It’s hard to watch the Congressional hearings on Capitol Hill. The chest beating and bewilderment expressed by the nation’s lawmakers seems a tiny bit overdone, doesn’t it? Meanwhile, investors around the globe are anxiously awaiting consensus, so that we can try to move forward.
Things sure have changed in a week. Last Thursday at around lunch time, it really looked like the financial markets were on their way to a major melt-down. We are not talking a few percent each day… the system was freezing up, both Wall Street professionals and individual investors were in full blown panic mode (as a former commodities trader, I recognize what that looks like) and the world was bracing for a calamity.
After Paulson and Bernanke consulted with the President and leaders of Congress to tell them what was really going on and their plan to help stave off financial disaster. I remember watching the lawmakers as they walked out of their meeting with Paulson and Bernanke—they looked shell-shocked. As we learned about the details of the meeting and the planned government intervention into the crisis, a funny thing happened: markets recovered and investor confidence started to become restored.
Then they started to talk…and talk and talk and talk. I understand that some of these elected officials are trying to ask reasonable questions about the plan---but can’t they get to the point a little more efficiently? In the three days since the Hill huffing and puffing began, the Dow has given back 563.27 points and fear has crept back into the system as investors around the world gobbled up short-term Treasury bills in a flight to quality. Yesterday morning, the yield on the one-month T-bill fell to 0.01% and buyers were willing to accept almost a zero percent return to know that their funds were safe. The one-month bill ended the day at 0.2%. Do we need to talk much more before we are back to last week’s levels? That’s why President Bush went prime-time last night. He needed to say that “our entire economy is in danger” and warned of "financial panic" and ultimately "a long and painful recession" if Congress doesn't move quickly. Amen, Mr. President!
We can’t conduct Congressional hearings on why the Titanic has hit the iceberg—we already hit it, so let’s figure out how to prevent disaster. Early this morning, the Wall Street Journal was reporting that “Democratic leaders hope to nail down details of the measure early Thursday,” before an afternoon summit at the White House with the President, McCain, Obama and top leaders from Congress. The likely bill “would include limits on executive pay in situations where the government puts a large amount of money into a failing institution. In certain cases, the government could receive warrants that would give it the right to acquire shares in the company. Also included is beefed-up oversight through the Government Accountability Office, an investigative arm of Congress. Likely not included is a controversial idea to let judges alter the terms of mortgages during bankruptcy proceedings.” Those additions to the plan seem fine, but please, let’s stop the huffing before the whole house blows down!
Thursday, September 25, 2008
Wednesday, September 24, 2008
Back in the real world
As lawmakers grill Henry Paulson, Ben Bernanke and Christopher Cox, those of us back here on earth are struggling to keep our heads above the fray. With markets gyrating and the economy teetering, it sure is hard to not bury your head and abandon the financial plan that you created. Like almost every tense issue that you confront in life, you need to take a deep breath and remind yourself what you are trying to accomplish.
For most people, the financial planning and wealth management process allows you to articulate your short and long term goals and then develop strategies to help you achieve them. If you have done this, then you probably were able to shield the short-term money from most of the problems that are plaguing the markets right now. After the government insured money market accounts last week, you likely have very little to worry about. With no reason to panic about immediate needs, you may start to feel anxiety about the longer term money.
One woman recently noted that she was simply “not going to open her retirement statement until this is all over.” That’s not exactly the behavior we would recommend. Besides being a bit irresponsible, you may find that if you have here a diversified portfolio that things are not as bad as you thought. This happened just the other day, when I spoke to a client. He said “the stock market is down more than twenty percent and that makes me crazy!” I responded that his portfolio was down only 9%, which is painful, but not fatal to his long-term plans.
With so much negative news swirling, it’s hard not to think that you are going down with the ship. It is completely understandable that every investor wants to participate on the way up and avoid the pain associated with bear markets. Recent research by Prof. Loewenstein and his colleague Duane Seppi found that investors in Scandinavia looked up the value of their holdings 50% to 80% less often during bad markets. As my mother likes to say, “Who needs absolute confirmation of the bad news?” This is born out by experience--according to Vanguard, mutual-fund holders checked their account values far less often in this year’s market tumbles than they did in mid-to-late 2007, when stocks were setting new highs.
OK, let’s assume that you are going to check the accounts because you are (a) guilt-ridden or (b) responsible. Obviously when the market is in free-fall, you are unlikely to feel good about the entire exercise. But here is an excellent coping mechanism: remind yourself that you are in this for the long-term and take a few moments to go back in market history and see how stocks did after other periods of despondency like 2002, 1998, 1991, 1987, 1982, 1974 and so on. If history is any guide, your inclination to act like an ostrich is a strong indication that the market is about to turn into a phoenix.
For most people, the financial planning and wealth management process allows you to articulate your short and long term goals and then develop strategies to help you achieve them. If you have done this, then you probably were able to shield the short-term money from most of the problems that are plaguing the markets right now. After the government insured money market accounts last week, you likely have very little to worry about. With no reason to panic about immediate needs, you may start to feel anxiety about the longer term money.
One woman recently noted that she was simply “not going to open her retirement statement until this is all over.” That’s not exactly the behavior we would recommend. Besides being a bit irresponsible, you may find that if you have here a diversified portfolio that things are not as bad as you thought. This happened just the other day, when I spoke to a client. He said “the stock market is down more than twenty percent and that makes me crazy!” I responded that his portfolio was down only 9%, which is painful, but not fatal to his long-term plans.
With so much negative news swirling, it’s hard not to think that you are going down with the ship. It is completely understandable that every investor wants to participate on the way up and avoid the pain associated with bear markets. Recent research by Prof. Loewenstein and his colleague Duane Seppi found that investors in Scandinavia looked up the value of their holdings 50% to 80% less often during bad markets. As my mother likes to say, “Who needs absolute confirmation of the bad news?” This is born out by experience--according to Vanguard, mutual-fund holders checked their account values far less often in this year’s market tumbles than they did in mid-to-late 2007, when stocks were setting new highs.
OK, let’s assume that you are going to check the accounts because you are (a) guilt-ridden or (b) responsible. Obviously when the market is in free-fall, you are unlikely to feel good about the entire exercise. But here is an excellent coping mechanism: remind yourself that you are in this for the long-term and take a few moments to go back in market history and see how stocks did after other periods of despondency like 2002, 1998, 1991, 1987, 1982, 1974 and so on. If history is any guide, your inclination to act like an ostrich is a strong indication that the market is about to turn into a phoenix.
Monday, September 22, 2008
Just when you thought it was safe…
Last week ended on a high note—stock markets rallied to virtually unchanged on the week, after the announcement of the proposed $700 billion government bailout of the financial sector. Many were breathing a bit easier over the weekend, but then yesterday, just when you thought it was safe…well, you know the rest. I know you don’t want this to happen—nobody does! We all wish that we never got here, but instead, we are forced to swallow a $700 billion bitter pill and at the same time, deal with the reality that this is likely to be a lengthy and messy process.
Yesterday, as investors slowly recognized this fact, they also had to contend with a sinking dollar and soaring oil prices. Crude oil prices spiked more than $25 at their intraday high and finished with a gain of $16.37, or 16%, at $120.92 a barrel. (Expiration of contracts for October delivery added volatility to the market, but some thought it also could have been hedge fund liquidation.) The less-than-rosy news drove investors to the sidelines. The Dow plummeted 372.75 points, or 3.3%, to 11015.69, down 17% on the year; the Nasdaq Composite Index dropped 4.2% to end at 2178.98, down 18% on the year and the broader based S&P 500 plunged 3.8% at 1207.09, down 18% on the year. The one bright asset class was gold—the December contract jumped $44.30, or 5%, to $909, as investors sought a safe-haven.
Perhaps you thought that the bailout would prevent these kinds of days, but in fact, the plan was a bitter reminder that something this big had to happen to prevent a total seizure of the credit and financial markets. “If we have to live through more of these days, then maybe I think I speak for taxpayers across the country when I say that I would rather not shell out these big bucks,” noted one friend. In the abstract, that might be the case, but we know for certain that doing nothing could have resulted in a financial calamity, so maybe a few 3% swings isn’t the worst thing in the world. In other words, a fence at the top of a cliff is better than an ambulance at the bottom. There will be plenty of time to point fingers and beat our chests about how unfair this whole situation has been, but let’s get things stable before the ambulance arrives.
As Robert Jenkins, the chairman of Investment Management Association said last week, “The crisis arose from the combination of greed, imprudence and leverage. Greed is not new. Reckless lending is not new. Imprudent borrowing is not new. What is new and what distinguishes this credit crunch from past excesses is the unprecedented level of leverage. We will not outlaw greed and cannot legislate against stupidity. But regulators can and must address the issue of leverage.” And indeed we all hope that regulators will refocus and become proactive in the future. But for now, I know that I speak for most investors when I say that all we want is a few days where we can escape history-making headlines or game-changing deals. We just want a few moments of calm, when we can dip our toes in the water without fearing the next massive wave.
Yesterday, as investors slowly recognized this fact, they also had to contend with a sinking dollar and soaring oil prices. Crude oil prices spiked more than $25 at their intraday high and finished with a gain of $16.37, or 16%, at $120.92 a barrel. (Expiration of contracts for October delivery added volatility to the market, but some thought it also could have been hedge fund liquidation.) The less-than-rosy news drove investors to the sidelines. The Dow plummeted 372.75 points, or 3.3%, to 11015.69, down 17% on the year; the Nasdaq Composite Index dropped 4.2% to end at 2178.98, down 18% on the year and the broader based S&P 500 plunged 3.8% at 1207.09, down 18% on the year. The one bright asset class was gold—the December contract jumped $44.30, or 5%, to $909, as investors sought a safe-haven.
Perhaps you thought that the bailout would prevent these kinds of days, but in fact, the plan was a bitter reminder that something this big had to happen to prevent a total seizure of the credit and financial markets. “If we have to live through more of these days, then maybe I think I speak for taxpayers across the country when I say that I would rather not shell out these big bucks,” noted one friend. In the abstract, that might be the case, but we know for certain that doing nothing could have resulted in a financial calamity, so maybe a few 3% swings isn’t the worst thing in the world. In other words, a fence at the top of a cliff is better than an ambulance at the bottom. There will be plenty of time to point fingers and beat our chests about how unfair this whole situation has been, but let’s get things stable before the ambulance arrives.
As Robert Jenkins, the chairman of Investment Management Association said last week, “The crisis arose from the combination of greed, imprudence and leverage. Greed is not new. Reckless lending is not new. Imprudent borrowing is not new. What is new and what distinguishes this credit crunch from past excesses is the unprecedented level of leverage. We will not outlaw greed and cannot legislate against stupidity. But regulators can and must address the issue of leverage.” And indeed we all hope that regulators will refocus and become proactive in the future. But for now, I know that I speak for most investors when I say that all we want is a few days where we can escape history-making headlines or game-changing deals. We just want a few moments of calm, when we can dip our toes in the water without fearing the next massive wave.
President Paulson and VP Bernanke
President Bush didn’t announce it, nor did Congressional leaders. Rather, it was US Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, his intellectual backer, who proposed a vast bailout of financial institutions in the US, requesting unfettered authority to purchase up to $700 billion in distressed mortgage-related assets from private firms, after which it will try to resell them to investors. Given the experience of these two, it is preferable that they run the show amid the escalating financial crisis and become the shadow president and VP of the US economy.
On Friday, Paulson first announced a structural solution for the problem of toxic financial assets in the system. At that time, the concept being floated was along the lines of the Resolution Trust Corp., a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. The news helped calm investors and pushed stocks to essentially unchanged on the week.
It’s hard to believe that it was just one week ago that we were wrestling with the failure of Lehman Brothers, purchase of Merrill Lynch by Bank of America and the near-implosion of AIG. On Thursday, it was clear that the case-by-case, reactive approach to the crisis was not enough to prevent widespread panic across financial markets. To help stabilize the broader economic and structural problems plaguing the market, Paulson and Bernanke, himself a student of the Great Depression, gathered Congressional leaders and scared them straight. The lawmakers emerged from the meeting visibly shaken, but ready to swallow the bitter pill that Paulson and Bernanke prescribed. By yesterday, it appeared that the US was entering unchartered territory of the credit and housing crisis that would require a new regulatory structure.
Paulson noted that “lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing” and that cancerous mortgage-backed securities had become “frozen on the balance sheet of banks of banks and financial institutions…the inability to determine their net worth has fostered uncertainty about mortgage assets and even about the financial conditions of the institutions that own them.” As Joe Nocera pointed out in the New York Times, “Nobody understands who owes what to whom — or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances.”
There are hoots and hollers that we have morphed from capitalism to socialism over the course of a week. To that, one has to wonder whether such free-market adherents were willing to see the entire system seize up and watch idly as the global economy entered what could have been another Great Depression. With a number of terrible choices, Hank Paulson and Ben Bernanke chose the one that seemed the least odious. As Bernanke told colleagues last week, “There are no atheists in foxholes and no ideologues in financial crises.”
The plan is a proactive, systematic approach that attempts to stabilize confidence, which should temper the severe price action and prevent a seizing-up of market liquidity. The action demonstrates that US authorities were unwilling to sit idly and watch the economy slide into a Japanese-like, decade-long malaise. The results of the exceptional government intervention will be written about in history books, but for now, investors are hopeful that with time and this powerful policy response, confidence will be restored and markets and the economy will eventually recover.
On Friday, Paulson first announced a structural solution for the problem of toxic financial assets in the system. At that time, the concept being floated was along the lines of the Resolution Trust Corp., a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. The news helped calm investors and pushed stocks to essentially unchanged on the week.
It’s hard to believe that it was just one week ago that we were wrestling with the failure of Lehman Brothers, purchase of Merrill Lynch by Bank of America and the near-implosion of AIG. On Thursday, it was clear that the case-by-case, reactive approach to the crisis was not enough to prevent widespread panic across financial markets. To help stabilize the broader economic and structural problems plaguing the market, Paulson and Bernanke, himself a student of the Great Depression, gathered Congressional leaders and scared them straight. The lawmakers emerged from the meeting visibly shaken, but ready to swallow the bitter pill that Paulson and Bernanke prescribed. By yesterday, it appeared that the US was entering unchartered territory of the credit and housing crisis that would require a new regulatory structure.
Paulson noted that “lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing” and that cancerous mortgage-backed securities had become “frozen on the balance sheet of banks of banks and financial institutions…the inability to determine their net worth has fostered uncertainty about mortgage assets and even about the financial conditions of the institutions that own them.” As Joe Nocera pointed out in the New York Times, “Nobody understands who owes what to whom — or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances.”
There are hoots and hollers that we have morphed from capitalism to socialism over the course of a week. To that, one has to wonder whether such free-market adherents were willing to see the entire system seize up and watch idly as the global economy entered what could have been another Great Depression. With a number of terrible choices, Hank Paulson and Ben Bernanke chose the one that seemed the least odious. As Bernanke told colleagues last week, “There are no atheists in foxholes and no ideologues in financial crises.”
The plan is a proactive, systematic approach that attempts to stabilize confidence, which should temper the severe price action and prevent a seizing-up of market liquidity. The action demonstrates that US authorities were unwilling to sit idly and watch the economy slide into a Japanese-like, decade-long malaise. The results of the exceptional government intervention will be written about in history books, but for now, investors are hopeful that with time and this powerful policy response, confidence will be restored and markets and the economy will eventually recover.
Friday, September 19, 2008
Giddy Up
Remember on Seinfeld when Kramer was so excited that he exclaimed, “Giddy Up”? Well markets decided to saddle up yesterday and see what it’s like to trade higher—certainly a novel idea as “the most significant financial crisis since the Great Depression” continues to unfold (Note to the networks—love the new graphics!)
After being down 150 points at 1:00 pm or so, stocks meandered to the unchanged line. Then at approximately 3:00 pm, something happened…all of the sudden, buyers piled into equities, as reports emerged that the federal government was about to take steps to create the mother of all bailouts. While there were few details available, the simple notion that the government was going to do something BIG, allowed investors to breathe a sigh of relief. The surge was lead by financial companies as the Dow Jones Industrial Average swung in a 567-point range from the low of the day to the close, ending 410.03 points higher, up 3.9%, at 11019.69. The S&P 500 Index climbed 4.3%, its biggest daily percentage gain in nearly six years, to end at 1206.33 and the Nasdaq Composite Index leapt 4.8%, its biggest daily move in more than five years, to end at 2199.10 as big technology companies posted solid gains. Gold had closed before the bailout news hit, so it is likely that yesterday’s nearly $50 move up will be erased today.
Markets had been trading higher earlier in the day on Thursday after the Fed authorized a $180 billion expansion of its swap lines with other world central banks. But soon that was not enough, so Henry Paulson and Ben Bernanke, (the President and Vice President of our economy), determined that something bigger was necessary. The plan is to create some sort of government agency that would purchase distressed mortgages at deep discounts from banks and other financial institutions. This is something along the lines of the Resolution Trust Corp. (RTC), which was a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. Created in 1989, the RTC disposed of bad assets held by hundreds of crippled savings and loans that had been burned in the eighties real estate boom. The RTC closed or reorganized 747 institutions holding assets of nearly $400 billion. By 1995, the S&L crisis had passed and the RTC was folded into the FDIC. The difference is that the 2008 version of the RTC would have the government taking over the distressed assets, not the entire institutions.
Beyond the RTC-like plan, before the opening bell today, the government unveiled a plan to shore up money-market funds, which experienced massive redemptions as one fund “broke the buck” and fear intensified earlier this week. There is likely to be some sort of federal insurance for investors in money market funds (which total $3.4 trillion), akin to the coverage offered by the FDIC for bank accounts. Finally, the SEC (remember them?) is reinstating the temporary ban on short-selling of hundreds of financial stocks. The move comes a day after the UK’s Financial Services Authority (FSA) announced that it was banning short selling on financial stocks until the end of the year. Put all of this together and it looks like another up day for stocks…giddy up!
After being down 150 points at 1:00 pm or so, stocks meandered to the unchanged line. Then at approximately 3:00 pm, something happened…all of the sudden, buyers piled into equities, as reports emerged that the federal government was about to take steps to create the mother of all bailouts. While there were few details available, the simple notion that the government was going to do something BIG, allowed investors to breathe a sigh of relief. The surge was lead by financial companies as the Dow Jones Industrial Average swung in a 567-point range from the low of the day to the close, ending 410.03 points higher, up 3.9%, at 11019.69. The S&P 500 Index climbed 4.3%, its biggest daily percentage gain in nearly six years, to end at 1206.33 and the Nasdaq Composite Index leapt 4.8%, its biggest daily move in more than five years, to end at 2199.10 as big technology companies posted solid gains. Gold had closed before the bailout news hit, so it is likely that yesterday’s nearly $50 move up will be erased today.
Markets had been trading higher earlier in the day on Thursday after the Fed authorized a $180 billion expansion of its swap lines with other world central banks. But soon that was not enough, so Henry Paulson and Ben Bernanke, (the President and Vice President of our economy), determined that something bigger was necessary. The plan is to create some sort of government agency that would purchase distressed mortgages at deep discounts from banks and other financial institutions. This is something along the lines of the Resolution Trust Corp. (RTC), which was a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. Created in 1989, the RTC disposed of bad assets held by hundreds of crippled savings and loans that had been burned in the eighties real estate boom. The RTC closed or reorganized 747 institutions holding assets of nearly $400 billion. By 1995, the S&L crisis had passed and the RTC was folded into the FDIC. The difference is that the 2008 version of the RTC would have the government taking over the distressed assets, not the entire institutions.
Beyond the RTC-like plan, before the opening bell today, the government unveiled a plan to shore up money-market funds, which experienced massive redemptions as one fund “broke the buck” and fear intensified earlier this week. There is likely to be some sort of federal insurance for investors in money market funds (which total $3.4 trillion), akin to the coverage offered by the FDIC for bank accounts. Finally, the SEC (remember them?) is reinstating the temporary ban on short-selling of hundreds of financial stocks. The move comes a day after the UK’s Financial Services Authority (FSA) announced that it was banning short selling on financial stocks until the end of the year. Put all of this together and it looks like another up day for stocks…giddy up!
Thursday, September 18, 2008
Blood in the Streets
Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when there is "blood in the streets." To some, the first three days of this week indeed feels like blood is spilling on capitalism’s most famous avenue, that is, Wall Street. Yesterday felt like a replay of Monday, only without a big deal or a government loan announced.
Despite Treasury Secretary Paulson’s efforts to stave off a financial panic with an $85 billion rescue of AIG, stocks resumed their descent. The pain was spread across the board, with few places to hide for stock investors. The Dow ended near a three-year low, down 449.36 points, or 4.1%, at 10609.36, off 7.1% so far this week; the S&P 500 dropped 4.7% to 1156.39, down 7.6% for the week; the Nasdaq was down 4.9% at 2098.85, down 7.2% for the week; and the small-stock Russell 2000 fell 4.8% to 676.38.
The catalyst for the selling was fear, plain and simple. It started on Tuesday night, when the cost for borrowing skyrocketed, which put more pressure on investment banks, which need short-term funds to operate. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, led the selling spree. Specifically, unsubstantiated rumors were swirling around Morgan as speculation mounted that it would be the “next Lehman”. Both firms reported earnings that were in the black, and Morgan’s beat estimates handily, but that did not assuage nervous investors, who drove down MS shares by 24% and Goldman’s by 14% yesterday.
Both firms railed against short-sellers and the SEC finally listened and announced three actions addressing shorting. First, the SEC adopted a rule requiring short sellers and their broker-dealers to deliver securities by the settlement date (three days after the transaction date) and imposing penalties for failure to do so. In addition, the SEC eliminated the option market-maker exception to the three-day delivery requirement and finally, the SEC adopted a new anti-fraud provision making it unlawful for sellers to deceive specified persons about their ability or intention to deliver securities by the settlement date. Unfortunately, these measures come a little too late. As written in this column this year, the SEC should never have eliminated the Uptick Rule (which they did in the midst of a bull market!) and appears to be asleep at the switch when it comes to eliminating abusive short selling and rampant rumor mongering.
With that rant out of the way, what about that Baron Rothschild? Those investors who embrace his advice might be strong enough to turn a blind eye to the fear and panic gripping the markets and start dipping their toes in the murky investment waters. If you have a long time horizon, this could be a time to increase your retirement plan contributions or add a little extra each month to your investment account. Yes, it is difficult to do, but years from now, you just might look back and thank Baron Rothschild for turning you a bit more bullish at a time of maximum pessimism.
Despite Treasury Secretary Paulson’s efforts to stave off a financial panic with an $85 billion rescue of AIG, stocks resumed their descent. The pain was spread across the board, with few places to hide for stock investors. The Dow ended near a three-year low, down 449.36 points, or 4.1%, at 10609.36, off 7.1% so far this week; the S&P 500 dropped 4.7% to 1156.39, down 7.6% for the week; the Nasdaq was down 4.9% at 2098.85, down 7.2% for the week; and the small-stock Russell 2000 fell 4.8% to 676.38.
The catalyst for the selling was fear, plain and simple. It started on Tuesday night, when the cost for borrowing skyrocketed, which put more pressure on investment banks, which need short-term funds to operate. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, led the selling spree. Specifically, unsubstantiated rumors were swirling around Morgan as speculation mounted that it would be the “next Lehman”. Both firms reported earnings that were in the black, and Morgan’s beat estimates handily, but that did not assuage nervous investors, who drove down MS shares by 24% and Goldman’s by 14% yesterday.
Both firms railed against short-sellers and the SEC finally listened and announced three actions addressing shorting. First, the SEC adopted a rule requiring short sellers and their broker-dealers to deliver securities by the settlement date (three days after the transaction date) and imposing penalties for failure to do so. In addition, the SEC eliminated the option market-maker exception to the three-day delivery requirement and finally, the SEC adopted a new anti-fraud provision making it unlawful for sellers to deceive specified persons about their ability or intention to deliver securities by the settlement date. Unfortunately, these measures come a little too late. As written in this column this year, the SEC should never have eliminated the Uptick Rule (which they did in the midst of a bull market!) and appears to be asleep at the switch when it comes to eliminating abusive short selling and rampant rumor mongering.
With that rant out of the way, what about that Baron Rothschild? Those investors who embrace his advice might be strong enough to turn a blind eye to the fear and panic gripping the markets and start dipping their toes in the murky investment waters. If you have a long time horizon, this could be a time to increase your retirement plan contributions or add a little extra each month to your investment account. Yes, it is difficult to do, but years from now, you just might look back and thank Baron Rothschild for turning you a bit more bullish at a time of maximum pessimism.
Wednesday, September 17, 2008
AI-G-WHIZ
It seems that I can no longer prepare my articles until the wee hours of the morning. Yesterday morning, I was planning to write about the details of the Fed meeting (they left rates unchanged at 2%). By the afternoon, I was conducting research on bankruptcy of insurance companies (great information at www.nolhga.com). Late last night after learning that the government provided AIG with an $85 billion bridge loan to prevent the mammoth company’s failure, I figured the writing would have to wait.
At 6:00 am on Wednesday morning, here is what we know. After a weekend when government officials allowed Lehman Brothers to fail, the Federal Reserve reversed course and determined that mega-insurer AIG had far too many tentacles across the financial system and could not allow the company to fail. The underlying problem is that AIG played a big role in underwriting insurance contracts on esoteric debt instruments that were originally connected to the housing market.
As a reminder, banks wrote mortgages and sold them to investment banks, like Lehman Brothers or Merrill Lynch. The investment banks then packaged the mortgages into securities and sold them to (mostly) institutional investors. To protect investors against defaults, AIG sold insurance on those securities (credit default swaps). These unregulated insurance contracts required AIG to cover losses suffered by buyers in the event the securities defaulted, putting AIG on the hook for losses associated with billions of dollars of risky securities that were once viewed as safe.
AIG posted collateral to guarantee that it could repay investors if needed. The contracts specified that if AIG’s credit ratings were cut, it was required to post more collateral. Credit agencies cut AIG’s ratings on Monday, pushing AIG to the brink of bankruptcy. Here is the problem: if AIG would have failed, it would have set off a dangerous chain reaction where institutional investors would have then been forced to sell the bad stuff, driving prices even lower. AIG was simply too connected to various key markets, including: credit derivatives, mortgages, corporate loans and hedge funds. Additionally, there is a vast consumer component to the AIG story because the failure of AIG would affect millions of insurance policyholders, retirement plan participants and investors with money market funds with AIG. Simply put: AIG was just too interconnected to fail.
The world’s financial system could not easily absorb an AIG bankruptcy so the Fed acted. (It would have been nice if the ECB stepped up, considering that at midyear, ¾ of AIG’s credit default swaps were held by European banks, but that is another column.) Under the plan, the Federal Reserve will extend a two-year loan to AIG, of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80% ownership of the insurer, if the existing shareholders approve. Finally, AIG will continue to operate during this period so if you own an AIG product, try not to drive yourself crazy. In essence, the government has provided you with a big safety net and hopefully, a better night’s sleep.
At 6:00 am on Wednesday morning, here is what we know. After a weekend when government officials allowed Lehman Brothers to fail, the Federal Reserve reversed course and determined that mega-insurer AIG had far too many tentacles across the financial system and could not allow the company to fail. The underlying problem is that AIG played a big role in underwriting insurance contracts on esoteric debt instruments that were originally connected to the housing market.
As a reminder, banks wrote mortgages and sold them to investment banks, like Lehman Brothers or Merrill Lynch. The investment banks then packaged the mortgages into securities and sold them to (mostly) institutional investors. To protect investors against defaults, AIG sold insurance on those securities (credit default swaps). These unregulated insurance contracts required AIG to cover losses suffered by buyers in the event the securities defaulted, putting AIG on the hook for losses associated with billions of dollars of risky securities that were once viewed as safe.
AIG posted collateral to guarantee that it could repay investors if needed. The contracts specified that if AIG’s credit ratings were cut, it was required to post more collateral. Credit agencies cut AIG’s ratings on Monday, pushing AIG to the brink of bankruptcy. Here is the problem: if AIG would have failed, it would have set off a dangerous chain reaction where institutional investors would have then been forced to sell the bad stuff, driving prices even lower. AIG was simply too connected to various key markets, including: credit derivatives, mortgages, corporate loans and hedge funds. Additionally, there is a vast consumer component to the AIG story because the failure of AIG would affect millions of insurance policyholders, retirement plan participants and investors with money market funds with AIG. Simply put: AIG was just too interconnected to fail.
The world’s financial system could not easily absorb an AIG bankruptcy so the Fed acted. (It would have been nice if the ECB stepped up, considering that at midyear, ¾ of AIG’s credit default swaps were held by European banks, but that is another column.) Under the plan, the Federal Reserve will extend a two-year loan to AIG, of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80% ownership of the insurer, if the existing shareholders approve. Finally, AIG will continue to operate during this period so if you own an AIG product, try not to drive yourself crazy. In essence, the government has provided you with a big safety net and hopefully, a better night’s sleep.
Subscribe to:
Posts (Atom)
