December 15, 2008
A Car Czar. What?
There was a bad idea. A czar is a distant potentate. Someone, by definition, who is not worldly, someone who does not have to deal with reality. That's who congress wanted running Detroit? Methinks that Congress should take a closer look at the financial bailout first, who got the money, and how it has been used.
December 9, 2008
Here is a link sent by Red and White D to a 'cheery' article titled '10 clues: A new bubble is blowing Bet on Wall Street hyping a recovery, big earnings, new bull in 2009', by Paul B. Farrell.
December 8, 2008
Today my December 15 copy of Time Magazine arrived. Let me give a quote from the lead article on Detroit's car manufacturers (p. 37).
Horsehockey.
I once bought a set of new Goodyear tires. Over the next two years three of the four tires blew out on the sidewall. I did not protest to the company. I simply will never buy Goodyear tires again. I also lost three out of four new Firestone tires on a fishing trip to a fairly remote spot in Wyoming. Again, I did not protest to the company. But I will never buy Firestone tires again. That's how I handle things. I am not alone either. I note that the tire stores in downtown Casper (my hometown) that sold Goodyear and Firestone are no longer in business. A lot of other customers besides me must have been unhappy.
Mr. Wagoner may be making great cars now, and he may have a great business plan. But it is not the 'global financial crisis' that is hurting his, or the other two companies' sales. What is hurting their sales is what is probably parked in your driveway, or your neighbor's. What is parked in mine is a 1996 Ford Contour. The front doors don't work right, and that is very irritating. It's the hinges. They are hinges designed to work for five years. The car is 13 years old now. Ford probably saved 12 cents putting 5 year hinges on instead of 25 year hinges.
You know what I am talking about. Those kinds of problems are driving all around you, even if you aren't driving one. Parts don't fit right. Paint does not adhere to metal. Paint does not adhere to plastic bumpers. Knobs come off. Windows quit working. The engine runs fine past 100,000 miles but the transmission gives out. Or the transmission is fine but the engine is shot after 100,000 miles. The list goes on and on. The big three built all these problems into the cars that are still on the road and their owners are reminded of them every time they drive them.
Did you ever try to actually buy a part for your car? I was in the local Ford dealership this fall looking for a part. I had not been in the establishment for at least 12 years. I was soon reminded of why I had not been there for so long. They did not have my part. They could not even promise to get it to me in two weeks...for a 1996 car. It occurred to me as the parts man was telling me this, that I had been visiting the local Casper Ford dealership over a period of 42 years, for both my own used vehicles and brand new company vehicles, and not once had it ever had my part, not once.
The Contour is my wife's car. But I drive it at least once a week. Everytime I drive it I have to open the door, one of the doors with the 5 year hinges, and I am reminded each and every time why I probably don't want to own another Ford. My other vehicle is an old Toyota pickup. It is 5 years older than the Ford, and everything on it works. Hmmm.... and they say that Honda and Toyota have been taking market share away from the big three? Really?
The Big Three have at least twenty years to live down the cars they used to make. A lot of us American consumers simply do not trust them any more to build a decent car. And if they can make one as good as the Japanese cars now, why didn't they do it twenty years ago, and save us good old American consumers all that money and all that grief? And do I get a discount if I buy an American car now for having owned one of the old defective American cars of yore? Not even if we give them the emergency loans?
Speaking of the loans...the Big Three wants $34 Billion. If the Big Three makes 13 million cars in the next 12 months, that's about $2,600 per car. Ouch!
December 2, 2008
Rich Kolon sent a link to this article: 'America's Coming Financial Vortex', by Paul Mladjenovic on FinancialSense.Com. It is very well written and is worthy of your time.
I must say though that I do not agree with this writer's first point: "You will see an inflationary depression that will be evident by 2010."
I think Mr. Mladjenovic has missed the importance about what has been happening in the U.S. in the past dozen years, or so. We've already had the inflation. The overspending by our government need not be inflationary if it is absorbed by the deflating of the inflation we have already seen.
There is a capital exchange that can occur that results in both the buyer and the seller losing money. Commonly, for the average person this can happen, ironically, with the largest purchases he/she makes: a home, or an auto.
A home buyer can take on a mortgage. If the realty market then goes south and/or he/she loses a job and the house gets turned back to the mortgagee, both buyer and seller of the mortgage lose money.
It's also easy to get upside down making payments on a two year old auto that is worth 40 percent of what you paid for it and you still owe two thirds of the money on it. This is particularly onerous if one you lose a job and can not afford the gas for the buggy. The bank, or car company can also lose money if you turn the keys in. What are they going to do with that gas guzzler except lose money when they sell it?
We have just lived through a period of extravagant credit that fed rampant inflation (the inflation I said we've already had). Think about house prices. If you own a home and the value of that property went up by 140 percent over those twelve years, even if it has fallen twenty or thirty percent, you are still looking at some incredible inflation.
For my money, house prices have not fallen nearly far enough. House prices are still way too high. Here is one arguement. Given a simple supply and demand situation, and given that no houses were built during the aforementioned twelve years, what would have to happen to make houses double in price? Well, demand would have to double...population would have to increase dramatically. That did not happen, and houses were built during those twelve years. So what made prices more than double? Easy access to credit. It's just that simple.
So if the U.S. government throws a trillion or two dollars at the problem will that be inflationary? The answer is that it does not have to be if that money is soaked up by losses that have occurred already, and will be occurring as house prices take the hit.
So how, dear reader could we have had such horrible inflation and none of it even made the papers? Well, your Government has been lying to you, particularly about inflation. The scarry part about the lying is that the Government itself does not know how bad the inflation has been. It is opperating in a fog of self delusion and/or denial.
It's even more difficult to fix a problem when you can not even see it.
November 24, 2008
WE MUST BELIEVE IN SOMETHING
Why did a Congress inclined to give money to the auto makers not give them any money? .... because the auto makers failed to give Congress something it could latch onto...a story it could believe.
Remember in Peter Pan when the audience is asked to believe in order to bring Tinker Bell back to life? Well, the auto makers forgot to bring Tinker Bell with them when they testified. They left Congress dangling with nothing to believe in.
That's how we invest folks. We develop a story line that we believe in enough to risk our capital. No Belief = No Investment. It may sound crazy, but that's how we humans are. And we are capable of incredible self delusion. As long as markets are going up and our story lines are supported, we will believe almost anything.
But if the story line gets broken, if we no longer can believe, then we pull back and refuse to take risk. That is why all that money is parked in Treasuries at stupidly low interest rates right now. Nothing new has been developed in which investors can believe.
Looking at it from a Neyian point of view: the flock has suffered some losses, the sheep are scared, they're holed up in a cave where the wolves can not get to them.
Now if you are a wolf, what do you do?
Why, you allow a trading range to be put in that the sheep can believe in...and you tell them that the markets are...you guessed it: 'FORMING A BOTTOM! The sheep are safe in the Cave of Treasuries, and they will find Bottom Formation strangely calming.
And what comes after a bottom? Why yes. We'll have to HAVE A RALLY! Let's make it a good one. I know, we'll have a parade, just like the circus is in town. Everyone loves the circus. We'll have naked ladies and elephants, a brass band with a big booming drum, lions and tigers and bears, trapeze artists, tight rope walkers, and lots and lots of clowns. And slowly at first the sheep will emerge from the cave... one by one, and then more...and thick and fast, they'll come at last, all scrambling to buy more.
Those sheep will be dazzled. They'll be amazed. They'll tell themselves that "it's different this time." Those silly woolies will never notice that they're being led into a box canyon...a place carefully selected beforehand for an awful and bloody shearing.
Now we know that the redemption money from the hedge funds has to be put back to work. There are tax reasons to prompt the sheep out of the cave...and hey, if there is a parade passing by at the time, so much the better. How jolly.
When will that money leave the cave? I'm guessing we'll have a bit of a Christmas rally. There's nothing like a few sugar plums to loosen up the sheep's grasp of reality.
We've just seen the first sugar plum appear. The AP and the Wall Street Journal have writers who have to come up with reasons why the markets went up or down. They have to do this about 280 times a year. Reporters run out of ideas of their own pretty fast (I used to work in a news room, so just trust me on that.) So the reporters develop 'sources', old stock hands who will feed them a believable story line that will explain the market action de jure. That's how and why you will see a headline like this:
'Low interest rates weigh heavily on the markets'
A month later you might see this one:
'Low interest rates boost markets'
Or you might see this old saw:
'Falling oil prices boost markets'
A month later you might read a headline like this:
'Falling oil prices dampen markets'
Headlines that explain why whole markets do something are just plain wrong about 80 percent of the time. So what sugar plum did we just see?
'Obama puts financial team together, markets rally'
Really? Did you buy that one? That's like going to the doctor because your back aches. He prescribes some massage therapy. You feel better immediately...before you even see the therapist. That simple script in your hand made your back all better, right?
Jim Cramer, good Democrat that he is, read that headline and swallowed the whole thing...hook line and sinker. You'd know that if you caught the beginning of his show tonight.
Manipulation is as bad as I have seen it right now. I would expect insiders to pull one of their old tricks out of the bag to further the rally, like a delayed opening, or some computer glitch.
The rally will gather strength near January 10 when much of the money decisions are going to be made. I'd expect that rally to peak for the Innauguration on January 20. I would look for a Time Magazine cover in January ballyhooing the 'Obama Rally', or some such nonesense. Expect an awful racket soon thereafter, partner, as the wolves do a number on the sheep in the canyon where they can not escape the ambush.
And that will be handy because the incoming administration will already have plans made to rescue those sheep, and what with those sheep having just recently had the tar kicked out of them, it'll be easy to sell that rescue plan. Those wolves will have provided Congress the Tinker Bell it can believe in.
November 23, 2008
THERE IS NO MAGIC NUMBER
How far will markets fall? Beats me. There is no magic number, 'levels of support' are illusions folks.
What I see in my crystal ball is establishment of a Primary Low. From that level we will likely see a rally which could go to January 20 or could go on into March. After that we will see markets start falling. Not only will they fall past the Primary Low, they will fall further in an attempt to establish The Low. After that my crystal ball gets cloudy. For, in truth, The Low may not happen until the coming summer.
My guess, and it is only a guess, is that the Primary Low is somewhere in the DJIA 7,000s range and The Low is likely going to be in the 5,000s.
Certainly, we see evidence for what I am predicting. Big 'Smart' money is parked on the sidelines right now in Treasuries, whose interest levels are at historic low levels. That is panic folks. The lower those interest levels go the tighter the constriction on the collective investing airways is.
We had a snap back rally on Friday. Whoopee. I need to see more followup before I would be inclined to go long. Meanwhile the Short ETFs, like SKF, are at dangerously high prices. I feel there is no need to jump into that market at its extreme high.
Many people have written of late. Here is some of what they sent me.
From Rich Kolon:
Bad Timing: Get Ready for Higher Taxes on Your Investments
Greece braces for shipping storm. I quote it below.
'Panic is one word to describe what is going on,' said Polemis, sat beneath an oil painting of one of his family's first vessels, bought some 200 years ago. 'People are selling some ships in a panic mode ... Some companies will go bust.'"
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From the Orange Section:
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From Ben Smith:
This critical theme was developed with hopes that our subscribers would not repeat the mantra of central bank infallibility to their clients. There are at least two main failures. One is in the financial markets, the other is in central planning. The notion that that a speculative collapse could have been prevented by more regulation is absurd, and reminds of the old saying from the old and notorious Vancouver Stock Exchange: 'So long as it is going up the public will believe the most preposterous story'. The most preposterous story in financial history has been that a committee can 'manage' the economy.
Somewhere there should be a rule that those who did not anticipate the disaster should be prevented from vain attempts, with taxpayers' money, to end a financial disaster. This would be particularly applicable to those who claimed that with their skills a disaster was impossible."
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From Red and White D:
The Ending of the Big Government Era Comes to An End. This is humor.
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From Jay Steele Adopted Lab Helps Little Girl Eat Again. This is great news.
November 14, 2008
Red and White D send this link along with the idea that perhaps banks are just being prudent this time:
'Banks must start lending: Senate panel'
Ben Smith sends along these two links.
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID1926808' http://www.foxnews.com/story/0,2933,450464,00.html
November 11, 2008
Here is a link to a 'must read' article: 'The Problem With Deleveraging', by John Mauldin of Minyanville.Com. I quote sections below.
...The internal data was even worse. New orders fells to 32, suggesting further weakness in the manufacturing world. Backlog of orders was 29. New export orders, a source of growth in recent months, fell from 52 to 41, a rather large drop for a single month. This shows the rest of the world is beginning to slow down as well. Boding poorly for employment, only 43% of companies reported that they were planning to add additional employees.
...Basically, automobile manufacturers, in their drive to sell as much as possible, "brought forward" future sales of cars and, as a side effect, put lots of still quite good used cars on the road. New car sales are likely to be depressed for some time. It is somewhat like the housing problem. There is just too much inventory on the road that will have to be worked through. When Detroit gives me a real reason to buy another car, like an electric-powered vehicle, I will. And a lot of Americans, with a need to save money for retirement, are going to feel the same way.
...Hedge funds are also being forced to de-lever. While for most styles of hedge funds, leverage was not all that high (an average of about 1.4 times equity), large redemptions, especially by funds of funds, are forcing sales of all types of assets, but in particular stocks. As an aside, this selling is not over. Mutual funds are seeing large withdrawals, and are also selling."
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Here is a note from the Orange Section in response to my comments about China.
Another issue for China seems to be product quality. (This is probably not across the board) Their products are getting a bit of reputation state side for their cheap quality. In tighter economic times this could become an issue for them.
I have concerns that an administration as pro-labor as Obama's will likely choose to bail out the Detroit Autos. This will solve nothing. Those corporations are sick for a variety of reasons, amongst which is over bearing labor contracts. The fact is, they need to be building better cars at a lower cost basis than their competitors. Right now they have huge pension liabilities and a high labor cost due in part to the UAW. This is compounded with a poor reputation for quality and decreasingly competitive products. If the UAW and their Democratic allies want to see this fixed it is not going to come through Government subsidy. They need to start producing products that people want to buy. Otherwise the Federal government is just flushing tax payer money down the toilet. Of course, when was the last time congress cared about wise spending choices?"
I seriously doubt it will do our domestic car producers much good to bail them out before bankruptcy. Bankruptcy would allow the car makers to shed a lot of obligations to unions (to the tune of about $25/hr/worker). It is those obligations that make a domestic car about $1,600 more than a domesticly-produced Japanese car.
November 10, 2008
Ben Smith sends this link to 'Marc Faber Sees Bankruptcy for the US'.
Rich Kolon says: "The Rydex Nova / Ursa ratio suggests a large shift into bull funds vs bear funds.
http://www.schaeffersresearch.com/streetools/market_tools/rydex_nu.aspx
And that suggests a good possibility of a stock market rally."
Meanwhile China has come up with a stiumulus plan. Here is a link:
'China's stimulus plan buoys markets', from the International Herald Tribune.
The problem with the idea that China is going to lead the way out of economic troubles is twofold. One, it is still heavily dependent on exports...exports that just are not going to be there in future months. Two, as Ben Smith points out, a lot of those exports were subsidized so that China could keep the masses busy. When those factories close, they probably will not reopen.
It looks to me that China is following a sensible plan to invest in infrastructure. That will help some, but will not 'turn the machines back on.' I look for China to import less oil in the future and to sell gold to finance its infrastructure play. The implications for commodities in general are still grim.
November 6, 2008
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I was pretty down about my recent buy of STP until I looked again at the chart. The volume today, and the 'W' formation tell me it has capitulated and should start rising soon.
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November 5, 2008
Rich Kolon sends this link to 'A "Perma-Bear" Warms to Stocks', by Lawrence C. Strauss of Barrons.
I think I agree with William Fleckenstein. This thing is like a double or tripple header. We are still playing the first game. We still don't see the effects of the economic slowdown that is surely coming.
What I see is a recovery rally here....then more downside.
November 3, 2008
Red and White D sends this link to a wonderful spoof.
'Recession-Plagued Nation Demands New Bubble To Invest In', by TheOnion.Com.
Red and White D also sends this link.
'Money for (Almost) Nothing', by the Wall Street Journal.
Ben Smith sends this link.
'How Low Can Stocks Go?', by Morgan House of The Motley Fools.
Here is a link to 'Five Things You Don't Want to Know', by Kevin Depew of Minyanville.Com.
October 31, 2008
Happy Holloween!
Lar sends along this link to 'Why raising interest rates won't work', by Jon Danielsson of the BBC. It is a good summary of what went wrong in Iceland.
Here is a link to 'Preparing for the Coming Crises in Jobs, Funding', by William Fleckenstein on Minyanville.Com. I quote it below. The bolding is my own.
Given the capital destruction and credit contraction now underway, I have a hard time seeing where new jobs will come from to handle all the layoffs that are going to take place. Additionally, given how wild consumer spending has been, there are lots of marginal businesses that are simply not going to make it, on top of all the carnage in anything related to real estate or finance.
...I hope that as the government goes about spreading taxpayer money everywhere, it does something intelligent - like spending money to rebuild our infrastructure (roads, bridges, ports, etc.), and perhaps undertaking the task of stimulating alternative energy resources (while also building plenty of nuclear-power plants), so we can create jobs and eliminate our dependence on entities like OPEC.
...To sum up in baseball metaphors: I believe the credit crisis is probably in the eighth inning. The economic crisis is still doing batting practice. As far as the funding crisis goes, I don't think folks have realized that the game has even been scheduled."
Fleckenstein hits several nails on the head here. Think back two years. The U.S. economy is booming...or is it? A lot of houses are being built at prices beyond which the average family can afford to pay. House builder stocks are some of the darlings of the stock markets. Folks are getting rich 'flipping' homes. Hell, there are television shows devoted to 'flipping'. This isn't the dot-com bubble writ large...writ on the one item that just happens to be the average American family's biggest investment. No, this isn't a bubble. It's different this time.
Idiots are walking off the streets into mortgages there is no way they can afford. Other idiots are lending the money to them. There is a shaddow mortgage industry that is almost completely unregulated, that can nontheless borrow huge amounts of money from the regular banking system, and thus indirectly from the FED itself. Even the 'big boys' like Lehman are neck deep in the funny mortgage business, busy engineering credit default swaps for sub-prime loans.
Most of the growth in the U.S. economy is linked to home building, mortgages, real estate, and U.S. consumers taking out second and third mortgages on their homes to buy all kinds of things from tuition for college, to vacation homes, to Harleys, to goodness knows. And the whole thing is being financed by foreign money. (Now wait a minute there Houston...if the economy is doing so great, expanding a mile a minute, why do we need foreign financing anyway? I guess no one thought to ask that question at the time.)
Fleckenstein tells us that the second crisis isn't even up at bat yet. It's the second game to be played in the tripple header. He's not just woofin' there. Markets have not begun to deal with the layoffs and slow-downs. How could they? The news hasn't even been reported yet. How could it be? Most of the bad stuff that is going to happen hasn't even happened yet. (Comforting thought that, heh?)
Still in the dugout, not up until the third game in this tripple header, is the funding crisis. By the time we really get to cranking up the infrastructure play, will we still be able to borrow from the foreigners like we did back in the bubble days? Will we? Will they? Really?
And this leads me to talk here about energy. It is the most critical challenge we face. We need to develop a lot more of it. The 'drill babby drill' crowd misses the real point I think. We already are. There are no spare rigs around. We are drilling as fast as we can right now. The drilling businesses in North America are running flat out right now. The rigs are busy and committed far into the future.
T. Boone Pickens is dead on when he states that this is one energy crisis we can not drill our way out of. Even if we had the rigs, and we don't; even if we could start drilling off the East Coast and California, and we can't do that either because the states still have veto power on that; we could not drill enough wells to move domestic production of oil from the current 29 percent of our total usage to 30 percent; at least not without a huge drop in domestic demand due to a deep and severe recession.
There I've said it. The only way we are going to be able to increase our domestic oil production, in relation to our total usage, is for our total usage to take a really big hit. Do you get that? Our current producing fields produce less and less each year. We have to drill like crazy just to replace the production we are losing from existing fields. All drilling off-shore can ever promise is to help maintain the status quo, to help us keep up our 29 percent. And to do that we have to build a lot of new off-shore rigs. We don't have any to spare. So if drilling off the East Coast or California is going to happen, new rigs will have to be built to do that, and that will require billions of dollars in investment.
Meanwhile, we need to convert to compressed natural gas (CNG) and electricity to drive our trucks and autos. We need to get that new electrical power from new Nuclear Plants, and from Wind. Clean Coal technology is not ready, not available for this crisis, neither is coal gasification. Neither is truly efficient solar power, though solar can still play a limited role. Solar panels need to go onto the roofs of houses in a big way, both on new and existing homes. They can be effective there. But solar/electric technology is still not efficient enough for commercial installation. In order to create enough electrical power for a city the size of Denver, we would have to pave about two thirds of Nebraska with Solar Cells.
CO2 sequesterization, which would revolutionalize Coal Fired electrical plants by actually eliminating the CO2 they throw into the atmosphere, has never been tested yet. We don't know if it will work anywhere. But we are sure that many parts of the country don't have the right kind of geology for it to work there.
We need to get moving with the technology at hand as soon as a new administration takes over. We don't have time anymore for technology to catch up. We have to start now with the technology we have that works, and that will give us non-poluting electrical power. That boils down to Nuclear and Wind. Period.
October 27, 2008
Here is a link to 'Monday Morning Quarterback: The Great Wonder of the World', by Todd Harrison of Minyanville.Com. I quote its not-so-reassuring words below.
If you're feeling financially inadequate, know you're not alone. This year alone, Brazil is down 51%, China is off 67%, India is 58% lower and Canada (-32%), France (-46%), Germany (-49%), Hong Kong (-60%), Italy (-48%), Japan (-53%), South Korea (-50%), Singapore (-54%), Switzerland (-36%) and the U.K. (-42%) are listening to similarly sullen chin music."
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The Orange Section writes some more:
Americans save in different ways through financial markets whether it be in a Pension or a 401K. I would argue that the main issue is the level of savings and lack of understanding of the ideal of sacrifice.
I don't think you have to look any further than the polls to see the problem. A Majority of Americans are preparing to elect a candidate who is promising to make their lives easier by taking away from those who have succeeded. They think they are getting something for nothing, but they fail to see that Obama's taxation proposals are not just a tax hike for the wealthy, they are also a barrier to opportunity. A progressive tax is also a barrier to upward mobility.
I don't think those voters have done enough time thinking about what it means to call America the Land of Opportunity, and what it means for the country to make it harder to achieve such opportunity. Obama ridicules the income gap and yet his policies will do more to preserve such a gap than any tax hike could ever hope to accomplish. How is that for Irony?
The larger point though gets back to sacrifice. What happened to the breed of American that looks to the accomplished individual and instead of jealousy says 'I want that for myself.' Our culture is so busy lavishing praise of victimhood we are ignoring the fruits of the go-getter. What a tragedy.
Well it started out on savings, but I see the savings as being symptomatic of larger issues in American Society. I have a friend in Texas who puts it much more bluntly: People are whiners."
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I bought some SIMO today at $2.70. It has $2.633 Cash Per Share, with a Debt to Equity Ratio of 0.014. I don't care how long I have to hold SIMO. Here is a chart with SIMO and two other ideas. The numbers come from Yahoo Finance as of today. Note the dividends from NRP and NCV.
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October 26, 2008
Ben Smith reports that there are alerts out for the U.S. Dollar. It is expected to fall soon and test the 50-day moving average.
Here is a link to 'The Other Side of the Trade: Bear Trap!', by Todd Harrison of Minyanville.Com. I quote it below.
...Seeds of isolationism continue to sow as the going gets tough and the tough tend to their own interests. Derivatives may be financial weapons of mass destruction but liquidity is the neutron bomb - pull the pin and it'll suck the life out of the global economy." [Bolding is my own...the Bender.]
In this article Mr. Harrison links to one of his older articles: 'Our Wishbone World'. I quote it below.
...We are approaching a critical crossroads. Structural imbalances have cumulatively increased since the back of the tech bubble and risk has built to a crescendo. The credit contagion simply served as a catalyst to bring this conundrum to bear. All that remains to be seen is where the bear will domicile.
Let's look at both sides of the great debate. To the left is the socialization of markets, nationalization by governments and hyperinflation. To the right, we have asset class deflation, risk aversion and the unwinding of the debt bubble.
...As Mr. Practical observed as we surveyed the situation, 'None of these plans will affect the larger deflationary credit contraction. Debt deflation is occurring outside of the Fed's control at the world's money center banks, where supply and demand for credit has undergone a rapid and significant decline.' [Bolding is my own...the Bender.]
This process will take years to manifest but will ultimately yield positive results. The destruction of debt will allow world economies to build a solid foundation for future expansion that is entirely more secure than what we currently have in place."
And here is a link to a very gloomy article: 'Taiwan Dumps Fannie, Freddie. And Uncle Sam?', by Randall W. Forsyth of Barrons. I quote it below.
October 24, 2008
Many readers wrote that the Orange Section had it right. Here is what Red and White D said:
I have read and re-read Orange Section's comments. He is right! It is not the tool that failed, it is the people using the tool. Like dynamite, derivatives can be helpful or destructive. You can make tunnels through mountains or you can blow your arms off. Put dynamite in the hands of idiots and fools and they do some odd things with it.
The question is the same as always.....how to manage risk.
Thank you for conducting this nice forum. It is fun."
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The Orange Section wrote this follow up.
DTCC is an arm of DTC, the Depository Trust Company. DTC is where all equities and most non US government bonds are settled or cleared. They have a product called DERIV-Serve which is essentially a system to facilitate communication between Brokers and Counterparties in the Over the Counter Derivatives world. Virtually all Credit Derivatives are traded over the counter. Each contract is a customized arrangement. (The ability to customize is probably the most important attribute for this market.) Naturally, this is the opposite of standardization. This created a systemic risk that Greenspan called out in the middle part of this decade. (I think 2004, but I could not find the appropriate speech to reference, my apologies.) The idea of DERIV-Serve is to provide a clearing function with some standardization for this market place in order to facilitate efficient settlement for the contract holders.
The idea that the market was jittery about this seems a little odd tome. I can see how this is the first real test of the system in a turbulent market and how that might cause some stress to participants, but being jittery about Deriv-serve would mean that market participantswere being jittery about whether or not they would get their money in a timely fashion or that it would be properly allocated by DTCC. My sense of the markets is that they were more likely jittery about whether or not they would get their money which has little to do with Deriv-Serve and DTCC. I could be wrong though.
One thing to consider worrying about is this: Deriv-Serve was created because there was a vacuum in the markets as far as infrastructure was concerned when it comes to the settlement of OTC Derivatives. Unfortunately, the Clearing arena is not the only part of the system that lacks appropriate infrastructure. Most accounting systems that handle these types of transactions were not build for Derivatives. In most cases they cannot handle the myriad of entries required to represent such a holding on the books. More often than not these contracts are reported using a mess of exception processing entries. This can lead to incomplete or faulty information being reported up to management which in turn can drive bad decisions.
You also have situations where holders of such instruments do not fully appreciated what they are holding or what their exposures are. The FASB accounting standards for reporting derivatives are at best a discombobulated maze. These securities are still very much in their infancy, market participants are still learning how to handle them and to quantify them in a portfolio. Mistakes will continue to be made."
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Duncan writes: "This is the best article I have seen that details the death of journalism in America. And it was written by a Democrat." He refers to 'Would the Last Honest Reporter Please Turn On the Lights?', by Orson Scott Card of Meridian Magazine. I quote it below.
Your job, as journalists, is to tell the truth. That's what you claim you do, when you accept people's money to buy or subscribe to your paper.
But right now, you are consenting to or actively promoting a big fat lie ? that the housing crisis should somehow be blamed on Bush, McCain, and the Republicans. You have trained the American people to blame everything bad ? even bad weather ? on Bush, and they are responding as you have taught them to."
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I write the following, not to cast blame, but to remind and to enlighten.
First, here is a link to 'Legacy Watch: Greenspan as Mr. 'Shocked Disbelief'', from the New York Times. I quote nearly the whole thing below.
But his testimony Thursday before the House Committee on Oversight and Government Reform changed all that. At the hearing, Mr. Greenspan offered a mea culpa in which he essentially said he assumed that greed guaranteed a basic level of intelligence. Now, two years after his retirement as chairman of the Federal Reserve, he professes to suffer from 'shocked disbelief' that greed apparently can sometimes actually impair intelligence."
If you go to this link and read all the comments on the blog, please do remember that I do not agree with any of those additional comments. They are slanted way too far away from the reality of Greenspan's actual job history.
But the words quoted above do make a point. Not only can greed impair and override intelligence, it can keep on doing it day after day, until all those days have added up to decades. (See 'Greenspan's Hindsight is 20/20', by Scott Reeves of MinyanVille.Com.)
I am reminded of the old French tale of a farmer going to town on market day and returning with a 'pig in a poke'. The piglet, which would have been worth the money he spent, turns out to be a kitten for which he has no use at all. Certain people and Wall Street firms were in positions to get rewarded by selling 'kittens in pokes' (a poke is a bag).
A hoard of others, according to the Orange Section, set up an industry buying and selling pokes. Most of the bags, by percentage, had real pigs in them. But quite a few did not. The poke business became such a standard practice that folks forgot that they could not actually see inside the pokes.
This 'lack of transparency', the innability to judge the real value of the poke, is what has the financial world in turmoil still.
The chain of transactions that the Orange Section describes so well had too few limits, and that was part of the problem. Folks who traded those pokes could have looked into a poke now and then, they could have marked the outside of a poke now and then. They mostly did not do this. The series of transactions he describes as starting with him and me, then going on to Mr. Jones, and then to Mr. Smith need not have ended with, and most likely did not end with Mr. Smith. No, the trail of ownership led to many many more entities. It is more than likely that the same entity bought and sold the same poke multiple times, and most likely did not recognize it the fourth, fifth, and sixth time through, let alone the twenty fifth time.
Another bothersome thing about the 'poke' trade was valuation. The uniqueness of each poke ruled out standardized poke valuations. And with each transaction the poke was being valued anew. What about misvaluation? When the same poke is traded again and again, what happens when an error in valuation occurs? People are messy things. They make errors. In this 'poke' trade does an error get magnified as it creeps through generations of transactions? Would it come to be a sort of awful financial genetic mutation? And does the last owner get left holding the bag with this awful thing inside?
In a way, Mr. Greenspan made an assumption about the 'poke' trade, and in making that assumption he gave official sanction to a practice that should have been much better scrutinized. Ain't hindsight great?
It's not Greenspan's only error, nor is it his greatest one.
Americans have long been criticized for not being a nation of savers. How much can you make at your local bank on a savings account? Can you get one percent on your money? Two? At what rate can the bank borrow from the FED? Why should the bank pay you more than it pays the FED? Taking your money involves a lot more work, a lot more bookkeeping. So the bank will always pay you less than it pays the FED. That's a fact of life.
That being the case, at what rate can the bank borrow money from the FED right now? Keeping that rate very low for a very long time kills the incentive for people to save money. Now remember what Greenspan did along that line. He kept rates very low for a very long time. Few people have ever thought about what that did to savings.
As far as I can tell, we will never see a rebirth of savings until banks offer better rates. That is not going to happen in the current financial environment.
