Money, Credit, and Greed

M & T on the Banking Industry

2011-04-09T13:45:00.003-04:00

I owe this one to Mario Gabelli who recently spoke to Tom Keene from Bloomberg. While speaking with Tom, Mario mentioned that every politician should read M & T Bank's 2010 Annual Report. He referred to the section titled "Regulation and The State of The Banking Industry." This is a wonderful read highlighting many changes that have occurred in the banking industry over the last 80 years. Below is a link to the whole Annual Report, the banking industry section starts on PDF page 15.

This explanation is worth so much, defining systemic risk, M&T CEO Wilmers says, "the aggregation of risks in the hands of so few has the potential to impact the fortunes of so many." What a great way of explaining a concept that has been thrown around so much and never explained in the most general sense.

M&T Bank 2010 Annual Report

China Shakes the World

2011-04-05T23:46:00.000-04:00

"If the Chinese were ever to consume at the American levels of 2001, they would need to guzzle three times the world's total consumption." This is a quote from China Shakes the World by James Kynge; I recently finished reading this. The book has been around for 5 years or so, and I thought I'd share a some of the things that I found particularly interesting and revealing.

"Each year since 2004, China has installed the equivalent of all the generating capacity of a country such as Spain"

Kynge argues that due to the patriarchal system and lack of status, "Some 56 percent of the world's female suicides occur in China"
Summarizing the population density: "The weight of their presence is everywhere." and "Numbers posses a power that transcends the mechanics of mathematics."
Throughout the book Kynge explains the fallacy of the billion + person market. Western multinationals believe that by opening up in China they will have access to this market. However, Kynge explains that the corporations forget...there are over a billion people in that nation trying to gain access to the exact same market, and guess what? They already live there and know the culture. Quoting Kynge, "When a market is finally found, aggressive domestic competitors have usually got there first." This market fallacy can be summarized, "it is the prospect of a large market, rather than its actual existence, that is the key to luring foreign investors."
But all this growth must mean profits and profits, banks would never lend if there are no profits...or would they? 2 points in China Shakes the World stand out: 1) "China is not a normal market economy. It does not have a well-functioning bankruptcy law, so the liquidation of insolvent companies is difficult. In addition, banks are awash with liquidity," might I add, that they must put to use, they are still banks. And 2) Yu Yaochang explained, "The banks only care if your company is getting bigger and stronger. If you expand production, you are increasing scale and reducing unit cost. That is bigger and stronger. And anyway, we are the biggest local company. If they don't lend to us, who are they going to lend to? [Emphasis mine]"

These bits and pieces from Kynge's book are important, as they, and Kynge's book, reveal much more about China than just the rapid economic growth and outsourcing stories that have become mainstream. They demonstrated the difficult cultural, political and economic hurdles that must be overcome. Rapid expansion is wonderful in many ways, but it also creates more room for error, as speed and excess often do.

I would certainly recommend Kynge's China Shakes the World, it will give you a better insight into the things that the Chinese people and Nation are facing as they move forward with their growth. Below are links to the book at Amazon, if you would like to read it yourself.

China Shakes the World: A Titan's Rise and Troubled Future -- and the Challenge for America

The Weekly Spot Rate

2011-04-05T13:33:00.001-04:00

I was scanning through Business Insider earlier and came across this post. There are some great examples of creating brand awareness, like Baltica Dry.

http://www.businessinsider.com/24-clever-advertisements-guerilla-marketing

Also the YouTube video below is from Shark Tank, a venture capital reality TV show. This product is just plain funny. Enjoy!

Check them out below and have a great week.

The Weekly Spot Rate

2011-03-20T21:30:00.000-04:00

I should have posted this a while ago, it's an hour-long interview of Steve Wynn by Charlie Rose. This is one of the best interviews I have seen. Steve Wynn is one of the most spirited and inspiring business men. I came away excited and driven to achieve something incredible at the very moment I had finished watching the interview. I hope you enjoy it as much as I did.

This is the link to the online streaming video.
http://www.charlierose.com/view/interview/752

These are links to Amazon if you want to purchase a copy of the interview in DVD or download format.
Charlie Rose with Steve Wynn (July 8, 2005) [DVD]
Charlie Rose with Steve Wynn (July 8, 2005) [Download]

Hedge Fund Wisdom

2011-02-22T23:58:00.000-05:00

I recently finished Inside the House of Money by Steven Drobny. The book is a series of interviews with global macro strategy hedge fund managers. Global macro has many definitions as a read through Drobny’s book will show you, but one can think of it as the ability to invest in any market and instrument around the world. These are some interesting quotes and thoughts from the book. (There is a link to the book at the end of this post)

Answering a question about missing “the trade [that] never would have happened” Christian Siva-Jothy says markets “are unbelievably slow to react to big events that there is no script for.” I like this quote because it reminded me of the ‘never sell in a panic’ and similar cliques; it explains that markets are driven by humans who exhibit irrational behavior, especially when surprised.

How often are we taught the lesson of ‘if it sounds too good’…Dr. John Porter reminds us why this occurs in finance and business time and again: “It’s funny how people are very reassured by numbers just because they’re numbers. They rarely look at where the numbers come from or how stable they might be.” It would be valuable to remember this lesson.

Some quick quotes for you…

If you’re right at the wrong time, you’re wrong.

-Yra Harris

Politicians throughout history have gotten things wrong turning a semicrisis into a crisis and then into a disaster.

-Jim Rogers

A little education about short selling:

This quote explains how the return from shorting is maximized and that waiting for the downtrend to start is equally profitable. Scott Bessent said, “You made just as much shorting $100 million of Enron at $25 as you did shorting $100 million of Enron at $50. It’s better to have more conviction and do twice as much.”

And a little something for the GREED in us…

Anybody who knows how much he is worth does not have enough.

-Jim Rogers

Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Markets

The Weekly Spot Rate

2011-02-13T19:52:00.000-05:00

This week's spot rate is all about inflation. Friday I was listening to Bloomberg Radio's On The Economy where they interviewed Jagdish Bhagwati a professor at Columbia University. I greatly enjoyed Professor Bhagwati's description of the current food inflation problem. He says that with the lack in global food production and increased food inflation, in order to bring down food prices we need to increase production and "to provide new agricultural productivity. That means we've got to bite the bullet with all these worries about Frankenstein foods, because Frankenstein is only potential whereas the Grim Reaper is here and now." What Professor Bhagwati means is that we need to embrace the use of genetically modified foods (Frankenstein) to feed the world today, and not let the Grim Reaper (the dearth of food and rising prices) starve out our population; better save people with something that may or may not cause harm than knowingly let people die. I thought this way of viewing the problem was amusing and insightful, hope you do to.

The Billion Prices Project is a project led by two MIT professors who are trying to capture daily inflation fluctuations. They are using a basket of millions of online products to determine what the inflation rate is in a variety of countries. It is worth noting that the United State's official inflation rate is significantly below that of the Billion Prices Project's. The link is posted below.

Have a great week.

http://bpp.mit.edu/

Bank Information Website

2011-02-09T22:19:00.000-05:00

I was just searching through Google and came across this website http://www.bankregdata.com/main.asp It is definitely worth a look, some great information available. I am not sure about the accuracy, but it would be a great starting point for any analysis.

The Weekly Spot Rate

2011-02-09T21:55:00.000-05:00

Alan Blinder the vice chairman of the Federal Reserve wrote a great article in the WSJ about the Carbon Tax idea. This struck me as a great way to implement a new tax, regardless of what it is. Blinder's plan is to approve the tax legislation and tier the tax up over time, but the part I really like is to start at a 0% tax rate. This is a great way, as Blinder point out, to allow business to see where rates will go in the long term and give them time to adjust. Below is a link to the article.

Bloomberg Radio had an interview with Peter Schaffrik, head of Euro fixed income strategy for RBC capital markets in London, on February 7th, 2011. In this interview Schaffrik spoke about 2 kinds of inflation: internal and external. He defined internal inflation as economic overheating and external inflation as rising commodity prices. As can be seen, one form is controllable by the state and the other is not. I though that this was a great insight, as all too often we find people focusing on inflation, as they should, but they do not separate inflation into the controllable and non-controllable forms. Something to keep in mind when we think about inflation and deflation for that matter.

The Carbon Tax Miracle Cure by Alan Blinder

http://online.wsj.com/article/SB10001424052748703893104576108610681576914.html

The Weekly Spot Rate

2010-11-04T14:02:00.000-04:00

In the "The Crisis of Credit Visualized" Mr. Jarvis offers a wonderful simplified explanation of how the housing bubble was built up, peaked and fell.

The original source of the video is http://crisisofcredit.com/

Semiannual Bond Pricing Template

2010-10-01T21:28:00.000-04:00

This is a template to price bullet semiannual bonds with maturities up to 40 years. All you need are the face value, coupon rate and a yield (YTM or required return) to get the model price. Feel free to download the template and pass it around.

Pricing Semiannual Bonds

The Weekly Spot Rate

2010-10-01T19:57:00.004-04:00

This is the inauguration of The Weekly Spot Rate, a weekly article, video, cartoon or other form of media that I have found particularly interesting. The media may be from the current week or something from the past of interest.

To kick us off I have selected a video of various newscasters trying to pronounce the name of the Icelandic Volcano that erupted this past Spring. Not that I could do any better. Enjoy!

Proprietary Trading Gone Forever or Temporarily Hiding?

2010-09-30T16:47:00.003-04:00

Michael Lewis begins a recent article with, "In the run-up to the vote on the financial overhaul bill, the big Wall Street banks squashed an attempt by Senator Carl Levin to pass a simple ban on any form of proprietary trading." It would appear that the big banks were protecting their freedom; however, Lewis points out that recently "Morgan Stanley, JPMorgan and Goldman Sachs all intend either to close their proprietary trading units or to sell their interests in the hedge funds they control." Which begs the question, why fight to save something you don't plan to utilize? Lewis offers a few ideas, but I believe he avoids another likely possibility.

Lewis presents 3 possibilities, starting with the "Nice Guys" theory. Lewis postulates that the big banks have grown fat at the expense of other smaller institutions, which have failed during the crisis, and now they feel a sense of moral remorse for their actions. As such, the big banks have decided to focus more on the client relationships rather just seeking bigger and better profits. Although he dismissing this theory. It would be naive for anyone to assume that a business would make the conscious choice to forgo profits simply for better client relationships. I would argue that if immediate profits are pushed aside through greater client focus, than the firm must be expecting this to establish a competitive advantage and generate greater future profits.

Lack of Value is Lewis' second theory for the decline in prop trading. He cites the changed macroeconomic environment as a challenge for traders to find parties to take the other side of their trade. In other words, the current environment has caused a decrease in the number of ignorant parties with which to trade the losing side of a trade, therefore, the big banks are closing up their prop shops.

The big banks are not abandoning their prop desks, but rather they are changing their technical name or location. Lewis states that it is possible that the firms are doing this in the hopes that the regulators will not pry into their newly renamed prop shops. I believe that Lewis may have hit it close when he discusses this third theory. Deception is a very useful tactic in the boardroom and the battlefield.

It is very possible that the big banks are temporarily cutting back on proprietary trading and shifting these resources to newly named devisions and companies with the intent to shift focus away from prop trading to other areas of the banking industry and economy. The advantage to waiting and avoiding attention is two fold; (1) people will forget about the profits made while the country was undergoing difficulty, and, (2) the regulators may forget or be pushed away from the proprietary trading issue onto other areas in need of regulation. At the end of the day, it is possible that a quick deception by the banks could lead to fairly lax regulation of prop trading. Therefore, once the dust has settled and main street and the media are focused elsewhere, the banks can easily ramp up their proprietary trading operations.

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Lewis's article can be found at Bloomberg: http://www.bloomberg.com/news/2010-09-30/mystery-of-disappearing-proprietary-traders-commentary-by-michael-lewis.html

Michael Lewis is the author of The Big Short: Inside the Doomsday Machine, a fast paced look into the world of securitization and those who saw the insanity of the housing bubble. I would recommend this book for finance students, professionals and anyone interested in another side of the bubble; it is also an easy read.

Investopedia.com defines Proprietary Trading as "the firm has decided to profit from the market rather than from commissions from processing trades."

The Classic Subprime Powerpoint

2010-09-28T23:42:00.001-04:00

This is a presentation that circulated soon after the crash in 2007 when people were curious about how we got to where we were. The slideshow comically addresses the way in which the housing bubble rose to such proportions and affected a variety of "institutional" investors.

CDO Powerpoint SubPrime Primer

Umbrella Partnership REIT Structure

2010-09-28T13:45:00.006-04:00

URREITs offer significant tax advantages for property owners. The structure is used as a means to avoid unwanted capital gains, and subsequent taxation. Essentially these structures allow property owners to adjust their cost basis upwards by transferring their property to the REIT in exchange for operating partnership units. The value of units exchanged will equal the value of the property. By undergoing this transaction the original property owner receives units, which can be sold without incurring a capital gains.

For example: one owns a property at a cost basis of $10 million, which has appreciated to $20 million. In order to avoid the capital gains on $10 million ($20mln - $10mln), the owner can exchange their property for units in a UPREIT. The UPREIT would supply say 20,000 partnership units to the owner worth $1,000 each. The original property owner could then exchange their partnership units for shares in the REIT. These shares could then be sold for their $20 million value, and as the cost basis is $20 million there would be no capital gains tax and the investor gained.

The link below is to an article that outlines some of the challenges and advantages of engaging in a transaction with a UPREIT.

The benefits of selling property through an UP-REIT

A little humor

2010-09-20T22:04:00.001-04:00

This clip from South Park has got to be an all time favorite!

What a creative way to explain some of the causes of the crisis.

I found this great video while searching around another blog.

Tricky Policy

2010-09-20T15:34:00.009-04:00

What follows is a response to the the Economist's article "Economics focus: War footing” of Sept 4, 2010.

This article discusses the challenges of simultaneous fiscal and monetary policy implementation. Having reached interest floors, central bankers are concerned with the sole option of applying fiscal policy. Although neither fiscal nor monetary policy is ineffective in theory; Eric Leeper’s presentation addresses the practical difference, whereas monetary policy undergoes vast economic analysis, “fiscal policy is highly politicised.” Politicization decreases the timeliness and effectiveness of policy, leading Leeper to say “Fiscal alchemy can undermine monetary science.”

Leeper warns, if the public loses confidence in the Government’s ability to cover the cost of its fiscal stimulus and the central bank will “inflate away the debt,” hyper-inflation may ensue. To prevent this problem central bankers are calling for austerity measures or limits to fiscal stimulus. Along with the historically low interest rate environment, inflation expectations have been driven away, similar to Japan’s “lost decade.” To avoid deflation, Mr. Leeper suggests, “simultaneous fiscal and monetary expansion.”

A key caveat to quantitative easing is that central bankers cannot “force banks to lend or companies and households to borrow.” Therefore, although QE is intended to increase the money supply and lower interest rates, the potential benefits may never reach the economy. This would lead to sustained high unemployment and the threat of deflation.

The depression of interest rates and long-term threat of inflation caused by QE must be carefully dealt with. This is evident from the United States’ implementation of fiscal and monetary stimulus during WWII, which led to inflation thereafter. To avoid such a problem stimulus must be injected into the economy today and fiscal austerity imposed in the future.

“A Bull Market in Pessimism”

2010-09-20T15:28:00.002-04:00

The following is a brief summary and response to the Economist article “A Bull Market in Pessimism” from Aug. 21, 2010.

Currently in a tough place, the Federal Reserve is facing two threats: deflation and inflation. The Fed must tread lightly to avoid spiraling either monetary effect out of control. Were the Fed to inflate its way out of potential deflation, real-returns would rapidly turn negative (especially given the current low interest rate environment), thus leading to a mass exodus of Treasury bond-holders. Furthermore, were the fed to raise interest rates, bond-holders would also be squeezed out of the market, given the inverse relationship between bond prices and yields, the value of their bonds would decrease. As if the situation were not challenging enough, by purchasing Treasuries with the monies provided by maturing mortgage debt the Fed is adding to the downward pressure on Treasury yields. These combined effects; along with increased investor demand for Treasuries (putting further downward pressure on yields) has positioned the Fed with an inflexible exit strategy. Given the challenging situation the Fed’s attempts to alter monetary policy will likely be rife with error.

The Economist

A lens into macro policy: Pension problems

2010-09-19T12:50:00.006-04:00

News outlets have recently been discussing underfunded pension funds. This discussion has been well timed given a recent concern of mine regarding macroeconomic policies. I have been questioning why it is that deflation and slow or no growth economic periods are so harmful to our economy, but more so why must macroeconomic policy always be pushed as expansionary? I don't understand why we must push for greater and greater growth than can be achieved without government intervention. The way I see it, expansionary policies are a form of economic leverage. For example, as opposed to having economic growth of 1%, expansionary policies leverage this growth to 3.5%. Why must a nation constantly force greater growth, as opposed to allowing organic expansion?

I cannot see how any form of "macro-management" can go on forever, there must be a point at which economic policies cannot continue to support unsustainable growth rates. The US may be good modern example of when expansion works for a time, but will eventually be unsustainable. One would be hard pressed to find someone who believes that the US can continue to borrow to finance its economic expansion, as that is what all the borrowing is for. Yes, the US borrowed to stabilize its economy, but nonetheless this was to prevent economic contraction, but why not allow things to run a more natural course. Although I am a firm believer that the economy needed to be buoyed during this crisis, I do not see sustainability in constant expansionary policies.

This brings me to pension funds. The Economist does a good job of explaining the risk of economic contraction for pensions: "deflation is a hidden risk for pension schemes. If it occurs, it will cut the nominal incomes of those (companies, public-sector bodies) that have to fund future pensions, creating another potential gap between assets and liabilities." To prevent such gaps expansionary policy must be maintained. It is simple, as long as long as the economy expands pension contributors should be able to fund their pensions due to rise in incomes from inflation and economic expansion. But as I have said, this is an unsustainable model; it is quite possible that the current model for pension funds is also unsustainable. It is most certainly unsustainable when near 8% annual returns are required for funds to meet payment needs.

Given such a deficit in pension assets, the Economist reports, more saving will be needed to shore up the funds. This will come from a paradigm shift of "borrow now, pay later" to "save now, rather than starve later." In other words, investors will begin to save more, as the fear a prolonged low interest rate environment and retirement uncertainty.

Whatever the reasons for consistent expansionary policy, it should be not be taken so lightly. An unsustainable model will fail at some point and the pension fund capital issue is an example of how this may be occurring today.

Sept. 20, 2010 --- Related Article

`Death Spiral' Besets State Pensions as Benefits Grow
http://www.bloomberg.com/news/2010-09-15/-death-spiral-awaits-state-worker-pensions-as-illinois-leads-underfunding.html

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The Economist article quoted is Buttonwood | Another paradox of thrift; Sept. 18, 2010

The pension returns is from the Economist article Finance after the crisis: CalPERS Sept. 18, 2010

Just don't call it stimulus

2010-09-18T21:17:00.001-04:00

Discussing Obama's recent economic proposals the Economist published an article by the title Just don't call it stimulus in its Sept 11th 2010 publication. There were a few things that caught my attention in this article: (1) the infrastructure bank and (2) the oil and gas tax breaks.

For a politician so hellbent on increasing transparency and decreasing politicization why would you propose an infrastructure bank. The economist cites one opinion of this as a politicizing action, but nonetheless it is upsetting to see hypocritical rhetoric and action. How another bureaucratic institution will benefit the American public is beyond me. Paying more people to funnel money around to some more people who get paid to move that money to someone else is not efficient nor transparent.

Apparently to finance this infrastructure bill we will need to eliminate the "tax breaks for multinationals and oil and gas companies." How does eliminating the tax breaks for natural gas companies help utilize the abundant energy resources that the US posses? If the US is determined to eliminate its dependence upon foreign energy resources than why not facilitate the expansion of natural gas usage? This would be a logical step in securing the US' self-sufficiency in energy. However, eliminating the economic incentives for the private sector to expand upon this resource (especially considering the current economic conditions) is just plain stifling growth.

Greed is good or maybe not…

2010-09-18T21:07:00.006-04:00

Mr. Gekko (played by Michael Douglas) said, “Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge, has marked the upward surge of mankind and greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the U.S.A.” However, a quick look at the US unemployment rate would make anyone question the current environment…

So what brought us to these levels of unemployment? Have we not been greedy enough? Have we, in fact, been far too greedy?

Everyone has heard the terms subprime crisis, housing crisis and asset backed securities; but what I haven’t heard discussed much are the numbers behind some of these terms. More specifically, what the growth rates looked like for the securities and loans that lead to the widespread use of these 3 terms. The other day I was reading through a somewhat dated (May 2008) report to the Joint Economic Committee entitled “THE U.S. HOUSING BUBBLE AND THE GLOBAL FINANCIAL CRISIS: HOUSING AND HOUSING-RELATED FINANCE,” the report has some great appendices with US credit growth data, which I have included below.

John Kenneth Galbraith said it best, "The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version." Every invention is intended to reduce risk and increase reward, but time and again the invention fails. It also appears as if each failure has occurred due to a new form of leverage; the 1920’s and holding companies, the junk-bunks of the 80’s and most recently the asset-backed markets. Leverage is a powerful tool that can beautifully enhance returns, but just as rapidly wipe all equity levels. Have markets forgotten the most important concern with making money? That you need to get your money back to earn more. If you lose it all than what good was that one interest payment, that one dividend; it isn’t good.

Bill Gross discussed this issue in his September 2010 Investment Outlook. In discussing the aftermath of the Great Depression he says that people recalled the “importance of a return of their money as opposed to a return of their money.” And although I agree with the Gekko idea that we greed causes man to exploit inefficiencies and brings about evolution, there is without question a need for the investment community to recall that a high-return is useless without the return of one’s principal. We forgot this during the past decade, as can be seen from the massive increase in the US credit market. But, greed like leverage can be beautiful or bloody.