doc mortgages they were signing.  They, too, are soon going to get plenty of help from our friends in Washington.

You see, everyone says we need housing to rebound in order for the economy to recover, so by god, we are going to make the housing market rebound, even if it means the government has to buy up all those nasty little mortgages and restructure them, as Senator John McCain has so magnanimously offered to do (and to hell with the free market and the natural laws of supply and demand).

But really, who could possibly blame the American people for wanting to be spared the pain of an economic downturn?? They’re just following the lead of our most esteemed industry and financial leaders and watching with green eyes as the government tosses around hundreds and hundreds of billions of dollars like so much loose change.

How fitting that the first ones at the government trough were the Wall Street pigs who cooked up this unhealthy smorgasbord slop and fed it to the ravenous, greedy (but mostly unsuspecting) crowd of American consumers.

Oh, it may seem unseemly that the ones largely responsible for creating this mess would be the first to come begging for help, but The Powers That Be knew the financial system that Wall Street had so cleverly manufactured was so fragile that many of these banks couldn’t fail. They knew that the pyramid scheme would have to be unraveled slowly or the entire economy would shut down.

So in order to prevent exposing the rot in the system to the public, regulators forced Bear Stearns into the hands of the relatively well-capitalized JP Morgan Chase, guaranteed the losses with a $29 billion loan and then lowered interest rates in an emergency session.

But that was just the start. You know the rest of the story. The scope of the problems became obvious, and it was clear the cancer had metastasized to every corner of our financial system. Housing in particular was a disaster, so we nationalized Fannie Mae and Freddie Mac (which should never have been privatized in the first place, as one of the only things scarier than capitalism gone mad, is capitalism with implicit government backing gone mad ).

AIG, too, needed help since it had gotten caught insuring a lot of these failing institutions, so we rescued that firm with $85 billion (and then watched as some of that promised money was immediately spent on a lovely sales retreat, replete with a $23,000 spa bill).

And yet all that government assistance still wasn’t enough, so the Treasury and the Fed went to Congress and pleaded for another $700 billion, and only after getting that pork-laden package passed have they begun figuring out exactly how they are going to use that money to save our banking system and economy.

It is all just so very frightening, but the last straw for me was reading an article about some of those poor, poor folks in the hedge fund industry who are now hoping they’ll also see some of that bailout money. Treasury Secretary Paulson insists the money is just for banks and thrifts, but that ‘plans could change’.

You’ve got to be kidding me!!

I mean, for crying out loud, it was only a decade ago when the government and a bunch of banks bailed out a hedge fund company named (ironically enough) Long-Term Capital Management.

Long-Term Capital, with its use of insane leverage (at least 25x) in highly illiquid, poorly regulated financial instruments, including some of the very same derivatives and mortgage-backed securities that are now causing us grief, was in many ways Version 1. 0 of the current Wall Street mess. And yet we ultimately learned very few lessons from that clear early warning sign (This Working Group document has some great background on the LTCM debacle as well as a number of generally ignored conclusions and recommendations).

Frankly, we missed a golden opportunity to increase supervision and disclosure requirements to help rein in some of the industry’s excesses.

Even worse, the LTCM bailout (and the subsequent lowering of interest rates by then-Fed Chairman Easy Al Greenspan) helped fan the flames and foster the environment that we now find ourselves in by encouraging more ill-advised risk taking while institutionalizing the idea that the government will always be there to cover up for our mistakes.

But there is a price to be paid for that largess. Eventually, we’re going to have to pay for this misguided philosophy. I’m just worried that it’s too late, that we’ve dug ourselves into a hole so deep it will take a generation or more to climb out of.

So it’s time to stop the capital injections and bailout plans, the incessant pumping of liquidity into the markets and the careless printing of money, the debt issuance and the interest rate cuts. We’ve done enough to unfreeze the markets and prevent a systemic collapse. It’s time to let the brutally effective corrective mechanisms of capitalism take care of the rest.

As Obama said during the most stirring moment in his Denver keynote convention speech:

‘Enough!’

How The American Dream created this American nightmare …

You hear a lot of conservatives nowadays wanting to place blame for the country’s current economic crisis on the Community Reinvestment Act of 1977, which encouraged commercial banks to lend money to borrowers in low-income areas.

The implication is that the CRA, enacted and significantly expanded under two different Democratic administrations, led to the creation and proliferation of the risky subprime mortgages that have brought the U.S. banking system to the brink of collapse.

Never mind the fact that CRA-regulated commercial banks originated less than half the total subprime mortgages or that at least as much share of the blame for how things got out of hand has to be placed on the Republican-led repeal of the Glass-Steagall Act, which allowed investment banks and other less regulated institutions to engage in similarly risky lending (and to do so without the leverage restrictions placed on commercial banks).

But conservatives do have a point (even if it’s not the one they really intend to make): This country’s myopic focus on home ownership as the be-all and end-all of The American Dream did indeed help spawn the housing and credit bubble, and the CRA is just another in a long list of government policies that have encouraged home ownership as an important component of economic development and societal stability.

OK, maybe I’m just a bitter renter who’s trying to justify his lifestyle and puny net worth, but I do wonder … is home ownership really that important?

The National Association of Realtors certainly thinks so, and some of their rationale makes sense. For society as a whole, home ownership may in fact offer some advantages, as people who buy their homes are more likely to be invested in their communities and neighborhoods than renters. However, I would think these benefits have diminished over time as the nation has developed and become more settled.

Encouraging broad home ownership probably also acts as an alternative means of reducing income inequality in a capitalist economy, and at the same time instills in citizens the importance of private property rights, both of which lead to increased stability in our society. Given that our national savings rate is negative, home ownership also encourages people to invest and save funds they might otherwise not.

But that capital comes at a cost, an opportunity cost. Homes are static entities, non-productive investments. By themselves, homes don’t create anything of tangible value.

And homes are not particularly good investments, either. Robert Shiller did a hundred-year study and found that homes increased in value about 3% a year on average, not much more than the rate of inflation, with only a couple of temporary periods of dramatic outperformance.

Another study by two professors, Roger Ibbotson and Jack Clark Francis, found that housing increased in value about 8.6% a year from 1978 to 2004. Not bad, but not as good as commercial real estate at 9.5% and well behind stocks at 13.4%. (Granted, you can’t live in a stock).

The math gets a bit better when you account for the substitution costs of renting, but a lot worse when you include the other costs associated with home ownership – and there are plenty of them, such as mortgage interest, insurance, upkeep, refurbishing and property taxes. The WSJ estimated that a $300,000 house could end up costing an owner more than $1 million over 30 years. And that excludes the costs of buying and selling a home, which can add up to as much as 10% of the transaction value and make moving to a location that better suits one’s needs or skills a much more expensive prospect than it’d otherwise be.

A good trader friend of mine, who used to live in a rented NYC apartment, described his St. Louis home as a ‘money pit’ and usually wishes he was still renting.

Unlike with stocks, where diversification is possible and laudable, owning a home often requires a person putting almost of his or her eggs in one basket. And if you bought a home in the last couple of years, that’s a much smaller basket now.

Bottom line: Obviously, every locality is a bit different, but I think owning a home can make sense for people who plan on staying in the same place for about 5-10 years, or who enjoy the responsibilities of upkeep and maintenance (I, however, recoil at the prospect of lawn mowing and do-it-yourself repair projects).

But even in the best of scenarios, home ownership is rarely the best path to getting rich. And as we’ve found out in recent months, making it a key goal for a society – at the expense of other worthwhile goals and values – can lead to a rather unwise deployment of capital and some really nasty unintended consequences.

Ok, Here’s the rally … Now what??

OK, so I was a day or two late with my short-term bottom and violent rally call, but it’s party time on Wall Street today with the markets almost up more than double digit percentages.

So where do we go from here? Well, my prediction that we could get back close to Dow 11K will likely prove far too aggressive, but it’s very likely this will have at least some legs. There’s just too many people bearish and short for it not to last a bit longer (People who are short are at least not in the market will worry that we’ve seen the bottom and will fear missing out if the rally continues).

But also remember that V-type bottoms (where we sink dramatically only to immediately recover all that ground and then some, such that the price charts resemble the letter V) are very rare beasts.

In the short term, I think this rally could last a while but that the downtrend will remain in place and that we will revisit the lows from last week sometime in the next few months, if not sooner.

In the medium-term, if this winds up being just a normal recession, we have seen the lows and will probably start to move higher as much of the bad news and lowered profits have been discounted by the market. Remember, during your garden-variety recession, the stock market tends to do well since it begins to anticipate the recovery period.

Unfortunately, I think we are in for something far worse and we will likely meander in a range near the 8-9K level on the Dow for a year or more, and we could even end up breaching those lows from last week.

The problem is unless you’re an active trader or will need a lot of your invested money sometime in the near future, you should probably mostly sit tight and ride out the storm. I’ve said it many times, this could end up being economic Armageddon but it’s not the likeliest scenario and panicking or changing your long-term investment strategy won’t do much to help you.

Add some gold (or gold ETFs or gold stocks) to your portfolio if you’re really worried.

For an insightful, more positive take on the long-term prospects on the market, this provides some great analysis.

We need more panic, not less …

Damn, I thought I was going out on a limb when I called for a violent (though short-lived) rally to the upside. But if the press and the pundits who speak their mind in the press are any indication, that’s a very crowded limb.

I’ve been watching CNBC A LOT for the past few days, and it seems like nearly everyone is looking at this crash as a great buying opportunity, telling people not to panic, saying a bottom is at hand and a violent rally is on its way.

And sure enough, it looks like the bottom seekers are out in full force this morning, completely reversing a panicky, early 600-plus point loss on the Dow that brought us to an 8000 level we haven’t seen since 2003. It’s almost too textbook.

I understand that the press doesn’t want to be seen as fanning the flames, and a lot of the pundits have (third-degree burned) skin in the game and are engaged in some unsurprising wishful thinking. And they’re probably right – surely if you have any kind of long-term horizon, this is a better time to buy than sell – but it’s all making me nervous because lasting bottoms generally only come when no one wants to buy … when you can see the whites of their eyes, so to speak.

The complacency is unsettling … This is scary stuff. These are unprecedented events. The economy is on the brink (and whether the market bottoms here or not, Main Street is due for a long period of suffering).

What’s worse is that so many of these people have been naysaying the problems all the way down – Vince Farrell, Brian Wesbury, Erin Burnett, Larry Kudlow, the list goes on and on. I wish the pollyannas would say ‘We were wrong, so we honestly can’t now say we know what’s going to happen.’

And now that I’ve gone out on that crowded limb calling for a short-term bottom and a violent rally, I hope I don’t have to join them.

Short post on short selling and a short-term bottom …

I think we’re about to get a much-needed reminder that stock markets don’t always go down.

Could happen today, could happen tomorrow, and it may or may not happen after one last big selloff, but we’re going to get a relief rally very soon. I don’t expect it to last long, but I do expect it to be rather violent and dramatic. Maybe we get back close to 11,000 on the Dow.

My short-term optimism (and change in opinion) stems from a conversation I had with a hedge fund guy at a conference on Tuesday. He said every hedge fund guy is desperately looking for new stocks to short. ‘You can’t have enough short ideas,” he told me.

It’s counter-intuitive, but it’s actually good when investors are all bearish because that means there’s a lot fewer people with stock they want to sell. (Remember, short selling is a bet against the market in which investors sell borrowed shares of stock in hopes of buying them back at a lower price and pocketing the difference).

It’s been especially difficult for hedge funds because the government unwisely banned short-selling in more than 1,000 different stocks (the list was at first 800 stocks, and was supposed to be limited to financial companies, but the list has expanded to the point of ridiculousness both in terms of size and scope).

At first, I thought the short-selling ban was keeping the market unnaturally high, but now I think it may have had the unintended consequences of making things worse. Hedge funds who may have covered their shorts haven’t done so because they know they can’t put them back on. Some sectors like technology may have been especially hurt as hedge funds looking for shorts have had to target companies outside the financial industry.

So I think the lifting of the short-selling ban Wednesday night could prove to be a catalyst to spark that rally. The Fed could come together with the European Central Bank to lower rates in a coordinated attempt to stimulate the markets.

Again, in the long term, I don’t think anything the government does will prevent an extended, deep slowdown, the likes of which we haven’t seen for decades, if not generations. The market will probably sink much lower than where it is today.

But at this point, even a short-term rally would be most welcome.

Some perspective on a Gray Monday …

So, the market is down 555 points, almost 5 percent. Yet so far this is no October Black Monday, like when the market dropped 13 percent on October 28th, 1929 or when it dropped 22% on October 19, 1987. (Note: Things are moving fast, market down more than another 100 points since I started writing).

This is, in many ways, even worse – just another Gray Monday, where we get the continued, orderly drip-drip-drip of a market with no confidence, and no idea of where we are headed.

Did you know in the Great Depression the market fell 89% from its 1929 peak? And that it took us three years to get there? I’m not saying that’s what is going to happen now. The world is very different. The genesis of this crisis is very different (whether that’s good or bad, who knows?). But it’s something to consider. I think we’re headed toward that panic sell-off … but we’re not there yet, and even if we have it, I don’t expect to get the immediate recovery we got in 1987.

Things will likely get worse before they get better. Good people will suffer. But to complain seems rather silly when so many people around the world have much bigger problems. As far as I know, I’m healthy. My family is healthy. i have so much love in my life. I know how I’m going to find my next meal. I live in a country where I can speak my mind, and vote my conscience.

Yes, even on Gray Mondays, life goes on.  I walked my dog in Central Park this afternoon and the sun was still shining. It was a beautiful early fall day, and I enjoyed every moment, watching my cocker spaniel search for any bits of food left by careless picnickers and chase squirrels he’ll never catch and wouldn’t know what to do with even if he did.

This election both presidential candidates have been tossing out words like Hope and Change as if they were cheap plastic political buttons, offering very few specifics about how we are going to get out of this mess. But Hope and Change are powerful concepts, and if applied correctly can help people get through tough times.

Today, I’d like to add one more:

Gratitude.

You’re kidding, right?? ….

So yesterday I wrote about how the Senate was making the bailout plan bigger but not better in order to get reluctant legislators aboard.

Oh man, you have no idea. It makes me want to cry.

According to the WSJ, A bill that was originally 3 pages is now more than 400 pages. Among the useless ‘sweeteners’ tacked onto the plan:

  • Economic development credit to American Samoan businesses
  • 50% tax credit for some expenditures on maintaining railroad tracks
  • 7-year recovery period for motorsports racetrack property
  • Special expensing rules for film and TV productions
  • Income averaging for Exxon Valdez litigants for tax purposes
  • $10,000 tax credit for training of mine rescue team members
  • Deduction for income from domestic production in Puerto Rico
  • Increasing cover of rum excise tax revenues to Puerto Rico and the Virgin Islands

AND MY FAVORITE …

  • Exempting children’s wooden arrows from excise tax

YOU’VE GOT TO BE KIDDING ME!!!!

McCain says all the time that if he becomes President, we will know the names of the politicans who try to push their own pet earmarks. It’s one of the things he says that resonates with me.

I know people say this is the way Washington works. It’s how laws get passed. Give and take. You scratch my back, I’ll scratch yours. Gotta please the constituents … That’s bullshit.

It takes a lot for me to get outraged at something our government does. I’m as cynical as they come. But how dare these politicians use this moment, this time, with the economy on the edge of collapse and the financial fate of millions of Americans on the line, to muddy up an already outrageously expensive plan with such useless additions.

Let’s get something straight: These changes do not make the plan better. And they weren’t needed to get this deal passed. Politicians who voted against the bill were already worried that their ‘No’ vote pushed a teetering economy over the edge, and many of them were looking for a second chance to make amends. A couple of small, but relevant, changes to the plan would have provided all the cover they needed.

All this additional pork is a travesty of the legislative process. And if the candidates really mean it when they spout the word Change like it’s some kind of magical Buddhist mantra, it’s the kind of crap they’ll try to put a stop to when they get elected.

Is this a better bailout … or just a bigger, badder one?

So now the Senate is going to try its hand at passing a bailout plan. I’d make a prediction that the bill will almost certainly be passed by both chambers of Congress, but I apparently am a lot better at sports and market predictions than political ones.

The Senate bill seems extremely similar to the one rejected by the House earlier this week, save for a few sweeteners thrown in to try and mollify the politicians who thought the the original plan either did too much to blow up the deficit and prevent the market from self-cleansing (Republicans) or not enough to help lower- or middle-class Americans (Democrats).

Unfortunately, most of these ‘sweeteners’ really aren’t so sweet. Instead of exemplifying the wonderful compromises that can be created when a messy political system works its gridlocked magic, many of these proposed changes are just more sour examples of a broken Washington that encourages myopic legislation.

For instance, let’s take a look at perhaps the most controversial addition to the bill: Modification of the current mark-to-market accounting policies now in place that force banks to price their assets at current market levels.

This is a complicated issue, but mark-to-market basically forced banks to take huge writedowns on the mortgage-backed securities that are at the core of the current crisis and still mostly rotting away on balance sheets throughout the system.

Critics say the mark-to-market rule has a couple of main problems: 1) Banks which are forced to take writedowns must raise more capital and curb lending to satisfy reserve requirements or face insolvency, which only helps contribute to the spiraling meltdown 2) Mark-to-market leads to inaccurate or unnecessarily overstated writedowns, since in many cases the market for these mortgage securities is non-existent or in a state of unusual distress.

These critics say that if mark-to-market stands while the bailout plan is implemented, banks will be less likely to sell their bad assets to the government at low prices because that will mean they will have to book huge losses on the rest of their balance sheets. These critics instead want these assets to be valued by bank regulators … the same regulators who had little to no idea of the problems being created by the housing bubble.

In my opinion, getting rid of mark-to-market would be a big mistake. Marking to market ensures that banks take their lumps and move expeditiously to shore up their balance sheets. Japan’s decade-long retrenchment has lasted as long as it has partly because banks refused to face up to current realities. A report from a Credit Suisse analyst put it best: “Which information is more relevant, what you paid for an asset in the past or what it’s worth right now?”

This may be one of the worst changes, but almost all of the other ‘sweeteners’ in the Senate version of the bill will raise the total cost of the plan while producing, at best, unclear benefits. I fear that the cost of this bailout package will soar past initial estimates, and younger generations will be paying for this mess for decades to come.

Among the other changes being discussed in the Senate bill:

  • Temporarily raising FDIC insurance to $250,000 per account. This is a mostly cosmetic move designed to bolster people’s confidence in banks and keep them from moving funds out of the system, esp. with regards to smaller institutions. Alas, if a lot of banks go under, the FDIC won’t be able to afford the increased coverage and will have to borrow more from the Treasury. Ugh.
  • Relief from the alternative minimum tax, or the AMT. Call me biased, but this is a good idea. The AMT has gone far beyond what it was originally intended to do, which was to make sure that very rich folks do not use deductions to avoid paying their fair share of taxes. Because it hasn’t been indexed to inflation, the AMT now affects millions of middle-class Americans, including yours truly. But whether AMT reform makes sense or not, relief won’t come without a price (and stop me if you’ve heard this one before): An even bigger deficit.
  • The creation or extension of a slew of tax breaks, including an R&D credit for businesses, and local and state tax deductions for individuals. Some of these deductions do encourage desirable behavior, such as the purchase of solar panels, but I’m sure some of them will end up being as stupid as our ethanol subsidies, and all of them will come with a cost.
  • A mental healthy parity law, which requires certain health insurance companies to provide the same coverage for mental illness and addiction as they do for physical illness. OK, this may be a fine and worthwhile legislative initiative, but it has absolutely no place being added to a bailout plan.

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