Investing Curiouscatblog

Tag: credit crisis

  • Charlie Munger’s Thoughts on the Credit Crisis and Risk

    Charlie Munger’s Thoughts on Just About Everything by Morgan Housel

    The academic elites failed us with their utterly asinine ideas of risk control. It was grounded on the idea that all risk took Gaussian distributions, which is just totally wrong. Very high IQ people can be completely useless. And many of them are.

    Benjamin Graham used to say, “It’s not the bad investment ideas that fail; it’s the good ideas that get pushed into excess.” And that’s a lot of what happened here.

    Some economic distortions come from the masses believing that other people are right. Others come from the need to make a living through behavior that may be less than socially desirable. I’ve always been skeptical of conventional wisdom. You have to be able to keep your head on when everyone else is losing theirs.
    …
    Take soccer as an example. It’s a tremendously competitive sport, and often times one team tries to work mayhem on the other team’s best player. The referee’s job is to limit this mayhem and rein in extreme forms of competition.

    Regulation is similar. Most ambitious young men will be more aggressive than they should. That’s what happened with investment banking. I mean, look at Lehman Brothers. Everyone did what they damn well wanted until the whole place was pathological about its extremeness.
    …
    A lot of this [financial collapse] can be blamed on accountants. Accountants as a whole have been trained with too much math and not enough horse sense. If some of these insane accounting practices were never allowed, huge messes could have been avoided. Bankers have become quite good at manipulating accountants
    …
    Learning has never been work for me. It’s play. I was born innately curious. If that doesn’t work for you, figure out your own damn system.

    More good thoughts from Warren Buffett’s partner at Berkshire Hathaway.

    Related: Buffett and Munger’s 2009 Q&A With Shareholders – Berkshire Hathaway Annual Meeting 2008 – Misuse of Statistics, Mania in Financial Markets – Leverage, Complex Deals and Mania

  • Is the Euro Going to Survive in the Long Run?

    To me, the prospects of a Euro currency surviving over the long term were not helped this week. The markets have behaved as though some great solutions have been adopted but it seems to me the fundamental problems if anything are worse now. It is true the short term is more stable. But at what cost?

    Bailout Is ‘Nail in the Coffin’ for Euro, Rogers Says

    The 16-nation currency weakened for a second day against the dollar after rallying as much as 2.7 percent on May 10, when the governments of the 16 euro nations agreed to make loans of as much as 750 billion euros ($962 billion) available to countries under attack from speculators and the European Central Bank pledged to intervene in government securities markets.

    “I was stunned,” Rogers, chairman of Rogers Holdings, said in a Bloomberg Television interview in Singapore. “This means that they’ve given up on the euro, they don’t particularly care if they have a sound currency, you have all these countries spending money they don’t have and it’s now going to continue.”
    …
    “It’s a political currency and nobody is minding the economics behind the necessities to have a strong currency,” Rogers said. “I’m afraid it’s going to dissolve. They’re throwing more money at the problem and it’s going to make things worse down the road.”

    This makes sense to me. The problems with the Euro also explain why the dollar hasn’t fallen more over the last few years. The only significant alternative is the Yen. The BRIC countries (Brazil, Russia, India and China) are looking to increase the profile of their currencies supposedly – or even forming their version of the Euro (I can’t see how that could happen).

    Greece’s budget deficit of 13.6 percent of gross domestic product is the second-highest in the euro zone after Ireland’s 14.3 percent. As part of the bailout plan, Spain and Portugal also pledged deeper deficit reductions than previously planned.
    …
    [Rogers suggests] Investors should instead buy precious metals including gold or currencies of countries that have large natural resources, Rogers said. Among other asset classes, he favors agricultural commodities as the best bet for the next decade as well as silver because prices haven’t rallied.

    It is very difficult for the politicians in the USA, United Kingdom and other countries to behave fiscally responsible when their taxpayers will eventually have to pay the bill. When you can hope to have others bail you out it seems that much less likely people will behave responsibly. Then again I was skeptical the Euro would be created without first having more consolidation of European governments. There are lots of good things about having the Euro, but in the long run there are very challenging issues to deal with.

    Related: Jim Rogers on the Financial Market Mess – Why the Dollar is Falling – A Bull on China

  • Making Debt Holders into Unpaid Regulators

    The credit crisis has shown the lack of political (or regulatory) skill, ethics and character that the USA has now. The solutions are not simple. Some are obvious, like limiting leverage, not providing huge favors to those that pay politicians huge amounts of cash… While Canadian banking regulators actually did their jobs well it is hard to believe most any American regulators will do well given the last 20 years of failures. Raghuram Rajan provides some interesting thoughts on potential improvement in: Making Debt Holders into Watchdogs

    The type of risks that put banks in the greatest jeopardy – and led to the recent crisis – are called tail risks. They have a small probability of turning out badly but are extremely costly if they do. Banks took on two kinds of tail risks prior to the crisis. One was economywide default risk, the risk that a broad portfolio of assets, such as mortgages, would suffer deep losses. The other was liquidity risk, essentially the way they financed the first kind of risk.

    Some banks – such as Citibank, Lehman Brothers, and Royal Bank of Scotland – loaded up on both risks, holding enormous quantities of mortgage-backed securities on the asset side and paying for them with short maturity debt on the liability side. Why did they do it? The simple answer: It was very profitable, provided the tail events did not materialize. Think of insurers that write a lot of earthquake policies (another tail risk). If you didn’t know they were writing earthquake insurance and not setting aside reserves, you would think they were enormously profitable until there’s a quake. For banks, there was always the threat of a day of reckoning when liquidity dried up and defaults skyrocketed. But they set aside few reserves against that happening.
    …
    Particularly worrisome, as my colleague Douglas Diamond and I have argued, is that once banks are leveraged enough that they will be severely distressed if economywide liquidity dries up, they double down on risky bets.
    …
    Here’s the drill: To make it harder for tail-risk-taking banks to grow, all banks should be required to issue a minimum level of debt (say, 10% of assets) that is automatically impaired – either converted to equity or written down – if the bank suffers sufficient losses. This will quickly change debt holders’ views on risky expansion. Moreover, no financial institution should be allowed to hold this debt.

    Related: Why Congress Won’t Investigate Wall Street – Scientists Say Biotechnology Seed Companies Prevent Research – Drug Prices in the USA

  • Paying Back Direct Cash from Taxpayers Does not Excuse Bank Misdeeds

    Many people are ignoring huge costs (to the economy) and benefits (to those financial companies that ruined so many people’s lives and severely damaged the economy. Paying back money the government paid you is not that same as being innocent. While several of the too big to fail banks have paid back the direct cash they were given that is not an indication they are now off the hook for their disastrous behavior.

    First we know that much of the money “sent to AIG” just went directly to Goldman Sachs and others. Those big banks had taken risks and the only way those risks paid off was with billions from taxpayers. Without that they would have been bankrupt. And then when they paid the money they received directly they still haven’t paid back the billions they got from taxpayers (via AIG). And this money was paid back at 100 cents on the dollar though those instruments were trading for much less in the market (the government certainly would have found a less costly solution but for ignorance or a desire to reward their former company and friends at Goldman Sachs.

    Second, rates have been kept artificially low, to among other things, allow the big banks to make tens of billions (and costing savers tens of billions). Those savers have not been reimbursed for the losses caused by the big banks.

    And third if I gamble with money from my company and win my bet on the Super Bowl and then put the money back, I am still not innocent. Just because many of the big banks have paid back the money they were given directly by taxpayers does not mean they didn’t get huge benefits from the government. Pretending they are not bad guys because after ruining the economy, costing millions of people their jobs and savings, getting many benefits from the government, they then pay back the direct cash payments is not accurate.

    Response to: The New Bank Tax

    Related: Elizabeth Warren Webcast On Failure to Fix the System – The Best Way to Rob a Bank is as An Executive at One – Failure to Regulate Financial Markets Leads to Predictable Consequences – Jim Rogers on the Financial Market Mess – Congress Eases Bank Laws (1999)

  • “What the Financial Sector Did to Us”

    Nobel Prize winning economist Joseph Stiglitz explores the current financial system and the damage done to the economy due to that system. As he states in the video the credit crisis is not something that happened to the financial institutions. The credit crisis caused recession is something the financial sector did to us.

    He covers the topics he discusses in the video in his new book: Freefall

    Related: There is No Invisible Hand – Failure to Regulate Financial Markets Leads to Predictable Consequences – Market Inefficiencies and Efficient Market Theory – Congress Eases Bank Laws (1999) – Volcker on the Great Recession and Need for Reform

  • Where to Invest for Yield Today

    Yields are staying amazingly low today. Due to the credit crisis the federal reserve is shifting hundreds of billions of dollars from savers to bankers to allow banks to make up for losses they experienced (both in losses on bad loans and huge cash payments made to hundreds of executives over more than a decade). For that reason (and others) yields are extremely low now which is a great burden on those that saved and counted on reasonable investment yield.

    Don’t be fooled by apologist for those causing the credit crisis that try and excuse their behavior and act as those paying back the bailout payments means they paid back the favors they were given. They have received much more from the policies of the federal reserve that has taken hundreds of billions of dollars from savers and given it to bankers. It has the same effect as a direct tax on savers being paid to bankers.

    What is an investor/saver to do? James Jubak provides some excellent advice.

    How to maximize what your cash pays even when nothing is paying much of anything now

    A three month Treasury bill pays just 0.12%. A two-year note pays just 0.79%. Inflation may not be very high at an annual rate of 2.6% for headline inflation (and 1.6% minus volatile energy and food prices) but it’s enough to eat up all the interest from those investments and more. (TIPS, Treasury Inflation-Protected Securities will protect you from inflation but the yields are really low (1.43% for a 10-year TIPS at recent auction) and they only protect you from inflation and not rising interest rates. I-Bonds, a savings bond that pays an interest rate that combines a fixed component, currently 0.3%, with an inflation-adjusted variable rate, current 3.06%, offer a higher yield but since the variable rate is pegged to inflation and not interest rates, the yield on these bonds won’t necessarily go up if interest rates do. You also have to hold for at least 12 months. (After that and until you’ve held for 5 years you lose the last 3-months of interest when you sell.)

    You could lock your money up for decades and get 4.56% in a 30-year Treasury bond but 30 years is forever. And besides interest rates have to go up from today’s lows and that means bond prices will be coming down, probably fast enough to eat up all the interest that bond pays and more.
    …
    Not if you remember that interest rates are going up in most of the world (except maybe Europe and Japan) quite dramatically over the next 12 months. A year from now, perhaps sooner, you’ll be able to get yields swell north of anything you can find now.

    That pretty much means that you’re guaranteed to lose money two ways by locking it up for the long term now.
    …
    For the short term you need to put your cash into something that’s as safe as possible but that offers you as much income as possible—and that doesn’t lock up your money for very long.

    My choice dividend paying stocks—if they pay a high dividend, are extremely liquid, and are battle tested.

    Whether you agree with his suggestions in the article is up to you. But even if you don’t he provides a very good overview of the options and risks that you have to navigate now as an investor seeking investments that provide a decent yield. I agree with him that interest rates seem likely to rise, making bonds an investment I largely avoid now myself.

    Related: posts on financial literacy – Jubak Picks 10 Stocks for Income Investors – S&P 500 Dividend Yield Tops Bond Yield: First Time Since 1958 – Bond Yields Show Dramatic Increase in Investor Confidence

  • USA Unemployment Rate Remains at 9.7%

    The slow recovery from the massive credit crisis caused recession remains underway. Nonfarm payroll employment declined 36,000 in February, and the unemployment rate held at 9.7%, the U.S. Bureau of Labor Statistics reported today. Employment fell in construction and information, while temporary help services added jobs. Severe winter weather in parts of the country may have affected, negatively, payroll employment and hours.

    In February, the number of unemployed persons, at 14.9 million, was essentially unchanged. Among the major worker groups, the unemployment rates for adult men (10.0%), adult women (8.0%), whites (8.8%), African-Americans (15.8%), Hispanics (12.4%), Asians was 8.4%, and teenagers (25.0%) showed little to no change in February.

    The number of long-term unemployed (those jobless for 27 weeks and over) was 6.1 million in February and has remained stable since December. About 4 in 10 unemployed persons have been unemployed for 27 weeks or more.

    In February, the civilian labor force participation rate (64.8%) and the employment-population ratio (58.5%) were little changed.

    The number of persons working part time for economic reasons (sometimes referred to as involuntary part-time workers) increased from 8.3 to 8.8 million in February, partially offsetting a large decrease in the prior month. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job.

    Since the start of the recession in December 2007, payroll employment has fallen by 8.4 million.
    Related: Unemployment Rate Reached 10.2% – Another 450,000 Jobs Lost in June 2009 – Can unemployment claims predict the end of the American recession?
    (more…)

  • Buffett Calls on Bank CEOs and Boards to be Held Responsible

    In his most recent letter to shareholders Warren Buffett suggests that bank CEOs and board members be held accountable when the risks they take (and reward themselves obscenely for when they payoff) backfire:

    In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control. If he’s incapable of handling that job, he should look for other employment. And if he fails at it – with the government thereupon required to step in with funds or guarantees –
    the financial consequences for him and his board should be severe.

    It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden, with 90% or more of the value of their holdings wiped out in most cases of failure. Collectively, they have lost more than $500 billion in just the four largest financial fiascos of the
    last two years. To say these owners have been “bailed-out” is to make a mockery of the term.

    The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their
    recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.

    The lack of accountability or ethics from those risking the economy so they can take huge payments (and paying off politicians to allow those risks) has hugely damaged the USA and the economic future of the country. The longer we allow such unethical leadership to continue to the more we will suffer. The current low interest paid to savers and the wealth thus transferred to the banks (who then pay themselves even more bonuses) are but one legacy of this economically devastating path.

    By the way, there is no way the bankers will actually be held accountable. The behavior of politicians we continually elect shows they will not do something that those giving them the huge amounts of cash don’t like. If we don’t like that we have to elect different people – maybe people that care about the country and have moral principles instead of those lacking such qualities, that we do elect.

    The politicians believe in holding those that don’t give them huge payments accountable for their actions. They just draw the line at holding people that they play golf with accountable.

    Related: CEOs Plundering Corporate Coffers – Credit Crisis the Result of Planned Looting of the World Economy – The Best Way to Rob a Bank is as An Executive at One – Fed Continues Wall Street Welfare – Political Favors for Rich Donors – Why Pay Taxes or be Honest

  • Home Prices Increase for 5th Straight Month

    Home Prices in 20 U.S. Cities Rose for Fifth Month

    The seasonally adjusted 20-city index has been rising on a month-to-month basis since June, the first gain since it started dropping in June 2006.
    …
    “The tax credit had the intended impact of drawing buyers in and lowering inventory,” Lawrence Yun, the real-estate agents group’s chief economist, said in a news conference. “An estimated 2 million buyers have taken advantage of the credit.”
    …
    Foreclosure filings in 2009 will reach a record for the second consecutive year with 3.9 million notices sent to homeowners in default, RealtyTrac Inc., the Irvine, California- based company said Dec. 10. This year’s filings will surpass 2008’s total of 3.2 million.

    The housing market seems to have been stabilized with the tax credits, previous declines, continued low mortgage rates and a somewhat better credit environment. The market is still far from healthy. And the credit environment is still very tight. But housing may have hit a bottom nationwide, though this is not certain. I do expect mortgage rates to increase in 2010 which will put pressure on housing prices.

    Related: House Prices Seem to be Stabilizing (Oct 2009) – USA Housing Foreclosures Slowly Declining – The Value of Home Ownership – Your Home as an Investment

  • Commercial Real Estate Market Prospects Remain Dim

    Why This Real Estate Bust Is Different by Mara Der Hovanesian and Dean Foust

    But the Goldman deal, with its unrealistic assumptions, multiple layers of investors, and stratospheric prices, helps illustrate why this downturn is more complicated than previous ones—and will turn out to be far costlier. Already, prices have plunged 41% from the peak in 2007, according to Moody’s/REAL Commercial Property Price Index—worse than the 30.5% fall in the housing market from its 2006 apex. “We’ve never seen this extreme a correction as far back as the data go, which is the late 1960s,” says Neal Elkin, president of Real Estate Analytics, the research firm that created the index. Adds billionaire investor Wilbur Ross: “Commercial real estate has gone from being highly liquid at sky-high prices to being extremely illiquid at distressed prices.”
    …
    While the housing crisis seems to be easing, the commercial storm is still gathering strength. Between now and 2012, more than $1.4 trillion worth of commercial real estate loans will come due…

    The USA commercial real estate market, by many account, is going to continue to have trouble. I would like to add to my commercial real estate holdings in my retirement account, because I have so little (and other options are not that great), but with the current prospects I am not ready to move. I would not be surprised if the market comes back sooner than people expect: it seems like it is far too fashionable to have bearish feelings about the market. However, it doesn’t seem like the risk reward trade-off is worth it yet.

    Related: Commercial Real Estate Market Still Slumping – Victim of Real Estate Bust: Your Pension – Nearly 10% of Mortgages Delinquent or in Foreclosure (Dec 2008) – Urban Planning