Oil dropped below $40, standing at $36 and changes. That is lowest in last four years. Just a few months ago it was at above $150, and expected to go to $200. What happened? Supply and demand? Not entirely.
Remember a few months ago, no matter how much production increase OPEC countries implemented, the oil price just kept going up. Now it is the opposite: no matter how much production cut, the oil price keeps dropping. Yesterday OPEC leaders announced a huge production cut, 2.2M barrels/day, or 7%, after slicing 1.7M/day already in the past three months. Surprise, oil price dropped >9%. Go figure!
There are just too much speculative trading in oil by the Wall Street. It is creating tremendous volatility in oil price that is very bad for businesses. Same situation is happening to currency exchange. Dollar has gone from dog house to king's castle in a matter of past three months. A few months ago, one Euro can buy more than $1.50. A few days ago it went down to $1.27. And in last few days, it is back to $1.43. Volatility in basic materials and currency exchange is very damaging to global trade and business investments. When business cannot reasonably forecast their input costs and trading revenue (in foreign countries), how can they conduct effective business planning? They will often have to engage in expensive hedging plans to offset the uncertainties. That benefits the Wall Street but hurts economy.
We HAVE to regulate more the hedge fund industry and stop this type of crazy speculations that damage real people and real economy.
Thursday, December 18, 2008
Bernard Madoff's "Giant Ponzi Scheme"
The Bernard Madoff saga continues to dominate the financial news headline. This 70-year old fellow has been running a "giant Ponzi scheme" (in his own words) for the past two decades. Loss to the investors could exceed $50B, largest financial fraud in history. Where were the auditors? Where was the SEC?
Ponzi scheme is a term named after Charles Ponzi, a financial con artist. But even Ponzi was not able to deceive people for so long. A Ponzi scheme is like robbing Peter to pay Paul. Investors are promised high return. So they gave the money to the fraudster. The fraudster pay the earlier investors with money gotten from the later investors. As long as money keeps pouring in, the scheme can continue. But if new investors do not come in, the music stops.
Madoff has aroused a lot of suspicion over the years. Today's Wall Street Journal profiled a guy by the name of Harry Markopolos who had been prodding the SEC to investigate Madoff for years. SEC basically ignored him.
Over the past several years, government regulatory agencies have become too cozy with the businesses they regulate. President Bush wants the government agencies to "serve" the industry, and be "business friendly". Republican ideology is "let business self regulate". What you end up with is "Robber Barons" style capitalism. Large business hire lobbyists to pass government policies that favor the big businesses and create barriers for competition. Small businesses and consumers are left in the dark.
I doubt there will be any significant change even under Obama. There are just too many vested interests out there. It would be enormously hard to overcome them. The American public is stupid , and can be easily misled by these big interest groups who control the media and the propaganda machines. If Obama wants to change all that, he will be slandered and demonized, and then rendered completely ineffective. I think Obama understands that. If he really wants to do something good for America, he should make small incremental changes. Gradualism is the key. Don't step on too many toes. I hope he is smart enough. He does not want to end up like JFK, right?
Ponzi scheme is a term named after Charles Ponzi, a financial con artist. But even Ponzi was not able to deceive people for so long. A Ponzi scheme is like robbing Peter to pay Paul. Investors are promised high return. So they gave the money to the fraudster. The fraudster pay the earlier investors with money gotten from the later investors. As long as money keeps pouring in, the scheme can continue. But if new investors do not come in, the music stops.
Madoff has aroused a lot of suspicion over the years. Today's Wall Street Journal profiled a guy by the name of Harry Markopolos who had been prodding the SEC to investigate Madoff for years. SEC basically ignored him.
Over the past several years, government regulatory agencies have become too cozy with the businesses they regulate. President Bush wants the government agencies to "serve" the industry, and be "business friendly". Republican ideology is "let business self regulate". What you end up with is "Robber Barons" style capitalism. Large business hire lobbyists to pass government policies that favor the big businesses and create barriers for competition. Small businesses and consumers are left in the dark.
I doubt there will be any significant change even under Obama. There are just too many vested interests out there. It would be enormously hard to overcome them. The American public is stupid , and can be easily misled by these big interest groups who control the media and the propaganda machines. If Obama wants to change all that, he will be slandered and demonized, and then rendered completely ineffective. I think Obama understands that. If he really wants to do something good for America, he should make small incremental changes. Gradualism is the key. Don't step on too many toes. I hope he is smart enough. He does not want to end up like JFK, right?
Bailing out auto companies without debt restructuring amounts to bailing out Wall Street
I agree with the Senate republicans: if the auto companies don't restructure the huge amount of debt on their balance sheet, giving them any amount of money will not help them. The money they receive will only be enough the service the interest payment on the debt. Who owns their debt? Wall Street investors. So without first restructuring the debt, the money will just end up in the hands of the debt investors. And a few months (or even weeks) down the road, these dying auto companies will have to come back to ask for more financial help.
A debt restructuring without filing for Chapter 11 is the best way out. Their debt is already trading at below 19c on a dollar. To me that means debt investors are waiting for a Chapter 11 type of debt restructuring.
A debt restructuring without filing for Chapter 11 is the best way out. Their debt is already trading at below 19c on a dollar. To me that means debt investors are waiting for a Chapter 11 type of debt restructuring.
Wednesday, December 10, 2008
Treasury yielding 0%: absolute risk averse of the investors
Yesterday, the Treasury auctioned $30B worth of 4-week bills with 0% interest to the investors. For the off-run 3-month treasury, the yield briefly was pushed to negative territory. Basically investors are lending money to the Treasury (Uncle Sam) for free, or even paying the government for storing their cash (in the case of the negative yield 3-month bills), while demanding high interest rate to lend to corporations and individuals even with good credit. In a finance lingo, the credit spreads are unusually wide. That means investors are absolutely risk averse.
We are in an uncharted territory here. Last time when the Treasury auctioned short terms yielding 0% was late 1930s and early 1940s, during the great depression. This is certainly not a good sign.
When the private sector is not willing to take any risk, which is reflected in the ultra low interest rates on public debt and exorbitantly high interest rates on other debts (commercial, local municipalities, and individual loans), should the government step in to provide credit for the economy, as Keynesian economists would propose? I think the answer is absolutely yes.
The banks are not doing the lending. They took the cash from the Treasury's TARP (Troubled Assets Relief Program, widely known as the $700 Wall Street Bailout), and stuffed it in their vault. Homes are continuing to default. Businesses cannot get loans. Individuals cannot buy a house even they can afford (the credit standard has tightened too much). The result is that real economy is suffering. The Treasury bailout did not benefit the main street. It only fattened the pockets of the financial institutions.
Now it is the time to give money to the main street, to the real economy that creates real value to the country, not the paper-flipping Wall Street firms. How do we do that? I think the Obama economic stimulation plan is a good start. But it is not enough. And it is not quick enough. Let's put cash to work, right now!
First, the Treasury should use its cheap financing option to pump cash directly to the mortgage market, by buying high quality mortgage loans. (In my previous post, I argued that this action would even make money for the Treasury). Along the same line, the Federal government should aid the State and local governments by directly giving low interest loans to them to meet their budget shortfalls because they cannot borrow in the municipal bonds market. And yes, the Treasury should rescue the auto industry. Not only that, it should also help other domestic companies who cannot borrow from the commercial paper or corporate bond market.
The Treasury needs to act quickly. TARP is not working. Credit for the real economy is still frozen (although inter-banking lending has loosened). By real economy, I mean those "goods-producing" companies, not those trading financial papers (Wall Street). According to some estimates, there will be $800B corporate debt that needs to be refinanced in 2009. And $200B faces refinancing in the next quarter! If the credit spread does not narrow, many companies will be put to the brink of bankruptcy. The ripple effect throughout the economy would be unthinkable.
We need to end this lame duck government sooner than Jan 20. Can we amend the Constitution to allow Obama to swear in right now?
We are in an uncharted territory here. Last time when the Treasury auctioned short terms yielding 0% was late 1930s and early 1940s, during the great depression. This is certainly not a good sign.
When the private sector is not willing to take any risk, which is reflected in the ultra low interest rates on public debt and exorbitantly high interest rates on other debts (commercial, local municipalities, and individual loans), should the government step in to provide credit for the economy, as Keynesian economists would propose? I think the answer is absolutely yes.
The banks are not doing the lending. They took the cash from the Treasury's TARP (Troubled Assets Relief Program, widely known as the $700 Wall Street Bailout), and stuffed it in their vault. Homes are continuing to default. Businesses cannot get loans. Individuals cannot buy a house even they can afford (the credit standard has tightened too much). The result is that real economy is suffering. The Treasury bailout did not benefit the main street. It only fattened the pockets of the financial institutions.
Now it is the time to give money to the main street, to the real economy that creates real value to the country, not the paper-flipping Wall Street firms. How do we do that? I think the Obama economic stimulation plan is a good start. But it is not enough. And it is not quick enough. Let's put cash to work, right now!
First, the Treasury should use its cheap financing option to pump cash directly to the mortgage market, by buying high quality mortgage loans. (In my previous post, I argued that this action would even make money for the Treasury). Along the same line, the Federal government should aid the State and local governments by directly giving low interest loans to them to meet their budget shortfalls because they cannot borrow in the municipal bonds market. And yes, the Treasury should rescue the auto industry. Not only that, it should also help other domestic companies who cannot borrow from the commercial paper or corporate bond market.
The Treasury needs to act quickly. TARP is not working. Credit for the real economy is still frozen (although inter-banking lending has loosened). By real economy, I mean those "goods-producing" companies, not those trading financial papers (Wall Street). According to some estimates, there will be $800B corporate debt that needs to be refinanced in 2009. And $200B faces refinancing in the next quarter! If the credit spread does not narrow, many companies will be put to the brink of bankruptcy. The ripple effect throughout the economy would be unthinkable.
We need to end this lame duck government sooner than Jan 20. Can we amend the Constitution to allow Obama to swear in right now?
Thursday, December 04, 2008
Treasury to the rescue: 4.5% mortgage interest rate?
Today Wall Street Journal revealed that the Treasury Department is mulling a plan to bring down mortgage interest rate to as low as 4.5%. According to WSJ, this can be accomplished by direct purchasing of new mortgages by the Treasury through Fannie and Freddie. You know what? This is a fantastic idea. Only the Wall Street type would come up with this great idea. The Treasury is headed precisely by a Wall Street pro, Hank Paulson. (No, I am not being sarcastic here. I mean it. Finally, some real good idea came out of there.)
How does this work? Let me explain.
Right now the Treasury Bonds are trading at an extraordinarily low interest rate. Yield on the 30-year T-Bond is below 3.1%, while yield on the 10-year bond is around 2.6%. That means the Treasury right now can borrow money at very low cost. In the meanwhile, the interest rate on Mortgage debt is relatively high. A 30-year conforming loan right now is yielding around 5.3%. In the Wall Street lingo, the "spread" between Treasury and Mortgage is very wide, at least 2.2% (5.3%-3.1%).
What if Treasury borrow money from the financial market by selling Treasury Bonds at an interest cost of 3.1%, and then use the money to buy mortgage debt that generates a much higher interest income. The higher interest income the Treasury would get from the Mortgage investment would more than enough to pay for the borrowing cost on the Treasury Bonds, still leaving a smart chump for the Treasury.
How much the Treasury could make if it indeed decides to go ahead with such a plan? The Treasury will not buy all mortgages. It will buy only high quality conforming mortgages, minimizing default risk. Total market for these mortgage loans could be more than $600B/year. Let's assume that the Treasury would buy $100B of these Mortgage loans at a target interest rate of 4.5%. On the other hand, the Treasury would have to first issue $100B Treasury Bonds, probably at a higher cost than current, say 3.5%. So the spread would be a full 1%, which translates into $1B net interest income per year for the Treasury.
Secondary effects of these transactions would be very positive. Home sales would go up because of the attractive interest rate. Existing mortgages should be repriced because of thawing up of the mortgage market. Indirectly banks would be helped because their mortgage investments will regain liquidity. I think this is a great idea. This is an idea that would first help homeowners and also help the financial institutions. So far the $700B Bank Bailout Plan (the "trickle-down/top-down plan", as I would call it) has not produced the desired result. Banks are hoarding the cash they got from the government, instead of lending out to businesses. Credit market has not seen any much loosening so far. I believe this proposed plan, (a "bottom-up plan" as I would call it) would produce the desired result: loosening up the credit market.
One caveat remains: the money Treasury would get from Mortgage payments should go back to pay down the debt it borrowed in the first place. The government cannot get its hand on this bucket of money for other budget use. Any profit from the transaction should also be used to pay down the government debt. This way, we would not end up creating another inflationary bubble.
How does this work? Let me explain.
Right now the Treasury Bonds are trading at an extraordinarily low interest rate. Yield on the 30-year T-Bond is below 3.1%, while yield on the 10-year bond is around 2.6%. That means the Treasury right now can borrow money at very low cost. In the meanwhile, the interest rate on Mortgage debt is relatively high. A 30-year conforming loan right now is yielding around 5.3%. In the Wall Street lingo, the "spread" between Treasury and Mortgage is very wide, at least 2.2% (5.3%-3.1%).
What if Treasury borrow money from the financial market by selling Treasury Bonds at an interest cost of 3.1%, and then use the money to buy mortgage debt that generates a much higher interest income. The higher interest income the Treasury would get from the Mortgage investment would more than enough to pay for the borrowing cost on the Treasury Bonds, still leaving a smart chump for the Treasury.
How much the Treasury could make if it indeed decides to go ahead with such a plan? The Treasury will not buy all mortgages. It will buy only high quality conforming mortgages, minimizing default risk. Total market for these mortgage loans could be more than $600B/year. Let's assume that the Treasury would buy $100B of these Mortgage loans at a target interest rate of 4.5%. On the other hand, the Treasury would have to first issue $100B Treasury Bonds, probably at a higher cost than current, say 3.5%. So the spread would be a full 1%, which translates into $1B net interest income per year for the Treasury.
Secondary effects of these transactions would be very positive. Home sales would go up because of the attractive interest rate. Existing mortgages should be repriced because of thawing up of the mortgage market. Indirectly banks would be helped because their mortgage investments will regain liquidity. I think this is a great idea. This is an idea that would first help homeowners and also help the financial institutions. So far the $700B Bank Bailout Plan (the "trickle-down/top-down plan", as I would call it) has not produced the desired result. Banks are hoarding the cash they got from the government, instead of lending out to businesses. Credit market has not seen any much loosening so far. I believe this proposed plan, (a "bottom-up plan" as I would call it) would produce the desired result: loosening up the credit market.
One caveat remains: the money Treasury would get from Mortgage payments should go back to pay down the debt it borrowed in the first place. The government cannot get its hand on this bucket of money for other budget use. Any profit from the transaction should also be used to pay down the government debt. This way, we would not end up creating another inflationary bubble.
Bailout for the Auto industry: good or bad?
Chiefs of the Big Three auto companies came to the Capitol Hill to beg $34B to bail out their companies. This time, they did not come on their private jets. They took Southwest Airline and took a train to the Capitol. But there are still significant doubts among the lawmakers whether the bailout will be sufficient to turn around the failing US auto industry.
First of all, I think the government SHOULD help the auto industry. As to what is the best way to help them, I am not sure. Will writing them a check for $34B help? I don't know. But we cannot let the auto industry fail. It is one of the very few REAL industries that the US still has. If the federal government can spend a tune of $5 trillion (based on some analysts' estimate) to bail out the fraudulent financial industry, how can it not spare a small change of $34B to rescue the REAL economy?
But I do have lots to complain about the US auto industry:
1) Don't blame your failure on the Union
Sure it would be nice to have low labor cost. But why not these companies also reduce their executive compensation? Alan Mulally, the CEO of Ford, made $55M in last two years, while the company lost over $15B during the same period.
2) Big Three's problem is not that their cars are not cheap enough. Their problems is people don't want to buy their cars no matter how cheap they are
So the Big Three's problem is more of a REVENUE side, than a COST side. If they can sell more cars, they would be able to make a profit. But their market shares are dwindling despite the fact that they offer so much enticement for people to buy their cars, such as 0% financing and thousands of dollars of rebate. Lowering cost would not reverse the trend of their market share loss.
How do we deal with the problems at the Big Three? Honestly I have no clue. And I do not think anybody has any clue. Until we can convince American consumers to buy US cars not Japanese cars, no matter how much money we give them it will save them.
First of all, I think the government SHOULD help the auto industry. As to what is the best way to help them, I am not sure. Will writing them a check for $34B help? I don't know. But we cannot let the auto industry fail. It is one of the very few REAL industries that the US still has. If the federal government can spend a tune of $5 trillion (based on some analysts' estimate) to bail out the fraudulent financial industry, how can it not spare a small change of $34B to rescue the REAL economy?
But I do have lots to complain about the US auto industry:
1) Don't blame your failure on the Union
Sure it would be nice to have low labor cost. But why not these companies also reduce their executive compensation? Alan Mulally, the CEO of Ford, made $55M in last two years, while the company lost over $15B during the same period.
2) Big Three's problem is not that their cars are not cheap enough. Their problems is people don't want to buy their cars no matter how cheap they are
So the Big Three's problem is more of a REVENUE side, than a COST side. If they can sell more cars, they would be able to make a profit. But their market shares are dwindling despite the fact that they offer so much enticement for people to buy their cars, such as 0% financing and thousands of dollars of rebate. Lowering cost would not reverse the trend of their market share loss.
How do we deal with the problems at the Big Three? Honestly I have no clue. And I do not think anybody has any clue. Until we can convince American consumers to buy US cars not Japanese cars, no matter how much money we give them it will save them.
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