Category: Investing

So, the Fed is in the Mortgage Business?

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Steve Barr:

Apparently, Britney has some shaky assets on her balance sheets. Well, don’t worry Britney. You’re not the only one.
In an announcement that has sent produced a large and varied reaction, the FED has announced that they will attempt to bail out banks by letting them use mortgage-backed securities as collateral for loans. This move is unprecedented in the Fed’s history. For the first time, they are entering the mortgage business. Since its inception, the Fed has used open market operations (the buying and selling of treasury bonds) to expand or contract the monetary policy. A good detailed discussion is here, at interfluidity. Simplistically, the Fed’s balance sheet looks like:

A Bailout, for Everyone by Steven Pearlstein:

Last week, it was a $200 billion cash-for-bond swap for the banks.
This week, it was a $200 billion bond-for-bond swap for the big investment houses.
If they keep this up, pretty soon you’ll be able to walk into any Federal Reserve bank and hock that diamond brooch you inherited from Aunt Mildred.
Forget all that nonsense about the Bernanke Fed being too timid or behind the curve. In the face of what is turning into the most serious financial market crisis since the Great Depression, the Fed has been more aggressive and more creative in using its limitless balance sheet — in effect, its ability to print money — than at any time in history.
We can argue till the cows come home about whether this is a bailout for Wall Street. It is — but only to the extent that it is also a bailout for all of us, meant to prevent a financial and economic meltdown that drags everyone down with it. In broad strokes, we’re going through a massive “de-leveraging” of the economy, wringing out trillions of dollars of debt that had artificially driven up the price of real estate and financial assets, and, more generally, allowed Americans to live beyond their means. The Fed’s goal has not been to impede that process, simply to make sure that it proceeds in an orderly fashion. But even that has required central bank intervention that is unprecedented in scale and scope. And despite yesterday’s huge rally in the stock market, Fed officials warn that this de-leveraging is nowhere near finished.

The Dealer Made Me Do It

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Steve Finlay:

First off, I’m not excusing auto dealers. Or lenders.
They have a moral and business responsibility to try to stop their customers from doing something stupid, such as buying a vehicle with a sticker price that will stick them with an oppressive debt.
But customers have responsibilities, too. It is their purchase, their money and their car payments. It is up to them, more than anyone else, to know their financial limitations and not cross them.
Yet, so many consumers today buy too much vehicle. Then, when the financial squeeze becomes eye-popping, they look for someone to blame. The dealership and lender make nice targets. Seldom do the debt-ridden blame themselves.
I pondered that while reading a Los Angeles Times article headlined, “New Cars That Are Fully Loaded – With Debt.”
The story tells how some Americans of average means roll over an existing loan on an expensive vehicle in order to get another expensive vehicle. They end up with two loans in one, when they couldn’t afford one.

From the LA Times article:

Americans haven’t just been taking out risky mortgages for homes in the last few years; they’ve also been signing larger automobile loans for significantly longer terms than they used to.
As a result, people are slipping into a perpetual cycle of automobile debt that experts think could lead to a new credit crunch extending from dealerships to driveways and all the way to Wall Street.

12th Annual Lump of Coal Awards

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Chuck Jaffe:

At most holiday feasts, the second helping is more filling than the first.
That should be the case in my annual buffet of fund buffoonery, the 12th annual Lump of Coal Awards, recognizing managers, executives, firms, watchdogs and other fund-industry types for action, attitude, behavior or performance that is misguided, bumbling, offensive, disingenuous, reprehensible or just plain stupid.
Last week, I highlighted 10 award winners who deserved nothing more than coal in their holiday stocking this year. Here are the rest:
Failing to get out the vote: Managers of the Blue funds. The tiny Blue funds allow Democrats to invest in companies that “act blue” and “give blue.” Beyond that, management claims to be “actively engaging in shareholder resolutions and proxy voting in an effort to promote increased transparency in corporate political giving.”

A Glimpse of Pottersville

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Daniel Munson:

THE 1946 MOVIE IT’S A WONDERFUL LIFE has become a holiday favorite for many Americans. The heart-rending story of George Bailey (played by Jimmy Stewart), who in his hour of despair is vouchsafed a glimpse of what the world would be like if he’d never been born, holds great meaning for many Americans. So does the drama played out between George and his father, Peter, and their professional nemesis, rich old banker Henry Potter (Lionel Barrymore), which provides a vivid look at the dramatic changes that had taken place in American finance in the years leading up to the time the movie was made.
The recent problems in the mortgage market bring the story and its characters to life once again. The Baileys and Old Man Potter disagreed about a number of things, but principally about the credit-worthiness of what Potter calls “the riff-raff,” the average citizens in their home town of Bedford Falls. The Baileys believe they are credit-worthy, and Potter generally does not.
Potter remembers the recent past, when lenders made the rules, insisting on repayment in gold coin or its equivalent, on big down payments and short terms. Most important for middle-class folks, Potter sees residential real estate as illiquid, mediocre collateral. George and Peter Bailey and their Building & Loan envision a future of suburban development, of small down payments and decades to pay. When George looks at the world had he never been born — and sees a vacant field instead of the Bailey Park housing development financed by the Bailey Building & Loan — he is looking at what would have been Pottersville.

Ministers of Silly Walks

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“Sudden Debt”:

Put yourself at Bernanke’s shoes; better yet, get Paulson’s shoes too and combine them: wear Ben’s shoe on the left and Hank’s on the right. The goal is to try and walk a straight and narrow a line for the economy, without embarrassing yourself. I submit that this is, in fact, impossible.
On the one foot, the Fed is getting screamed at to lower interest rates by at least another 200-250 basis points: PIMCO, Greenspan, The Conference Board, every bank and broker in town and abroad – they all demand and expect cheaper money for a variety of reasons, all immediately and extremely mercenary. The bond fund managers are salivating at the potential of capital gains from short and medium treasurys, the banks and brokers need the massive cash bailout to stanch the bloodletting from their toxic paper and real estate portfolios, the businessmen need the consumer to keep spending and Greenspan wishes above all to remain relevant – even in retirement.

My Hero, Benjamin Grossbaum (Graham)

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James Grant:

It is a pleasure to be here this evening. I am under strict instructions from the rector of Grace Church, Brooklyn, not to let down the Episcopal side. Uphold the highest standards of the Episcopalian intellectual tradition, he told me. What that tradition might be, he couldn’t say, and neither can I. But I’ll do my level best.
My subject is Benjamin Graham: his life, his investment philosophy, his writings and his Jewishness. About his love life, I will say little, as my time this evening is limited—just three hours, I believe. Some years ago, Fortune Magazine, in a squib it published on the occasion of Graham’s induction into the U.S. Business Hall of Fame, said that the thrice-married father of value investing “leaped from blonde to blonde like an Alpine goat springing from peak to peak.”
I am a frankly worshipful admirer of Graham’s. I love him for his heart as much as for his head. Between 1929 and 1932, his investment partnership lost 70% of its value. Not until 1936 did it recoup all it relinquished since the Crash. Yet Graham persevered and, along with his partner, Jerry Newman, went on to achieve a brilliant long-term investment record—not excluding those three disastrous years. We have all heard the platitude, “The first rule of investing is not to lose money and the second rule is not to forget the first.” Very helpful. Well, Graham shows that a debilitating loss is no reason to give up. . . . Never quit.

The Real Reason for the Fed’s 50bp Cut

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Hellasious:

Occam’s Rule: Sometimes the truth is so simple that even as it stares us in the face we are blind to it.
The Federal Reserve cut its Fed Funds benchmark rate by 50 bp to 4.75%, more than most analysts’ expectations. Already there have been trillions of pixels written to explain why, but none that I have seen follow the time-honored Occam or KISS principle (Keep It Simple, Stupid).
Here is a chart that explains the FRB’s move; for the non-professional there is an explanation after it.

“Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich.”

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James Grant:

THE subprime mortgage crisis of 2007 is, in fact, a credit crisis — a worldwide disruption in lending and borrowing. It is only the latest in a long succession of such disturbances. Who’s to blame? The human race, first and foremost. Well-intended public policy, second. And Wall Street, third — if only for taking what generations of policy makers have so unwisely handed it.
Possibly, one lender and one borrower could do business together without harm to themselves or to the economy around them. But masses of lenders and borrowers invariably seem to come to grief, as they have today — not only in mortgages but also in a variety of other debt instruments. First, they overdo it until the signs of excess become too obvious to ignore. Then, with contrite and fearful hearts, they proceed to underdo it. Such is the “credit cycle,” the eternal migration of lenders and borrowers between the extreme points of accommodation and stringency.
Significantly, such cycles have occurred in every institutional, monetary and regulatory setting. No need for a central bank, or for newfangled mortgage securities, or for the proliferation of hedge funds to foment a panic — there have been plenty of dislocations without any of the modern-day improvements.
Late in the 1880s, long before the institution of the Federal Reserve, Eastern savers and Western borrowers teamed up to inflate the value of cropland in the Great Plains. Gimmicky mortgages — pay interest and only interest for the first two years! — and loose talk of a new era in rainfall beguiled the borrowers. High yields on Western mortgages enticed the lenders. But the climate of Kansas and Nebraska reverted to parched, and the drought-stricken debtors trudged back East or to the West Coast in wagons emblazoned, “In God we trusted, in Kansas we busted.” To the creditors went the farms.

Grant writes the excellent “Grant’s Interest Rate Observer“.

The Quants Explain Disaster

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Joe Nocera (Subscription):

Back in 1998, that now infamous quant fund really did melt down, not only liquidating, but shaking the entire global financial system. Long-Term used complex computer models that failed to anticipate some severe once-in-a-lifetime market events, and it was shockingly leveraged — it was using $100 of borrowed money for every dollar of its own capital — which magnified its losses. It was also run by some of the smartest people on Wall Street. “When Geniuses Fail” was the apt title to Roger Lowenstein’s fine book about that fiasco.


Ever since, whenever quant funds stumble, it’s “When Geniuses Fail Redux.” Wall Street wags begin to wonder if those losses will lead to something truly cataclysmic, while newspaper reporters take a certain undisguised glee in reporting on really smart people losing money. Even now, there’s enough Luddite schadenfreude in the air that rumors continue to circulate that AQR is continuing to absorb substantial losses — which is the exact opposite of the truth, Mr. Asness says.

Ritholtz has more here and here.

“The Stock Market is Still Extremely Expensive”

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Henry Blodget:

don’t know whether this is a “correction in a bull market” or the “start of a bear market,” but I am far more persuaded by the latter case. After ten years on Wall Street, however, I can promise you this: No one else knows either. Go ahead and listen to the parade of smart guests on Bubblevision–their reasoning ranges from impeccable to hilarious–but just don’t let yourself get seduced into betting big one way or the other. Because no one knows. (We have 50/50 odds, though, so half of us will be “right”).
One thing we do know: Based on correctly calculated long-term valuation trends (cyclically adjusted P/E), the stock market is still extremely expensive (close to the peak levels of 1929, 1966, and 1987, and only below the all-time peak of 2000). I expect that this will eventually revert to the mean, and that one of these days we will see the “start of a bear market” that could take us below the 7700 trough on the DOW in 2002. This could be it (and if it is, this is just what it will look like). And given the housing market, credit crunch, oil prices, etc., it’s not hard to see how we would get there. But anything is possible, and long-term valuation trends are nearly useless for near-term timing calls.