Saturday Is For Art

January 31, 2009, the end of the first month of the year and only two more months of cold and snowy weather. In addition to the Obama postage stamp painting that I post today, I will post a couple of photos from this past week's snow fall. I want to repeat, I take pictures, I am not a photographer, so please realize that I just click and shoot. That's it, I don't do any more.

The Obama postage stamp painting was inspired by the recent ESQUIRE magazine cover. I changed it a bit and rather than paint President Obama in red and shades of blue, I painted him in shades of raw sienna and white mixed. I am thinking about reducing the image and printing them on 19"x13" paper on an Epson printer and offering them for sale. But then I might just reduce them down to the size of a postage stamp and sell sheets of them as stickers for people to use when they write their elected representatives. If you support the policies of the Obama administration, perhaps when you write to Washington it is good to let them know where you stand.

I hope everyone has a nice safe weekend and enjoy the Super Bowl if you are a fan.

Where Our Capital Winds Up

There is a lot of debate on the cable TV news programs as to what is stimulative and what is not stimulative for our domestic economy. I should not have to say “our domestic economy” as that is a bit redundant, but I do it for a reason, to emphasize the importance of differentiating between money that stays here in the United States, and money that leaves our economy. There is a difference in my opinion.

Earlier today a talking head made the comment that money given back by the government in the form of lower taxes or a tax rebate and used to pay down mortgage or credit card debt is not stimulative. I disagree. The problem in part is because there is a crisis of confidence within the banking system. I think that if the banking system saw mortgages current and credit card debt being paid back in a timely manner that that would give those institutions more confidence in our domestic economy as well. Those dollars that are used by consumers to pay down debt, do not necessarily leave the domestic economy. Those dollars create demand deposits at commercial banks which permit and encourage banks to lend money.

The problem that has been with us for some time is the fact that each year, for now a generation or more, larger and larger amounts of our money leaves our domestic economy and goes to pay for commodities and goods made overseas.

Think of the domestic economy as a basketball and the air that gives the ball its bounce as the money. But, if the ball is leaking air, the bounce changes and eventually there is not enough air in the ball for it too bounce. The government can put more money into the domestic economy and the bounce will come back, but if the leak is not corrected the bounce will eventually go flat. Money spent for oil imports and all the products that are imported from China and the rest of Asia, is money leaving our domestic economy.

The best stimulative bang for the buck for the Federal Government is investing in infrastructure and creating a demand for goods and services made in the USA. Hardwood floors that are made in Massachusetts by American workers is the kind of work that is stimulative for our domestic economy. Oil and products imported from abroad has less stimulative benefit because the money leaves the system.

This is why the economists that understand the importance of the movement of capital and its travels through our economy are all in agreement that the stimulus package needs greater attention and proportion to rebuilding our infrastructure.

Over the years America has become a nation that imports everything it wants. Fruit from South America in the winter, to clothes, cars and electronics from the Far East, to $700 billion dollars in oil from around the world and the Middle East. There is a price to be paid for not having a balance in our trade with the rest of the world. Stimulating our economy is just a piece of the problem, where that capital eventually ends up is also important to the long term welfare of our economy.

Stay tuned.

What Can I Say

Economics is a science and politics is an art, and when you put the two together you wind up with a politico-economic interpretation of history.

The Republican Party, the same political party that held the White House the last eight years and control of Congress up until 2006, now that they are out of the White House and no longer have control of the Congress, now suddenly have the economic solutions to all of our economic problems. This is possible, but not likely.

The banter about pork in the Stimulus Bill is just so much nonsense. It is because of policies going back a generation or more, that the money spent by Americans, leaves the country all too soon and does not continue to circulate within our domestic economy. The $700 billion dollars that we send overseas each year to pay for our oil is a nice chunk of change, that, if kept within the United States, would continue to circulate in our domestic economy, and be a source of capital for savings, investment, jobs and further consumption. Unfortunately, this path is short circuited by the fact that we do not have a comprehensive energy policy and thus, we are exporting our capital in exchange for oil. Where have the Republicans been since 1981?

The Republican Party must come up with something as they are the loyal opposition, but unfortunately, even the brighter conservative economists know that the Stimulus Bill needs to be bigger, more spending not less. To argue that a few million dollars here or there is pork is nuts when we are talking about spending nearly one trillion dollars.

If anything speaks to the sorry state of the Republican Party, that at one time had some very smart people, is the fact that the radio guy, Rich Limbaugh, is now the philosophical head of the Republican Party. If ever there was an argument for the dumbing down of America, recent events make this only too clear. I can not believe that a guy, whose followers call themselves “ditto heads” got into my blog about economics.

I need to take a step back and think for a while about this. In the mean time, the Stimulus Bill will pass. I only hope that the Obama administration will address the issue of the rating agencies in the near term.

Stay tuned.

The Smartest Guys In The Room

On Sundays, besides reading the Sunday New York Times, I watch a couple of the news programs. I started watching MEET THE PRESS when I was a young boy with my father. Back in the 1950’s, the program had a moderator and a panel of newspaper reporters and they would ask the guest questions. That must have been more difficult for the politicians and other guests as the panel had time to listen to the answers and ask tough follow up questions. Today the format is more of a one on one, and even a not so smart politician can get through the interview.

Talking about not so smart politicians being interviewed, John Boehner (R) Ohio, 8th District, was on MEET THE PRESS Sunday. Congressman Boehner I do not think has a Ph.D. in economics like former Senator Phil Gramm, which I think is a good thing because Senator Gramm, John McCain’s economic advisor during the presidential campaign, said that the recession was a mental recession, just in our heads, and that Americans were being a bunch of wieners.

Congressman Boehner lead off with the words, “I don’t think it will work”, when referring to the Obama administration’s stimulus plan. He does not think America can borrow and spend our way back to prosperity. For the last 8 years a Republican President, George W. Bush, and a Republican Congress has created a trillion dollar deficit and now they are the smartest guys in the room. Give me a break.

Now I would like to relate a story I read several years ago in The Wall Street Journal. The Wall Street Journal is, in my opinion, a damn good newspaper. While I did not agree with their editorials, the articles that appeared on the front page were well researched and very informative. One that I remember well was about a company in Massachusetts that wanted to sell a particular metal to the Defense Department. The Defense Department had plenty of that metal in stock, and did not want to be forced to buy more. But, the Congressman from their district got the Defense Department to buy the metal from the company anyway. Which brings me to the point, One man’s pork is another man’s what? Congressman Boehner thinks there is too much pork in the stimulus package that the Obama administration has put together. Whenever the spending is not for something related to defense, it is pork to the Republicans. Waste more money on metals that even the Generals in the Department of Defense do not need or want, but do not spend money on education, health care or infrastructure. Personally, I do not think that the Republicans in Congress, like John Boehner, are the smartest guys in the room. If they were, we would not be in the situation we are in today. Yes, I lay this recession and the financial meltdown directly at their feet. It is time for the men with the pretty faces to step back and let the guys with some brains take over.

I would think that the Republicans in Congress would be smart enough to get behind this president and his administration and work their butts off to help bring this country out of a recession that is, in my opinion, largely attributable to the incompetence of the Bush administration. That is, unless you believe that the Bush administration was successful in almost destroying the middle class and that was their objective. Take your pick, either they knew what they were doing and they achieved their desired results, or, the Bush administration was a bunch of incompetent hacks. Either way, the country is in the most serious place it has been economically since The Great Depression.

Stay tuned.

Washington: We See The Problem

After reading my Sunday New York Times, it appears that the new administration is moving in the right direction. The headline on the front page reads “Obama Plans Fast Action To Tighten Financial Rules” “New Scrutiny for Hedge Funds, Derivatives Market and Credit Rating Agencies.”

It does not appear that this administration is ready to scrap the credit rating companies and take the responsibility and put it with the Federal Reserve Bank or the Securities & Exchange Commission. In the real world this kind of drastic action will only be taken if all else fails, I guess. This is what the Times had to say,

“Some of these actions will require legislation, while others should be achievable through regulations adopted by several federal agencies.
Officials said they want rules to eliminate conflicts of interest at credit rating agencies that gave top investment grades to the exotic and ultimately shaky financial instruments that have been a source of market turmoil. The core problem, they said, is that the agencies are paid by companies to help them structure financial instruments, which the agencies then grade. Until we deal with the compensation model, we're not going to deal with the conflict of interest, and people are not going to have confidence that the ratings are worth relying on, worth the paper they’re printed on,”(said) Mary L. Shapiro, who testified earlier this month before being confirmed by the Senate to head the Securities & Exchange Commission.”

It does not take an Einstein to know that if the credit rating agencies are being paid by the investment bankers, who underwrite the structured financial instruments, that unless the underwriters get the AAA rating they are looking for, that they will then “shop” for another credit rating agency that will give them the AAA rating. Because these companies, the credit rating agencies, are corporations that are publicly traded with quarterly earnings reports, and CEOs, whose salary and bonus are usually tied to the growth in earnings of their corporation, the greed factor is alive, well and at work. Figuring out how to remove this major conflict of interest that the rating agencies have with their clients, the investment banks on "Wall Street", is at the heart of the matter. Without this conflict of interest worked out of the equation, it will be business as usual. Greed trumps all cards.

The article goes on to say,

“They are considering proposals to have the S.E.C. become more involved in supervising the underwriting standards of securities that are backed by mortgages.”

That sounds good, but they do not say how they are going to eliminate the conflict of interest. I happen to know a person that owns a company that writes mathematical models for structured finance. I also know that the credit rating agencies declined their offer to help them with their task of rating mortgaged-backed bonds. Had the credit rating agencies used the models offered to them, they would not have been able to give many of these mortgaged-backed bonds their AAA rating.

The real story is that the credit rating agencies really did not want to know that they should not be passing out their AAA rating like candy to children on Halloween.

Unless the conflict of interest problem is resolved, and it will take some tough and comprehensive regulations and oversight to do that, the problem of confidence in structured financial instruments will remain. The way out of the recession has many avenues, but the credit rating agencies solution is, in my opinion, directly tied to the speed of the economic recovery.

Stay tuned.

Saturday Is For Art

Today I am posting three paintings that are not finished, but I thought they were far enough along that they would nevertheless be interesting to look at. The first painting is a redo of a quite similar painting that I did in 1991 in oil and enamel paint and measured 36"x48". This painting is 16"x24" and is painted in acrylic. Over the years several people have given me favorable comments about the original painting. I thought it might be interesting to see if I could reproduce the original and perhaps create and little more depth in the painting by using color and perspective. The second painting was inspired by a recent VANITY FAIR cover. Then I saw the ESQUIRE cover with President Obama and decided to do that cover as well. Back in the early 1990's, I created six postage stamps on paper in oil. These two stamps are on MDO plywood and measure 24"x16" and are painted in acrylic. The VANITY FAIR postage stamp is 42 cents. Can you guess the postage number for the President Obama stamp? Right! 44 Cents. I thought they would make a nice pair of "stamps". Political art for me is a way to express my interest in what's happening in our country.

Trying To Hang On

A lot has happened this past week, and I think it is going to take me a while to let it all sink in. While the politicians in Washington debate, many throughout the country try to hang on. We have been told that the economy may get worse before it gets better. The Federal Government can take steps to slow, stop and turn around the economic spiral downward. It need not be done because of a war like it was done at the time of World War II. There is much work that needs to be done right here within the United States. The banking system and the capital markets need to be addressed. The flow of money, the creation of credit, the securitization of debt and the distribution of honest investment products are all necessary components of our economy in the 21st century. Without all of these components working properly, the growth, the expansion and the revitalization of our domestic economy is not possible. The field needs to be leveled, the white lines drawn and the rules of the game need to be enforced. People will come and play, but only when they perceive that the game is on the up and up. Trust and confidence must be restored so the game can go on. I just hope that there are enough people in Washington that care that there are people throughout the country trying to hang on.

Stay tuned.

They Float Above Us

When I was in high school, my classmates said I thought up dump things to argue about. I did not agree that I thought up dumb things to argue about, but I did think of things to argue. Here is one for today.

The nomination of Tim Geithner for Secretary of the Treasury and the nomination of Hillary Clinton for Secretary of State bothers me. I think President Obama knows smart people when he meets and works with them, but I do not like smart people that think they are above the law.

Forgetting to pay your taxes happens to lots of people, but they usually do not get asked to be Secretary of the Treasury. The Clintons have a foundation that does a lot of good work. The problem is that foreign donations to the foundation by wealthy foreign individuals on behalf of their country could create the appearance that our Federal Government is for sale, or at least that money can buy influence, or access to influence.

I know that the young boy that walked the streets of Indonesia and grew up to become our 44th President does not need any appearance of wrong doing in his administration. I just wish that he could have started with a clean slate. President Obama deserves no less.

I guess what bothers me about this is that in my life, I have met people that think the laws are for the masses, not them. They are smarter than 99% of the people so they are above the law. I have seen that attitude before. While we in the United States do not have royalty by birth, there is an attitude that there is a type of royalty by education, position or money.

I believe the Obama administration wants to level the playing field, but leveling the playing field needs to start with that 1% that thinks they are royalty and float above the law.

Stay tuned.

Dear Mr. President

President Obama
The White House
1600 Pennsylvania Avenue
Washington, D.C.

Dear Mr. President:

The recovery of our economy I know is of paramount importance to you and your administration. You have assembled a great economic team with many knowledgeable and experienced individuals. And it is conceivable that what I have to say about the rating companies is already in your sights; however, I would nevertheless like to add my two cents.

The present system of the private rating agencies is a failure and stands in the way to our rapid economic recovery. The rating system as it exists today is broken. The trust in companies that sell debt ratings for structured financial products does not exist and will not exist until this responsibility is taken over by the Federal Government. Investment bankers can not be permitted to “shop” for a AAA rating for mortgage-backed bonds, manufactured housing bonds, car loan bonds or any other debt instruments that are essential to the movement of capital and the growth of our economy.

The Federal Reserve Bank can flood the banking system with cash, but the movement of that cash, once the loans are made, is dependent upon the capital markets. The crisis of confidence is with the rating agencies. Their failure is hurting the whole movement of money from the point of purchase to the eventual point where the debt is purchased as a structured debt investment.

While there are several finer points to the capital markets that need to be addressed, the matter of confidence in the rating of debt instruments is critical to the recovery and expansion of our economy. If this important matter is not in your sights, I think it should be. The capital markets can not function without confidence and trust in the rating system.

Good luck in the days ahead.

Sincerely,

Moneythoughts

P.S. To readers of this blog: You may send this letter to President Obama if you desire. Perhaps, if several copies of this letter are sent to The White House, one will get through, and hopefully someone that understands it, will read it.

January 20, 2009: Inauguration Day

Today the United States not only begins a new chapter in our history, but a whole new volume. The whole world is watching. We are the engine in so many ways.

Stay tuned.

U.S. History: A Clean Page

Tomorrow is Inauguration Day and I am planning to drive up to Columbus to watch the inauguration of President-elect Barack Obama with some friends. Having worked in the state capitol for the state for over nine years, I naturally made a few friends. One friend, in particular, I have managed to stay in contact since my retirement has invited me to come up and watch and celebrate the inauguration in his offices.

As I wrote a few days ago, this inauguration is not just an important event for those of us in America, but it is also an important event for the rest of the world. Without going into our recent history, the United States lost much of the goodwill that it had been the beneficiary of since the attack on 9/11. Invading Iraq and the success of that venture will remain unclear for some time. What we do now as a country may determine whether the policies of the Bush administration were correct. I am hopeful that the Obama administration can build on the decisions that were made with regards to Iraq and that the United States can repair its image and its diplomatic relationships around the world. Given where we are economically, the United States could benefit from a more peaceful world. While that scenario is highly unlikely, the new administration nevertheless needs to extent a hand of friendship and mutual respect to the other nations of this planet.

If ever there was a president that could recapture the admiration and respect of the peoples around the world, that president is president-elect Barack Obama. If ever there was a time in the history of the United States that the incoming president truly had a clean page of history to write on, it is this new president.

This new era in the history of the United States was made possible by the men, women and children that joined the struggle for racial equality, justice and the civil rights of all in these United States. While we set aside today to remember one man, Dr. Martin Luther King, Jr., for his achievements and his efforts to bring equality, justice and civil rights to all Americans, we should never forget that the struggle started many many years before his life began. Each new generation must remember that his work is never done, that we must work to renew that dream of equality, justice and civil rights for all every day.

Stay tuned.

Saturday Is For Art

Late Thursday night, America lost one of its great artist, Andrew Wyeth. Wyeth was 91. Some of the news stories I read the other day about Wyeth's life were very interesting and familiar. I knew of Andrew Wyeth through his work going back to the 1950s. My father introduced me to his work as he was a fan of Wyeth's talent and work. But, what I find amusing are the detractors of his talent and his work. People in the art field calling him an illustrator, or even worse, that he did not know how to paint. To say Andrew Wyeth did not know how to paint, is like saying Ted Williams could not hit a baseball. But, in a free society, everyone gets to express their ideas. Just some people in the art world do not really have any of their own ideas, they play a game and call it thinking. The next time I travel to the Philadelphia area, I am going to try and pay a visit to his museum. I have admired his work for many many years and even have a copy of the paperback that contains the Helga drawings and paintings. He was a different man, a special person, who had his own vision and feelings for what he saw and painted. Whether we can get to the place where he stood is not as important as at least trying to understand his unique vision. He leaves the world a lot of beauty to look at.

I am going to post a few of my pencil drawings today as my tribute to this wonderful artist.

Capital Markets: Forest and Trees

Today is a time to step back from the trees and see the whole forest. Then to focus in on one of the main problems.

One of the purposes of the capital markets is to facilitate the movement of capital to companies (corporate bonds) , individuals (car loans & mortgages) and governments (municipal bonds) so they can continue to grow our economy.

Before there were mortgage-backed bonds, banks and savings & loans made mortgages and kept them. Because they kept the mortgages in their own portfolio of mortgages, each mortgage application was carefully screened before a mortgage was granted. After the creation of the mortgage-backed bonds, the bank or savings bank could sell the mortgage and then with the proceeds from the sale of the mortgage start the process all over. This changed everything as now the originator of the mortgage no longer needed to be as careful about who they gave a loan to as they would be selling the loan anyway. The next step was that the mortgages were bundled and converted from many mortgages into a series of mortgage-backed bonds. The bonds were then rated by the rating agencies and then sold to investors, individuals and institutions, by the investment bankers. The system broke down because the ratings of these bonds did not reflect the risk they carried. When the real estate bubble burst, or was near bursting, the Wall Street mortgage-backed bond traders started to back away from bidding on these mortgage-backed bonds.

The original intent of the bailout money, the $700 billion, was to buy up these distressed bonds from the major players, the banks, so they could get them off their books. Because of something called “mark to market”, these banks and insurance companies saw their capital requirements failing. The first thing that needs to be done, even before the Federal Government buys up all this distressed debt paper, is to correct the situation with regards to the rating agencies. Without making this needed correction, more of the same is highly likely as far as structured financing is concerned. The only other thing that they could do is require that the originators of mortgages take on a percentage of the bonds that they present to be bundled into mortgage-backed bonds. In other words, putting their feet to the fire along with the eventual investors that buy these mortgage-backed bonds. But, that, in my opinion, just short circuits the whole idea of having mortgage-backed bonds in the first place. The real problem is making a correction in the rating agencies and that means turning that function over to the US Treasury or the Federal Reserve Bank. There is no way a system where the investment bankers are paying the rating agencies for structured finance bond ratings is going to be free of “shopping for ratings”.

Until the best and the brightest of the Obama administration figure this out, the longer the recession is going to last. Stimulus is all well and good. But stimulus is like having gas in the tank, but the distributor is not firing because the distributor cap is laying on the ground. When surgery is needed, whether it be a person or the capital markets system, there is no substitute. The sooner the rating agency fiasco is corrected the sooner the movement of capital can take place again.

Investors must have confidence in the bond ratings on structured finance instruments. Without that confidence, we do not have a dynamic capital markets system. The movement of capital is as essential as the existence of capital. The strength of the U.S. Government permits us to borrow from around the world. There is no question that U.S. Treasury debt obligations are AAA in the minds of investors around the world. That part of the equation is good for now. Now we need to get the capital in the hands of those that need it to build the economy. That piece of the equation needs work. As soon as they, those well dressed politicians in Washington, figure this out, the sooner the recovery can begin.

Stay tuned.

More About Madoff and Trustees

I just finished reading another piece on the Internet about the Madoff fraud. In this piece they told how an investigation of the statements Madoff sent out to his clients did not even have the right price at which stocks were purchased on a particular day. This is just one more reason why a foundation, endowment, charitable trust or any other large portfolio of money and securities should have been held in safe keeping with the trust department of a commercial bank. If at the end of each month the statment from the money manager can not be reconciled with the statement from the trust department, then you have a problem. The trust department runs their own statement at the end of every month and uses a pricing system to generate the correct prices of each stock and bond and thus the total portfolio is priced independently of the money manager's statement and pricing. Again I ask, where were the people that sat on the boards of these organizations? How could not one of them ask, how are we reconcilling the money manager's statement at the end of every month? I don't care if Bernie Madoff walked on water, where were the checks and balances for these multi million dollar portfolios?

My next comment is with regards to performance benchmarks. What performance benchmarks was Madoff being measured against? Without specific benchmarks, the performance returns are meaningless. In order to have the correct benchmark, you must have the correct prices and the right securities in the portfolio for that benchmark. Again, where are the trustees?

Conclusion. There are a lot of people sitting on boards that have no business sitting on boards or investment committees. Perhaps it would not be a bad idea for people to pass a test before they took a seat on a board of trustees of a foundation, chartiable trust or an endowment fund. Having a lot of money and nothing between the ears when it comes to investments is a dangerous combination for any organization. Better yet, organizations should stop putting people on their boards if they truly do not know something about investing. Giving lots of money to an organization is fine, but holding on to that money is even finer.

Stay tuned.

An Event That Can Change The World

It is seldom that anyone lives to see an event that will change the world, but next Tuesday such an event will occur.  For us in the United States, it will be a change in our president, something that happens every four years.  Nothing special about that except that this time, for the first time in U.S. History, a black man will become President of the United States.  For many of us old enough to have lived through the Civil Rights era of the 1950's and 1960's, it is the culmination of a historic struggle.  History is about the struggles of peoples to liberate themselves from chains, ghettos or just plain ignorance. 

But, the real historic event is in the way the people of color around the world will come to view the United States.  No longer will the United States be only a land for the white race to reach the highest seat of government.  This one image, a black President, will transform the world's view of the United States. That will be the real story next Tuesday all around the world. 

Don't under estimate the effect this single event and image will have on the rest of the world.  It may have taken this country a few hundred years to live up to its creed that all men are created equal, but next Tuesday there will be an event that will drive this point home.  Not just here in the States, but around the world.  The United States next Tuesday will change the world. 

The above piece I wrote to a friend the other day. For those of you who did not grow up in the 1940’s, ‘50’s and ‘60’s, the election of a black man as President of the United States may not seem like such a big thing. However, if you are a student of history, you know what life was like for black Americans and other peoples of color in the United States before the 1970’s. I remember the University of Pittsburgh not being able to take a black member of their football team to a bowl game in the south. I remember visiting my aunt and cousin in Lexington, KY and seeing signs that read “White Only” and “colored” for things as simple as a drinking fountain. This country changed itself, and for this we all can be justly proud. It did not take an invasion by a foreign army for us to move our country in the direction of a more level playing field, we did this ourselves.

There has been a great deal of discussion about what measures will best bring our economy out of the recession. The details of the economic stimulus plan will become known after the Obama administration takes office. As I have said before, the economics of a stimulus plan is the easy part, the harder part will be the willingness of the politicians to put the good of the country first. Even in times of war, this is not always the case. Perhaps this time, with so many facets of our economy in trouble, the politicians will do the right thing and accept a stimulus plan that will meet the needs of the country. There are a lot of people without jobs that want to work. I sure hope that the well dressed politicians in their warm offices remember what it is like to be unemployed.

Stay tuned.

Black Swans And Dead Ducks?

Below is the response of a friend that I went to school with (7th grade thur college) that lives on the west coast and whose company is closely involved in writing software for the investment bankers on Wall Street and around the world. My original e-mail to him dealt with Value at Risk (VaR). The reason I am including his response in this post is because of what he has to say about systemic risk in the market because of the lack of regulation and transparency. Those that read MONEYTHOUGHTS know that I have been beating the drum about the need for more regulation, oversight, transparency and enforcement in the securities markets. Below is another man’s opinion who has been very successful in his business career and has been involved in creating models that deal with risk.

Hi Fred,

Just finished the Nocera article on risk management. Thanks for the heads-up
on the article.

It all makes sense -- the black swans are there (I was told the origin of
the term comes from medieval Europeans who couldn't conceive of the idea of
a black swan because they don't exist in Europe - but they do exist in
Australia). But it’s a real problem as the article says, if you believe in
black swans you'll never do a trade. It doesn't matter how many spinners
there are in your stress-testing model.

So you try and hedge with counterparties -- even against the black swan. But
it doesn’t work because the real source of risk is not the day-to-day
fluctuations in market values -- it's the more systemic problem of a
counterparty defaulting on its hedging contract with you. Then the whole
skein of contracts, like the credit default swaps, just unravels. As long as
there is no clearing house so that you can know your counterparty's
exposures, there's no way to know the value of your own net positions. In my
humble opinion we need more regulation and disclosure requirements.

And of course, the CEO's are going to hyper-leverage and go for broke. They
get huge real bonuses (even if their profits are just accounting figments)
and they get to keep them even after their firm's implode and they are
fired. Heads they win and tails their shareholders and creditors loose).

Thanks for reading my rant!

I love it when someone has something to say and says it. My old friend on the west coast is no exception when it comes to telling it like it is.

The battle lines have been drawn with regards to the issue of more comprehensive regulation, oversight, transparency and enforcement. Wall Street CEOs will fight against more regulation all the way. The politicians will do as little as they can get away with because Wall Street is a source of campaign contributions.

There are even those that say the Securities & Exchange Commission should be scraped and a new more comprehensive organization put together. Whether a two or three peak plan is adopted is only important if the plan has teeth and is backed with sufficient funds and personnel to do the job right.

That still leaves my favorite whipping boy, the rating agencies. Finally, someone besides myself has called them what they are, a failed state. The rating of debt paper must be picked up by some organization and my opinion is that the Federal Government is the best choice to do this necessary job right. The securitization of mortgages, car loans and credit card debt is not the problem. The problem arises when the ratings on this debt does not reflect the risk that they carry. If the mortgages are done right and are not a travesty, mortgage-backed bonds and other asset-backed paper has a place in the fixed-income section of a large and well diversified portfolio.

Bringing back our economy and in turn helping the rest of the world’s economies get moving again will take more than low interest rates on U.S. Treasuries. The Federal Reserve Bank has already shot that arrow. It is time to realize that low interest rates are not the only problem in the capital markets system.

If my old friend on the west coast knows this and others are writing about this, how long will it take before those in Washington, D. C. open up their eyes?

Stay tuned.

Red Flags, Red Spots, It Is All The Same

Did anyone watch 60 Minutes Sunday night after the football game? If you watched 60 minutes, you learned a little about what deregulation did to the trading of commodities and especially what deregulation did to the trading of oil futures. Did you catch the part where they talked about Enron pushing the Federal Government for deregulation so they could make big profits in the trading of energy futures? When it comes to economics, markets, regulation, oversight and changes in our securities laws, shit does not just happen, it is planned that way. Lots and lots of money go to politicians to make sure that the laws are changed so they can make marks out of the rest of us. Enron is gone, but the changes in the trading of energy futures that they pushed for and got from the Bush Administration lead to the high price of oil and gas that we all experienced last year.

This nonsense that there is liberal and conservative economics is just so much crap. It is like saying there is liberal and conservative adding and subtracting. Economics is economics until the politicians enter into the equation and then it becomes shit. Then all the idiots can go around saying “shit happens.” Shit does not just happen, it is legislated to happen. The politicians, in most cases, do not understand what it is they are voting to change, so they listen to lobbyists that fill their campaign coffers. But, this time, perhaps, they created so much shit that people will wake up to the fact that they have been screwed over by a few wealthy people, hell bent on making marks out of as many individuals and institutions as time will allow.

The idea that markets do not need to be regulated with laws, oversight, transparency and enforcement is a failed economic philosophy. Anyone that still clings to the ideas of deregulation is intellectually dishonest or too stupid to understand how a global economy works. The changes that brought about the weaker oversight of the securities industry and the laws changed with regards to our commercial banks and our futures trading, did not just affect the United States’ economy, but had a huge ripple across the rest of the world.

The Bernie Madoff fraud is only the red spots on the epidermis of our financial structure, the disease is much more systemic. Perhaps now that even the wealthy among us have seen the devastation caused by a system whose controls were crippled and deformed to the point of being useless, that meaningful and corrective action will take place.

The problem is that the people that will be asked for suggestions and the people that write the laws, do not speak the same language, nor share the same philosophy. Arthur Levitt needs to be a major part of the process. Paul Volcker sits on President-elect Obama’s right arm and can be a tremendous advocate for change. Paul Volcker can not be bought. Arthur Levitt is another man that can help bring about the changes in the securities industry that are so desperately needed.

The rating agency problem must be dealt with before the new system can move forward. The internal bleeding that this failure continues to cause will prevent the complete recovery of the capital markets. Without ratings, trading and investing grind to nearly a halt. Why are U.S. Treasury Bills, Notes and Bonds selling for such low yields if not because the market has no confidence in any fixed-income debt instruments other than the U.S. Treasury’s own paper? An engine can not run on one cylinder when the other cylinders are useless. The rating agency scandal must be fixed so that the movement of debt capital can once again move properly through the economy. The traders and the portfolio managers know this, but how long will it take before the politicians figure this out.

The stimulus package that the Obama Administration wants to put in place as soon as possible is all well and good, but without addressing the weaknesses in the present system of checks and balances will only result in the same out come. Changes must be made in the conduct of the way business is done on Wall Street. A system that lets people becomes marks, to be be shot like fish in a barrel, can not build the kind of capital market structure that will be necessary to take our economy to the next level. Change for more equitable capital markets is essential.

Stay tuned.

Madoff Fraud: More Than One Pair of Hands?

$50 billion is a lot of money, and while many "feeder" funds made this number possible, the thought that this fraud took more than one pair of hands to be pulled off only seems a very reasonable assumption for me to make. That the Securities & Exchange Commission (SEC) was asleep at the switch is an understatement. But, what we all must realize is that the SEC for many years has been influenced by a Congress and Presidents that sought to reduce oversight and permit more investors to become marks of the securities industry. The heavy hitters and large political contributions that come to the politicians from Wall Street, the brokerage and money management industry, are meant to ease the way and make it possible for marks to be shot like fish in a barrel. The same politicians that now act so upset by the Madoff fraud are many of the same politicians that did the securities industry bidding in the halls of congress. How did this fraud get over looked for so long without the help of "friends" on the inside? It is certainly time for all Americans to ask where was the oversight, regulations and enforcement and bring pressure on their representatives to rebuild and correct the weaknesses of the SEC. Finally, even the wealthy got hurt. Now the wealthy investors can know what smaller investors have faced and have had to deal with for many years. This time the big investor got hurt. Perhaps now we will see the proper actions taken to protect investors from the future Bernard Madoffs of the world.

Stay tuned.

The Madoff Fraud: Stupidity, Greed or Both

Today, I am going to share with my readers a letter that was published today in the oldest English Jewish weekly in America, THE AMERICAN ISRAELITE, established July 15, 1854 in Cincinnati. The letter is in response to the Madoff fraud that cost many people and organizations everything they had. Drawing on my years working with investment securities, I thought I would add my two cents to the discussion. Below is my letter to the editor.


Dear Editor,

The huge losses and tragedies that have been created by the Bernard Madoff fraud could have been avoided. No foundation, endowment or any other large portfolio of money should have ever been placed in the hands of one money manager, nor without the protection of a trustee like the trust department of a bank. If each of the investors and organizations would have diversified their portfolio among a few or several money management companies and had those moneys held in the trust department of a commercial bank, the size of the loss to each organization would have been more manageable and no one would have been completely wiped out. By using a trust department the investment securities of the foundation or the endowment would be held for the trust department at the Depository Trust Company (DTC) for safe keeping. As almost all stocks and bonds today are held in book entry form, DTC acts to facilitate the transfer of investments securities in today’s book entry world. In the old days actual paper stock and bond certificates had to be mailed to the broker and new stock certificates exchanged. This old way hardly exists today except for a few people that keep their stock certificates in a safety deposit box.

If Madoff required a minimum investment of ten million dollars to invest with him, no organization with less than 100 million should have ever even considered him or his fund for investment. No organization should put more than ten percent of their fund with one money manager, much less outside the protection of a trustee. The State of Massachusetts Employee Retirement System lost $12 million, but that is a portfolio that is in the billions of dollars. Where were the advisers to all these organizations?

I have worked in five trust departments and for one state agency where we managed several billion dollars and had over a hundred money managers from around the country. The vast majority of the investments were in stocks and bonds and were held by a bank trust department, in Columbus, that in turn used DTC in New York to facilitate the trading of all securities. A small portion of this state fund was placed in alternative investments. What is an alternative investment? Everyone has their own definition of what an alternative investment is, but for me, an alternative investment is one that does not fit into the mold of a stock or a bond, and, most importantly, the money or funds actually leave the portfolio and are no longer held by the bank trust department or DTC. Hedge funds, private equity funds and any other investment vehicle where the actual money is transferred into the hands of the money manager is an alternative investment. These types of situations are the most dangerous because control of the assets is taken away from the trust department and DTC. When the assets, the stocks and bonds, are managed by an outside money manager from the trust department where they are held, the money manager never touches the money. Trades are conducted through the trust department by the equity and fixed income traders in the trust department. By having the trust department place the trades, the foundation or endowment fund avoids the possibility of the portfolio manager “cherry picking” their stocks. This is just one more fine point that too many people do not understand. Front running is a whole other matter. The only money that the money managers get their hands on is their management fee. That fee is paid to them quarterly and is based on the market value of the assets held in the portfolio that they are managing. Without a monthly or quarterly statement from the trust department, the foundation or endowment really does not know what the value of their portfolio is. Private equity funds should be held at book value, in my opinion, and not market. Market value can over state the value of a private equity fund and thus over state the overall value of the portfolio, but on that issue I will defer to the accountants.

The private equity fund is, in my opinion, usually the safest of all alternative investments. Private equity funds require periodic draws where money leaves the trustee and is wired to the private equity fund manager. But, the private equity fund also has an annual report and there are companies that they are invested, and an annual meeting to attend and ask questions. This does not protect the investor from stupid private equity fund managers, of which there are a few. The better private equity funds are usually not that easy to get into because they have a reputation for making their investors lots of money. There is also the option of investing in a private equity fund of funds. This works well where the investment committee has little if any knowledge in evaluating private equity fund managers. I have seen some good private equity fund managers and I have seen some pretty bad ones too.

Foundations and endowments and any other charitable organization has no business investing all of their money with one money manager or in a single hedge fund. This happens because people are either stupid, greedy or both. I spent over 35 years working with investment securities. I have had considerable experience managing and trading bonds and equities. I have managed portfolios and worked as a senior investment officer to a multi billion dollar state fund, and yet in my 66 years, I have never been asked to help a board of trustees with their investment responsibilities or to sit on an investment committee. Unfortunately, people are not picked to serve on these boards for what they know, but rather for who they know or what they give in donations. I know I could have helped prevent much of the tragedy that Madoff caused, but I have never been asked. I am now just an old man living a quiet life in Northside. If any organizations would like my help, I am in the phone book.

Stay tuned.

Money Makes The World Go Round

Today, I feel in the mood to talk about money. We all know what money is, and for most of us, we never seem to have quite enough of it. Lately, there has been a lot of talk in the news about getting the economy going again and getting people back to work. Almost every economist in the United States has some plan or idea of action that the Federal Government should take. This is the easy part, having a plan. The hard part is getting the plan converted into action. Politics enters into the equation because politicians are going to vote on the bill that will stimulate the economy. I know how to get the money spent in the fastest way possible, but my equation is quite simple because I am not a politician. But, before I present my plan, I would like to talk a little about money and its relationship to the side effects from the Federal Government’s spending plan.

The most immediate concern of the new administration is getting money into the hands of working people and retired people too. At this point, there should be little concern for inflation or the inflating of the money supply. The Federal Reserve Bank can set the reserve requirement to expand or contract the money supply, but, like pushing on a string, unless people want to borrow and banks are willing to lend, the money supply will not expand (Last year, in one of the MONEYTHOUGHTS postings, I discussed how commercial banks create new demand deposits from loaning money, and how the Fed, by setting the reserve requirement for commercial banks can influence the growth rate of the money supply. So, we have already covered that ground before.) At this point, the only debate among economists is what is the fastest way to get money into the hands of the people. Concerns about inflation are taking a back seat to concerns about deflation. Deflation is when prices of commodities, products and services decline in price. It is unlikely that the service industry will be able to cut prices as declining labor costs will only make the economic situation worse. At this point, deflation is a bigger threat to the economy than inflation or the rapid expansion of the money supply. In the future, the Fed will have to raise interest rates to prevent a rapid rise in inflation, but again, that is most likely months or years away. With all due respect to former Fed Chairman Martin, the “punch bowl” needs to stay in the center of the room, on the table and filled regularly.

My idea is quite simple. Put money back in the hands of consumers so they can keep the economy moving in the direction of a recovery along with infrastructure projects that have had to be shelved by states because of their budget deficits. The only problem with my plan is that the politicians can not take credit for bringing dollars to their state or district. This may sound like a petty reason, but it is the real reason it may not be done. And, I am talking about much more than $600 per person. Perhaps the number needs to be multiplied by a factor of ten. I know, I am a socialist or better yet a communist for making such a suggestion, but, at this point, labels are not what is going to get our economy moving. True, some people who don’t need the money will save it or invest it, but I think that there are a whole lot of people out there that would use that money to pay down debt and spend on those items they need for themselves and their families.

If you think my idea for getting our economy moving again has merit, then write or call your representative and tell him or her what you think. 2009 does not have to be a bad year. 2009 can be the year that our economy starts moving in the right direction.

Stay tuned.

Two Articles to Read

There are two articles in the Sunday New York Times, January 4, 2009, that I would like to bring to the attention of people that read this blog. The first article is titled THE END OF THE FINANCIAL WORLD AS WE KNOW IT by Michael Lewis and David Einhorn, and is in the Week In Review section, pages 9 and 10. Those that are interested in more of the same about the mistakes that were made and what caused the financial crisis will find this short article of interest. At the end of the article they list several items that contributed to the financial meltdown and things they think should be done in the future. The second item is titled "End the official status of the rating agencies." I would like to re-print the short piece they wrote here. "Given their performance it's hard to believe credit rating agencies are still around. There's no question that the world is worse off for the existence of companies like Moody's and Standard & Poor's. There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided."

Several weeks ago I wrote a piece that I titled the Federal Fixed-Income Rating Agency or FFIRA. In this piece, I called for a federal agency that would provide credit ratings, thus eliminating the "shopping" of ratings by the investment banking firms doing the underwriting of structured financings such as mortgage-backed bonds. I maintain that without the AAA-rating of all that mortgage-backed paper by the rating agencies, the real estate bubble could not have been inflated in the first place. Because interest rates were kept low by design of the Federal Reserve Bank's monetary policy, and the pressure to reach for higher yields that were not available from other types of debt instruments, the demand among investors around the world gave a great incentive for home borrowing requirements to be relaxed and lowered to fill the huge demand for mortgage-backed bonds from the underwriters and the portfolio managers. But, without the AAA-rating this whole train of events would have never reached a melting point.

The second article is in The New York Times Magazine, January 4, 2009, and is titled RISK MISMANAGEMENT by Joe Nocera. This article deals with risk management tools used by Wall Street to run banks and securities firms. The model for VaR, Value at Risk, is discussed and how it was misused. I am not a quant guy, so I will not make many comments about this article other than to say that garbage in garbage out has to apply even to VaR. This goes back to the ratings that were given to the structured finacing pieces of debt that were traded and positioned by the several trading desks on Wall Street. A final number at the end of the day, referred to as the 415 number because it was presented to the CEO of the bank or brokerage firm 15 minutes after 4pm, when the markets closed, and was suppose to be a number that the company could hang its hat on. Again, when the fire got too hot, everything started to melt and then Wall Street had the huge meltdown of 2008.

Both of these articles are well written and worth reading if you are interested in knowing a little more about what brought about the financial crisis of 2008. I think, most fair minded economists would agree that the financial crisis spilled over into and contributed to the economic crisis of 2007- 2008. It should be no surprise to anyone that has been reading my blog that the economic crisis was brought about by the sudden and steep jump in the price of oil. Gas prices rose to over $4 a gallon at a time when such a "tax increase" on the American consumer could be least absorbed. Had the President taken action to slow the sudden and swift increase in the price of gas and diesel in 2007 and 2008, the American consumer may have been better abled to maintain their home mortgage payments and the resulting unemployment, loss of jobs, may have been slowed from its rapid pace. But, that did not happen in 2007-2008, so we are now waiting for a stimulus package from the Obama Administration to put people back to work and hopefully reduce and/or stop the number of home foreclosures in the United States. We are now just two weeks away from a new administration, let us all hope and pray for its success.

Stay tuned.

Saturday is For Art

These two paintings were exhibited in 1992. Even back then, Energy Policy and Housing or more accurately the Savings & Loan crisis were topics of discussion. Here we are in 2009, and Energy Policy and Housing or the financing of housing is very much in the news. Perhaps, this is the administration, the Obama Administration, that will tackle these very important issues that affect our economy and our standard of living. The works were done on paper in oil paint. Naturally, the paper was first primed with gesso front and back. As a some time collector of American postage stamps, I like creating commemorative stamps that our Post Office would never consider. In 2009, I hope to return to creating a few new commemorative stamp issues.

An Economic FORCE From A Distant Planet

Last night as 2008 was coming to end, there was a bright light in the sky. The light came closer and closer and eventually landed in my back yard. A man took one step and left what might be considered a spaceship, but this vehicle was no more than the size of the man. Surprisingly he spoke English, and he spoke in complete sentences. His voice was not loud, but strong and reassuring. He said he had come a long way, from a planet in a distant solar system, and that he was here to bring the power of the FORCE to the new Obama administration. He talked about the days ahead, and how difficult they would be, but that in time the economy of the United States would once again be the engine that would pull the rest of the world's economy forward and to new levels. He spoke about a new day for medical research and he assured me that the stem cell research would unlock many of the secrets to a healthier life. When I looked at the man from a far away place, he appeared to look a lot like myself. In fact, other than his dress, he looked like me. Perhaps this is the way these people protect themselves from harm. I took a quick picture before he took off. He said his planet was prepared to send enough Force to correct the mistakes that were made over the last several years. When I questioned him as to why they had come to planet Earth to do their work, he waved me off and ascended into the sky. His short visit gave me a great deal of hope that there was a Force out there and that help was on the way.

Stay tuned.