Money Factory--Great for a Money and Banking class

If you are in a Money and Banking class, you will definitely want to watch this one!

Hulu - National Geographic Channel: Money Factory:

"Money: everyone wants it, dreams of it and schemes for it. Find out how U.S. currency is made, faked and protected, and meet the mastermind behind one of the biggest counterfeit.."

The Sky is falling!!! but maybe not all the way

With apologies to chicken little, it is bad out there: over half a million jobs lost in one month and almost 2 million so far this year, stock markets down, people fearing for their jobs, and the governments bail outs seemingly being every day events.

Not surprising this bad news is forcing investors to become more risk averse and many to become more pessimistic. Indeed, with all this bad news economists are suddenly making Thomas Malthus (the person largely responsible for Economics being called the Dismal Science) seem the norm.

A few of the more dire forecasts:

MarketWatch reports that

"...former Goldman Chairman John Whitehead? He "sees" a tragic ending: This Reagan Deputy Secretary of State and former New York Fed chairman "sees" America burning through trillions, over many years: "Nothing but large increases in the deficit ... worse than the Depression." See previous Paul B. Farrell. He worries that "tomorrow is the day Moody's and S&P will announce a downgrade of U.S. government bonds." Politicians and public are delusional, promising huge new programs plus tax cutting: "This is a road to disaster.' .... he says: "I don't see a solution.

(FTR the article presents several near Doomsday scenarios)

Faced with these possibilities, the government is doing what it can to prevent a repeat of the Great Depression of the 1930s.

Clusterstock quoting the Spectator:

"The Americans allowed a depression to develop in the 1930s because they were afraid of the consequences of losing the principles of sound money. In an effort to avoid a re-run of the 1930s, the Western world is imposing the opposite, equally unbalanced and intemperate solution. We might thereby avoid a depression — but the bad stuff which follows currency compromise will crash down upon us with great vigour. This is the one and only one, and probably last, shock that the credit crunch has yet to impose on a still unsuspecting world.

....The world has survived and thrived under a paper regime. But the greybeards were right, too. Within 15 years, the currencies of Russia, Germany and Austria were worthless. France’s had dropped in the eight years up to 1926 by 86 per cent, Portugal’s was down by 93 per cent and by 1930 only six had held steady against the ‘gold exchange’ dollar of 1918. The rules were understood by all. If you were going to have an inconvertible currency, you had to behave impeccably: deficits were dangerous and there must be no growth in the money supply."

Will it work? We don't know. But they are trying. Will it lead to inflation? Maybe. Probably. Is inflation better than the alternative of a long long recession/depression? Again, the best I can give you is a "probably".

How long will recession last? No idea.
How bad will it get? No idea.

So instead of just guessing, let's turn to noted NYU Economist, and famous Bear, Dr. Roubini. "Dr. Doom" does think equities will fall by another 20-30% and further drop in equities but that the recession will only last another year.

Dr. Doom Foresees Much More Pain So Why Is Roubini's 401(k) All in Stocks: Tech Ticker, Yahoo! Finance:
"

Roubini predicts that macroeconomic news and earnings will be much worse than expected in the coming months, as the dollar weakens even further. 'The surprise is how bad the the economy [will get].'""

But adds

" I'm not in the Armageddon camp," forecasting a severe recession through 2009, but not a repeat of the Great Depression.

Treasury Weighs Plan To Cut U.S. Mortgage Rates : NPR

Treasury Weighs Plan To Cut U.S. Mortgage Rates : NPR:

"The Treasury Department is considering a plan to dramatically lower mortgage rates for homebuyers to as low as 4.5 percent — more than a full point below currently offered rates, sources say."

It seems that this would be done by the government buying up mortgages much like the Fed recently said they were going to do. One problem, as the piece suggests, is that if this idea is allowed to hang around without action it may have the reverse effect since buyers may wait for the lower rates much like deflation.

"Why should I buy a house today with a 5.5 percent mortgage rate if I can wait a month or two and buy it with a 4.5 percent mortgage rate?" says David Kotok, chief investment officer at the money management firm Cumberland Advisors.

So, he says, the government really can't take much longer to announce what's its planning to do."

CNN adds a very troubling aspect:

"Lobbyists are pushing the Treasury Department to consider a plan to purchase mortgage-backed securities in the hopes of driving mortgage rates to as low as 4.5%, an industry source said."

It is almost certain that the lobbyists and other industry groups are made up of people and as such they are looking out for what is the best for them, not necessarily the country. (And I can not stress enough I do not know enough about this to be in favor or against it. My prior is still less government intervention is better, but do not know the details so will be quiet). And weren't really low rates (almost artificially low) cited as one of the causes of the orginal real estate bubble. How will it be different this time is a big question that needs to be answered.

ML analyst suggests oil could go to below $25 a barrel!

Bloomberg.com: Worldwide:

"Crude oil may dip below $25 a barrel next year if the recession that’s slashing fuel demand around the world spreads to China, Merrill Lynch & Co. said.....Global oil demand has slumped as the U.S., Europe and Japan face simultaneous recessions for the first time since World War II. The number of Americans collecting jobless benefits rose to 4 million in the week to Nov. 22, a 26-year high, the Labor Department reported today. European Central Bank President Jean- Claude Trichet said the euro region’s economy will shrink in 2009."

It seems only yesterday (actually was end of spring semester) that experts were calling for $200 oil, which might suggest how much weight we should given so called-experts and their forecasts.

Freeport-McMoRan Gets Out The Ax - Forbes.com

Great class example.

Freeport-McMoRan Gets Out The Ax - Forbes.com: "

The Phoenix-based mining company said Tuesday it was suspending its dividend, scaling back production and slashing its 2009 capital expenditures plans...Shares of Freeport tumbled 17.3%, or $3.77, to close Wednesday's trading session at $18.05"

A few comments:
1. Dividend cuts convey additional information about the future (signaling)
2. Capital Expenditures cuts are also generally seen as bad news and a bad sign for future.
3. That commodity prices had fallen was not news, so it does not explain why price of stock fell.

The first two points are included in the tables from Smith and Masulis that we use in class regularly.

BTW As an aside, the SBU Student Managed Investment Fund currently does own Freeport-McMoran. Oops!

For first time in 50 years, stocks yielding more than bonds - MarketWatch

For first time in 50 years, stocks yielding more than bonds - MarketWatch:

"As of Tuesday's close, for example, the S&P's dividend yield was 3.3%, while the 10-year T-Note was yielding 2.7% -- a spread of 0.6 percentage points in favor of stocks. To put this in historical context, the spread since 1958 has averaged 3.7 percentage points in favor of bonds."

Before 1958 what now seems an inversion was the norm. The MarketWatch article quotes Peter Bernstein on when dividend yields first became lower than t-bond yields:

"This ... was unprecedented. The two yields had come close in the past but had always backed away at the critical moment. In 1958, they reversed their historical positions and have never looked back."

Why? It is difficult to say but risk aversion is the likely culprit. The time prior to 1958 was close enough to the Great Depression that many investors still feared stocks and needed to be persuaded to buy ("can I get you to buy the riskier asset?") stocks. Again from the same article (citing Cliff Asness' work) that looks at the longer term relationship of T-Bond yields and dividend yields (from 1871 to present time)

"...the key element of this bet is investors' expectations....The memory of the Great Depression lingered for years after it ended...which is one reason why stocks' dividend yields remained so high.

In contrast, the Baby Boom generation (at least possibly until now) had no traumatic memory similar to their parents' memory of the Great Depression. That in turn helps to explain why stocks' dividend yield slipped in the 1960s and beyond, relative to bonds' yields.

The bottom line? If enough investors become sufficiently traumatized by what's going on right now, and as a result more or less permanently expect stocks' volatility to remain a lot higher than bonds' volatility, then stocks' dividend yield is likely to remain above bond yields.

Thanks Jon S for the link!

The Bailout So Far - WSJ.com

As Big Three auto manufacturers asks for $34 Billion (up $9 billion in a week) from the government, the government's TARP program comes under attack from the GAO for its loose controls, and AIG plans on asking for a still better deal, the WSJ gives us a look at the Bailout so far.

Important background for those who do not know who Doug Flutie is or do not remember the play for which he is most famous watch this video.

Holman W. Jenkins Jr.: The Bailout So Far - WSJ.com:

"We have gone from arm's length, free market, just-in-time availability" of funding to a system where big credit-reliant businesses now have only one place to turn, government.

With pundits threatening the economy with deflation and another Great Depression, none have really been able to argue effectively against this expansion of government responsibility and interventionist zeal....

Maybe Washington will succeed in forestalling a deep and prolonged recession. Maybe all the money ($8 trillion by one count) being printed to acquire or insure mortgages, student loans, credit card receivables, commercial paper and banking shares will be seamlessly withdrawn once those assets are sold back to willing parties in the private sector when the panic has passed. Maybe taxpayers will even make a profit on the deal.

As Doug Flutie can testify, sometimes a 65-yard pass into the end zone lands in the hands of your own receiver....

The U.S. was not Japan when we started but may be Japan when we're done. Remember, the Japanese had a much more closed financial system when entering their post-bubble "lost decade" of the 1990s. We have venture capital, private equity, hedge funds, and an entrepreneurial tradition....

All that may come to an end as cheap government credit drives financial entrepreneurs to the sidelines. We may be able to roll over the resulting mounting federal debt at cheap rates for a while if international markets are willing (there is still confidence in government at least). But unless Gerard Phelan catches the ball in the end zone and GDP bounces back strongly, the bailout's end result may be towering tax rates, drastic spending cuts or serious inflation -- or all three."

How Stocks Have Returned 10% Per Year

After Henry Blodget from Clusterstock was on NPR saying that stocks were back to "fair value" (i.e. their long run average), he had a listener email him about how the 10% annual return in stocks is found. His answer is below:

How Stocks Have Returned 10% Per Year:

"...the 10% number includes dividends, which is the way people normally look at stock market returns. On a pure price basis, returns have been far lower.

In fact, here's an approximate breakdown of the 10% average return for the last 80 years:

4 points: Dividends
2 points: Real EPS growth
3 points: Inflation (reflected in EPS growth)
1 point: Multiple expansion

Now that stocks have finally dropped back to fair value again, I thinkt the long-term return from here is likely to be in the average range again. The multiple expansion might not continue, and dividends are currently about 3%, not 4%, so it could be lower. But the dividend payout ratio could rise again, and it may be that structural changes (more cash-efficient services companies vs. low-return-on-capital industrial companies) will lead to continued PE expansion"

Videos explaining aspects of the current financial situation

Wow. The Unknownprofessor over at Financial Rounds really found some great lessons done in video format. AMAZINGLY good and am embarrassed to say I had not seen them before today.

My personal favorite uses an Arctic Expedition to show what has happened and what credit default swaps are.




The second video is on CDOs. GREAT!







Thanks to Financial Rounds!

And finally one that I just found when watching the other two:

Potentially the biggest (most serious) situation since the American Revolution?

Granted this was a month ago, but bigger than the US Civil War? Bigger than the Depression? WW II? Wow. That was one of the warnings from Nissan Taleb on the PBS news Hour in late October about the current financial situation.




Thanks to Mark for pointing this one out to me.

Universities as sellers

Bloomberg.com: Exclusive:

"A push by the richest U.S. universities to unload their stakes in private-equity funds is flooding the market, driving down prices for the world’s best- known buyout firms.

Investors led by Harvard University, which manages the largest U.S. endowment at $36.9 billion, may increase so-called secondary sales of private-equity funds to more than $100 billion during the next year, overwhelming available pools of capital. Interests in funds managed by KKR & Co., Madison Dearborn LLC and Terra Firma Capital Partners Ltd. all are being offered at discounts of at least 50 percent, according to people familiar with the sales."

in the same article about UVA.

"The University of Virginia in Charlottesville said in a statement posted on its Web site that it may sell some of the $1.6 billion it has invested in buyout funds, noting that proceeds “may be far below face value.”"

Dealbook - Putting a Value on a C.E.O. - NYTimes.com

The NY Times has an interesting look at CEO pay and how having the government playing a role may lead to different outcomes. Using Citi as an example, the article asks how pay can be structured to bother create proper incentives and reward managers.

Dealbook - Putting a Value on a C.E.O. - NYTimes.com:

"...many people argue that Wall Street’s approach to compensation helped get us in this mess to begin with. Bankers were rewarded for taking risks that they clearly failed to manage. So something has to change.

The trick, of course, is to dole out enough rewards to keep executives working, and working hard, but not to dole out too much....firms need to find ways to keep and attract talented people who can make smart decisions, without lavishing pay on them or rewarding them for shoddy performance."

Which is easier said than done.

Remember there are two big questions with respect to pay that often get blurred. The level of pay (how much) and the form of pay(how do we pay them). And as we change one, the other must be accounted for as well.

What would I liek to see? Many CEOs (and others) get zero this year. If you get large rewards for good times, you must be penalized in bad times. Indeed, in some of these instances, you would really like to see the managers pay the firms back for what they made in the past as their systems led to the current problems.

Fed and tresury officials on why they did what they did

I am a "glass is half full" person who on top of that thinks that we will probably find more water before even that is gone. But I do get a tad concerned when smart people who have informational advanatges get worried. We had two examples of this today.

FromTreasury Secretary Henry Paulson as quoted at Bloomberg.com: Worldwide:

"Treasury Secretary Henry Paulson said his actions bailing out some U.S. companies to help strengthen capital markets, while “objectionable,” were necessary to prevent a deeper collapse of the global economy.

“Some of the things that I’ve been part of have been very, very objectionable decisions, but they haven’t been difficult decisions” because the alternative would be “much worse,” Paulson said, responding to questions after a speech in Washington. “I’ve looked at some of the things I’ve done as being essential to preserve the free market system.”"

And from Ben Bernanke the Fed chairman in a speech in Texas:

"..this extraordinary period of financial turbulence is now well into its second year. Triggered by the contraction of the U.S. housing market that began in 2006 and the associated rise in delinquencies on subprime mortgages, the crisis has become global and is now affecting a wide range of financial institutions, asset classes, and markets. Constraints on credit availability and slumping asset values have in turn helped to generate a substantial slowing in economic activity.

The Federal Reserve's strategy for dealing with the financial crisis and its economic consequences has had three components. [1]First, to offset to the extent possible the effects of the crisis on credit conditions and the broader economy, the Federal Open Market Committee (FOMC) has aggressively eased monetary policy. ...The Committee's rapid monetary easing was not without risks. Some observers expressed concern at the time that these policies would stoke inflation, and, indeed, inflation reached high levels earlier this year....[but] As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation appears set to decline significantly over the next year toward levels consistent with price stability.

[2]... the second component of the Federal Reserve's strategy has been to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector--that is, by lending cash or its equivalent secured with relatively illiquid assets.

To ensure that adequate liquidity is available, consistent with the central bank's traditional role as the liquidity provider of last resort, the Federal Reserve has taken a number of extraordinary steps. For instance, to provide banks and other depositories easier access to liquidity...Judging the effectiveness of the Federal Reserve's liquidity programs is difficult. Obviously, they have not yet returned private credit markets to normal functioning. But I am confident that market functioning would have been more seriously impaired in the absence of our actions.

and finally:

"...the third component of our policy response has been to use all our available tools to promote financial stability, which is essential for healthy economic growth. At times, this has required working to preserve the stability of systemically critical financial institutions, so as to avoid further costly disruptions to both the financial system and the broader economy during this extraordinary period. In particular, the Federal Reserve collaborated with the Treasury to facilitate the acquisition of the investment bank Bear Stearns by JPMorgan Chase and to stabilize the large insurer, American International Group (AIG). We worked with the Treasury and the Federal Deposit Insurance Corporation (FDIC) to put together a package of guarantees, liquidity access, and capital for Citigroup. Other efforts include our support of the actions by the Federal Housing Finance Agency and the Treasury to place the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac into conservatorship and our work with the FDIC and other bank regulators to assist in the resolution of troubled depositories, such as Wachovia. In each case, we judged that the failure of the institution in question would have posed substantial risks to the financial system and thus to the economy."

As CNN points out, these programs do come with big downsides:

"...there is a downside to all of the Fed's programs. Fed lending has ballooned. Bernanke said that the central bank's balance sheet will need to be brought back to a sustainable level in the future. The government does not want financial institutions to become reliant on the Fed for liquidity, and an enormous balance sheet could result in high inflation down the road.

"That is an issue for the future," Bernanke said. "For now, the goal of policy must be to support financial markets and the economy.""

It's official: U.S. in a recession since December 2007 - Dec. 1, 2008

It's official: U.S. in a recession since December 2007 - Dec. 1, 2008:

"The NBER is a private group of leading economists charged with dating the start and end of economic downturns. It typically takes a long time after the start of a recession to declare its start because of the need to look at final readings of various economic measures.

'The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment,' said the group's statement. 'This series reached a peak in December 2007 and has declined every month since then.'

Employers have trimmed payrolls by 1.2 million jobs in the first 10 months of this year."

Interesting. Earlier than I would have guessed.