Wednesday, December 31, 2008
This is my last post of MONEYTHOUGHTS for 2008. When I started this blog on February 13, 2008, I had no idea where I was going with it, or for that matter, whether I would continue to write something almost every day. This has been a year for the history books with all that has happened in the United States both politically and economically. Some might say that this year saw all the financial and economic bombs, that were armed over the proceeding years, explode in 2008. The panic that followed should not have surprised anyone. Earlier this week, the six month T-Bill went at auction for a yield of 0.25%. 25 basis points or a quarter of one percent, whichever way it is easiest for you to understand. The world has rushed for cover, and cover comes in the form of the safety of U.S. Treasury Bills.
During the year, I have attempted to describe financial and economic events and ideas in a simple way by staying, as much as possible, away from jargon and big words that explain very little. I like, by my nature, to keep things simple.
By pure luck, I had the opportunity to read an article in VANITY FAIR over the weekend, as I do not usually read this magazine. As I was reading the list of articles in the January 2009 issue with Tina Fey on the cover, I came across an article written by the Nobel-Laureate economist Joseph E. Stiglitz. The article is titled “CAPITALIST FOOLS”, and is divided into five parts. Each part is a mistake that was made over the years that finally came together to cause the financial and economic crisis of 2008. Naturally, I am in complete agreement with professor Stiglitz and the five major points he makes in this article. It is a short article and well worth reading.
I have tried to keep my language clean for the most part, but there have been times when I felt that the word needed to carry the way I felt about the whole situation or idea, so, I said it, and I hope I made my point. Professor Stiglitz has written an excellent article, too bad all members of congress are not required to read his article before taking their seat. Those of you who are interested in Professor Stiglitz’s analysis, should either go to the library and read this article or buy a copy of this issue of Vanity Fair. Everyone should read this article including Phil Gramm and Alan Greenspan. They above all others could stand to learn something from their mistakes. I have to assume that these two men, who played such a large role in the undoing of our economy and the financial and economic crisis that followed, were motivated by their sincere beliefs, and not by the fact that they had shit for brains. Read Stiglitz’s article, it discusses the five key areas where the mistakes were made. Before we can go forward with a successful recovery plan, we need to understand the mistakes that created the situation at hand, both financial and economic .
Wednesday, December 24, 2008
To all of my many many readers of MONEYTHOUGHTS, I would like to take this opportunity to wish you all a very Merry Christmas, Happy Hannukah and a Happy and Healthy New Year!
It is now less than 30 days until the Obama administration takes over. The first African American President is about to run onto the field and call his first play in the huddle. The ball, our economy, is not on the one yard line, but somewhere deep in our own end zone. But, don't you worry, a black quarterback is never given the ball in good field position in our political football game. Fox News is running the instant replay cameras, and Keith Oberman is in the booth calling the play by play. Chris Mathews is cheering Obama on from the sidelines and the nation awaits his first call. I think he will call a two-hole trap run up the middle. By the time the defensive backs , spell that blitzing Republican Senators, realize what has happened, Obama will be past the secondary. How long will he run? This run will take at least four years and hopefully eight. If his own people don't get in his way, this may turn out to be the best quarterback we have had in The White House ever.
Monday, December 22, 2008
2008 has been filled with news about the economy, yet talking about economics and the markets is not exactly entertaining. As a result of that fact that economics is not exactly entertaining, there is unfortunately a lot of talk by the talking heads that attempts to make the subject of economics and the markets more entertaining. We hear a lot of analogies and cute stories, and every once in a while a real economist says something, but for the most part, the people doing most of the talking do not know enough about how things really work on the inside for their comments to really light up the TV world.
To change how business is done on Wall Street will be no easy matter. There are many moneyed interests that do not want their game changed. They still have lots of money to get their point of view heard, so, it will be interesting to see how the lines of battle will be drawn. I am hopeful that this fraud involving Bernie Madoff will effect so many people that when the result of his actions are fully known, that the forces of good will out number the forces of greed by a huge number.
Make no mistake, this financial crisis with the meltdown of the asset-backed bond market was man made. The pressure for less regulation came from Wall Street and the politicians in Washington did their bidding. Now that the stupidity of deregulation has blown up in everyone's face, it is time to get real and bring back law and order to Wall Street.
I happen to know for a fact that the melt down of the mortgage bond market could have been prevented. The rating agencies were offered mathematical models for the structured financing that could have prevented the asset-backed bond market disaster. These mathematical models, if used, would have prevented the rating agencies from giving their AAA rating to many of the mortgage-backed bond issues. But, then that would have meant that the rating agencies would make less money because without them passing out their AAA rating, the Wall Street underwriters would not be paying them the big fees to rate their mortgage bonds. Did you know that the rating agencies were paid a fee by the underwriter of the bonds? This in a sane world would be known as a conflict of interest. However, on Wall Street and Washington, D.C., it is known as business as usual.
Obama, Biden and the new administration will need all the luck, stars in the right position and the power of the FORCE to make a dent in this culture. May the FORCE be with them.
Sunday, December 21, 2008
I have a few closing thoughts about the financial crisis that hit this country and then the world this past year.
When I worked for my state, Ohio, I had the opportunity to see first hand and up close how when things go bad, the politicians run for cover and/or throw the nearest body under the bus. As politicians in Washington, D.C. are no different from the politicians in any state capitol, I can conclude that the same is true at the national level as it is at the state. The article last Sunday, December 14, 2008, in The New York Times about the political influence and how that influence had a direct and negative effect upon the financial markets, and how the TV news programs and talking heads have ignored this front page article leaves me to believe that the road a head is going to be rough. The power and fear created by major political players can silence the debate for reform in the regulation of our financial markets can not be doubted. Unless this story gets out, and people know the truth about the mistakes their leaders make, no change will take place. 2009 is just a few days away, and a new president and administration is on the way, and I hope this administration will have the guts to do the right thing. It will be interesting.
Saturday, December 20, 2008
Last Saturday I posted a piece I made from cardboard and cereal boxes. Several photos were posted showing the development of the project from beginning to end.
Today I am posting three paintings that are far enough along to post.
The first painting is of the face of a tank watch. Expensive tank watches with their black Roman numerals were very popular on Wall Street among the men and women that referred to themselves as "Masters of the Universe." This term as you can see denoted the elevated position in which they thought of themselves before many were humbled by the current financial crisis. Because I am an old bond guy, I included in this piece the names of two former brokerage firms, known once for their "expertise" in bonds, that like the top three names exist no more. The black hands of the tank watch lay at the bottom no longer functioning for time has run out. The painting is still under construction as the gold case of the tank watch is still unfinished.
The second painting is a copy of an early painting of mine that was done in oil on board in a much larger size. These three paintings I am posting today are painted in acrylics on 1/2 inch MDO plywood that is first primed with gesso. This piece is also not finished. Those that paint and are not particular what kind of surface they paint on, may check out MDO plywood at your local lumber yard. I bought a scrap piece that I had them cut for me into 6 "canvases", 24x16 inches, and all for under $30. Naturally, when I sell my paintings, I hope to do a little better on the price.
The third and final painting is for a very special friend. This painting like the other two measures 24x16 inches. In the early 1990's, I painted six stamps in oil on gessoed paper for an exhibit of my early work in Covington, KY in May, 1992. This stamp incorporates several of my icons I use and have used in the past , and it is also not completed.
This may be my last post for the year. So, I would like to wish all of my many readers a safe and happy holiday season. In my previous life, I celebrated so many holidays that I feel entitled, now that I am retired, to have the luxury of celebrating nothing if I so desire.
Friday, December 19, 2008
Of all the stories in the news this week, the one story that has importance and significance, in my opinion, to the financial crisis and the bond market meltdown, is totally absent from TV news. I am talking about the excellent article that appeared in The New York Times, Sunday, December 14, 2008 about Senator Charles "Chuck" Schumer and his direct influence on the rating agencies and the whole issue of regulation and Wall Street. Is this Senator so powerful that he can force the TV news, cable included, to give him a pass? Of all the bullshit issues that there is time for on TV news, I find it hard to believe that this comprehensive article about the way things happened in Washington and Wall Street, and appearing on the front page of the Sunday New York Times, that not one journalist or talking head has made a peep about this article this week. If this is the state of journalism in America today, then it is going to be a long road before regulation, oversight and transparency in the banking and securities industry sees a brighter day. While President-elect Obama has picked individuals of ability and, I hope, character, the battle to better regulation of the banking and securities industry will not be won easily. Such power to keep any follow up of this article, which I mentioned in MONEYTHOUGHTS on Monday, December 15, 2008, off network or cable news programs, is just beyond me. Either the talking heads and journalists that cover politics and the market do not understand the significance of this article, or, the power to bury this piece of journalism is on par with Darth Vader's death ray. I realize that the story about Bernie Madoff losing $50 billion is more fun to report, but its significance is only made greater by its connection to the overall lack of regulation, oversight and transparency in the securities industry. It is because of the culture of abuse and contempt for regulation in the brokerage and money management business, as well as their shills in Washington promoting their interests, that this huge tragedy could happen. Our only hope is that the New York Times does not let this issue of Senator Schumer and his influence on Wall Street regulation die.
Thursday, December 18, 2008
Yesterday I saw on the 6:30pm news that the Federal Government’s program to help people avoid foreclosure on their homes has not helped one single home owner from foreclosure. All the people pulling down a salary and not one home owner has been helped. They must have gotten their play book from FEMA. It is hard for me to believe that in this big country that a Federal program that was designed to prevent people from losing their homes, after all these months, has helped no one. Try to get your mind around that one. That means, if the Obama administration comes in and saves one home owner from foreclosure, that would be a 100% increase! Our Government is not working. People are drawing salaries and nothing is happening. Sad.
Back to talking about economics. The commodity oil is down in price. Yesterday a barrel of oil reached just below $40. OPEC has decided to cut back on production because of the slowing of the world’s economy. This may or may not happen, let me explain. OPEC is not a country. OPEC is an organization that stands for Oil Producing Exporting Countries. OPEC may call for a reduction in production to try and keep oil prices from falling even further, but each oil producing exporting country has their own bills to pay and programs to fund. OPEC does not have any of this stuff to worry about. The oil producing countries in the past have been know to “cheat”. Cheating is when you produce more oil than your quota. But, sometimes a country’s quota for output is out of line with its need for cash. Remember, OPEC is not a country and has no people to keep from causing a revolution. It will be interesting to see if OPEC is able to keep its members together and cooperating during this period of a world wide economic downturn.
The decline in the price of oil has lead to a decline in the price of gas. This is a good thing for the United States that has no energy policy to speak of. With the price of gas at the pump coming down, families have more money to spend on other consumer items like food, clothing, mortgage payments and health care. High gas prices work like a tax on the consumer as they take money out of the economy. Why does it take money out of the economy? It takes money out of the economy because the United States imports 70% of the oil it needs. Those dollars we use to pay for imported oil leaves our domestic economy. This adversely effects our economy because the dollars taken out of circulation do not create demand for more goods and services. The creation of more goods and services and the money to pay for them is what drives our domestic economy.
The price of oil will go back up, but not so fast this time. The world wide recession has taken a grip on several economies and it will take time before those economies are back to full employment. By the time the Obama administration takes office, oil prices may have even declined further. The smart thing to do if and when the price of oil starts back up, is for the Obama administration to counter this by selling oil from the Government reserve. But, before they do that, they should start buying up oil to stabilize its price so alternative forms of energy are not priced out of the market. Then when the price of oil starts back up, and if our economy is still on its way up to full employment, the Government can sell oil to force the price of oil down, or at the very least stabilize the price.
Oil and money are commodities, and if handled correctly can help bring back our economy to full employment. When the economy gets going again in a few years, it will take a smart central banker to realize that it is time to raise interest rates to slow down the expansion of the money supply. Monetary policy can work, we just need people smart enough and courageous enough to do the job.
Wednesday, December 17, 2008
The Federal Reserve Bank yesterday lowered the Fed Funds rate to 0% to 0.25%, in an effort to get the economy going. I, like all of you, am hopeful that this move by the Federal Reserve Bank will help jump start the economy and get everyone back to work that wants to work.
I have little if anything to say about Mr. Madoff. I did not know Mr. Madoff and to the best of my knowledge do not recall ever meeting Mr. Madoff. I think that everyone that has read about Mr. Madoff and what he did to so many people and foundations, losing their money to the tune of $50 billion, that the argument for better and more regulations, oversight and enforcement at this point should be a no brainer. The SEC means nothing if it is not going to do its job, and that means equal enforcement of the laws. Just because you know a few important people should not mean that you are not held accountable to the same laws and regulations as the rest of us. Why was Mr. Madoff given a pass when it came to review and accountability?
Now let us get back to the Federal Reserve Bank, interest rates and the economy. It just so happens that with the American auto makers in the news as well, that I attempt to explain this economy in terms of an internal combustion engine, a gasoline driven engine. With gas in the tank and all the parts working perfectly, a gas engine will not turn over and run without a small piece of equipment found under the hood of the car. This small piece is part of a larger small piece, but without it, nothing moves. This small piece of equipment is called the distributor, and the even smaller piece is called the distributor cap, if the distributor cap is missing, it is enough to keep a 2,000 + pound car from moving one inch. No spark to the spark plugs and the pistons do not move. Everything else can be ready to go, and without this small piece of the equation, the car stands still. Our economy, unfortunately has more than one piece of the equation missing or broken. Let me explain.
The ratings of bonds and debt obligations is the distributor cap of the financial sector of our economic engine, in my opinion. In this case, it is not just missing, it is broken. Perhaps, it is time for Paulson and Bernanke to roll up their sleeves and get under the hood of the economic engine and get their hands dirty.
Back in the mid 1970’s, after New York City defaulted on their general obligation (GO) notes, several of the institutional bond departments brought together their own analysts to produce their own municipal bond research in a booklet form on a weekly basis. I remember this well because I received these pieces of research from several of the municipal bond departments of the large institutional brokerage firms in New York, and which no longer even exist. I read the research each week and paid particular attention to those large new issues of municipal debt that I might consider buying for the tax free common trust fund that I managed. Each brokerage firm had their own distinct texture and color nine by twelve paper envelope. I used to save the envelopes to draw on and take into boring meetings with me so I would not fall asleep. I believe I even designed the storm windows I made out of redwood for my old house (1901) on these large envelopes. Well, what is my point? My point is this. When the rating agencies let the bond investor down by not sticking with their downgrade of New York City G.O.’s in the early 1970’s, there were brokerage firms that put out their own research. Today that is impossible. Even if the firms were prepared to do this, no one would place any faith in their ratings because they are behind the securitization of asset-backed bonds.
Believe it or not, asset-backed bonds in and of themselves is not the problem. The problem is in the lack of faith in the rating agencies that give the bond rating to the asset-backed bonds like mortgage bonds. Without the mortgage lenders having the ability to sell their mortgages to the underwriters of mortgage-backed bonds, there will be little if any movement in the recovery of the housing market. Recovery of the housing market is essential to the full recovery of the economy. It all fits together Mr. Paulson and Mr. Bernanke, you just have to open the hood and get your hands dirty.
Take the rating responsibility of asset-backed debt away from the rating companies. The investing public has no confidence in the rating agencies. Without creditable bond ratings, bonds do not get underwritten and without bond underwritings, there will be little if any real movement in the financing of homes. The sale of cars is also tied to the asset-backed bond market in that car loans are also bundled and packaged and rated as asset-backed debt. Without the distributor cap nothing moves.
There must be some strong political opposition to my idea of the Federal Government taking over the responsibility of debt ratings. Confidence drives the bond market, and until there is confidence in bond ratings the investing public will continue to place their confidence in U.S. Treasury obligations. This is why interest rates are so low for U.S. Treasuries, the whole world is seeking the safest form of debt obligations, and U.S. Treasuries fill the bill. Until there is creditability in the rating of asset-backed debt obligations, spell that mortgage and car loan bonds, the economy will continue to misfire.
Tuesday, December 16, 2008
The interest rate on U.S. Treasury Bills, these are discounted notes issued by the U.S. Treasury, are selling to yield the investor four one hundredths of one percent, also known as four basis points. A little review, 100 basis points equals one percent. The women will understand this better than the men because women know that a one carat diamond has 100 points, so the arithmetic is the same for interest rates (100 basis points = 1 percent) as it is for diamonds (100 points = 1 carat). Why have interest rates on U.S. Treasury Bills, Notes and Bonds fallen to such low levels? The answer is that investors around the world are seeking to place their money in, first, a safe currency, and second, in a country that is going to be around in the morning. It really is that simple, investors are scared, and when investors are scared they put their money into the safest instruments they can find. The safest vehicle for their wealth, remember not everyone buying U.S. Treasury Bills, Notes and Bonds is an American citizen, is in their mind, U.S. Treasury securities.
The U.S. Treasury yield curve is almost a perfect positive sloping yield curve. Treasury interest rates are running like this:
3 months 0.04%
6 months 0.26%
1 year 0.47%
2 year 0.76%
3 year 1.03%
5 year 1.48%
10 year 2.49%
30 year 2.94%
If you take a piece of graph paper and place a dot on the paper to represent each interest rate and date to maturity and then connect the dots, you will have created a yield curve. The line will start at the bottom left hand corner of the graph and run upward and to the right. As investors are willing to part with their money for longer periods of time, the interest rate they are paid goes higher. This is known as a positive sloping yield curve. Remember also that the longer the maturity the greater loss in value when interest rates go up because of the concept of present value and the inverse relationship between price and yield. (see posting from April 10, 2008 for more information about price/ yield and present value.)
The problem that the economy is facing is that the banks are not lending money and borrowers are not borrowing money. The Federal Reserve Bank is now going to reduce the Fed Funds rate to try and encourage more economic activity. The talk is that the Fed may lower the Fed Funds rate, that is the over night rate banks lend money to each other to meet their reserve requirements, to as low as a half of one percent or also known as 50 basis points.
Houston we have a problem. What is the problem Ben Bernanke? We can not get enough people to borrow money to get economic activity going. Borrowing is key to expanding the money supply and developing economic activity. Well, just imagine if we took away all the traffic lights on the streets and highways. Then we turned off all the railroad signals across the country, and then we sent all the air traffic controllers home and told the airlines to just take off and land whenever they felt like it. Do you think such a plan would reduce the movement of people around the country, the states and even the cities? How might such a plan affect economic activity in the United States? Well, that is about what happened to the financial markets with the stupid idea and philosophy of deregulation. People are so scared that they are not borrowing money and they are investing their money in the safest instruments they know of, U.S. Treasury Bills. Basically, economic activity as we have known it over the last several years has shut down. You can thank the idiots we sent to Washington, D.C. to make the laws that run this country for the financial crisis, the bond market meltdown and now the recession. They have succeeded in running this country’s economy into the ground.
Some politicians may think a complex financial system can run without regulations, but any idiot knows that that is impossible. The economic reality we all are experiencing today proves my point.
Monday, December 15, 2008
The New York Times takes a lot of heat from its critics from time to time, but without The New York Times, we all would be a much poorer nation.
Again, the Sunday New York Times, December 14, 2008, the front page far left hand column and above the fold, “A Champion of Wall Street Reaps the Benefits” by Eric Lipton and Raymond Hernandez, digs out in detail much of what I have been writing about since I started my blog MONEYTHOUGHTS back in February of this year. If you are interested in the details that back up every word I have written about the political influence on regulation in the banking and investment securities industry, then read this article. These two guys spell it out in detail with naming names and dates and specific legislation that was either blocked out right, or, if passed was weakened afterwards to the point that it was no longer effective.
Christopher Cox, the head of the Securities & Exchange Commission (SEC) has taken heat for what happened on Wall Street. Even Presidential Candidate Senator John McCain said he would fire Christopher Cox because of what happened on Wall Street. What this article brings out, is that Christopher Cox was not the villain in this Wall Street drama. The real villain is none other than the senior senator from New York Charles “Chuck” Schumer. This so-called liberal senator did the bidding for Wall Street’s “masters of the universe” as he collected big bucks for political campaigns along the way. I do not want to steal these two men’s thunder. They did the research and asked the questions and listened to the answers in the interviews and put together this fine article that gives light to what really happened on Wall Street and in Washington,D.C. The real villains are hiding in the capitol because they had a big hand in the disappearance of all the capital from those 401-k and investment portfolios.
As I have written several times before, this financial crisis was man made. People in key positions worked hard to make sure regulations and common sense would not prevail, and that this financial crisis and meltdown would ultimately take place. If you have read my blog and you are familiar with the language, the terms and the jargon of Wall Street, you will not regret taking the time to read this well researched and written article.
The wealthy ones that run the large corporations on Wall Street will not give up their power or the way business is conducted in the securities and banking business without a great deal of public pressure. The bottom line is that our Senators in the United States Senate had as much to do with the financial crisis, or, in my opinion more, than the people on Wall Street. This financial crisis was man made in Washington, D.C. in the Capitol Building of our nation and signed by the Presidents in office at the time of the bills that were passed to weaken and ultimately destroy the safe guards put in place after The Great Depression. That these same men now come in front of the cameras and talk about all the other players in this farce, is the state of the reality we live, in America today. Listen to Obama’s words carefully. These people will not give up their power or the way they do business without a fight. I truly wish President elect Obama God’s speed and protection as he begins to take on these bastions of power and greed in his crusade to bring about a new day in America. God knows it will not be easy.
Let the battle begin.
Sunday, December 14, 2008
When I was a child, I had this belief that adults did the right thing. Unfortunately, as we all grow up, we see that adults don't always do the right thing or the smart thing. Some of us have even become those adults that have done the wrong thing, or the not so smart thing. The difference between those of us here, in our towns and cities, is that our decisions are, for the most part, based on what we think is the right thing to do for ourselves or our families, but not the entire nation. I wish I could say that for the Republican Senators in Washington that have opposed the loan to the American auto makers. After championing government deregulation for so many years, and, undoing the safe guards put in place during FDR's years as President, the Republican Senators are now pulling together to cause this nation, if not a longer recession, than what very well might become a depression, by their stupidity masked as political ideology. When the amounts being asked for by the American car makers is compared to the amounts of money given to AIG, the insurance company, you have to wonder, is class warfare alive and well in America in 2008? To ask so much from the UAW, in my opinion, is to set them apart and make them the scape goats of an economic disaster that was armed by the very Senate that is now refusing to give a hand. When the economic historians sit down to write the history of this period, they will no doubt recognize the gall of the Southern Senators and the role they played in deregulation of the banking and securities industry, while at the same time wanting to shift the blame for the failure of the auto loan program to the UAW. I am amazed that the talking heads have not seen through this weak attempt at class warfare by the Southern Senators to blame the unions. Sometimes, I wonder if President Lincoln did the right thing, perhaps the South should be a separate country.
Saturday, December 13, 2008
I am presently working on 3 paintings, but unlike some artists that post their work before it is finished, I will hold off until the pieces are completed or very near completed. The one piece that I posted along the way, in progress, was the piece I made out of styrofoam, cardboard, gesso and paint. I thought it might be of interest to some, to see how a piece like this is constructed from the beginning. So today I am going to look for those photos while under construction and post them again. As I no longer have my wood work shop, I decided to try a construction piece using materials that did not require a saw, a hammer or nails. This entire piece is made of paper and glue, then covered with gesso and painted. One of my icons is the "mother & child" that I have used in my paintings and drawings since 1989. I hope you enjoy this week's Saturday is for Art posting.
Friday, December 12, 2008
(I am reprinting a post from April 10, 2008 because I have noticed that people from all over the world read this posting. Evidently, I must have explained a few things about bonds, their price, their yield and the relationship that price, yield and time have to one another in the life of a bond rather well. So, for those that may have missed or not read this posting, here it is again. Enjoy.)
For some the arithmetic of money is a piece of cake, and yet for others it is shrouded in mystery. Today I am going to try to remove some of that mystery. To understand in a little more detail what is happening in the bond market and why some of this does not appear to be crystal clear, I would like to talk a little about time and money and the relationship time has to money. We have all heard the expression “time is money”, well today I want to take that another step.
First let us start with the parts of a bond, which is no more than a loan. There are several kinds of bonds. There are of course US Treasury bonds, municipal bonds issued by states, counties, cities and various authorities like school districts. There are of course corporate bonds and then there are many asset backed bonds like mortgage bonds and manufactured housing bonds. For the most part all bonds have certain things in common. First, they all have a maturity date. This is the date that the principal and final interest payment are paid to the owner of the bond. Second, a bond will have a stated rate of interest that will be paid usually semiannually to the bondholder.
Problems arise when interest rates change. They either go up or down. If interest rates go down, the value of the bond goes up, but if interest rates go up, the bondholder now has a bond worth less than its face or par value. What has happened? Now I am going to introduce a new phrase for some of you, Present Value. A bond has a present value based on its interest rate, its maturity and where interest rate are at present in the market. If you are holding a US Treasury bond with a 3% interest rate and interest rates for the same maturity as your bond goes up to 5%, your bond has to be discounted to its present value. Why would anyone buy a bond paying a 3% interest rate for a face or par value of $1,000 when they could buy the same quality bond with a 5% interest rate for $1,000? It is obvious, no one would. But, if the price of the bond is reduced to an amount that with the 3% interest rate and the capital appreciation the bondholder will receive when he cashes in the bond at maturity, the investment in the 3% US Treasury bond becomes a reasonable investment. So, the new buyer pays a discount for the bond from the bond’s original face value. Now if the 3% bond that is selling to yield 5% is held to maturity, a new term creeps in to the discussion, Yield to Maturity.
If you follow me this far good. Now we have to go one more step, but this is a big step. If the 3% bond has a maturity of say 5 years and sells at a yield to maturity of 5%, it will sell at a higher price than a 3% bond with a maturity of 10 years also selling at a yield to maturity of 5%. Now we get into something called the discount to the present value. As the bond with the longer maturity, say from a 5-year bond to a 10-year bond to a 20-year bond, the discount from the face or par value gets to be a bigger number. The price of the bond is tied to two things. The stated interest rate of the bond and the years to maturity of the bond. I like to refer to this as the inverse relationship between yield and price. As the yield to maturity on a bond goes up, the price of that bond moves in the opposite direction, it goes down. So, if you believe interest rates are going to go up because of inflation and you want to sell your bonds, the bond trader will pay you a price for your bonds based on what the stated interest rate on your bond is, and how many years, months and days until it matures and pays its principal. With knowing the interest rate, the maturity date and a yield to maturity, the bond trader can come up with a price that they will pay you for your bond. This price may be a discount if interest rates have gone up, or it may be a premium if interest rates go down. Simple enough, so what is the problem?
The problem occurs when bond traders have no confidence in the bonds they are trading and stop bidding on the bonds they make a market in. It is no different than the airlines grounding 800 flights and nobody moves around the country. Everything comes to a stop. Now we have a melt down, because unless you are selling a US Treasury and not a mortgage-backed or other asset-backed bond, you are in trouble. No one is bidding for your bond and you now have a non-marketable bond. Do you still want to be a bond portfolio manager when you grow up?
It is important to know the difference between the words marketable and liquid. A money market fund is liquid or is said to have liquidity. You put a dollar in and you get your dollar out plus the interest you earned while the money market fund held your dollar. Marketable is that there is a market for your bonds or stocks. Their price can go up or down, but it is easy to convert your investment to cash. A house is marketable, but not as marketable as a stock that trades regularly on the New York Stock Exchange. If you are a pension fund with several billion dollars in bonds and the bond market is not making a market in the bonds you own in your pension fund bond portfolio, you now can not actively manage that bond portfolio. At this point, all the terms like interest rate, par value, maturity date, yield to maturity cease to mean anything because everyone is grounded. No flights are taking off and no flights are landing, nothing moves.
Oh how I would love to pull out my soap box around now and just lay into all those people that believe in less regulation to no regulation to laisse faire economics in the 21st century, but I will not do that today. You know when you build a frame house, and you build walls with studs 16 inches on center. Why? Why not 32 inches on center, or 64 inches on center? Does it have to do with something called stress and weight bearing stress? Abstract things have weight bearing stress too. Take enough “studs” out of the equation and you know what you get? You get grounded or a melt down. Take your pick.
Thursday, December 11, 2008
I am giving it a rest. I have expressed my opinions on a number of things as they relate to our economy and the markets. I have also written about my belief that the present situation with regards to the rating companies is unsatisfactory and needs to be changed. I strongly believe that much of the financial crisis that in part lead to and complicated the economic crisis, was brought about by the disaster created in the mortgage-backed bond market. Low interest rates presented the underwriters with the fertile ground that made mortgage-backed bonds attractive to institutional investors that were shopping for a higher yield than was available in a more conventional type of debt, such as treasuries or straight corporate debt. With a potential market of buyers of the mortgage-backed bonds running into the billions and even trillions of dollars when the international investors are added in, gave the investment bankers of Wall Street enough incentive to "pull" more mortgages through the system. The only speed bump in the road was the rating companies, and it appears that a few dollars were able to remove that hurdle from the straight line between the home buyer, the mortgage lender, Wall Street and the mortgage bond buyer. Once the mortgages were made in to marketable mortgage-backed bonds, and given the good housekeeping seal of approval by the rating companies, their AAA-rating, it was pedal to the metal for the institutional sales forces of the Wall Street firms that were the underwriters of the bonds. With the process of securitization completed, the AAA-rating on the wrapper, and a hungry bunch of fixed-income portfolio managers shopping for a better yield, also known as a higher return, the stage was set for an international bond market meltdown.
If our Federal Government does not see the need for the rating of complex debt securities to be the responsibility of the Federal Government, then it is just a matter of time before we visit this crisis again. It maybe 20 or 30 years, but then again it could happen in as little as 5 or 10 years. Institutional investors, here in the United States, as well as around the world, will get back into the market when they can be assured that the bond ratings mean something, and, that the ratings were not bought.
Naturally, there will be a lot of politics that will influence the direction that our Congress and President take in dealing with the rating issue. The political-economy was alive and well in 1803 when President Jefferson bought the Louisiana territory from France for the reported sum of $15 million dollars. The purchase, I discovered when I did a little research and wrote my paper for my class in the Economic History of the United States, had more to do with the economics of the interior and the movement of commodities down the Mississippi River from the states, than the idea of Manifest Destiny, which came about many years later. How many more times are we, the American people, going to tolerate a man made financial crisis of this magnitude? I guess we will find out.
Monday, December 8, 2008
The New York Times, Sunday December 7, 2008, 67 years to the day after the attack on Pearl Harbor, has placed Gretchen Morgenson’s article, (one of my favorite business writers that appears in The New York Times), about Moody’s, (the rating agency that I have talked about as arming the bomb that lead to the mortgage bond meltdown), on the upper left hand corner, above the fold, of the front page of their Sunday newspaper.
Finally, after all these months, the story of the rating companies makes the front page. Buy, borrow or go the library and read this article by Gretchen Morgenson. While the article does not have all the good stories about Moody’s, the article, nevertheless, gives important information about why the rating companies and structured finance lead to the present situation in the asset-backed bond market. Those that want to know what lead to the present situation and the financial crisis we are in, and those in Congress that need to know because it is their job to know, should read this article.
“Debt Watchdogs: Tamed or Caught Napping?” is too kind a title for an article of this magnitude. I did a little research on Ms Morgenson, and found that she was only a teenager, probably still in high school, when the bells of the munifacts machine went off near my desk in the early 1970’s. Back in those days financial information came to those of us in the securities business by phone or munifacts. I remember it was five bells and everyone came running over to the machine to see what the news was about. Moody’s had downgraded the City of New York from an A-rating to a Baa-rating on their General Obligation bonds. Municipal Bonds, to keep it simple, in those days were either GO’s or revenue bonds. GO bonds were paid from taxes as opposed to revenues like say a turnpike revenue bond. The age of structured financing was still a few years away. What is so important about the New York City downgrade was the fact that the next day the five bells rang out again, only this time the news was that Moody’s had reconsidered the rating downgrade and returned New York City GO municipal bonds to their A-rated status. Moody’s caved to pressure from the Director of Finance of the City of New York. A few years later the City of New York would default on its GO notes and Felix Rohatyn, a very bright and capable man, would come to the aid of the City and work his magic and restructure New York City’s debt.
The rating of debt in this country needs to be removed from the private sector, period. Companies that are publicly traded, that answer to shareholders, that have profit as their foremost goal can not be expected to give bond rating opinions that are worth the paper they are printed on if the main goal of the company is to generate a return on equity. Is no one out there, with enough ethical high ground to back me up? I can not be the only person who has ever worked with bonds that sees this problem.
There are more stories to tell, but this is not the time to tell them. Today’s point is, if you want to know more about the role that the rating companies played in the current financial crisis, read Gretchen Morgenson’s front page article in the Sunday edition of The New York Times. I wonder if the editors of the Times had any motive in saving this great article for Sunday December 7?
Anyone who would like to read the article I have talked about can go to this link.
Sunday, December 7, 2008
It is 17 degrees this morning in the Queen City. On a morning like today, I ask myself why would anyone settle a village on the Ohio River rather than continue going south to a warmer climate? The early settlers of the Queen City must have enjoyed cold weather a hell of a lot more than me. Sometimes we get a pass for December, but it sure doesn't look that way this year.
Well the University of Cincinnati football team got to travel to Hawaii to play a little football. I'll bet they are happy the game wasn't here. The No. 13 ranked Bearcats beat Hawaii 29-24. I don't even want to know what the temperature was at game time.
There was some good football on the tube yesterday. I painted and listened and watched the Army-Navy game. It wasn't much of a game for Navy as they rolled over the scoreless Black Knights of West Point. It is quite clear that Navy has a football program and Army does not. When you get knocked off that many years in a row, you need to make some changes. Any good military mind would see that.
But the real bright military mind goes to our leader here in the Queen City, Mike Brown. The Bengals, our own professional football team travels up I-74 today to "play" the Colts in Indy's enclosed stadium. With temperatures right now below freezing, the Bengals don't need another obstacle to winning.
I enjoyed watching the Florida-Alabama game too. These two schools have excellent football programs and could teach our Bengals a thing or two about winning programs. But then again they don't have Harvard educated Mike Brown running their programs. That honor is left for us in the Queen City. Aren't we lucky.
Saturday, December 6, 2008
The above 9 pieces are paintings that I call THE ENVELOPE COLLECTION. The original paintings were done in acrylics on the back of a 12" by 9" black envelopes that I received reports in at my job from 1996 to 2005. The prints are enlarged slightly and are printed with an Epson printer on Epson Professional Paper that measures 19" by 13".Prints of these works are available to be purchased from me directly. I can even have them framed for you and sent to you directly from the professional frame shop I use in Cincinnati. Anyone interested in any one of thses prints can contact me at email@example.com. Prints purchased unframed are mailed in a tube. One more thing, I will sign each print just under the image on the right corner in black ink or pencil, which ever you prefer.
Friday, December 5, 2008
There are natural disasters and then there are man-made disasters, and then there are natural disasters made worse by an inadequate response to a natural disaster. The latter one is called Katrinia, like in hurricane Katrinia.
The latest chapter of the Economic Crisis of 2008 involves the question of whether the Federal Government should loan the three American Auto makers money so they can stay in business without having to go through bankruptcy. Almost everyone who has commented on this chapter has brought up the fact that much more money was loaned to the banking and investment banking sector commonly known in the jargon as “Wall Street”.
Money and the movement of money has an essential role to play in an economy as complex as ours. Cut off the flow of cash and credit in this economy and it would amount to cutting off the flow of blood to the heart and the brain at the same time. Such an action would produce the death of our economy as we know it. To rebuild would take years and the pain and suffering would be almost unimaginable. But what about cars and trucks?
For a whole lot less money, the Federal Government can keep millions of workers working and all the related industries working as well. But, there is a difference, it is not the brain and the heart, it is only both arms or a leg and an arm of our economy. Either way, in my opinion, not to give the three auto makers the loan is just plain stupid. Actually, it is worse than stupid. If any American thinks that letting the three auto makers go under will not affect their house, they are not thinking clearly, or, more importantly, like a macroeconomist with a world view. Why a world view?
Does anyone on this planet believe if this same thing happened in Japan, that the Japanese Government would hesitate for one second to come to the aid of their auto industry? I rest my case.
It is time to get real in America. The policies that our Federal Government pursued since the end of World War II hold the key to our present economic situation. Not to look at the big picture and just beat on the heads of the auto worker of today is, in my opinion, just plain stupid and mean. How can I expect our Congress to understand what history, our own making of history, has done to the position of the auto industry in American today, when all they know how to read is polls? Foreign competition has pushed Detroit to build a better car, I will agree with that. But, the whole foreign policy, (the Containment Policy), of the United States coming out of W.W.II and the start of the Cold War with the Soviet Union, was predicated on the belief that the way to fight communism was to have strong economic healthy democracies surrounding the Soviet Union. This is where our foreign policy intersects with domestic economic policy and results in the trade agreements with the Germans and the Japanese. These trade agreements helped to make their economies develop and grow strong. In no small part, again in my opinion, was this part of what lead to the fall of the Soviet Union. Germany and Japan, not the United States, had rebuilt themselves from the end of W.W.II, and their defeat, and now had surpassed the Soviet Union’s economy.
A thick book could be written as to why we should not let the three American car makers go into bankruptcy, but that should not be needed. All that is needed is a little understanding of why the present situation was created. We produced first the financial crisis that lead to the present economic crisis by our own hands America, this was not a natural disaster.
Thursday, December 4, 2008
The present economic crisis is man made, just like the Great Depression was man made. The big difference this time around, I hope, is mass communication. In the early 1930’s, radio was in its infancy, and TV was yet to be invented. The movement of ideas traveled at a much slower pace or perhaps not at all. This time there are any number of ideas out there about how to fix the present economic crisis. Economists appear on TV, in print in the newspapers and even on their blog or web site. I also feel good about the fact that many of the people being assembled for the new Obama administration are bright and capable people. And, President-elect Obama states that there will be strong debate within his administration and hopefully this will bring out the best ideas for the measures to be taken for the economic recovery.
One aspect of all this is: what happens to our money? I am not talking about the new designs the U.S. Treasury seems to be coming up with each week. I understand that new technology can be used to safeguard our currency. The last thing we need is for another country to flood the world with bogus one hundred dollar bills, we will be printing enough of those babies ourselves.
Knowing Paul Volcker will be hanging around, and, I hope, have the president’s ear, makes me feel better about our chances for a sound recovery. But, that said, there are still some very basic things about monetary policy that I would like to address.
Whether the federal government borrows the money or just prints it, the specter of inflation is out there. Those that hang in there for the most part, I think will be fine. The stock market will go back up as earnings turn around for corporations. The idea that stocks will no longer sell at a price earnings ratio will never happen. When earnings projections start back up, the stock market will begin its recovery. Like the stock market, the real estate market will come back as well. Unless someone can make a case for a huge wave of deflation, housing prices will come back much like the stock market. But, what about those people that hold cash?
Those individuals that know they do not understand the stock market or trust a broker to put them in the right mutual fund, are left with their savings account at their bank, or, their box of money under the bed. If they were smart enough to make that gold coins in the box under the bed, then even if the house burns down, they still have their gold coins.
The amounts of money that our government is going to spend and print will cause a new round of inflation. This may not appear for a while, but it is coming. Those that know something about hedging for inflation may want to revisit their plans again. Those who will invest will see their investments move up in value over time. The prices we pay today for goods and services will go up, and while it is hard to believe this now as prices are going down today, believe me, this phase of the economic cycle will happen. My question is: what is the federal government going to do to protect all those people who will be left with much reduced purchasing power for the money they saved. The argument that Americans do not save, to me is a joke. Why save money that will buy you less goods and services the following year even if you saved it? If the government keeps interest rates low, two things will happen. The first one is that people will not save. In the 1970’s and 1980’s money market funds were all the rage because people were being compensated for giving up the use of their money for an attractive interest rate. Second, low interest rates are good for developers of real estate and other expensive or capital intensive projects. But when interest rates are held down for political reasons, like to keep the party in power and the party going, it causes investors to reach for yield, and, now do you see where I am going? Yes, reaching for yield can be spelled investing in asset-backed bonds, and, now you know the rest of the story.
Wednesday, December 3, 2008
More Richard Nixon tapes have been released and George W. Bush’s interview with Charlie Gibson playing on TV, how could life in America get any better? For a few moments there, it is like a deeply moving religious experience for me, getting to listen to these two Republican presidents from different times, all speaking now to us in the present. The inspiration that their words fill my body and mind are so powerful that I can not waste my time writing about our economy, or bonds, or for that matter anything else. This kind of inspiration calls for me to paint. The call to create political art plays in my head. Enough said, it is time to paint.
Tuesday, December 2, 2008
I listen to too much TV news, and I know it, but at least I am painting while I am listening, so it is not entirely a waste of my time. As I have commented before, the TV news programs on cable do not employ economists to host these shows and therefore we hear a lot of nonsense. It is nonsense in my opinion anyway. So, lets talk about the market and monetary policy for a moment.
The stock market took a big hit yesterday losing its most points in a single day. But the question to ask, is it the largest percentage drop in history? It really does not make any difference. The people that make a market in a given stock, means that they are offering stock and buying stock of those companies that they are making a market in. As sellers enter the market, the market maker lowers the bid price that they will pay for the stock. If there are more sellers than buyers the bid price at which the market maker will pay for your stock will continue to drop. When buyers enter the market in large numbers or more stock of a particular company is being bought than sold, the price of that stock goes back up. There are also investors selling short stock they do not have a position in. That means that the stock market rules permit an investor to sell shares of a company that they believe is priced too high and believe is going to go down in price. This aspect of selling short adds volatility to the market. When it appears that the market is going to go back up, the short sellers have to sell their short position, also known as covering their short position. All of this activity adds volatility to the stock market. The important thing to remember is that good companies get battered in the stock market during turbulent times, but they are still well run companies. There are a number of these companies out there. They do business around the world and provide excellent products and services the world over. When the economy gets back on track, these good companies will improve their share of their markets and return even better earnings than before the economic crisis which we now can officially call a recession. This blog is not for giving out advice about what to do with your money or investments. It is to discuss, through my 66 year old left-handed Jewish brain, what I see and make of things after a few years working with this stuff. Years ago, an older gentleman I knew said that during periods of stock market volatility, that you ride it out like a ping pong ball in a storm. There is a lot of bouncing around, but when the storm is over the ping pong ball is still there. There are good reasons to believe this is true.
Money and monetary policy. The U.S. dollar is still a very stable currency. Why? As a history student, I had this idea that to really understand an historical event, it was necessary to look at more than just the event itself. Let me try an example: Woodstock, the music event of the 1960’s. To just look at what took place on the few days at Woodstock without understanding the culture of the whole ‘60’s movement would not make much sense. The events leading up to Woodstock are as important in understanding Woodstock as Woodstock itself.
Now look at immigration to the United States and what do you see? People are still coming to this country and trying to get in any way they can. What does this all mean? Quite simply, the United States is still the place to be. When the flow of people starts the other way, then I think it is time to be worried. The political and military strength of the United States is what is ultimately behind the value of the U.S. dollar. Yes, the dollar goes up and down in value on the currency exchange markets, but these are fine tunings to current monetary conditions. No one is getting out of the U.S. dollar in any big way. The wealth of this country, both physical and intellectual is enough to cover the value of our currency. When you add in our political stability and our military strength, this country is a long long ways from being valued correctly in the markets. A lot a nonsense passes for knowledge, but do not be fooled, this country is coming out of this recession and help is less than 50 days away.
Monday, December 1, 2008
Help is on the way, but it is going to be another 50 days, 30 plus 20, before the new administration takes office. Until then little if anything is going to be done to help our economy get back to full employment.
There are a couple of ways to look at this. First, there are those that want an imbalance between jobs to be filled and the number of laborers to fill them. This is classical supply and demand economics. The more laborers available the lower the salary or hourly wage the employer needs to pay. It is a buyer’s market if you are in the market for labor. This may have a tendency to push down wages and thus have a deflationary effect on the economy.
On the other hand, any stimulus coming from the Federal Government, though inflationary, is not likely to take place until after the new administration takes office. Even helping out the states so they do not have to lay off workers this Holiday Season could go a long way in keeping the unemployment lines shorter. However, I do not see the present administration doing anything like that. Obama is not yet president and the present president is not there either, so, as far as the economy is concerned we have no president.
Basically, the American economy is going to have to hang on until January 20, 2009. One good thing in our favor with regards to the poor state of the economy is Christmas. Thank God for Christmas. The spending that will hopefully take place during the Holiday Season, may get us over the hump until the new administration can take office. Those of you who do not believe in Christmas are certainly entitled to your beliefs, as we live in a free country, and people can believe as they wish. But this year, it is not just a matter of religious beliefs, it is a matter of economic survival.
This Christmas, buy an extra gift for someone who has done something special, but who is not expecting to receive a Christmas gift. It does not have to be a big or expensive gift for it to work. We all need to buy a little extra gift for someone who has touched our lives, perhaps during the past year, this Christmas. Our economy needs for people to have confidence in our ability to turn our economy around, but also for us as a nation to show to one another that we have heart.