Archive for December, 2009
Random Thoughts on 2009
Posted by Jody Eisenman | Filed under Uncategorized
As the year enters its’ last few trading days, I will share some recapping thoughts on what has transpired. For the year, the S and P 500 index has risen just under 24%, which is a pretty solid return historically. However, the real story is the two tiered nature of this performance. Between January 1 and March 8, the index went from 903 to 666, a terrifying drop of over 26%.
The crazy part of this rally is that very few retail (read: individual as to institutions) investors has participated, other than hanging in by not selling through the decline. According to a report on CNBC yesterday, TrimTabs.com reports that there has been a net OUTFLOW from mutual funds this year. In other words, the average investor has actually reduced their stock holdings during the rally. Generally, the opposite is true; this, people tend to buy when prices are rising. In addition, I have seen almost no analysts who recommended that clients stay long throughout this rally. Combined with very little insider buying (insiders are corporate executives whose buying patterns generally are a good bullish indicator) makes this the Incredible Rally That Almost No One Believes In. I find this truly amazing.
Although no one knows what 2010 will bring, I think it’s a safe bet that the volatility will not approach that of the last 2 years. Either way, it should be interesting.
Too Big To Fail
Posted by Jody Eisenman | Filed under Uncategorized
Back in 1870, the legendary John D. Rockefeller formed one of the first multinational corporations, an entity that became known as Standard Oil. For the next 40 years, Rockefeller employed a brilliant but controversial strategy. Rockefeller destroyed his competition via price cutting and mergers, and then proceeded to vertically integrate. By 1890, Standard Oil controlled an incredible 88% of the refined oil flows in the United States. In 1911, The Supreme Court ruled that Standard Oil was a monopoly that needed to be broken up for the good of society as a whole. As a monopoly, Standard could, in theory, raise prices unreasonably. Standard was then broken up in 34 different companies. Just to get an idea of the size, some of these subsidiaries included Exxon, Mobil, Sonoco, Chevron, Texaco and Gulf.
Although there are no banks today that rival the size of Standard Oil then, there still exists the concept of “too big to fail”. What this means is that a potential failure of any of these banks (which could include names like Citicorp, JP Morgan and Bank of America) could lead to an economic catastrophe. The current administration is now trying to limit this possibility by putting restrictions on the size and scope of bank activity. In addition, [ast Republican presidential candidate McCain has endorsed a bill that would effectively bring back Glass-Steagall. Back in 1999, congress the Glass-Steagall act which allowed banks to engage in brokerage activities. This led to the mega financial supermarkets that we have today.
While I think financial reform is necessary, I think what’s even more important than restricting bank activity is to limit the leverage that banks can use. Currently, banks, under certain circumstances, can leverage their balance sheets up to an incredible 35 to 1! This number must be brought down to a much more manageable level in order to avoid the financial maelstrom we had last year.
How Close Did We Get to the Brink?
Posted by Jody Eisenman | Filed under Uncategorized
Now that Wall Street and the banks seem to have stabilized, there is a claim by Goldman Sachs that they were never all that close to bankruptcy. On the other hand, we have Tim Geithner, secretary of the US Treasury, who asserts that not only was the entire financial industry at risk, but in an interview with Bloomberg television, “None of them would have survived” had the government stood aside and let the crisis run its course, he said. “The entire U.S. financial system and all the major firms in the country, and even small banks across the country, were at that moment at the middle of a classic run, a classic bank run.”.
This opinion is hotly disputed by Goldman President Gary Kohn, who stated “we had cash”. I’m with Geithner on this one. First of all, we were in the midst of a classic run on the banks. If the major banks like Citi, Bank of America and Wells Fargo failed, it’s hard to see how any of these banks could have survived. Banks typically keep less than two percent of their deposits on reserve. There is no way they could have met the demand for withdrawals.
In addition, it is pretty much common knowledge that Goldman had massive counter party risk to AIG. Had AIG not been bailed out, there is a real good chance Goldman would have been in deep trouble. The really scary part of this is that banks are now paying record bonuses for 2009. It is very likely, IMO, that they are talking many of the same risks they took previously which led to disaster. Unless the leverage starts changing dramatically, it is entirely possible this could happen again. As Geithner stated, “the basis problem we face across the system is that executives were paid for taking imprudent risks”. Lets hope the Fed puts the appropriate controls in place going forward.
