Looks like this whole blogging thing is more time consuming than expected, especially when the site is blocked at work. I would love nothing more than to steal work hours to blog throughout the day, but no such luck. Before I get going on some positives on the bailout package, I have a quick positive on the kickball situation. I went up to my cowardly friend and asked if he was ready to shake my hand last night. I think that was a positive step. That is until he gave me the cold shoulder yet again! He still would not put his pride aside and shake a friendly guy's hand at a bar. I should have updates on this every week since I now know how easy it is to get this kid going. I will make a valiant effort to bother him every week for the next few months. Now back to finance...
Since my last post, a lot has happened in the markets. This seems to be a recurring theme. We had a massive sell off last Friday. Then the G7 met and came up with a worldwide, comprehensive plan to help support the world's financial markets. Finally other central banks (even that lazy Trichet from France) agreed that action must be taken. The markets liked this news and we had the biggest point gain in history on Monday. We gave most of that gain back on Tuesday and Wednesday and had a decent recovery today. It's been difficult to follow and understand the action in the markets over the last few weeks due to the extreme volatility. For the first time in a very long time, 700 point swings throughout the day are becoming a common occurrence. It is the longest, wildest roller coaster I have ever ridden in my life. As much as I would like to talk about the intra-day action in the markets, I promised in the last post to focus on a few of the positive items in the U.S. bailout package and other positive steps that have been announced recently.
1. Ability to buy illiquid mortgages from the banks - I have already discussed the positive implications of this part of the bailout in my post entitled "A Glance at the Fed Bailout" on September 28th, so I will say no more on that topic.
2. Raising the FDIC insurance level to $250,000 from $100,000. This is a very important item in the bill. In the past, if you had more than $100,000 in a bank account at one institution, anything above that 100k was not insured by the federal government. So if the bank went under, there would be no guarantee on that money. This is a big issue, especially for small businesses who need to have well over that amount to finance their every day operations. When rumors came out about Washington Mutual being in big trouble, people with money at Wamu, especially more than $100,000, began withdrawing cash. This is commonly referred to as a run on the bank. Before JPMorgan decided to buy Wamu, billions of dollars were withdrawn. As discussed earlier, banks cannot operate without these deposits. These runs on banks caused big problems during the Depression and the S & L Crisis in the 80s and 90s. If you Google bank runs, you can probably bring up images of people waiting in lines at the bank to withdraw money. That problem today is even more prevalent since we can withdraw all of our funds electronically. It only takes a click of the mouse for me to pull all of my assets out of Sovereign Bank (soon to be Banco Santander). By raising the insurance limits, people will feel more comfortable leaving their money in the banks and these "runs" will hopefully subside.
3. Taking an equity stake in 9 of the largest U.S. financial institutions. Part of the $700 billion bailout gives the Treasury the ability to inject capital directly into the banks in exchange for an equity stake in the bank rather than simply buying distressed assets. This is the method that many of the governments in Europe have decided to implement. The U.S. followed suit on Wednesday by agreeing to inject $250 billion into 9 U.S. financial institutions. So what the hell does all this finance jargon really mean? The Treasury is basically buying senior preferred stock in the 9 companies. The Treasury will therefore now be an equity holder in the banks. They will get paid 5% per year on this money for the first 5 years and 9% thereafter. This is a win/win situation. The Treasury is making money for the taxpayer on this investment and the banks are able to borrow money at a very cheap rate for 5 years. The idea is that the banks will begin to lend out some of this money to unfreeze the capital markets and get the financial system back on its feet. There is more to the agreement, including the issuance of warrants, but I just want to get the most important points across.
4. The FDIC will now guarantee senior unsecured debt of eligible institutions issued before June 30th of 2009. This is also happening in Europe. This is a very big deal. This means that banks can raise money by issuing debt that is FDIC insured. This insurance will lower the cost of borrowing for the banks and also encourage people and institutions to invest in this debt. Typically during a difficult period in the market, debt (bonds) are considered safe investments. If a company is liquidated, the bond holders are the first ones to get paid. This crisis has been much different. Even the bond holders of U.S. companies, especially financial institutions, have been severely punished due to the lack of confidence between banks. When the Fed let Lehman Brothers fail, every institution holding Lehman Brother's bonds took a big hit. These same institutions then took a look at their other bond holdings and began to get rid of the debt of other banks that they thought were unsafe. If one of these banks wanted to issue new debt, they had to do so at very high interest rates in order to attract investors. This new insurance should lower the cost of capital for the participating institutions and bring back at least a little confidence in the system.
5. The last part of the package I want to discuss tonight is the Fed's recent announcement to enter the commercial paper market. Check out investopedia.com for a pretty good explanation of the commercial paper market. It is one of the most vital parts of the every day operations of businesses in America. Commercial Paper is basically very short term debt issued by companies to help finance their payrolls, inventories, etc. The market is huge and gives businesses access to capital at very low rates to help them operate. Over the past few months, this market has basically frozen up. Here's an example: Joe Plumber used to sell commercial paper to Barack McCain in order to finance his purchases of toilet plungers. He was able to borrow the money at a very low interest rate, so it made perfect sense. When the financial crisis began to trickle down into other businesses, Barack McCain began to get nervous about Joe Plumber's business, so he stopped buying the commercial paper. In fact, everyone stopped buying Mr. Plumber's paper (not toilet, commercial). Joe now has no financing and no way to buy more plungers to keep his business going. This is happening across every industry in America right now. This market is well over $1 trillion, so that's a lot of money to have frozen up. The Fed has announced that they will begin buying highly rated commercial paper from companies - I believe the facility will be set up in 2 weeks. This should help to unfreeze some of this vital market.
As stated previously, the credit markets will not be fixed overnight. We must be patient. It is important to understand that times are tough and will be for a while. But I think it's equally important to focus on some of the positive steps that are being taken. It's great to see governments and bankers all over the world working together to help get us through these difficult times. I'm sure the pain will continue, but I will make sure that I focus in on some of the positives as well. Hope this helps and as always, please feel free to ask questions if anything is confusing. Enjoy your Friday everyone.
16 October 2008
07 October 2008
Financial Bill or Chinese Buffet?
So sorry for the lack of posting on my part, especially during the pure and utter mayhem in the markets over the last week or so. I was hiking with my old man all weekend and did not what to ruin a great weekend on Sunday by thinking about finance. My apologies again - let's get back to it...
In my last post, I compared Congress to a bunch of fifth graders. It looks like I was giving them too much credit. They are more like 5 year olds. If a five year old won't do something and your patience is wearing thin, what do you do? You bribe them with candy! If Congress is too stupid to pass an incredibly important and time sensitive bill, what do you do? You bribe them with pork (evidently not too many vegetarians in Congress)! This bill had more pork than Chinese Buffet. Here are a few of my favorites: Tax breaks for a company that makes wooden arrows, tax breaks for alternative energy, tax breaks for Nascar. If you want some good thoughts on this bill, please take a look at the last comment on my last post by "thefreshmen." The post describes a lot of frustration that people are feeling today.
Even though our elected representatives made a once 3 page bill over 100 pages long, they did in fact pass the legislation. I totally disagree with the manner in which it was passed, but what's done is done. After the bill passed, the stock markets and credit markets have continued to come under pressure. Today the Dow closed below 9500 and the S&P closed below 1000. We are about 40% off of the highs hit only 1 year ago. Many people are asking why the market is dropping if this bill is in place. Shouldn't the mortgage problems now be solved?
Ladies and gentleman, these problems do not get fixed overnight. The Treasury now has to figure out which mortgages to buy and at what prices. If you have been following this blog, you already know how complex and difficult these securities are to price. It is going to take a little while for the Treasury to begin purchasing securities. And it is going to take even longer for the effects of these purchases to trickle down into the rest of the mortgage market. After all, Rome wasn't built in a day. We have become a society unwilling to wait for anything. This is a perfect time for Americans to relearn that long lost virtue called patience.
Another plausible explanation for the continued weakness in the market after the passing of the bill is the fact that investors are now focusing on the fundamentals of the economy rather than on whether or not the bill will be passed. On Friday, the Labor Department announced we lost 159,000 jobs in September. That is the worst number in 5 years. Manufacturing and auto sales data have also been extremely week. I do not want to bore you with the numerical details, so I'll just say flat out that the economy is weak and is continuing to slow.
Monday was also a horrific day on Wall Street. The focus on Monday was Europe and the European banks. Fortunately for the U.S., we have one national government and one central bank. The Fed was therefore able to pass legislation that encompasses the entire U.S. mortgage market. As discussed previously, the Fed realized that they could not save the system on a case by case basis. They needed broad-based legislation. Unfortunately, Europe does not have that luxury. The European Central Bank (ECB) carries out the monetary policy for its 15 member countries. That means that 15 very different economies governed by 15 unique governments are all affected by one central bank. This makes it very difficult for the ECB to pass a broad based bail out package for its member nations. It also makes their decisions on monetary policy very complicated. What's good for Germany may not be good for France, what's good for France may not be good for Greece, etc.
Last week, Ireland was nervous about people pulling money from their banks, so they decided to guarantee all deposits:
http://www.smartmoney.com/breaking-news/smw/index.cfm?story=20080930110502
What effect does this have on the rest of Europe? People pull their money out of other banks and deposit them in the Irish banks since the deposits are guaranteed. That means an immense amount of pressure is put on other European banks. After the announcement from Ireland, several other EU members followed suit with their own types of guarantees. I hope this clearly illustrates the problem in Europe right now. To get through this with minimal pain, they need to work together on a solution. The European bankers actually met today for precisely this purpose. I am about financed out for the night, so I'm not sure what kind of progress was made at the meeting today.
Just one more quick note before I go to the gym to see if any other CEOs of financial firms are getting punched in the face on treadmills (Google "Dick Fuld Gets Knocked Out") - Take a look at the following article if you still do not believe the close ties between Main Street and Wall Street:
http://biz.yahoo.com/ap/081007/meltdown_retirement.html
Sorry for the negative sentiment in this post. I will try and focus in on the positive steps that the Fed has taken in my next post and discuss how they may help us out of this mess.
Don't forget to watch Saturday Night Live, I mean the presidential debate, tonight! Until next time.
In my last post, I compared Congress to a bunch of fifth graders. It looks like I was giving them too much credit. They are more like 5 year olds. If a five year old won't do something and your patience is wearing thin, what do you do? You bribe them with candy! If Congress is too stupid to pass an incredibly important and time sensitive bill, what do you do? You bribe them with pork (evidently not too many vegetarians in Congress)! This bill had more pork than Chinese Buffet. Here are a few of my favorites: Tax breaks for a company that makes wooden arrows, tax breaks for alternative energy, tax breaks for Nascar. If you want some good thoughts on this bill, please take a look at the last comment on my last post by "thefreshmen." The post describes a lot of frustration that people are feeling today.
Even though our elected representatives made a once 3 page bill over 100 pages long, they did in fact pass the legislation. I totally disagree with the manner in which it was passed, but what's done is done. After the bill passed, the stock markets and credit markets have continued to come under pressure. Today the Dow closed below 9500 and the S&P closed below 1000. We are about 40% off of the highs hit only 1 year ago. Many people are asking why the market is dropping if this bill is in place. Shouldn't the mortgage problems now be solved?
Ladies and gentleman, these problems do not get fixed overnight. The Treasury now has to figure out which mortgages to buy and at what prices. If you have been following this blog, you already know how complex and difficult these securities are to price. It is going to take a little while for the Treasury to begin purchasing securities. And it is going to take even longer for the effects of these purchases to trickle down into the rest of the mortgage market. After all, Rome wasn't built in a day. We have become a society unwilling to wait for anything. This is a perfect time for Americans to relearn that long lost virtue called patience.
Another plausible explanation for the continued weakness in the market after the passing of the bill is the fact that investors are now focusing on the fundamentals of the economy rather than on whether or not the bill will be passed. On Friday, the Labor Department announced we lost 159,000 jobs in September. That is the worst number in 5 years. Manufacturing and auto sales data have also been extremely week. I do not want to bore you with the numerical details, so I'll just say flat out that the economy is weak and is continuing to slow.
Monday was also a horrific day on Wall Street. The focus on Monday was Europe and the European banks. Fortunately for the U.S., we have one national government and one central bank. The Fed was therefore able to pass legislation that encompasses the entire U.S. mortgage market. As discussed previously, the Fed realized that they could not save the system on a case by case basis. They needed broad-based legislation. Unfortunately, Europe does not have that luxury. The European Central Bank (ECB) carries out the monetary policy for its 15 member countries. That means that 15 very different economies governed by 15 unique governments are all affected by one central bank. This makes it very difficult for the ECB to pass a broad based bail out package for its member nations. It also makes their decisions on monetary policy very complicated. What's good for Germany may not be good for France, what's good for France may not be good for Greece, etc.
Last week, Ireland was nervous about people pulling money from their banks, so they decided to guarantee all deposits:
http://www.smartmoney.com/breaking-news/smw/index.cfm?story=20080930110502
What effect does this have on the rest of Europe? People pull their money out of other banks and deposit them in the Irish banks since the deposits are guaranteed. That means an immense amount of pressure is put on other European banks. After the announcement from Ireland, several other EU members followed suit with their own types of guarantees. I hope this clearly illustrates the problem in Europe right now. To get through this with minimal pain, they need to work together on a solution. The European bankers actually met today for precisely this purpose. I am about financed out for the night, so I'm not sure what kind of progress was made at the meeting today.
Just one more quick note before I go to the gym to see if any other CEOs of financial firms are getting punched in the face on treadmills (Google "Dick Fuld Gets Knocked Out") - Take a look at the following article if you still do not believe the close ties between Main Street and Wall Street:
http://biz.yahoo.com/ap/081007/meltdown_retirement.html
Sorry for the negative sentiment in this post. I will try and focus in on the positive steps that the Fed has taken in my next post and discuss how they may help us out of this mess.
Don't forget to watch Saturday Night Live, I mean the presidential debate, tonight! Until next time.
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