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.
Monday, November 24, 2008
Are we going back to gold standard? Not quite so fast
Recently there have been increasing number of pundits calling for bringing the dollar back to gold standard. If you have read the Wall Street Journal and Financial Times in the past few weeks, you would have seen on the opinion pages many anti-Keynesian economists arguing for the virtues of gold standard and a real free market monetary system. Many of them point out the current financial crisis is precisely caused by credit bubble created by an inflationary fiat monetary system. To cure the global financial malaise, they contend that we need a sound money, the value of which is not based on the illusive credit-worthiness of the government, but on the tangible worth of certain precious metal such as gold.
How does gold standard work? It is very simple. Under the gold standard, the value of the dollar will be determined by its exchange rate with gold. Usually government should be the only entity that issues (meaning prints) paper bills at a predetermined exchange rate with gold (which is dictated by the market). For example, gold is now trading at around $800/troy ounce. You can bring one troy ounce of gold to the government, it will print out $800 fresh paper dollar bills for you (maybe minus a small fee, which is called seignorage), and keep the gold in its vault. The government cannot print more paper money than the worth of gold it receives. Individuals can exchange paper money for real gold if they choose to. Under a true gold standard monetary system, the amount of paper money in circulation should be exactly the same as the amount of gold in government reserve (gold stored in its vault).
The advantage of gold standard is that the government has to eventually balance its budget. The government cannot simple print money to spend. It has to borrow money from the private sector at an interest rate that is determined by the free market, not by the Federal Reserve. If the government borrows too much, the market will demand a high interest cost for its borrowing, which deters the government from running up its budget deficit.
Another benefit of gold standard is the elimination of fluctuation in currency exchange rates which should greatly facilitates global trades. When currencies are all pegged to gold, the exchange rate between currencies will be fixed. Nations will not have to be concerned above currency manipulation by their trading partners. Corporations will not have to buy expensive currency hedges when doing business in foreign countries. Wall Street currency traders will lose their jobs (that is a good thing for the economy, less friction cost).
In order for the gold standard to work, the Federal Reserve has to be abolished. Under the gold standard, money supply is completely determined by the market, rendering the Federal Reserve irrelevant. In fact, any Federal Reserve intervention in money supply will undoubtedly break the link between value of the money and value of gold. That is why even before President Nixon completely decoupled US dollar from gold in 1971, gold had been already traded way above the official dollar/gold exchange value.
But gold standard is not without its potential perils. One of the gravest risks of gold standard is that it is highly susceptible to speculation. Speculators who amass huge amount of gold can manipulate the price of gold and wreck havoc on the financial market. By hoarding gold, they can potentially deplete bank reserves and create a run-on-bank. Even sovereign reserve can be depleted by speculators' manipulation (recall the 1997 Asian financial debacle that was largely caused by western financial speculators). That is why in order for gold standard to work, we have to have absolutely strong market oversight and appropriate rules and regulations in place to prevent speculators like Rothchild and George Soros from creating instability in the financial market.
Personally, I do not believe we will ever go back to gold standard. First, no politician will be able to muster the kind of support needed to pass a law to abolish the Federal Reserve. Second, governments around the world are addicted to the easy money afforded by the fiat monetary system. Third, people who support gold standard loath government regulation. I believe stringent government regulations are absolutely critical for gold standard to function properly. Without implementing proper rules and regulations, gold standard will be subjected to constant market manipulation and eventually lose popular support.
How does gold standard work? It is very simple. Under the gold standard, the value of the dollar will be determined by its exchange rate with gold. Usually government should be the only entity that issues (meaning prints) paper bills at a predetermined exchange rate with gold (which is dictated by the market). For example, gold is now trading at around $800/troy ounce. You can bring one troy ounce of gold to the government, it will print out $800 fresh paper dollar bills for you (maybe minus a small fee, which is called seignorage), and keep the gold in its vault. The government cannot print more paper money than the worth of gold it receives. Individuals can exchange paper money for real gold if they choose to. Under a true gold standard monetary system, the amount of paper money in circulation should be exactly the same as the amount of gold in government reserve (gold stored in its vault).
The advantage of gold standard is that the government has to eventually balance its budget. The government cannot simple print money to spend. It has to borrow money from the private sector at an interest rate that is determined by the free market, not by the Federal Reserve. If the government borrows too much, the market will demand a high interest cost for its borrowing, which deters the government from running up its budget deficit.
Another benefit of gold standard is the elimination of fluctuation in currency exchange rates which should greatly facilitates global trades. When currencies are all pegged to gold, the exchange rate between currencies will be fixed. Nations will not have to be concerned above currency manipulation by their trading partners. Corporations will not have to buy expensive currency hedges when doing business in foreign countries. Wall Street currency traders will lose their jobs (that is a good thing for the economy, less friction cost).
In order for the gold standard to work, the Federal Reserve has to be abolished. Under the gold standard, money supply is completely determined by the market, rendering the Federal Reserve irrelevant. In fact, any Federal Reserve intervention in money supply will undoubtedly break the link between value of the money and value of gold. That is why even before President Nixon completely decoupled US dollar from gold in 1971, gold had been already traded way above the official dollar/gold exchange value.
But gold standard is not without its potential perils. One of the gravest risks of gold standard is that it is highly susceptible to speculation. Speculators who amass huge amount of gold can manipulate the price of gold and wreck havoc on the financial market. By hoarding gold, they can potentially deplete bank reserves and create a run-on-bank. Even sovereign reserve can be depleted by speculators' manipulation (recall the 1997 Asian financial debacle that was largely caused by western financial speculators). That is why in order for gold standard to work, we have to have absolutely strong market oversight and appropriate rules and regulations in place to prevent speculators like Rothchild and George Soros from creating instability in the financial market.
Personally, I do not believe we will ever go back to gold standard. First, no politician will be able to muster the kind of support needed to pass a law to abolish the Federal Reserve. Second, governments around the world are addicted to the easy money afforded by the fiat monetary system. Third, people who support gold standard loath government regulation. I believe stringent government regulations are absolutely critical for gold standard to function properly. Without implementing proper rules and regulations, gold standard will be subjected to constant market manipulation and eventually lose popular support.
Thursday, November 20, 2008
What went wrong for the USA?
What's wrong with America? Who is to blame for the current financial and economic meltdown?
Some people blame the government for running up too much debt. Others blame the poor people for borrowing too much that they cannot afford to pay back. But the real cause is that America's financial industry outgrew the rest of the economy.
Financial industry does not create wealth. Let me repeat it again: financial industry does not create wealth. It only re-distributes wealth. Wealth is created in the real economy, the goods-producing economy. The problem is that America is producing less and less goods, because manufacturing has been increasingly outsourced to overseas. America's economy is becoming an empty shell. If this trend continues, our children will only find jobs in either Walmart, or Wall Street. No wonder we have seen in this country the wealth gap widening, and middle-class disappearing, because the good-paying manufacturing jobs have all but gone overseas. First was the textile industry, then the electronic industry, and now the automobile industry. If the US auto industry should disappear, and most likely it will, I don't know what real stuff America can produce any more.
On the other hand, the financial industry has been growing, and it has been obsessed with growth. It forced main-street companies to move production to low cost countries, so the profit can be larger and stock prices higher. Not only that, the financial industry has been using all kinds of tricks to convince peope to borrow more, because the more we borrow, the more profit for the industry. It uses all kinds of innovative financial engineering to make borrowing easier for everyone. To persuade individuals to borrow, they give us credit cards with rewards. The more you buy, the more you save. If you own a house, they want you to borrow against your house. They call that home equity loan. After you exhausted your home equity, they ask you to borrow against your next paycheck. To persuade government to borrow, they always support lower tax and higher spending. When it comes to persuading corporations to borrow, that is where they get extremely innovative. They design all kinds of financial instruments to allow corporations to borrow easily.
The end result was the enormous growth in credit, which in turn stimulated growth of the entire economy. But this type of growth can't sustain. When individuals, government, and corporations exhausted their ability to borrow further, that is when the house starts to crumble. That is exactly what is happening now.
Don't get me wrong. I have nothing against the financial industry (I for one work for the industry). The financial industry serves a vital function, which is to promote most efficient capital allocation. In a normally functioning financial market, capitals are taken away from failing businesses to support value-creating businesses.
Because of the vital role the financial market plays in real economy, there have to be stringent and adequate rules and regulations. You cannot have a great basketball game if there are no clear rules and referees, no matter how talented the players are. The problem with our current financial system is that government under enormous lobbying pressure does not want to set rules. Existing laws are antiquated because the industry always try to find ways to circumvent them. For example, banks set up SIVs, or Structured Investment Vehicles, to engage in non-regulated investment activities, putting depositors capital under risk. Insurance companies sell innovative quasi-insurance products, such as CDS, credit default swaps, without putting sufficient capital reserve as collateral. That was how AIG got into trouble. AIG's traditional insurance business was doing just fine. It was its non-regulated business (selling CDS) that incurred huge losses and needed $155B bailout from the government.
Some people blame the government for running up too much debt. Others blame the poor people for borrowing too much that they cannot afford to pay back. But the real cause is that America's financial industry outgrew the rest of the economy.
Financial industry does not create wealth. Let me repeat it again: financial industry does not create wealth. It only re-distributes wealth. Wealth is created in the real economy, the goods-producing economy. The problem is that America is producing less and less goods, because manufacturing has been increasingly outsourced to overseas. America's economy is becoming an empty shell. If this trend continues, our children will only find jobs in either Walmart, or Wall Street. No wonder we have seen in this country the wealth gap widening, and middle-class disappearing, because the good-paying manufacturing jobs have all but gone overseas. First was the textile industry, then the electronic industry, and now the automobile industry. If the US auto industry should disappear, and most likely it will, I don't know what real stuff America can produce any more.
On the other hand, the financial industry has been growing, and it has been obsessed with growth. It forced main-street companies to move production to low cost countries, so the profit can be larger and stock prices higher. Not only that, the financial industry has been using all kinds of tricks to convince peope to borrow more, because the more we borrow, the more profit for the industry. It uses all kinds of innovative financial engineering to make borrowing easier for everyone. To persuade individuals to borrow, they give us credit cards with rewards. The more you buy, the more you save. If you own a house, they want you to borrow against your house. They call that home equity loan. After you exhausted your home equity, they ask you to borrow against your next paycheck. To persuade government to borrow, they always support lower tax and higher spending. When it comes to persuading corporations to borrow, that is where they get extremely innovative. They design all kinds of financial instruments to allow corporations to borrow easily.
The end result was the enormous growth in credit, which in turn stimulated growth of the entire economy. But this type of growth can't sustain. When individuals, government, and corporations exhausted their ability to borrow further, that is when the house starts to crumble. That is exactly what is happening now.
Don't get me wrong. I have nothing against the financial industry (I for one work for the industry). The financial industry serves a vital function, which is to promote most efficient capital allocation. In a normally functioning financial market, capitals are taken away from failing businesses to support value-creating businesses.
Because of the vital role the financial market plays in real economy, there have to be stringent and adequate rules and regulations. You cannot have a great basketball game if there are no clear rules and referees, no matter how talented the players are. The problem with our current financial system is that government under enormous lobbying pressure does not want to set rules. Existing laws are antiquated because the industry always try to find ways to circumvent them. For example, banks set up SIVs, or Structured Investment Vehicles, to engage in non-regulated investment activities, putting depositors capital under risk. Insurance companies sell innovative quasi-insurance products, such as CDS, credit default swaps, without putting sufficient capital reserve as collateral. That was how AIG got into trouble. AIG's traditional insurance business was doing just fine. It was its non-regulated business (selling CDS) that incurred huge losses and needed $155B bailout from the government.
Tuesday, November 04, 2008
America, I am so proud of you! Dawn of Hope!
At this moment, 10:33PM EST, Obama has 207 electoral votes. OH, NM and IA are Obama's country. That is just an early indication of a landslide.
1) MLK can now rest in peace. Forty years after his famous "I have a dream" speech, this nation can now look beyond the color of an individual's skin, and judge the person on his or her own merits.
2) The world is now looking at America in awe! America is STILL the beacon of light for the world. It is still the symbol of hope and inspiration.
3) It is so unfortunate that Obama's grandmother could not live to witness his grandson winning this historic election. She died one day before the election. But I am sure she is now smiling in heaven.
4) Now it is time to get to work: we need to give some desperately needed help to the middle class and the poor. Then we need to invest in America's future, by supporting education, healthcare for everyone, alternative energy technologies, and rebuilding of the crumbling infrastructure.
Finally we can all go to sleep with smile. Sweet dream, America, and wake up to the dawn of a new era, an era of new hope.
1) MLK can now rest in peace. Forty years after his famous "I have a dream" speech, this nation can now look beyond the color of an individual's skin, and judge the person on his or her own merits.
2) The world is now looking at America in awe! America is STILL the beacon of light for the world. It is still the symbol of hope and inspiration.
3) It is so unfortunate that Obama's grandmother could not live to witness his grandson winning this historic election. She died one day before the election. But I am sure she is now smiling in heaven.
4) Now it is time to get to work: we need to give some desperately needed help to the middle class and the poor. Then we need to invest in America's future, by supporting education, healthcare for everyone, alternative energy technologies, and rebuilding of the crumbling infrastructure.
Finally we can all go to sleep with smile. Sweet dream, America, and wake up to the dawn of a new era, an era of new hope.
Saturday, November 01, 2008
McCain's tax plan vs. Obama's tax plan (satire)
Let's be frank about it. McCain has a better tax plan than Obama. Not only he gives some tax cut to the poor, he will also cut tax for the wealthy and big corporations, just in case they need it. McCain will cut tax for EVERYONE, not only the middle class and poor.
How will he balance the budget, if he cut taxes? He will freeze all domestic spending except the military. Sure, this will cripple domestic economy. But no worry, our corporations can always do business in other countries. And our military spending will definitely stimulate the economy of our friends in the middle east. Yes, tough economic time is ahead of us here in the US. But that is why we are asking you to put the country first.
Even freezing domestic spending would not balance the budget, because we are already running a half trillion dollar budget deficit. But, don't fret. The government can always borrow. We have been doing that in the last eight years! Why can't we continue doing that?
On the other hand, Obama only gives tax cut to those who need it. He asks the wealthy and the corporations to chip in a little bit more. That is socialism, my friends. Obama will reduce our military spending by ending the war in Iraq, and boost domestic spending to stimulate the US economy. He will give tax credit to small businesses that create jobs in the US, not ship jobs overseas. He will repair the crippling infrastructure, and encourage investment in alternative energy technologies. My friends, that does not work! That is government intervention. You democrats did that in the 90s, the early 60s, and the late 30s. The New Deal. The Great Society. Blah blah blah. Those are false hopes. They work for a while, until we republicans came in to crash them.
My friends, on November 4th, remember to vote for McCain.
How will he balance the budget, if he cut taxes? He will freeze all domestic spending except the military. Sure, this will cripple domestic economy. But no worry, our corporations can always do business in other countries. And our military spending will definitely stimulate the economy of our friends in the middle east. Yes, tough economic time is ahead of us here in the US. But that is why we are asking you to put the country first.
Even freezing domestic spending would not balance the budget, because we are already running a half trillion dollar budget deficit. But, don't fret. The government can always borrow. We have been doing that in the last eight years! Why can't we continue doing that?
On the other hand, Obama only gives tax cut to those who need it. He asks the wealthy and the corporations to chip in a little bit more. That is socialism, my friends. Obama will reduce our military spending by ending the war in Iraq, and boost domestic spending to stimulate the US economy. He will give tax credit to small businesses that create jobs in the US, not ship jobs overseas. He will repair the crippling infrastructure, and encourage investment in alternative energy technologies. My friends, that does not work! That is government intervention. You democrats did that in the 90s, the early 60s, and the late 30s. The New Deal. The Great Society. Blah blah blah. Those are false hopes. They work for a while, until we republicans came in to crash them.
My friends, on November 4th, remember to vote for McCain.
Thursday, October 30, 2008
Here we are again, 1% Fed Funds target rate
Yesterday, the Fed lowered the target rate for Fed Funds by 50bp to 1%, matching the lowest level set in 2003-2004 time frame under Alan Greespan. US Libor dropped less than 10bp on the Fed move. Clearly, the Fed simply cannot control the price of credit.
Fed action was matched by similar rate cuts in China and Europe. Stock markets in Asia seem to like the move. Overnight HenSeng went up more than 13%. US large cap was slightly down yesterday, while mid to small caps were broadly up. Today, the market followed through with a broad rally in the 2-3% range.
The congress today was deliberating on a potential fiscal stimulate package. Nuriel Roubini, the crazy economist of NYU, was testifying for such a stimulative spending package. Roubini tends to make exaggerated statements. But so far he has been right about the economy.
US government policy largely favors big businesses and financial institutions. When banks are running into problems, meaning they are over-leveraged or borrowed too much, the Federal Reserve lowers interest rate and inject capital to save them. But when it comes to ordinary consumer, if he or she borrowed too much, no one would come to the rescue. You know the financial institutions have a perverted way of doing business: they tend to lend to the rich at low interest rate. But when they lend to low-income households, they charge extraordinarily high interest rate. The poor on average are paying much higher borrowing costs than the rich. Is that fair? I guess it is :)
I have been thinking about gold-standard monetary policy. I used to be very supportive of that. But the current financial crisis made me think again. I think a gold-standard, or silver-standard for that matter, will collapse in a financial crisis when everyone is selling out risky assets to demand for cash. Under stringent gold-standard, there would not be sufficient liquidity (in this case gold money) to meet the demand. The whole system would crash. In the fiat system, the central banks can print as much cash as the market demands. The critical issue here is at what point it is appropriate for the central bank to intervene? In many cases, the central bank should not intervene, and let the financial market to work the trouble out by itself. But in situations like now, the central bank has to take drastic actions. Though it is rather difficult to determine where to draw the line.
Fed action was matched by similar rate cuts in China and Europe. Stock markets in Asia seem to like the move. Overnight HenSeng went up more than 13%. US large cap was slightly down yesterday, while mid to small caps were broadly up. Today, the market followed through with a broad rally in the 2-3% range.
The congress today was deliberating on a potential fiscal stimulate package. Nuriel Roubini, the crazy economist of NYU, was testifying for such a stimulative spending package. Roubini tends to make exaggerated statements. But so far he has been right about the economy.
US government policy largely favors big businesses and financial institutions. When banks are running into problems, meaning they are over-leveraged or borrowed too much, the Federal Reserve lowers interest rate and inject capital to save them. But when it comes to ordinary consumer, if he or she borrowed too much, no one would come to the rescue. You know the financial institutions have a perverted way of doing business: they tend to lend to the rich at low interest rate. But when they lend to low-income households, they charge extraordinarily high interest rate. The poor on average are paying much higher borrowing costs than the rich. Is that fair? I guess it is :)
I have been thinking about gold-standard monetary policy. I used to be very supportive of that. But the current financial crisis made me think again. I think a gold-standard, or silver-standard for that matter, will collapse in a financial crisis when everyone is selling out risky assets to demand for cash. Under stringent gold-standard, there would not be sufficient liquidity (in this case gold money) to meet the demand. The whole system would crash. In the fiat system, the central banks can print as much cash as the market demands. The critical issue here is at what point it is appropriate for the central bank to intervene? In many cases, the central bank should not intervene, and let the financial market to work the trouble out by itself. But in situations like now, the central bank has to take drastic actions. Though it is rather difficult to determine where to draw the line.
Friday, October 17, 2008
It feels good to agree with Warren Buffet
I have been saying here that it is insane to hold fast depreciating cash now, when the Fed is printing trillions of dollars of fresh new bills, and stocks are trading at extraordinarily low valuation. And I myself have been buying stocks hand-over-fist. Let me name a few example: Capital One (COF), trading below book value, with pristine balance sheet and more than adequate reserves for loan losses and credit charge offs. Western Digital (WDC), the best managed hard disk drive (HDD) companies out there, is trading at 4 times last year's free cash flow! As consumers generate more digital data (videos and photos), the demand for HDD will not go down, even there will be competition from flash memory storage products, which is much more expensive than HDD. Then there is Apple, trading 15x earnings, and has $23/share cash on the balance sheet.
OK, I am going to stop here. The point is that you can buy many great stocks at very cheap valuation.
Today, I am very glad to know that the investment guru Warren Buffet happens to think the same way. In his Op-Ed on today's NY Times, he urges investors to be "greedy" when others are running in "fear". He claims that he is buying US equities. Here is the reprint of his piece on NY Times:
-----------------------------------------------
THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.
Why?
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.
Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”
I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.
OK, I am going to stop here. The point is that you can buy many great stocks at very cheap valuation.
Today, I am very glad to know that the investment guru Warren Buffet happens to think the same way. In his Op-Ed on today's NY Times, he urges investors to be "greedy" when others are running in "fear". He claims that he is buying US equities. Here is the reprint of his piece on NY Times:
-----------------------------------------------
THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.
Why?
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.
Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”
I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.
Wednesday, October 15, 2008
McCain is an angry old man in today's debate
This is the last of the three presidential debate. Obama maintained his cool and showed America that he is of the Presidential material. But McCain throughout the debate was agitated, constantly making faces and showing emotion. He does not look presidential at all. He was constantly on the attack of Obama. But when it comes to articulating his own policy stances, he failed to present a coherent message. We really don't know what his policy is except the repeated slogan of "cutting taxes" and "small government". I think tonight's debate has put "the nail on the coffin" of this election. Obama is going to win in a landslide.
Yet another brutal day for the financial market
Stock market continues to slide today, erasing almost the entire gains of Monday rally. Major indexes dropped between 8-9% today, shattering the hope of the investors for a near term recovery. Investor confidence is in short supply. Even commodities are trading broadly lower. Crude oil tumbled 5.9% to $74.03, down almost 50% since its peak earlier this year. A slue of bad economic news (retail sales and Fed Beige Book) underpinned today's dramatic sell off. Where is an end to all this?
There are now so many cheap stocks you can pick from. You don't have to buy those risky controversial names. You can now buy solid healthy global franchises at bargain prices. Where are the risk takers in America? I think a few years down the road when we look back, we would appreciate what a tremendous time this is to buy stocks extraordinarily cheap.
Mutual funds and hedge funds are forced to sell their stock holdings because investors are pulling money out in fear. Irrational. Investors are so irrational.
There are now so many cheap stocks you can pick from. You don't have to buy those risky controversial names. You can now buy solid healthy global franchises at bargain prices. Where are the risk takers in America? I think a few years down the road when we look back, we would appreciate what a tremendous time this is to buy stocks extraordinarily cheap.
Mutual funds and hedge funds are forced to sell their stock holdings because investors are pulling money out in fear. Irrational. Investors are so irrational.
Tuesday, October 14, 2008
We are witnessing history
The current financial crisis is probably a once-in-a-lifetime type of event. And I feel awed to be in the middle of it.
After losing eight straight days, the stock market rocketed on Monday (yesterday) with all major indexes ending up more than 11%. Stocks around the world rose in double digit percentages yesterday, after central banks and governments around the world vowed to provide "unlimited" liquidity for troubled financial institutions. England led the pack by first nationalizing some of its major banks. European countries were all offering deposit insurance for bank deposits, in an attempt to preempt potential bank run.
International stock markets had nice follow-through upon yesterday's huge gain. Stocks around the world ended higher on Tuesday. US equities started off on a high note today, up around 3% in early trading. Treasury Department announced a plan to immediate inject $250B into nine major US financial banks (sure, Goldman is included, along with Morgan Stanley, Merrill Lynch, BoA, Citi, JPMChase, Well Fargo, Bank of NY Mellon, and State Street). But the early gain slowly fizzled, with the market ending slightly down.
I think the road ahead will still be rocky. Hedge funds are stocking cash preparing for a rush of investor redemption. That is why when stocks were moving lower, oil and gold were also moving lower. The only plausible explanation is that hedge funds are unwinding their long oil and gold positions to build up cash cushion for potential redemption. This can last for a quarter.
But the stocks are cheap. There are plenty of opportunities to find high quality names trading at depressed valuation.
This is probably also a once-in-a-lifetime opportunity to buy stocks extremely cheap.
After losing eight straight days, the stock market rocketed on Monday (yesterday) with all major indexes ending up more than 11%. Stocks around the world rose in double digit percentages yesterday, after central banks and governments around the world vowed to provide "unlimited" liquidity for troubled financial institutions. England led the pack by first nationalizing some of its major banks. European countries were all offering deposit insurance for bank deposits, in an attempt to preempt potential bank run.
International stock markets had nice follow-through upon yesterday's huge gain. Stocks around the world ended higher on Tuesday. US equities started off on a high note today, up around 3% in early trading. Treasury Department announced a plan to immediate inject $250B into nine major US financial banks (sure, Goldman is included, along with Morgan Stanley, Merrill Lynch, BoA, Citi, JPMChase, Well Fargo, Bank of NY Mellon, and State Street). But the early gain slowly fizzled, with the market ending slightly down.
I think the road ahead will still be rocky. Hedge funds are stocking cash preparing for a rush of investor redemption. That is why when stocks were moving lower, oil and gold were also moving lower. The only plausible explanation is that hedge funds are unwinding their long oil and gold positions to build up cash cushion for potential redemption. This can last for a quarter.
But the stocks are cheap. There are plenty of opportunities to find high quality names trading at depressed valuation.
This is probably also a once-in-a-lifetime opportunity to buy stocks extremely cheap.
Sunday, October 12, 2008
McCain finally showed some restrain
Attack on Obama from the McCain campaign in the past few weeks has really intensified. The strategy was to question the character of Obama, instead of discussing issues. He asked his supporters during a rally: "who is Obama?". His running mate Sarah Palin took on more direct and nasty role of attack, calling Obama "palling around with terrorists". McCain/Palin supporters have become increasingly vocal about their hatred towards Obama. The fact that Obama is leading McCain in major national polls makes these staunch republicans so mad. The madness seems to reaching to the boiling point which could have the potential to incite violence.
During the weekend, McCain wisely toned down his personal attack on Obama, calling him "a decent American". I am really glad to see this turn about. As to Palin, I really don't care. She is just a tool, a parrot. It is a joke that McCain selected her as VP candidate. That shows how desperate and irresponsible a McCain Presidency could be.
During the weekend, McCain wisely toned down his personal attack on Obama, calling him "a decent American". I am really glad to see this turn about. As to Palin, I really don't care. She is just a tool, a parrot. It is a joke that McCain selected her as VP candidate. That shows how desperate and irresponsible a McCain Presidency could be.
Thursday, October 09, 2008
Depression ahead of us?
Another brutal day on Wall Street. There seems to be no let up. The market did not have a single up day for the last eight days. The passing of the bailout last Friday did not serve to sooth jitter investors. Credit spreads remain wide, and stocks continue to sell off. Investors are shunning risky assets and parking liquidity in the "safe heaven" of Treasury bills. Most notable is that commodity prices are sliding as well, with crude oil now trading below $87, down from the peak of $147 set sometimes in March of this year. Gold edged up during this period of stock sell-off. But rise in gold price is not as much as I would have expected. It appears that the likelihood of going back to gold-based currency is very low (although that may be the right choice), because governments around the world are addicted to the power of printing money to finance spending without raising taxes.
Are you heading to a a 1929-style depression? Hardly. I think we have more financial tools now to prevent a depression from happening. I have long maintained we do not need a Federal Reserve (central bank) system to regulate the interest rate (or price of credit). In fact the Fed is incapable of regulating interest rate. Despite the rate cut Fed announced yesterday, Libor remains high. In normal situations, Fed action does affect the credit. But in times of financial crisis, Fed has very little power to influence the credit market. The Fed has pumped tremendous amount of liquidity (in the order of trillions of dollars) into the financial system, and in fact central banks around of the world have done the same. Yet banks are just hoarding the cash and refuse to lend.
Yesterday, UK government decided to take ownership of some of its banks. Today, Treasury secretary Paulson also indicated that the Treasury may buy stock shares of the troubled banks. It feels more and more like socialism. I guess when capitalism runs into trouble, socialism comes to the rescue. How ironic.
Notwithstanding the flaws of the Federal Reserve System and fiat money, I do think the Federal Reserve, if there is any use of it, is precisely designed for the current situation. Investors want to sell risky assets at depressed valuation and buy risk free Federal Reserve Notes? OK, keep coming. As long as the printing press at the Federal Reserve still works, there is infinite quantity of paper money to meet the demand. Someday these investors will realize what they are holding are worthless papers. Then they will start to come back into assets such as bonds and stocks.
In a long run, I think inflation will go up dramatically. Economic activities will be slow for a long stretch of time. Yes, there won't be a depression. But we are going to have multi-years of stagflation (stagnation + inflation).
For future reference, it is worthwhile to record the dramatic selloff of the stock market towards the afternoon of today. Here is what yahoo finance recaps today's financial market activities:
Stocks plunged Thursday, sending the Dow Jones industrial average down 679 points -- more than 7 percent -- to its lowest level in five years. Stocks took a nosedive after a major credit-rating agency said it might cut its rating on General Motors and Ford, further rattling investors already fretting over the impact of tight credit on the economy.
The Standard & Poor's 500 index also fell more than 7 percent.
The declines came on the one-year anniversary of the closing highs of the Dow and the S&P. The Dow has lost 5,585 points, or 39.4 percent, since closing at 14,164.53 on Oct. 9, 2007. It's the worst run for the Dow since the nearly two-year bear market that ended in December 1974 when the Dow lost 45 percent. The S&P 500, meanwhile, is off 655 points, or 41.9 percent, since recording its high of 1,565.15.
U.S. stock market paper losses totaled $872 billion Thursday and the value of shares over all has tumbled a stunning $8.33 trillion since last year's high. That's based on figures measured by the Dow Jones Wilshire 5000 Composite Index, which tracks 5,000 U.S.-based companies' stocks and represents almost all stocks traded in America.
Thursday's sell-off came as Standard & Poor's Ratings Services put General Motors Corp. and its finance affiliate GMAC LLC under review to see if its rating should be cut. The action means there is a 50 percent chance that S&P will lower GM's and GMAC's ratings in the next three months. GM has been struggling with weak car sales in North America.
S&P also put Ford Motor Co. on credit watch negative. The ratings agency said that GM and Ford have adequate liquidity now, but that could change in 2009.
GM, one of the 30 stocks that make up the Dow industrials, fell $2.15, or 31 percent, to $4.76, while Ford fell 58 cents, or 22 percent, to $2.08.
"The story is getting to be like that movie 'Groundhog Day,'" said Arthur Hogan, chief market analyst at Jefferies & Co. He pointed to the still-frozen credit markets, and Libor, the bank-to-bank lending rate that remains stubbornly high despite interest rate cuts this week by the Federal Reserve and other major central banks.
"Until that starts coming down, you'll be hard-pressed to find anyone getting excited about stocks," Hogan said. "Everything we're seeing is historic. The problem is historic, the solutions are historic, and unfortunately, the sell-off is historic. It's not the kind of history you want to be making."
The Dow ended the day at its lows, finishing down 678.91, or 7.3 percent, at 8,579.19. The blue chips hadn't closed below 9,000 since June 30, 2003, and haven't closed at this level since May 21, 2003.
The Dow's 2,271-point tumble over the last seven sessions is its steepest seven-day point drop ever. Its seven-day percentage decline of 20.9 percent is the largest since the seven-day plunge ending Oct. 26, 1987, when the Dow lost 23.8 percent. That sell-off included Black Monday, the Oct. 19, 1987 market crash that saw the Dow fall nearly 23 percent in a single day.
Broader stock indicators also tumbled Thursday. The S&P 500 fell 75.02, or 7.6 percent, to 909.92, while the Nasdaq composite index fell 95.21, or 5.5 percent, to 1,645.12.
The Russell 2000 index of smaller companies fell 47.37, or 8.7 percent, to 499.20.
A wave of fear about the economy sent stocks lower in the final two hours of trading after a volatile morning in which major indicators like the Dow and the S&P 500 index bobbed up and down. The Nasdaq, with a bevy of tech stocks, spent much of the session higher but eventually declined as the sell-off intensified. Still, its losses were less severe because of the relatively modest drops in names like Intel Corp. and Microsoft Corp.
On the New York Stock Exchange, declining issues came to nearly 3,000, while fewer than 250 advanced.
The sluggishness in the credit markets that triggered much of the heavy selling in markets around the world since mid-September appeared little changed Thursday following days of efforts by the Federal Reserve and other central banks to resuscitate lending.
Libor, the bank lending benchmark, for three-month dollar loans rose to 4.75 percent from 4.52 percent on Wednesday. That signals that banks remain hesitant to make loans for fear they won't be paid back.
The Fed and other leading central banks this week lowered key interest rates to help unclog the credit markets and promote lending to help the global economy. While a rate cut can take up to a year to work its way through the economy, the move was aimed as a boost to investor sentiment.
"We're stuck in a morass and I think it's going to take quite some time to come out of it," said Stephen Carl, principal and head of equity trading at The Williams Capital Group.
Demand remained high for short-term Treasurys, a refuge for investors willing to trade modest returns to protect their money. The yield on the three-month Treasury bill, which moves opposite its price, fell to 0.58 percent from 0.63 percent late Wednesday. Longer-term debt prices fell, with the yield on the 10-year note rising to 3.79 percent from 3.65 percent late Wednesday.
Investors across markets were mulling a plan being considered by the Bush administration to invest in hobbled U.S. banks as a way to stabilize the financial sector. The $700 billion rescue package signed into law last week allows the Treasury Department to inject fresh capital into financial institutions and obtain ownership shares in return.
Britain rolled out a similar plan, though no U.K. bank has received any investments. In Iceland, the government now has control of the country's three major banks as it struggles to contain the troubles there.
Wall Street is also looking for any effects of short selling now that a three-week ban imposed by regulators has expired. Short selling is a technique in which investors borrow shares in a company from a broker and sell them, hoping to buy them back later at a lower price. Essentially, it's a bet that a stock's price will fall. Short sellers can lose money if they have to repurchase the stock after it has risen.
Some analysts believe the unprecedented ban on short selling -- an effort to bolster investor confidence -- did more harm than good at a time of historic market volatility. They contend that short sellers help the market rally by covering their bets and creating demand for stocks.
"I think the market's way oversold. But I can't stand in the way of this falling knife -- I'd get sliced open," said Phil Orlando, chief equity market strategist at Federated Investors. "Investors are just saying, get me out at any price."
He also said that with the short-selling rule back in play, hedge funds might be shorting again to make up for their forced liquidations.
Energy names were among the biggest decliners as the price of oil fell and investors worried about a slowing economy. Exxon Mobil Corp. fell $9, or 12 percent, to $68, while Chevron Corp. fell $9.10, or 12 percent, to $64.
Light, sweet crude fell $1.81 to settle at $86.62 a barrel on the New York Mercantile Exchange, the lowest closing price since October last year.
Health insurer WellPoint Inc. fell $3.94, or 9.7 percent, to $36.50, while insurer and investment manager Lincoln National Corp. fell $9.66, or 35 percent, to $18.31.
The tech sector saw less selling than other parts of the market after IBM Corp. affirmed its forecast.
IBM fell $1.55, or 1.7 percent, to $89. Meanwhile, Intel fell 65 cents, or 4 percent, to $15.60 and Microsoft fell 71 cents, or 3.1 percent, to $22.30.
Consolidated trading volume on the NYSE came to 8.14 billion consolidated shares compared with 8.54 billion traded Wednesday.
In Asia, Japan's Nikkei 225 closed down 0.50 percent while the Hang Seng added 3.31 percent. In Europe, Britain's FTSE-100 fell 1.21 percent, Germany's DAX fell 2.53 percent, and France's CAC-40 declined 1.55 percent.
Are you heading to a a 1929-style depression? Hardly. I think we have more financial tools now to prevent a depression from happening. I have long maintained we do not need a Federal Reserve (central bank) system to regulate the interest rate (or price of credit). In fact the Fed is incapable of regulating interest rate. Despite the rate cut Fed announced yesterday, Libor remains high. In normal situations, Fed action does affect the credit. But in times of financial crisis, Fed has very little power to influence the credit market. The Fed has pumped tremendous amount of liquidity (in the order of trillions of dollars) into the financial system, and in fact central banks around of the world have done the same. Yet banks are just hoarding the cash and refuse to lend.
Yesterday, UK government decided to take ownership of some of its banks. Today, Treasury secretary Paulson also indicated that the Treasury may buy stock shares of the troubled banks. It feels more and more like socialism. I guess when capitalism runs into trouble, socialism comes to the rescue. How ironic.
Notwithstanding the flaws of the Federal Reserve System and fiat money, I do think the Federal Reserve, if there is any use of it, is precisely designed for the current situation. Investors want to sell risky assets at depressed valuation and buy risk free Federal Reserve Notes? OK, keep coming. As long as the printing press at the Federal Reserve still works, there is infinite quantity of paper money to meet the demand. Someday these investors will realize what they are holding are worthless papers. Then they will start to come back into assets such as bonds and stocks.
In a long run, I think inflation will go up dramatically. Economic activities will be slow for a long stretch of time. Yes, there won't be a depression. But we are going to have multi-years of stagflation (stagnation + inflation).
For future reference, it is worthwhile to record the dramatic selloff of the stock market towards the afternoon of today. Here is what yahoo finance recaps today's financial market activities:
Stocks plunged Thursday, sending the Dow Jones industrial average down 679 points -- more than 7 percent -- to its lowest level in five years. Stocks took a nosedive after a major credit-rating agency said it might cut its rating on General Motors and Ford, further rattling investors already fretting over the impact of tight credit on the economy.
The Standard & Poor's 500 index also fell more than 7 percent.
The declines came on the one-year anniversary of the closing highs of the Dow and the S&P. The Dow has lost 5,585 points, or 39.4 percent, since closing at 14,164.53 on Oct. 9, 2007. It's the worst run for the Dow since the nearly two-year bear market that ended in December 1974 when the Dow lost 45 percent. The S&P 500, meanwhile, is off 655 points, or 41.9 percent, since recording its high of 1,565.15.
U.S. stock market paper losses totaled $872 billion Thursday and the value of shares over all has tumbled a stunning $8.33 trillion since last year's high. That's based on figures measured by the Dow Jones Wilshire 5000 Composite Index, which tracks 5,000 U.S.-based companies' stocks and represents almost all stocks traded in America.
Thursday's sell-off came as Standard & Poor's Ratings Services put General Motors Corp. and its finance affiliate GMAC LLC under review to see if its rating should be cut. The action means there is a 50 percent chance that S&P will lower GM's and GMAC's ratings in the next three months. GM has been struggling with weak car sales in North America.
S&P also put Ford Motor Co. on credit watch negative. The ratings agency said that GM and Ford have adequate liquidity now, but that could change in 2009.
GM, one of the 30 stocks that make up the Dow industrials, fell $2.15, or 31 percent, to $4.76, while Ford fell 58 cents, or 22 percent, to $2.08.
"The story is getting to be like that movie 'Groundhog Day,'" said Arthur Hogan, chief market analyst at Jefferies & Co. He pointed to the still-frozen credit markets, and Libor, the bank-to-bank lending rate that remains stubbornly high despite interest rate cuts this week by the Federal Reserve and other major central banks.
"Until that starts coming down, you'll be hard-pressed to find anyone getting excited about stocks," Hogan said. "Everything we're seeing is historic. The problem is historic, the solutions are historic, and unfortunately, the sell-off is historic. It's not the kind of history you want to be making."
The Dow ended the day at its lows, finishing down 678.91, or 7.3 percent, at 8,579.19. The blue chips hadn't closed below 9,000 since June 30, 2003, and haven't closed at this level since May 21, 2003.
The Dow's 2,271-point tumble over the last seven sessions is its steepest seven-day point drop ever. Its seven-day percentage decline of 20.9 percent is the largest since the seven-day plunge ending Oct. 26, 1987, when the Dow lost 23.8 percent. That sell-off included Black Monday, the Oct. 19, 1987 market crash that saw the Dow fall nearly 23 percent in a single day.
Broader stock indicators also tumbled Thursday. The S&P 500 fell 75.02, or 7.6 percent, to 909.92, while the Nasdaq composite index fell 95.21, or 5.5 percent, to 1,645.12.
The Russell 2000 index of smaller companies fell 47.37, or 8.7 percent, to 499.20.
A wave of fear about the economy sent stocks lower in the final two hours of trading after a volatile morning in which major indicators like the Dow and the S&P 500 index bobbed up and down. The Nasdaq, with a bevy of tech stocks, spent much of the session higher but eventually declined as the sell-off intensified. Still, its losses were less severe because of the relatively modest drops in names like Intel Corp. and Microsoft Corp.
On the New York Stock Exchange, declining issues came to nearly 3,000, while fewer than 250 advanced.
The sluggishness in the credit markets that triggered much of the heavy selling in markets around the world since mid-September appeared little changed Thursday following days of efforts by the Federal Reserve and other central banks to resuscitate lending.
Libor, the bank lending benchmark, for three-month dollar loans rose to 4.75 percent from 4.52 percent on Wednesday. That signals that banks remain hesitant to make loans for fear they won't be paid back.
The Fed and other leading central banks this week lowered key interest rates to help unclog the credit markets and promote lending to help the global economy. While a rate cut can take up to a year to work its way through the economy, the move was aimed as a boost to investor sentiment.
"We're stuck in a morass and I think it's going to take quite some time to come out of it," said Stephen Carl, principal and head of equity trading at The Williams Capital Group.
Demand remained high for short-term Treasurys, a refuge for investors willing to trade modest returns to protect their money. The yield on the three-month Treasury bill, which moves opposite its price, fell to 0.58 percent from 0.63 percent late Wednesday. Longer-term debt prices fell, with the yield on the 10-year note rising to 3.79 percent from 3.65 percent late Wednesday.
Investors across markets were mulling a plan being considered by the Bush administration to invest in hobbled U.S. banks as a way to stabilize the financial sector. The $700 billion rescue package signed into law last week allows the Treasury Department to inject fresh capital into financial institutions and obtain ownership shares in return.
Britain rolled out a similar plan, though no U.K. bank has received any investments. In Iceland, the government now has control of the country's three major banks as it struggles to contain the troubles there.
Wall Street is also looking for any effects of short selling now that a three-week ban imposed by regulators has expired. Short selling is a technique in which investors borrow shares in a company from a broker and sell them, hoping to buy them back later at a lower price. Essentially, it's a bet that a stock's price will fall. Short sellers can lose money if they have to repurchase the stock after it has risen.
Some analysts believe the unprecedented ban on short selling -- an effort to bolster investor confidence -- did more harm than good at a time of historic market volatility. They contend that short sellers help the market rally by covering their bets and creating demand for stocks.
"I think the market's way oversold. But I can't stand in the way of this falling knife -- I'd get sliced open," said Phil Orlando, chief equity market strategist at Federated Investors. "Investors are just saying, get me out at any price."
He also said that with the short-selling rule back in play, hedge funds might be shorting again to make up for their forced liquidations.
Energy names were among the biggest decliners as the price of oil fell and investors worried about a slowing economy. Exxon Mobil Corp. fell $9, or 12 percent, to $68, while Chevron Corp. fell $9.10, or 12 percent, to $64.
Light, sweet crude fell $1.81 to settle at $86.62 a barrel on the New York Mercantile Exchange, the lowest closing price since October last year.
Health insurer WellPoint Inc. fell $3.94, or 9.7 percent, to $36.50, while insurer and investment manager Lincoln National Corp. fell $9.66, or 35 percent, to $18.31.
The tech sector saw less selling than other parts of the market after IBM Corp. affirmed its forecast.
IBM fell $1.55, or 1.7 percent, to $89. Meanwhile, Intel fell 65 cents, or 4 percent, to $15.60 and Microsoft fell 71 cents, or 3.1 percent, to $22.30.
Consolidated trading volume on the NYSE came to 8.14 billion consolidated shares compared with 8.54 billion traded Wednesday.
In Asia, Japan's Nikkei 225 closed down 0.50 percent while the Hang Seng added 3.31 percent. In Europe, Britain's FTSE-100 fell 1.21 percent, Germany's DAX fell 2.53 percent, and France's CAC-40 declined 1.55 percent.
Friday, October 03, 2008
700B bailout package truned into $850B spending
Politics in Washington DC defies logic. Last week, the House vetoed the 700B bailout package with a 228-205 vote. Then the Senate took on almost the same exact bill, adding to that an additional $150B pork spending. Surprise, surprise, the bill passed both the Senate (yesterday) and the House (today). Bush signed it into law immediately after.
Will the bailout help? Certainly it will help the banks' balance sheet. But I do not think the lending activity will come back quickly. The credit spreads won't narrow in short term, either. What the bailout will do for sure is to ensure some of the big banks to make a lot of money.
JPMorgan took on WaMu with its mortgage portfolio at depressed value without paying anything for it. Bank of America earlier took on Merrill Lynch, which also has lots of mortgage exposure. Now Wells Fargo and Citi are battling for Wachovia. Last Sunday, Wells Fargo pulled out in the last minute from the negotiation of potential take over of Wachovia. Citi came as the rescuer, after FDIC sweetened the deal with some loss guarantees for Wachovia's mortgage assets. Now with the knowledge of the bailout package likely to pass, Well Fargo came back today with a better offer to acquire the entire Wachovia at roughly $7/share. Citi's offer was a measly $1/share, only for the banking portion of Wachovia. Citi was hoping that Wachovia to provide it with the much needed cheap domestic source of financing, as most of Citi's deposits are international, while its investments are more geared towards US. It seems that it would be a great deal for Citi. But Well Fargo, with the backing of Warren Buffet, came in to spoil it.
A lot of people may be surprised to know that shares of Well Fargo, JP Morgan and many other banks are trading close to 52-week highs. These banks will do even better with the Treasury's $700B to help them shed those "toxic" assets from their balance sheet.
You got to love capitalism!
Will the bailout help? Certainly it will help the banks' balance sheet. But I do not think the lending activity will come back quickly. The credit spreads won't narrow in short term, either. What the bailout will do for sure is to ensure some of the big banks to make a lot of money.
JPMorgan took on WaMu with its mortgage portfolio at depressed value without paying anything for it. Bank of America earlier took on Merrill Lynch, which also has lots of mortgage exposure. Now Wells Fargo and Citi are battling for Wachovia. Last Sunday, Wells Fargo pulled out in the last minute from the negotiation of potential take over of Wachovia. Citi came as the rescuer, after FDIC sweetened the deal with some loss guarantees for Wachovia's mortgage assets. Now with the knowledge of the bailout package likely to pass, Well Fargo came back today with a better offer to acquire the entire Wachovia at roughly $7/share. Citi's offer was a measly $1/share, only for the banking portion of Wachovia. Citi was hoping that Wachovia to provide it with the much needed cheap domestic source of financing, as most of Citi's deposits are international, while its investments are more geared towards US. It seems that it would be a great deal for Citi. But Well Fargo, with the backing of Warren Buffet, came in to spoil it.
A lot of people may be surprised to know that shares of Well Fargo, JP Morgan and many other banks are trading close to 52-week highs. These banks will do even better with the Treasury's $700B to help them shed those "toxic" assets from their balance sheet.
You got to love capitalism!
Sarah Palin avoided another national embarassment
Yesterday's vice president debate turned out to be less a spectacle many of us have been expecting. Frankly, I was waiting for another comedy show by Palin in front of the national audience.
By sticking to the rehearsed talking points, and avoid answering questions, Palin avoided another national embarrassment. The entire republican party and McCain campaign sighed a collective relief. Sure, she was not answering questions directly. Sure she just repeated what she was instructed to say. But that was far better a performance than the interview she did with Katie Couric.
I thought Joe Biden did a great job, better than Barack Obama did in his first presidential debate. He kept hammering at McCain, calling him no maverick on critical issues, and continuing the failed Bush policies both domestic and international.
Indeed, there is basically NO difference when it comes to national defense policy, health care policy, tax policy, and energy policy, between Bush and McCain. Most troubling, and most dangerous (I believe), is that McCain has shown no sign of changing the course from the misguided Bush's beating-the-chest cowboy foreign policy, which has strengthened US enemies and alienated US allies. If this policy would continue, and I believe it would under McCain, we would continue to spending $10B/month in Iraq for the foreseeable future. McCain wants to cut domestic spending to preserve defense spending (Iraq war). That will lead to domestic economic decline and further stimulate the economy of the middle east. Thanks a lot McCain, our "friends" in the middle east would say.
We've got to elect Barack Obama President of the United States.
By sticking to the rehearsed talking points, and avoid answering questions, Palin avoided another national embarrassment. The entire republican party and McCain campaign sighed a collective relief. Sure, she was not answering questions directly. Sure she just repeated what she was instructed to say. But that was far better a performance than the interview she did with Katie Couric.
I thought Joe Biden did a great job, better than Barack Obama did in his first presidential debate. He kept hammering at McCain, calling him no maverick on critical issues, and continuing the failed Bush policies both domestic and international.
Indeed, there is basically NO difference when it comes to national defense policy, health care policy, tax policy, and energy policy, between Bush and McCain. Most troubling, and most dangerous (I believe), is that McCain has shown no sign of changing the course from the misguided Bush's beating-the-chest cowboy foreign policy, which has strengthened US enemies and alienated US allies. If this policy would continue, and I believe it would under McCain, we would continue to spending $10B/month in Iraq for the foreseeable future. McCain wants to cut domestic spending to preserve defense spending (Iraq war). That will lead to domestic economic decline and further stimulate the economy of the middle east. Thanks a lot McCain, our "friends" in the middle east would say.
We've got to elect Barack Obama President of the United States.
Monday, September 29, 2008
How to make the Bailout work?
Bloody Monday: Dow dropped 777.7 (6.98%), largest single day point loss in history, and largest percentage drop since 9/11/01 terrorist attack (or more accurately CIA attack). Nasdaq did even worse, dropping 199.76 (9.14%). S&P 500 declined by 106.62 (8.79%). There was no place to hide. Energy was hit the hardest, and even Health Care sector could not escape the sell-off pressure.
After working over the weekend in an attempt to come up with a modified $700B bailout package, the Whitehouse and bipartisan congressional leaders worked out a bill to present to the House for a vote. The bill suffered a surprising and stunning defeat, with 228 nays and 205 yeas. This morning, we were greeted with the news that Wochovia sold its entire banking business to Citi for a mere $2B, or $1/share. It looks like we are going to have only a handful banks left after this turmoil. That is certainly not good for consumers.
What is the root problem of the current financial crisis? In a very simple term, many banks have mortgage securities on their balance sheet that they have no idea how much they are worth. As a result, no one knows whether the banks have sufficient capital to operate. Many banks refuse to lend each other for fear of counterparty risk.
For the main street, many corporations find it hard to re-finance their short term debt now that the commercial papers market almost dried out, because of the scare of money market funds, caused by Lehman bankruptcy and Prime Reserve's Money Market Fund breaking the sacred $1/share mark (it traded 97c) in last week.
It seems that the contagion is spreading quickly. And I start to feel we have to have some sort of rescue plan to address the root problems of the financial market, because the crisis boils over to the main street.
I think the $700B bailout plan in its original form (3-page proposal by Hank Paulson) was a scam. But the insurance proposal by the House Republicans is even worse. Taxpayers may incur even larger loss under that plan.
I think the critical component of any rescue plan should contain the provision that allows the Treasury to purchase the mortgage assets from the banks at a fair value, thus establishing a liquid market for the mortgages that are currently hard to value. Once a market is established, banks' financial health can be easily ascertained. That will lead to banks more willing to lend to other banks with sufficient capital. It should not be a bailout for the failing banks. It should be an intervention of the government to establish and maintain an orderly market for the mortgage securities. I think if the rescue plan is presented in this way, it would be much easier for taxpayers to swallow.
You may ask how the Treasury determines what price to pay for the mortgage securities? Ben Bernanke's idea of paying at the hold-to-maturity price is scandalous. That would be a huge give away to the banks. I think a so called "reverse auction" process is much fairer. Basically banks would submit their bid to sell their assets. Treasury would buy the lowest bidders up to a certain percentage of the total bids (say 50%).
To address the democrats demand that taxpayers should participate the upside of the banks recovery, we may demand the bidding banks to issue warrants to the Treasury valued at 10% of the assets the banks sold to the Treasury. When the banks' stock recovers in the future, Treasury can convert the warrants to non-voting shares in the banks and sell the shares for a profit.
One more thing I think we should be addressing is the potential inflationary effect of the bailout package. In short term, I do not think the bailout to be too much inflationary. But once the market returns normal, the excess cash in the system would create inflation pressure. That is why it is important that when Treasury sells the mortgages it bought from the banks, the proceeds should not be considered government revenue. It should be ear-marked to pay down the national debt, which was taken on to provide the initial bailout money.
But who am I? Who would listen to me? Washington politics is not determined by reasoning or what is right or fair, it is determined by the final compromise among different interest groups.
Sigh!
After working over the weekend in an attempt to come up with a modified $700B bailout package, the Whitehouse and bipartisan congressional leaders worked out a bill to present to the House for a vote. The bill suffered a surprising and stunning defeat, with 228 nays and 205 yeas. This morning, we were greeted with the news that Wochovia sold its entire banking business to Citi for a mere $2B, or $1/share. It looks like we are going to have only a handful banks left after this turmoil. That is certainly not good for consumers.
What is the root problem of the current financial crisis? In a very simple term, many banks have mortgage securities on their balance sheet that they have no idea how much they are worth. As a result, no one knows whether the banks have sufficient capital to operate. Many banks refuse to lend each other for fear of counterparty risk.
For the main street, many corporations find it hard to re-finance their short term debt now that the commercial papers market almost dried out, because of the scare of money market funds, caused by Lehman bankruptcy and Prime Reserve's Money Market Fund breaking the sacred $1/share mark (it traded 97c) in last week.
It seems that the contagion is spreading quickly. And I start to feel we have to have some sort of rescue plan to address the root problems of the financial market, because the crisis boils over to the main street.
I think the $700B bailout plan in its original form (3-page proposal by Hank Paulson) was a scam. But the insurance proposal by the House Republicans is even worse. Taxpayers may incur even larger loss under that plan.
I think the critical component of any rescue plan should contain the provision that allows the Treasury to purchase the mortgage assets from the banks at a fair value, thus establishing a liquid market for the mortgages that are currently hard to value. Once a market is established, banks' financial health can be easily ascertained. That will lead to banks more willing to lend to other banks with sufficient capital. It should not be a bailout for the failing banks. It should be an intervention of the government to establish and maintain an orderly market for the mortgage securities. I think if the rescue plan is presented in this way, it would be much easier for taxpayers to swallow.
You may ask how the Treasury determines what price to pay for the mortgage securities? Ben Bernanke's idea of paying at the hold-to-maturity price is scandalous. That would be a huge give away to the banks. I think a so called "reverse auction" process is much fairer. Basically banks would submit their bid to sell their assets. Treasury would buy the lowest bidders up to a certain percentage of the total bids (say 50%).
To address the democrats demand that taxpayers should participate the upside of the banks recovery, we may demand the bidding banks to issue warrants to the Treasury valued at 10% of the assets the banks sold to the Treasury. When the banks' stock recovers in the future, Treasury can convert the warrants to non-voting shares in the banks and sell the shares for a profit.
One more thing I think we should be addressing is the potential inflationary effect of the bailout package. In short term, I do not think the bailout to be too much inflationary. But once the market returns normal, the excess cash in the system would create inflation pressure. That is why it is important that when Treasury sells the mortgages it bought from the banks, the proceeds should not be considered government revenue. It should be ear-marked to pay down the national debt, which was taken on to provide the initial bailout money.
But who am I? Who would listen to me? Washington politics is not determined by reasoning or what is right or fair, it is determined by the final compromise among different interest groups.
Sigh!
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