From The Wall Street Journal March 6, 2008 page A2
Even as financial firefighters try to douse the flames, the search is under way for the cause of the fire.
How could a mortgage-market meltdown -- losses of perhaps $400 billion, less than 2% of the overall value of the stock market -- cause so much of a disturbance and do so much damage to the U.S. economy? "After all," Federal Reserve governor Frederic Mishkin observed last week, "a 2% decline in stock-market prices sometimes happens on a daily basis, and yet leads to hardly a ripple in the U.S. economy."
And is the fire being fanned by the way commercial banks are required to keep their books and decide how much capital to hold as a cushion against bad times?
The short answer to the first question is leverage. The short answer to the second is yes. Leverage is borrowing money to make bigger bets. Invest $1, borrow $9, buy something for $10. If its value rises $2, you've tripled your initial investment. It works great when the market is on the way up. On the way down, it amplifies losses.
Banks are highly leveraged. That's how they make money. Peter Fisher of money manager BlackRock recalls giving a talk to a bunch of bankers and asking rhetorically: "What's the difference between a hedge fund and a bank?" Before he could answer, someone in the audience said, "Banks are more highly leveraged."
A bank has a set amount of capital. Based on regulatory rules and management's judgment, it borrows some multiple of that sum, either in the markets or by taking money from depositors. It puts that money into loans or securities, its assets.
Banks today find their assets worth less than anticipated, the consequence of a real-estate bust and falling market prices of securities. These losses erode a bank's capital cushion. With less capital, banks shrink their balance sheets; they lend less.
How much less? That's where leverage comes in.
Say for every $1 less in capital, a bank lends roughly $10 less. At a conference last week, sponsored by the Brandeis University and University of Chicago business schools, two Wall Street economists and two academics estimated that about half the mortgage losses, or about $200 billion, will be borne by banks and other leveraged financial institutions. That will lead them to shrink their balance sheets by about $2 trillion by lending less and selling assets.
With money cheap, banks gorged themselves with leverage in good times, making not only risky mortgages, but increasing leverage by investing in securities that rested on the riskiest slice of those mortgages. Bank balance sheets now are on a forced diet.
The impact on the rest of us depends on how much new capital banks raise and how much they reduce leverage. The four economists estimate all this will translate into $900 billion less in loans to households and businesses, and say that will reduce economic growth over the next year between one and 1.5 percentage points. Ouch.
That's the "what" and part of the "why." But the current approach to bank capital and accounting is exacerbating the ups and downs. When times are good, loans and securities look less risky, and banks increase leverage to make more money without building capital. When times are bad, they do the opposite.
"When asset prices rise, so does the value of collateral, which makes financing easier, increasing the demand for assets," Jaime Caruana, then Spain's central banker, observed in 2002. "That, in turn, pushes asset prices upward. In the downturn, as the value of collateral drops, financing possibilities decline, as does thus credit growth, a process often reinforced by financial institutions pursuing much more cautious credit policies as they are incurring losses or making smaller profits. ... Tighter credit policies reinforce recessionary forces and provoke additional reductions in asset prices."
For that reason, Spain, unusual among its peers, tweaked its rules in 2000 to require banks to set aside more capital when times are good so they have bigger cushions when times are bad.
The relatively new practice of requiring banks to value their loans and securities to market prices -- instead of assuming, unless there's good reason, the borrower will pay back the loan -- pushes in the same direction. It was a well-intentioned response to the mistakes of the past when Japanese banks and U.S. savings-and-loans were allowed to lie about the true value of their loans and collateral for years.
But, as economist Hyun Song Shin of Princeton University noted at last week's conference, when banks valued assets at what they paid for them, they had reason to sell when market prices rose and buy when market prices fell.
That welcome stabilizing effect has been lost. Banks today have incentives to buy more when prices are high, and are forced to sell when they are low.
As Mr. Shin and Tobias Adrian of the Federal Reserve Bank of New York wrote recently, "The expansion and contraction of balance sheets amplifies, rather than counteracts, the credit cycle." Capital standards and mark-to-market rules add to euphoria in good times and despair in bad.
That isn't smart.
Friday, March 7, 2008
Sunday, March 2, 2008
Interest Rates - If only we knew where they were going...
For the week ending Jan. 3, Freddie Mac reported that the average rate on a 30-year fixed-rate mortgage was 6.07%. By the week ending Jan. 24, the average rate dropped to 5.48% -- nearly a four-year low for the mortgage.
But rates reversed course, and for the week ending Feb. 28, the 30-year averaged 6.24% -- the highest it has been since November.
This comes after months of stability, with rates inching up or down week to week. So what's with all the recent volatility? Ask people who follow the rates and you'll get a variety of answers as to why rates have gone back up: inflation worries, weakness in the U.S. dollar, a reaction to the economic stimulus package. But many agree that issues being worked out in the credit markets will probably cause long-term mortgage rates to be somewhat volatile in months to come.
The experts who commented this week were basically split on whether rates would go up or down in the week ahead. Surprise, Surprise...
"This market is psychotic," as quoted by the president of Mortgage Grader. "In spite of a dwindling economy, rates have climbed back to 6%, which is where rates were before Mr. Bernanke took action 30 days ago. Stagflation should become part of everyone's vocabulary."
It takes a good crystal ball to know how mortgage rates will fare in the weeks ahead. But there's a good chance that this roller coaster of a rate ride isn't yet at a full and complete stop.
But rates reversed course, and for the week ending Feb. 28, the 30-year averaged 6.24% -- the highest it has been since November.
This comes after months of stability, with rates inching up or down week to week. So what's with all the recent volatility? Ask people who follow the rates and you'll get a variety of answers as to why rates have gone back up: inflation worries, weakness in the U.S. dollar, a reaction to the economic stimulus package. But many agree that issues being worked out in the credit markets will probably cause long-term mortgage rates to be somewhat volatile in months to come.
The experts who commented this week were basically split on whether rates would go up or down in the week ahead. Surprise, Surprise...
"This market is psychotic," as quoted by the president of Mortgage Grader. "In spite of a dwindling economy, rates have climbed back to 6%, which is where rates were before Mr. Bernanke took action 30 days ago. Stagflation should become part of everyone's vocabulary."
It takes a good crystal ball to know how mortgage rates will fare in the weeks ahead. But there's a good chance that this roller coaster of a rate ride isn't yet at a full and complete stop.
FDIC doesn't see bank failures surging
The Federal Deposit Insurance Corp. is trying to rehire 25 former employees specializing in bank insolvency, but the agency that insures bank deposits said it does not expect a surge of failures in the industry.
Federal Reserve Chairman Ben Bernanke raised some eyebrows this week when he suggested during congressional testimony that the U.S. will likely see some banks fail in upcoming months due to the ongoing credit crunch and a weakening housing market.
"There will probably be some bank failures," Bernanke told Congress Thursday. "There are some small and in many cases de novo [new] banks that have heavily invested in real estate in locales where prices have fallen. Among the largest banks, the capital ratios remain good and I don't expect any serious problems among the larger banks."
"Our problem bank list has 76 institutions, low by historical standards," said Andrew Gray, a representative for the FDIC. "In 1990, there were close to 1,500 on the list. Typically, the number of failures for a given year does not approach the number of banks on the list."
In contrast, more than 800 banks failed between 1990 and 1992 after a severe recession brought on by the savings and loan crisis proved to be too much for many overleveraged smaller banks.
Analysts also cried foul on Bernanke's suggestion, with Punk Ziegel analyst Dick Bove pointing out Friday that even when three small banks failed during the fourth quarter of 2008, the market barely registered the change.
All three of those were regional banks: Douglass National Bank in Kansas City, Mo., Miami Valley Bank of Lakeview, Ohio, and NetBank in Alpharetta, Ga.
"Virtually no one was even aware that this happened because it was akin to the proverbial tree falling in the forest," Bove said Friday, adding he isn't worried about the 76 banks currently on the FDIC's radar.
"The average asset size of these troubled banks and thrifts is less than $300 million. All of them could fail and it would have no impact on the system," Bove said.
FDIC report shows issues, but agency says they aren't terminal.
Recent data from the FDIC support the idea that these days most U.S. banks are well positioned to ride out any approaching storm.
"The industry as a whole is coming off a golden period of record profits," FDIC Chairwoman Sheila C. Bair said in the agency's Quarterly Banking Profile, released earlier this week. "Because of this financial strength, the overwhelming majority of banks and thrifts remain well-capitalized and profitable."
The report showed that 99% of insured institutions were currently well-capitalized at the end of 2007 and close to 90% of those were also profitable, despite the fact that profits at the banks and thrifts fell to a 16-year low in the fourth quarter of 2007.
Indeed, American banks posted earnings above $100 billion for the sixth consecutive year. But the industry as a whole took a bath on overall loan losses last year, with loan loss provisions more than doubling in 2007 to $68.2 billion from $29.5 billion a year earlier. "The rising trend in noncurrent loans indicates that write-offs and loss provisions will likely remain high for the near future," Bair said.
So far, banks are girding for the tough times ahead by shoring up close to $30 billion in capital during the fourth quarter alone. And while losses at American banks grabbed headlines in 2007, much of that news is attributable to a few highly publicized missteps by the banking sector's larger player.
"The magnitude of the decline in industry earnings was attributable to a relatively small number of large institutions," Bair said, pointing out that the median return on assets only fell 14 basis points compared with the much higher drop of 102 basis points for some larger banks.
"Seven large institutions accounted for more than half of the total year-over-year increase in loss provisions," Bair said. "Ten large institutions accounted for the entire decline in trading results."
Federal Reserve Chairman Ben Bernanke raised some eyebrows this week when he suggested during congressional testimony that the U.S. will likely see some banks fail in upcoming months due to the ongoing credit crunch and a weakening housing market.
"There will probably be some bank failures," Bernanke told Congress Thursday. "There are some small and in many cases de novo [new] banks that have heavily invested in real estate in locales where prices have fallen. Among the largest banks, the capital ratios remain good and I don't expect any serious problems among the larger banks."
"Our problem bank list has 76 institutions, low by historical standards," said Andrew Gray, a representative for the FDIC. "In 1990, there were close to 1,500 on the list. Typically, the number of failures for a given year does not approach the number of banks on the list."
In contrast, more than 800 banks failed between 1990 and 1992 after a severe recession brought on by the savings and loan crisis proved to be too much for many overleveraged smaller banks.
Analysts also cried foul on Bernanke's suggestion, with Punk Ziegel analyst Dick Bove pointing out Friday that even when three small banks failed during the fourth quarter of 2008, the market barely registered the change.
All three of those were regional banks: Douglass National Bank in Kansas City, Mo., Miami Valley Bank of Lakeview, Ohio, and NetBank in Alpharetta, Ga.
"Virtually no one was even aware that this happened because it was akin to the proverbial tree falling in the forest," Bove said Friday, adding he isn't worried about the 76 banks currently on the FDIC's radar.
"The average asset size of these troubled banks and thrifts is less than $300 million. All of them could fail and it would have no impact on the system," Bove said.
FDIC report shows issues, but agency says they aren't terminal.
Recent data from the FDIC support the idea that these days most U.S. banks are well positioned to ride out any approaching storm.
"The industry as a whole is coming off a golden period of record profits," FDIC Chairwoman Sheila C. Bair said in the agency's Quarterly Banking Profile, released earlier this week. "Because of this financial strength, the overwhelming majority of banks and thrifts remain well-capitalized and profitable."
The report showed that 99% of insured institutions were currently well-capitalized at the end of 2007 and close to 90% of those were also profitable, despite the fact that profits at the banks and thrifts fell to a 16-year low in the fourth quarter of 2007.
Indeed, American banks posted earnings above $100 billion for the sixth consecutive year. But the industry as a whole took a bath on overall loan losses last year, with loan loss provisions more than doubling in 2007 to $68.2 billion from $29.5 billion a year earlier. "The rising trend in noncurrent loans indicates that write-offs and loss provisions will likely remain high for the near future," Bair said.
So far, banks are girding for the tough times ahead by shoring up close to $30 billion in capital during the fourth quarter alone. And while losses at American banks grabbed headlines in 2007, much of that news is attributable to a few highly publicized missteps by the banking sector's larger player.
"The magnitude of the decline in industry earnings was attributable to a relatively small number of large institutions," Bair said, pointing out that the median return on assets only fell 14 basis points compared with the much higher drop of 102 basis points for some larger banks.
"Seven large institutions accounted for more than half of the total year-over-year increase in loss provisions," Bair said. "Ten large institutions accounted for the entire decline in trading results."
Friday, February 15, 2008
We are good advisors...
NBA players' financial security no slam dunk
It was a decade ago Kenny Anderson, then a Boston Celtics point guard, set a standard that has helped define the filthy-rich silliness of NBA players.
With the league two months into a lockout, Anderson lamented times were so tight, he might have to pare down his fleet of luxury automobiles.
He confided to The New York Times he owned eight cars, including a Porsche, a Lexus and a Range Rover. He was thinking of shedding a Benz.
Seen 10 years down a prosperous road, Anderson's parking garage looks downright quaint. With the average player's salary having approximately doubled in a decade to $5.36 million (U.S.), the definition of NBA excess has become, well, more excessive.
"I've seen (an NBA player) having two cars a day to drive. You know, 14 cars," said Raptors sharpshooter Jason Kapono the other day. "Think about how absurd it is. You say 14 cars. All right, you may have some kids, a family of nine. But a single guy having 14 cars?
"It's one thing if Bill Gates wants to do that. But when you're 22 years old and you don't even have kids yet, it's not good."
Kapono, then, wasn't the least bit surprised when a representative of the NBA Players' Association addressed the Raptors recently on matters of financial prudence. A statistic was cited during the meeting that startled some of the hoopsters. It was said that 60 per cent of retired NBA players go broke five years after their NBA paycheques stop arriving.
"How could that be?" said Jamario Moon, the Raptors rookie. "I don't want to believe that stat."
But that stat, used by the players' association to get the attention of young millionaires, is thought to be an educated estimate.
"Sixty per cent is a ballpark. But we've seen a lot of guys who've really come into hard times five years after they leave the league," said Roy Hinson, the former NBA forward who's a representative for the players' association. "The problems are, for a lot of guys, they have a lot of cars, they have multiple houses, they're taking care of their parents. They're taking care of a whole host of issues. And the cheques aren't coming in anymore."
Experienced players like Kapono, who has played on four different teams in his five-year tenure, were not surprised by the number.
"You see how guys live," said Kapono. "A lot of players get in trouble because they want everyone around them to lead the same lifestyle. So you fall into a hole. You buy this big house now for those people, and they no longer want to drive the low-end car to go with the big house. So the big house leads to the big car, to the better clothes, to the better restaurants and stuff. It's a snowball effect. That's why the stat isn't as shocking, because I've witnessed it."
It's not just the spending, it's the scamming. Hinson – who, as it happens, said he knows of a current NBA player who owns 15 cars – said unwitting athletes have been charged as much as $5,000 a month for bill-paying services and as much as a $100,000 to have their taxes prepared by unscrupulous agents and business managers.
"If you never check up on someone," said Raptors guard Darrick Martin, "you become a target."
Public stories of NBAers in financial trouble occasionally make headlines. Back in October, Jason Caffey, who made an estimated $29 million during his eight-year NBA career, was in bankruptcy court seeking protection from his creditors, among them the seven women with whom he fathered eight children. And late last year Latrell Sprewell, who famously turned up his nose at a $21 million contract offer – "I've got to feed my family," was the money quote – had a yacht worth more than $1 million repossessed.
Hinson said the problems go far deeper than the headlines. The players' association has long recommended a financial firm that offers players free second opinions on their financial particulars, but getting players to act is a challenge.
"Sometimes you can stop the bleeding, and other times you can't stop the bleeding," said Hinson, who added that many players associate with "too many `yes' people."
"Sometimes you need someone to say, `No, you can't buy that.' I fell prey to that myself, and I know a lot of people I played with who had the same problem," said Hinson, whose 10-year career ended in the early 1990s.
"It takes a strong constitution and a good team of advisors around you to make sure you're doing the right things."
Common sense and honest advocates are sometimes in short supply in NBA circles, but they do exist.
"My approach is I want to enjoy my life for the long term, and I want my family and my kids to be able to enjoy it," said Kapono, 26. "So there's a fine line between extravagance and having fun and enjoying it at a reasonable rate.
"Going above and beyond isn't worth it. I don't want to be a part of that 60 per cent that's in trouble five years down the road. It's a short career and I'm blessed to be earning a great salary playing basketball. But if it ended, my contract only takes me to age 30. Life expectancy is 80-plus. So I've got another 50 years.
"Do I really need to buy another car?"
It was a decade ago Kenny Anderson, then a Boston Celtics point guard, set a standard that has helped define the filthy-rich silliness of NBA players.
With the league two months into a lockout, Anderson lamented times were so tight, he might have to pare down his fleet of luxury automobiles.
He confided to The New York Times he owned eight cars, including a Porsche, a Lexus and a Range Rover. He was thinking of shedding a Benz.
Seen 10 years down a prosperous road, Anderson's parking garage looks downright quaint. With the average player's salary having approximately doubled in a decade to $5.36 million (U.S.), the definition of NBA excess has become, well, more excessive.
"I've seen (an NBA player) having two cars a day to drive. You know, 14 cars," said Raptors sharpshooter Jason Kapono the other day. "Think about how absurd it is. You say 14 cars. All right, you may have some kids, a family of nine. But a single guy having 14 cars?
"It's one thing if Bill Gates wants to do that. But when you're 22 years old and you don't even have kids yet, it's not good."
Kapono, then, wasn't the least bit surprised when a representative of the NBA Players' Association addressed the Raptors recently on matters of financial prudence. A statistic was cited during the meeting that startled some of the hoopsters. It was said that 60 per cent of retired NBA players go broke five years after their NBA paycheques stop arriving.
"How could that be?" said Jamario Moon, the Raptors rookie. "I don't want to believe that stat."
But that stat, used by the players' association to get the attention of young millionaires, is thought to be an educated estimate.
"Sixty per cent is a ballpark. But we've seen a lot of guys who've really come into hard times five years after they leave the league," said Roy Hinson, the former NBA forward who's a representative for the players' association. "The problems are, for a lot of guys, they have a lot of cars, they have multiple houses, they're taking care of their parents. They're taking care of a whole host of issues. And the cheques aren't coming in anymore."
Experienced players like Kapono, who has played on four different teams in his five-year tenure, were not surprised by the number.
"You see how guys live," said Kapono. "A lot of players get in trouble because they want everyone around them to lead the same lifestyle. So you fall into a hole. You buy this big house now for those people, and they no longer want to drive the low-end car to go with the big house. So the big house leads to the big car, to the better clothes, to the better restaurants and stuff. It's a snowball effect. That's why the stat isn't as shocking, because I've witnessed it."
It's not just the spending, it's the scamming. Hinson – who, as it happens, said he knows of a current NBA player who owns 15 cars – said unwitting athletes have been charged as much as $5,000 a month for bill-paying services and as much as a $100,000 to have their taxes prepared by unscrupulous agents and business managers.
"If you never check up on someone," said Raptors guard Darrick Martin, "you become a target."
Public stories of NBAers in financial trouble occasionally make headlines. Back in October, Jason Caffey, who made an estimated $29 million during his eight-year NBA career, was in bankruptcy court seeking protection from his creditors, among them the seven women with whom he fathered eight children. And late last year Latrell Sprewell, who famously turned up his nose at a $21 million contract offer – "I've got to feed my family," was the money quote – had a yacht worth more than $1 million repossessed.
Hinson said the problems go far deeper than the headlines. The players' association has long recommended a financial firm that offers players free second opinions on their financial particulars, but getting players to act is a challenge.
"Sometimes you can stop the bleeding, and other times you can't stop the bleeding," said Hinson, who added that many players associate with "too many `yes' people."
"Sometimes you need someone to say, `No, you can't buy that.' I fell prey to that myself, and I know a lot of people I played with who had the same problem," said Hinson, whose 10-year career ended in the early 1990s.
"It takes a strong constitution and a good team of advisors around you to make sure you're doing the right things."
Common sense and honest advocates are sometimes in short supply in NBA circles, but they do exist.
"My approach is I want to enjoy my life for the long term, and I want my family and my kids to be able to enjoy it," said Kapono, 26. "So there's a fine line between extravagance and having fun and enjoying it at a reasonable rate.
"Going above and beyond isn't worth it. I don't want to be a part of that 60 per cent that's in trouble five years down the road. It's a short career and I'm blessed to be earning a great salary playing basketball. But if it ended, my contract only takes me to age 30. Life expectancy is 80-plus. So I've got another 50 years.
"Do I really need to buy another car?"
Sunday, February 3, 2008
Investing in Diamonds...Baseball that is
Have you heard about this? Cleveland Indians minor league pitching prospect Randy Newsom is securitizing himself by selling off 4% of any future major league earnings he may realize. For $20 you can buy one share which entitles you (the shareholder) to 0.0016% of his big league earnings. By doing this, Newsom will raise $50,000 in capital. He has even established a company to facilitate future transactions - his own "investment bank" if you will.
The best discussion I have read about this is from Steven Levitt of Freakonomics fame. Professor Levitt conjectures that, assuming Newsom is risk neutral (a big “if” by the way), this price implies Newsom believes his future earnings will equal less than $1.25 million. I just wonder what is going on; if Newsom is simply in need of cash now or if he doesn't think he has a shot at the big leagues anyway. After all, there is enormous information asymmetry between Newsom, effectively the owner-manager, and the shareholder, so I assume we are adapting an extremely high expected return to our valuation. Alternatively, maybe he is most interested in the business and is using his own "stock" to help launch it, also a good way to hedge the possibility of never making the bigs.
I know that if I were a minor leaguer and could accurately assess my own probability of major league success, this scheme would have enormous appeal. Just think about the earnings differential between minor league and big league baseball. I mean, to a 25-year old who has spent his career playing minor league ball $50k is quite a bit of money, but to a millionaire superstar, the 4% of his million dollar salary is comparatively insignificant.
Here is Professor Levitt's discussion:
January 28, 2008,
With the Stock Market Down, Perhaps Diamonds Are a Good Place to Invest
By Steven D. Levitt
Not the sort of diamonds you wear on your finger, but baseball diamonds.
Randy Newsom, a minor league baseball player, recently offered himself up as an I.P.O. Interested investors can buy up to 4% of his future major league income. The price is not that high: $20 per share, with each share entitling the owner to .0016% of his potential major league earnings. So the total revenue he will raise in return for 4% is $50,000.
What does this tell us about the 25-year-old major leaguer? If he were risk-neutral, it would tell us he expects career earnings of less than $1.25 million (which is the expected value implied by selling his future at this price). Given that the minimum salary of a major leaguer is nearly $400,000 a year, and the median salary is about $1 million, the price does not seem very high. This means either that (a) Newsom is very risk averse (which might make this a very good investment opportunity); (b) Newsom is very dumb and is pricing himself too cheaply; (c) Newsom knows that he does not have the talent to make it to the major leagues (in which case he is probably very smart).
My first thought is that option (c) is the most likely scenario. Here is a description of some of his exploits:
In 2007, Randy had a dominating 1.50 E.R.A. in Advanced-A Kinston. He was quickly promoted to AA and was selected to the Eastern League All-Star Game in July. For the season, Randy went 4-1 with 18 saves and an outstanding 3.12 E.R.A. as a closer for the Southern Division champion Akron Aeros.
After quickly establishing himself as a prospect in the Indians’ farm system, Randy was invited to play in the Arizona Fall League. The A.F.L. is the top winter ball program in the country, only available to top prospects. After throwing a hitless first inning in the A.F.L., Randy continued to dominate other top prospects, throwing seven scoreless innings in the A.F.L., including two scoreless innings in the championship game. For the entire 2007 season, Randy went 4-2, with 18 saves and a 2.51 E.R.A.
Those sound like pretty good numbers to me. Perhaps some blog readers have sabermetric models that can inform the rest of us about Newsom’s chances of making it to the major leagues?
I’m always suspicious of people who are trying to sell things, especially when they provide a lot of private information. What are the advantages of selling shares to the public rather than going through more traditional risk-pricing mechanisms like Lloyd’s of London? The fact that Newsom’s shares are not exactly flying off the shelves furthers my suspicions; 2,319 1,345 [additional press coverage here -Ed.] of the original 2,500 shares are still available for purchase.
On the other hand, there is a brilliance to Newsom’s strategy and what the web site RealSportsInvestments.com is trying to do generally. What they are selling is not just a flow of future earnings, but a dream. There are very few forms of investment that are also fun: owning a race horse, collecting expensive art, etc. Investors should be willing to accept a lower return on their investment in return for having fun. Selling a small share of himself probably doesn’t diminish the fun of pursuing the dream for Newsom (maybe it even enhances it because now he has an army of supporters rooting for him), but it gives him a way to charge others for living vicariously through him. Thus, there are potentially large gains to be made in allowing fans to own pieces of players.
While absent in team sports, this sort of staking relationship is common in other settings. Many high-stakes poker players are staked, with others buying a piece of their action. When professional golfers first make the P.G.A. tour, they often have backers who pay their expenses in return for a share of earnings. I even had a friend who bought a piece of a professional bowler.
Given how much time and energy millions of Americans devote to fantasy baseball and football, taking real ownership in players seems like a logical next step.
Maybe I’ll buy a few shares. After all, the guy has a submarine delivery.
The best discussion I have read about this is from Steven Levitt of Freakonomics fame. Professor Levitt conjectures that, assuming Newsom is risk neutral (a big “if” by the way), this price implies Newsom believes his future earnings will equal less than $1.25 million. I just wonder what is going on; if Newsom is simply in need of cash now or if he doesn't think he has a shot at the big leagues anyway. After all, there is enormous information asymmetry between Newsom, effectively the owner-manager, and the shareholder, so I assume we are adapting an extremely high expected return to our valuation. Alternatively, maybe he is most interested in the business and is using his own "stock" to help launch it, also a good way to hedge the possibility of never making the bigs.
I know that if I were a minor leaguer and could accurately assess my own probability of major league success, this scheme would have enormous appeal. Just think about the earnings differential between minor league and big league baseball. I mean, to a 25-year old who has spent his career playing minor league ball $50k is quite a bit of money, but to a millionaire superstar, the 4% of his million dollar salary is comparatively insignificant.
Here is Professor Levitt's discussion:
January 28, 2008,
With the Stock Market Down, Perhaps Diamonds Are a Good Place to Invest
By Steven D. Levitt
Not the sort of diamonds you wear on your finger, but baseball diamonds.
Randy Newsom, a minor league baseball player, recently offered himself up as an I.P.O. Interested investors can buy up to 4% of his future major league income. The price is not that high: $20 per share, with each share entitling the owner to .0016% of his potential major league earnings. So the total revenue he will raise in return for 4% is $50,000.
What does this tell us about the 25-year-old major leaguer? If he were risk-neutral, it would tell us he expects career earnings of less than $1.25 million (which is the expected value implied by selling his future at this price). Given that the minimum salary of a major leaguer is nearly $400,000 a year, and the median salary is about $1 million, the price does not seem very high. This means either that (a) Newsom is very risk averse (which might make this a very good investment opportunity); (b) Newsom is very dumb and is pricing himself too cheaply; (c) Newsom knows that he does not have the talent to make it to the major leagues (in which case he is probably very smart).
My first thought is that option (c) is the most likely scenario. Here is a description of some of his exploits:
In 2007, Randy had a dominating 1.50 E.R.A. in Advanced-A Kinston. He was quickly promoted to AA and was selected to the Eastern League All-Star Game in July. For the season, Randy went 4-1 with 18 saves and an outstanding 3.12 E.R.A. as a closer for the Southern Division champion Akron Aeros.
After quickly establishing himself as a prospect in the Indians’ farm system, Randy was invited to play in the Arizona Fall League. The A.F.L. is the top winter ball program in the country, only available to top prospects. After throwing a hitless first inning in the A.F.L., Randy continued to dominate other top prospects, throwing seven scoreless innings in the A.F.L., including two scoreless innings in the championship game. For the entire 2007 season, Randy went 4-2, with 18 saves and a 2.51 E.R.A.
Those sound like pretty good numbers to me. Perhaps some blog readers have sabermetric models that can inform the rest of us about Newsom’s chances of making it to the major leagues?
I’m always suspicious of people who are trying to sell things, especially when they provide a lot of private information. What are the advantages of selling shares to the public rather than going through more traditional risk-pricing mechanisms like Lloyd’s of London? The fact that Newsom’s shares are not exactly flying off the shelves furthers my suspicions; 2,319 1,345 [additional press coverage here -Ed.] of the original 2,500 shares are still available for purchase.
On the other hand, there is a brilliance to Newsom’s strategy and what the web site RealSportsInvestments.com is trying to do generally. What they are selling is not just a flow of future earnings, but a dream. There are very few forms of investment that are also fun: owning a race horse, collecting expensive art, etc. Investors should be willing to accept a lower return on their investment in return for having fun. Selling a small share of himself probably doesn’t diminish the fun of pursuing the dream for Newsom (maybe it even enhances it because now he has an army of supporters rooting for him), but it gives him a way to charge others for living vicariously through him. Thus, there are potentially large gains to be made in allowing fans to own pieces of players.
While absent in team sports, this sort of staking relationship is common in other settings. Many high-stakes poker players are staked, with others buying a piece of their action. When professional golfers first make the P.G.A. tour, they often have backers who pay their expenses in return for a share of earnings. I even had a friend who bought a piece of a professional bowler.
Given how much time and energy millions of Americans devote to fantasy baseball and football, taking real ownership in players seems like a logical next step.
Maybe I’ll buy a few shares. After all, the guy has a submarine delivery.
Tuesday, January 29, 2008
A new way to hide losses: 'reclassify'
Commentary: Morgan Stanley's fine print suggests deeper woes
Imagine a Morgan Stanley broker telling his or her client about some assets that are nearly worthless because they can't be sold. Would that customer feel any better that the brokerage was simply "reclassifying" that investor's losses?
That seems to be the question facing investors in Morgan Stanley today after the brokerage and investment bank said it reclassified $7 billion of funded assets and $279 million in unfunded assets from Level 2 to Level 3.
The levels are a new kind of accounting parlance Wall Street instituted last year. The bigger the number, the harder it is to sell or value the securities in question. In other words, Morgan Stanley no longer knows how much these assets are worth because no one is buying.
Morgan Stanley says the "reclassification" affects commercial whole loans, residuals from residential securitizations, interest-only commercial mortgage and agency bonds as well as commercial and residential credit default swaps. These are the kinds of subprime derivatives that some firms have written off.
Just as troubling for investors is how Morgan Stanley announced the move: It was buried on page 64 of its 191-page quarterly report. It's been a long three months since the firm won kudos for taking an aggressive $3.7 billion write-down that many thought would represent the worst for the firm.
A few weeks later, that loss had grown to more than $9 billion. Now, it appears those losses are going to be reclassified higher, and to top it off, the brokerage is being investigated by regulators over its role in the subprime crisis.
No broker who wanted to earn his client's trust would try to hide a loss behind slick words. What does Morgan Stanley think of its investors?
Imagine a Morgan Stanley broker telling his or her client about some assets that are nearly worthless because they can't be sold. Would that customer feel any better that the brokerage was simply "reclassifying" that investor's losses?
That seems to be the question facing investors in Morgan Stanley today after the brokerage and investment bank said it reclassified $7 billion of funded assets and $279 million in unfunded assets from Level 2 to Level 3.
The levels are a new kind of accounting parlance Wall Street instituted last year. The bigger the number, the harder it is to sell or value the securities in question. In other words, Morgan Stanley no longer knows how much these assets are worth because no one is buying.
Morgan Stanley says the "reclassification" affects commercial whole loans, residuals from residential securitizations, interest-only commercial mortgage and agency bonds as well as commercial and residential credit default swaps. These are the kinds of subprime derivatives that some firms have written off.
Just as troubling for investors is how Morgan Stanley announced the move: It was buried on page 64 of its 191-page quarterly report. It's been a long three months since the firm won kudos for taking an aggressive $3.7 billion write-down that many thought would represent the worst for the firm.
A few weeks later, that loss had grown to more than $9 billion. Now, it appears those losses are going to be reclassified higher, and to top it off, the brokerage is being investigated by regulators over its role in the subprime crisis.
No broker who wanted to earn his client's trust would try to hide a loss behind slick words. What does Morgan Stanley think of its investors?
Tuesday, January 22, 2008
Should You Hold or Go to Cash in this Market?
With Monday’s bloodbath in Asia and in Europe, investors want to know what should they do? Should they panic and sell everything and move into cash, or should they hold on and keep absorbing large market losses?
Obviously if I actually could predict the future, I wouldn’t be blogging. Rather, I’d be sipping some kind of drink with an umbrella in it. But while none of us can see into the future, examining data from the past may help us shed some light on the current market situation.
An interesting article appeared in this weekend’s Seattle Times which spoke about previous market reactions to recessions. Whether we are in one or not is subject for another post. According to data dating back to 1953, recessions, on average, last 216 days, or just over seven months, and stocks post an average 8.64 percent decline during the first half of the pullback, according to Citigroup (C). That actually doesn’t sound too bad compared to the 16% we are down from high in October. Anyway, we are about half way through this cycle.
So what’s the good news? While the first half of a recession can punish stocks, the second half tends to reward investors. During the nine recessions dating back to 1953, S&P 500 stocks have gained 13.17 percent on average in the latter half of a recession, according to Citigroup.
Let’s hope history repeats itself again this year.
Obviously if I actually could predict the future, I wouldn’t be blogging. Rather, I’d be sipping some kind of drink with an umbrella in it. But while none of us can see into the future, examining data from the past may help us shed some light on the current market situation.
An interesting article appeared in this weekend’s Seattle Times which spoke about previous market reactions to recessions. Whether we are in one or not is subject for another post. According to data dating back to 1953, recessions, on average, last 216 days, or just over seven months, and stocks post an average 8.64 percent decline during the first half of the pullback, according to Citigroup (C). That actually doesn’t sound too bad compared to the 16% we are down from high in October. Anyway, we are about half way through this cycle.
So what’s the good news? While the first half of a recession can punish stocks, the second half tends to reward investors. During the nine recessions dating back to 1953, S&P 500 stocks have gained 13.17 percent on average in the latter half of a recession, according to Citigroup.
Let’s hope history repeats itself again this year.
What if the Fed Cut Doesn't Help?
With news Tuesday morning that the Fed is cutting the Fed Funds rate by three-quarters of a percent, it’s official: Things are worse than they seem with the economy.
The Fed, pushed by shattered worldwide investor psychology, is pulling out all stops to shore up confidence. Treasury chief Hank Paulson went so far as to call this latest cut a confidence builder.
Trouble is the “what if they give a party and nobody comes” syndrome. In this case, what if they do a big-bath cut and it doesn’t help?
The Fed did the right thing by cutting just a quarter of a percent a few weeks before the holidays. That would give them a chance to see how the consumer was really doing.
They got the answer pretty fast: The consumer is doing horribly. The value of their homes, especially in the most inflated parts of this country, has deflated. The availability of credit via their homes or other sources has deflated. The value of their 401ks and IRAs has deflated.
As a result, their confidence has been crushed, and it’s unclear how many rate cuts it will take to reverse the trend. The trouble, away from Wall Street, is really quite simple: America has been living out of its means, fueled by a Fed that made credit so cheap that it appeared, at one point, you were getting paid to take the cash. With today’s cut, the Fed Funds rate will fall to 3.50%; last time it was that low was August 9, 2005, when the market was higher than it is today. By contrast, it sank to 1% on June 25, 2003. Mortgage rates, meanwhile, for 30-year loans are averaging 6.33%, still well above their boom levels; ditto for the prime rate.
Here’s the problem: Even if rates once again fall to boom-era levels, credit standards have tightened to the point that even a little bit of sugar won’t help the medicine go down. And don’t go thinking everybody will refinance as mortgage rates slide. Unfortunately, their homes may not appraise out. Batten down the hatches: Ain’t over yet for the bad news — or the Fed.
The Fed, pushed by shattered worldwide investor psychology, is pulling out all stops to shore up confidence. Treasury chief Hank Paulson went so far as to call this latest cut a confidence builder.
Trouble is the “what if they give a party and nobody comes” syndrome. In this case, what if they do a big-bath cut and it doesn’t help?
The Fed did the right thing by cutting just a quarter of a percent a few weeks before the holidays. That would give them a chance to see how the consumer was really doing.
They got the answer pretty fast: The consumer is doing horribly. The value of their homes, especially in the most inflated parts of this country, has deflated. The availability of credit via their homes or other sources has deflated. The value of their 401ks and IRAs has deflated.
As a result, their confidence has been crushed, and it’s unclear how many rate cuts it will take to reverse the trend. The trouble, away from Wall Street, is really quite simple: America has been living out of its means, fueled by a Fed that made credit so cheap that it appeared, at one point, you were getting paid to take the cash. With today’s cut, the Fed Funds rate will fall to 3.50%; last time it was that low was August 9, 2005, when the market was higher than it is today. By contrast, it sank to 1% on June 25, 2003. Mortgage rates, meanwhile, for 30-year loans are averaging 6.33%, still well above their boom levels; ditto for the prime rate.
Here’s the problem: Even if rates once again fall to boom-era levels, credit standards have tightened to the point that even a little bit of sugar won’t help the medicine go down. And don’t go thinking everybody will refinance as mortgage rates slide. Unfortunately, their homes may not appraise out. Batten down the hatches: Ain’t over yet for the bad news — or the Fed.
5 Picks Prove the Moral High Road Does Not Lead to Investment Success
The figures are in, and vice beats nice. Look no further than this comparison between The Vice Fund [VICEX] and The Timothy Plan Conservative Growth Fund [TCGAX], which claims to be “America’s first pro-life, pro-family, biblically-based mutual fund group.”
The Conservative Growth Fund is only one of the funds in the Timothy Plan, but the others fared no better. Apparently the moral high road does not lead to investment success.
Investors looking to take the opposite tact have several options in microcap stocks:
New Frontier Media: (NOOF) With a 10% dividend and institutional support, New Frontier may be the most intriguing sin stock out there. Steel Partners and James Simons’ Renaissance Technologies each took large stakes in the company, which distributes porn adult films via pay TV and also has a fledgling internet operation. New Frontier is profitable, earning $.09 last quarter.
The downside? New Frontier lacks both technical and fundamental momentum. Its stock is trading near a 52-week low and earnings are down year-over-year. Of course, its a lot easier to wait for a turnaround if you are getting paid a 10% dividend.
Private Media Group: (PRVT) Private Media produces and distributes adult films, magazines, and digital media. Like New Frontier, Private Media Group is profitable. Last quarter, it earned 0.5 million euros on revenues of 7.5 million euros — respectable numbers, but not especially attractive for an 85 million dollar company.
If Private Media is to unlock value, it will have to find a way to increasingly monetize its huge catalog. According to Private, the future is in IPTV (internet protocol television), internet and mobile. The company has invested heavily in these businesses, but so far has only garnered meager returns.
Rick’s Cabaret: (RICK) The name may be straight out of Casablanca, but this is a far cry from the gin joint Bogart made famous. Rick’s operates a chain of “upscale gentlemen’s clubs,” and all those lap dances have paid off. Over the past four years, shares have rocketed from a little above $1 to over $20. The consumer may be pulling back, but not here. Rick’s sales are up 57% year-over-year. While the company may appear pricey relative to trailing earnings, Rick’s expects to earn $2 per share next year on the strength of recent and planned acquisitions.
VCG Holdings: (VCGH) A reader who is in the industry (on the business side, sorry to disappoint) suggested that VCG could be the next Rick’s. While the stock was on my watch list for years, I had long been skeptical of the related party transactions. Many of VCG’s clubs and operating contracts have been purchased from majority owner Troy Lowrie. The few deals I have examined do not appear particularly egregious, but the close dealing still warrants a certain level of caution. VCG expects to earn $.86-$.92 in 2008 and $1.15-$1.25 in 2009.
Playboy Holdings (PLA): No discussion of adult stocks would be complete without mention of Playboy. I expected it would be a much larger company, but it turns out that PLA only sports a $271 million market capitalization. Profits rose last quarter on increased licensing revenues, but the stock trades near its 52-week lows. The magazine may be in permanent decline, but the brand, 25-years of pictures and videos, pay-TV and internet businesses all have some value.
Please note that we are not advocating purchases in any of the above named securities, we are just noting that over the most recend time periods...there has been no advantage to taking the moral high ground when it comes to investing.
The Conservative Growth Fund is only one of the funds in the Timothy Plan, but the others fared no better. Apparently the moral high road does not lead to investment success.
Investors looking to take the opposite tact have several options in microcap stocks:
New Frontier Media: (NOOF) With a 10% dividend and institutional support, New Frontier may be the most intriguing sin stock out there. Steel Partners and James Simons’ Renaissance Technologies each took large stakes in the company, which distributes porn adult films via pay TV and also has a fledgling internet operation. New Frontier is profitable, earning $.09 last quarter.
The downside? New Frontier lacks both technical and fundamental momentum. Its stock is trading near a 52-week low and earnings are down year-over-year. Of course, its a lot easier to wait for a turnaround if you are getting paid a 10% dividend.
Private Media Group: (PRVT) Private Media produces and distributes adult films, magazines, and digital media. Like New Frontier, Private Media Group is profitable. Last quarter, it earned 0.5 million euros on revenues of 7.5 million euros — respectable numbers, but not especially attractive for an 85 million dollar company.
If Private Media is to unlock value, it will have to find a way to increasingly monetize its huge catalog. According to Private, the future is in IPTV (internet protocol television), internet and mobile. The company has invested heavily in these businesses, but so far has only garnered meager returns.
Rick’s Cabaret: (RICK) The name may be straight out of Casablanca, but this is a far cry from the gin joint Bogart made famous. Rick’s operates a chain of “upscale gentlemen’s clubs,” and all those lap dances have paid off. Over the past four years, shares have rocketed from a little above $1 to over $20. The consumer may be pulling back, but not here. Rick’s sales are up 57% year-over-year. While the company may appear pricey relative to trailing earnings, Rick’s expects to earn $2 per share next year on the strength of recent and planned acquisitions.
VCG Holdings: (VCGH) A reader who is in the industry (on the business side, sorry to disappoint) suggested that VCG could be the next Rick’s. While the stock was on my watch list for years, I had long been skeptical of the related party transactions. Many of VCG’s clubs and operating contracts have been purchased from majority owner Troy Lowrie. The few deals I have examined do not appear particularly egregious, but the close dealing still warrants a certain level of caution. VCG expects to earn $.86-$.92 in 2008 and $1.15-$1.25 in 2009.
Playboy Holdings (PLA): No discussion of adult stocks would be complete without mention of Playboy. I expected it would be a much larger company, but it turns out that PLA only sports a $271 million market capitalization. Profits rose last quarter on increased licensing revenues, but the stock trades near its 52-week lows. The magazine may be in permanent decline, but the brand, 25-years of pictures and videos, pay-TV and internet businesses all have some value.
Please note that we are not advocating purchases in any of the above named securities, we are just noting that over the most recend time periods...there has been no advantage to taking the moral high ground when it comes to investing.
Thursday, January 17, 2008
The Federal Reserve Has Failed Us
I happen to be one of those people that thinks the U.S. economy (and much of the world economy for that matter) is currently running in an unsustainable fashion with expectations of infinite growth (growth every single year) on a finite planet financed by debt.
I prefer to invest for the long term and as such I try and look at what will happen over longer periods of time. I can’t tell you if the price of gold or oil or any commodity will go up the next day. I can tell you what direction it will probably go over the next decade due to the fundamental economics. Much of the daily fluctuations in the stock market are not linked to fundamentals… but to fear, greed, wall street hype and the media machine. Sometimes the key to understanding where we might be headed is in looking at the basic building blocks of our situation.
Federal Reserve
The Federal Reserve is neither Federal, nor a reserve. It is a private bank that was established in 1913. I won’t bore you with the details. All you need to know is that it is owned privately - by people who could afford and had the power to start a central bank in 1913. It has never been audited. It controls the money supply. And the only Senator in the United States that seems to be asking hard questions of the Federal Reserve is Ron Paul. Perhaps he is the only Senator that understands economics? Perhaps he is the only one willing to stick his neck out to discuss the things that need discussion. I wish more Senators would question the Federal Reserve and whether we should abolish it.
The Federal Reserve controls the money supply by deciding to increase or decrease interest rates and whether to create more money. The whole point is to create a stable and steady economy. The U.S. dollar is NOT backed by gold. It is nothing more than a promissory note - a debt instrument. I believe fiat currencies are inherently flawed and doomed to eventual failure. Fiat currencies are easy to manipulate and that is significant problem. Leave my money alone! Don’t touch it, don’t manipulate it, don’t devalue it. Let it be.
In March 2006 the Federal Reserve stopped publishing the M3 index - reportedly because it costs a lot to collect this information and it wasn’t worth it. The M3 index is a report that tells us how many dollars are in existence. So lets get this right. The Federal Reserve (a privately owned company) has never been audited (ordinary citizens and corporations get audited all the time - The Fed hasn’t been audited since their creation in 1913) and now they NO LONGER PUBLISH HOW MUCH MONEY IS IN CIRCULATION. The same company that CONTROLS THE MONEY SUPPLY isn’t held accountable? How can you determine the value of a currency without that information? How do we truly know what the Federal Reserve has been doing? It could be conducting pure fraud and acting like a free ATM for its owners!? We don’t know. That should scare you. Sometimes I truly wonder, do the people have control over government anymore? Is voting once every four years really government by and for the people?
The Federal Reserve has been saving U.S. banks that invested in sub-prime mortgages. What about the pension funds? What about the average investor? Will they be bailed out? Nope. Just the banks. Funny how that works. The Fed bailing out their friends when they do dumb things that hurt the average American. Is it odd that the banks only own a small portion of the sub-prime mortgages and yet they are the only ones to get bail-outs…?
“The Federal Reserve is totally out of it. They’re destroying the currency
and driving up inflation, which will result in higher interest rates and a
worse economy. We now know the Fed doesn’t understand markets or
economics, but is just trying to bail out its friends on Wall Street at the
expense of 300 million Americans, nay, of the whole world.”
- Investment Guru Jim Rogers
Then there is the bigger question. Do you believe in the free markets and capitalism? Do you think the government should stay out of our business and let it be (laissez-faire)? I guess they think the free market won’t work without interference? Why else would we need the Federal Reserve? The whole point is to manipulate the money system in order to have a more stable economy. Tell me… is the economy stable? Was the economy stable in 1929 and the “Dirty 30’s”? The Federal Reserve has never done a good job.
Want another example of how the Fed has failed us? In the 1950’s a man could support his entire family with ONE average job. He could afford a nice home with the white picket fence and his wife didn’t have to work. Now women are forced to work outside the home just so the bills can be paid and her husband (and quite often her too) is working 80+ hours a week just to keep up with the workload. Inflation has slowly hidden the effects over several generations.
I tend to agree with the Austrian school of economics and believe government interference is counter-productive and has caused many problems. It has done nothing but push problems forward so that they can be dealt with another day. Pushing the problems forward hasn’t solved them… but merely delayed and intensified them and the consequences are scary. Instead of dealing with the problem of debt several decades ago, we are now in a much worse situation. We are headed towards economic disaster.
To stop a recession from happening after the internet bubble burst, the interest rates were lowered. That spurred a real estate bubble. Home values soared (people had cheap access to money) and people refinanced to take some of that money out and spend it. Others went into massive debt to build their dream homes. Lenders lowered their lending requirements to the point where they would lend money to people with no job, no income and no assets. Adjustable rate mortgages lured people in to dangerous mortgage situations. Interest only loans popped up. What happens when millions of people spend $500,000+ each on homes during the same two or three year period and also spend lots of money on furnishing their homes with appliances, decorations, furniture and electronics? A large economic boom! Now that so many people have spent 30+ years of their money all at once (thanks to the low interest rates decided by the Federal Reserve), the economy will slowdown even worse than what would have happened when the internet bubble burst… It’s inevitable. All those people will NOT spend another $500,000+ on another home this year… they already bought their home during the last three years… The Federal Reserve has interfered time and time again and it has always backfired later on.
Now What?
Now the Boomer’s will begin to retire. The most productive segment of society is going to become the biggest drain. The economy is in shambles, the stock market returns are lousy and homes are worth less than consumers paid for them (if they happened to be a recent buyer/builder as the Fed would have hoped they’d be).
The U.S. Dollar is falling… it is being done in such a way (hidden with no M3) that it actually looks like they are purposefully lowering the value of the dollar to cause wide-spread problems. Let’s face it, they are lowering the interest rates to help spur the economy but that is an action they know will lower the value of the dollar. Also by hoping more consumers take on MORE debt to stop the recession the economy will inevitably become even more shaky. Sorry, everyone is already maxed out! You can’t keep borrowing your way out of a recession. The dramatic swings in the U.S. Dollar are just the beginning. Soon, no one will know what the U.S. dollar is worth and foreign countries will sell their reserves. Then, the Fed or the government will probably create a solution: Ditch the dollar and create the Amero and a North American Union. This is scary stuff when you truly realize what it does to your constitutional rights and the future of the United States.
So far all the Federal Reserve has done is do a good job of getting EVERYONE into debt to others. Being indebted to others feels like a form of wage slavery. How much debt do you have?
I prefer to invest for the long term and as such I try and look at what will happen over longer periods of time. I can’t tell you if the price of gold or oil or any commodity will go up the next day. I can tell you what direction it will probably go over the next decade due to the fundamental economics. Much of the daily fluctuations in the stock market are not linked to fundamentals… but to fear, greed, wall street hype and the media machine. Sometimes the key to understanding where we might be headed is in looking at the basic building blocks of our situation.
Federal Reserve
The Federal Reserve is neither Federal, nor a reserve. It is a private bank that was established in 1913. I won’t bore you with the details. All you need to know is that it is owned privately - by people who could afford and had the power to start a central bank in 1913. It has never been audited. It controls the money supply. And the only Senator in the United States that seems to be asking hard questions of the Federal Reserve is Ron Paul. Perhaps he is the only Senator that understands economics? Perhaps he is the only one willing to stick his neck out to discuss the things that need discussion. I wish more Senators would question the Federal Reserve and whether we should abolish it.
The Federal Reserve controls the money supply by deciding to increase or decrease interest rates and whether to create more money. The whole point is to create a stable and steady economy. The U.S. dollar is NOT backed by gold. It is nothing more than a promissory note - a debt instrument. I believe fiat currencies are inherently flawed and doomed to eventual failure. Fiat currencies are easy to manipulate and that is significant problem. Leave my money alone! Don’t touch it, don’t manipulate it, don’t devalue it. Let it be.
In March 2006 the Federal Reserve stopped publishing the M3 index - reportedly because it costs a lot to collect this information and it wasn’t worth it. The M3 index is a report that tells us how many dollars are in existence. So lets get this right. The Federal Reserve (a privately owned company) has never been audited (ordinary citizens and corporations get audited all the time - The Fed hasn’t been audited since their creation in 1913) and now they NO LONGER PUBLISH HOW MUCH MONEY IS IN CIRCULATION. The same company that CONTROLS THE MONEY SUPPLY isn’t held accountable? How can you determine the value of a currency without that information? How do we truly know what the Federal Reserve has been doing? It could be conducting pure fraud and acting like a free ATM for its owners!? We don’t know. That should scare you. Sometimes I truly wonder, do the people have control over government anymore? Is voting once every four years really government by and for the people?
The Federal Reserve has been saving U.S. banks that invested in sub-prime mortgages. What about the pension funds? What about the average investor? Will they be bailed out? Nope. Just the banks. Funny how that works. The Fed bailing out their friends when they do dumb things that hurt the average American. Is it odd that the banks only own a small portion of the sub-prime mortgages and yet they are the only ones to get bail-outs…?
“The Federal Reserve is totally out of it. They’re destroying the currency
and driving up inflation, which will result in higher interest rates and a
worse economy. We now know the Fed doesn’t understand markets or
economics, but is just trying to bail out its friends on Wall Street at the
expense of 300 million Americans, nay, of the whole world.”
- Investment Guru Jim Rogers
Then there is the bigger question. Do you believe in the free markets and capitalism? Do you think the government should stay out of our business and let it be (laissez-faire)? I guess they think the free market won’t work without interference? Why else would we need the Federal Reserve? The whole point is to manipulate the money system in order to have a more stable economy. Tell me… is the economy stable? Was the economy stable in 1929 and the “Dirty 30’s”? The Federal Reserve has never done a good job.
Want another example of how the Fed has failed us? In the 1950’s a man could support his entire family with ONE average job. He could afford a nice home with the white picket fence and his wife didn’t have to work. Now women are forced to work outside the home just so the bills can be paid and her husband (and quite often her too) is working 80+ hours a week just to keep up with the workload. Inflation has slowly hidden the effects over several generations.
I tend to agree with the Austrian school of economics and believe government interference is counter-productive and has caused many problems. It has done nothing but push problems forward so that they can be dealt with another day. Pushing the problems forward hasn’t solved them… but merely delayed and intensified them and the consequences are scary. Instead of dealing with the problem of debt several decades ago, we are now in a much worse situation. We are headed towards economic disaster.
To stop a recession from happening after the internet bubble burst, the interest rates were lowered. That spurred a real estate bubble. Home values soared (people had cheap access to money) and people refinanced to take some of that money out and spend it. Others went into massive debt to build their dream homes. Lenders lowered their lending requirements to the point where they would lend money to people with no job, no income and no assets. Adjustable rate mortgages lured people in to dangerous mortgage situations. Interest only loans popped up. What happens when millions of people spend $500,000+ each on homes during the same two or three year period and also spend lots of money on furnishing their homes with appliances, decorations, furniture and electronics? A large economic boom! Now that so many people have spent 30+ years of their money all at once (thanks to the low interest rates decided by the Federal Reserve), the economy will slowdown even worse than what would have happened when the internet bubble burst… It’s inevitable. All those people will NOT spend another $500,000+ on another home this year… they already bought their home during the last three years… The Federal Reserve has interfered time and time again and it has always backfired later on.
Now What?
Now the Boomer’s will begin to retire. The most productive segment of society is going to become the biggest drain. The economy is in shambles, the stock market returns are lousy and homes are worth less than consumers paid for them (if they happened to be a recent buyer/builder as the Fed would have hoped they’d be).
The U.S. Dollar is falling… it is being done in such a way (hidden with no M3) that it actually looks like they are purposefully lowering the value of the dollar to cause wide-spread problems. Let’s face it, they are lowering the interest rates to help spur the economy but that is an action they know will lower the value of the dollar. Also by hoping more consumers take on MORE debt to stop the recession the economy will inevitably become even more shaky. Sorry, everyone is already maxed out! You can’t keep borrowing your way out of a recession. The dramatic swings in the U.S. Dollar are just the beginning. Soon, no one will know what the U.S. dollar is worth and foreign countries will sell their reserves. Then, the Fed or the government will probably create a solution: Ditch the dollar and create the Amero and a North American Union. This is scary stuff when you truly realize what it does to your constitutional rights and the future of the United States.
So far all the Federal Reserve has done is do a good job of getting EVERYONE into debt to others. Being indebted to others feels like a form of wage slavery. How much debt do you have?
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