Jody Eisenman on Finance

Final Thoughts on 2008

admin — Fri, 02 Jan 2009 04:36:24 +0000

Well, it was a quite a year. The stock and bond markets had perhaps the most volatile year in their existence. From the surge in commodity prices to its’ deep plunge, from the collapse of major financial institutions to perhaps the biggest Ponzi scheme in history, most investors took a significant step back financially. There were very few places to hide. Even with a 20% rise in the S and P since November 20, the broad index still closed down 38.5% which was the worst performance since 1937. The Dow Jones did slightly better, closing down 34%. Although the declines cut across almost every segment, the financials were clearly the hardest hit. Lehman, Bear Stearns and Merrill Lynch no longer exist, and AIG, Fannie Mae and Freddie Mac are only barely hanging on. Most of the other large banks like Citi, Morgan Stanley and Bank of America have needed massive bailouts in order to stay afloat, and they are hardly the picture of financial health. The auto industry is in deep trouble, and only an eternal optimist would believe that GM and Chrysler will continue to exist in their current state. As the recession deepened, retailers and the rest of Main Street began the painful process of lowered revenues, layoffs and increasingly difficult access to capital. As we close out the year, we are looking at substantial declines in corporate and municipal bond prices, and anemic treasury yields. In order to get a yield of even 1 per annum, you would need to lend your money to the US government for more than three years. Even 30 year treasuries yield only about 2.6%. At that rate, it will take you only about 27 years to double your money. On the other hand, your funds should be safe as long the US government honors its’ obligations as they have for the past 232 years.

The US government has increased its’ borrowings significantly. Contrary to popular opinion, US dollars are not backed by gold. Instead they are backed by the full faith and credit of the US. Although I am not predicting a default, it is clearly problematic to me that the US has increased the deficit over this time period. To use an analogy, imagine yourself getting your first job coming out of school. Although your salary is low, you can manage and even save a few dollars. As your career progresses, your salary continues to rise. However, instead of increasing your savings, you start spending more and more and even use credit cards to buy even more. Eventually, you are earnings substantial sums of money, but you continue to spend and borrow at a rapid rate. Then, the recession hits, and you lose your job. Unfortunately, instead of saving in the good years, you are actually in worst shape financially than you were at the beginning of your career! This, unfortunately, is not far from the position of the United States. Although we have gone through a 25 year period of growth, we have continued to spend and borrow at even faster rates. In other words, instead for using our growth to reduce the deficit, the US actually increased it rather dramatically. The federal deficit was $930 million in 1980, and comprised about a third of our Gross Domestic Product (GDP). As of 2008, the deficit has risen to over $10 trillion and is now over 70% of our GDP. Although it is still unclear how high the deficit will be for 2009, considering all the bailout money in use, it is almost certain this number will be at least $11 trillion. With GDP decreasing, these is a real possibility the national debt may actually comprise over ¾ of our GDP. I will try to talk more in detail about this over the weekend. However, rest assured that this increase is not a positive situation. Stay safe, and lets hope for a better 2009!

For Your Reading Enjoyment

admin — Wed, 24 Dec 2008 19:12:55 +0000

Please click this link from New York Magazine detailing some top analysts’ investment choices at the start of 2008. My favorite is from Elaine Garzarelli, who first achieved fame from supposedly calling for a steep decline prior to the market crash in October 1987. She was a bit off the mark this time:

“Garzarelli is advising investors to buy some of the most beaten-down stocks, including those of giant financial institutions such as Lehman Brothers, Bear Stearns, and Merrill Lynch. What would cause her to turn bearish? Not much. ‘Our indicators are extremely bullish.’”

Here’s a link to the entire article:

Happy Holidays!

Where Did the TARP Money Go?

admin — Tue, 23 Dec 2008 20:43:04 +0000

Imagine you meet some guy who’s down and out. He used to be a major player on Wall Street, but now he’s facing hard times. He begs you for a rather substantial loan. He tells that if he doesn’t get money soon, he will be facing bankruptcy and he hints that this could severely hurt lots of your friends who invested with him. On the other hand, he tells you that if you would just grant him this rather huge loan, he will not only survive, but will actually help lots more of your friends so that everyone benefits. Although he’s sort of vague about both how he will pay you back and what exactly he will do with the loan, you are persuaded to give it to him. He thanks you profusely and then goes on his way. A few months later, it seems that your friends are still in bad shape; in fact, they are worse then before! So, you go seek out your loan recepient and ask him very simply, “What did you do with the money I so graciously lent you under such favorable terms?” Imagine your surprise when he absolutely refuses to tell you what he did with any part of the money!

Apparently, the Associated Press decided to question 21 banks who received at least a billion each of the $350 billion in TARP money. Not a single bank would provide a specific answer. Here’s a link from Yahoo: http://news.yahoo.com/s/ap/20081222/ap_on_go_ca_st_pe/meltdown_secrets

Of course, I can think of a very good reason why the banks refuse to answer. Thanks to the incredibly generous and highly speculative ratios that the government allowed these banks to leverage their balance sheet at, (along with some poor investments in creative mortgage financing) most of these banks have lost the great majority of their equity. Many of them could very well be bankrupt right now save for the governments’ (read:taxpayers) largesse. You think any of them want to admit their that? I don’t. In addition, thanks to Paulsons’ and Bernakes’ high pressure efforts, there was absolutely no requirement that the banks loan out even a penny of their TARP bailout money. My guess is that they have actually lent out very little, preferring to shore up their own shaky balance sheets. Will anyone actually demand some accountability?

200 Years of Losses?

admin — Mon, 22 Dec 2008 02:14:21 +0000

In calculating Bernie Madoffs’ self admitted $50 billion in losses, I came up with the following:

Assuming 250 trading days per year, and a staggering $1million in losses per day, it would have taken Madoff 200 years to lose $50 billion. In connection with this massive fraud, I have included a link to an incredible document, namely, Harry Markopolos’ written complaint to the SEC in 2005. http://d.scribd.com/docs/1xze9pjljc8zx53bbsbj.pdf

Although it is 19 pages, I would suggest reading it to get a critical view of Madoffs’ strategy. In the complaint, Markopolos lists 29 red flags and states on page 2 of the document that it is highly likely that “Madoff Securities is the Worlds’ Largest Ponzi Scheme”. As we now know, the SEC chose to completely ignore this and any other complaints about Madoff even though according to Bloomberg, the misconduct dates back over 30 years. http://www.bloomberg.com/apps/news?pid=20601087&sid=aj44JrWmAOGA&refer=home

I think much of the investing world is transfixed by this incredible story.

In other news, it seems that the auto industry will receive over $13 billion in loans. It is not immediately clear how and under what terms these loans will be repaid. Thus far, other than emergency assistance, it is difficult for me to see any real improvement in our economy. Banks are still not making loans and investors are still shying away from fixed income investments that are not government guaranteed. I do not see how our country could avoid a severe economic meltdown unless this situation improves soon.

More on Madoff; Interest Rates and the Economy

admin — Thu, 18 Dec 2008 18:26:48 +0000

I will not repeat all the stories on Madoff which readers can find all over TV, newspapers and the internet. However, a few items strike me as significant. First of all, Madoffs’ hedge fund did not utilize the services of a prime broker. A prime broker generally acts as sort of a central clearing agency for all of funds’ trades. In other words, most funds have accounts at several different brokerage forms. It is quite cumbersome to review several brokerage statements; the prime broker consolidates everything for you. In addition, the prime broker can extend credit (i.e. margin) if the fund wishes to utilize it. Most funds, especially those in the billions of dollar range, utilize prime brokers’ services, which are offered by many major firms such as Merrill Lynch, Goldman Sachs and Jeffries. The fact that Madoff did not use one should have raised some major red flags. It is also inconceivable to me that Madoff acted alone. It is known that Madoff kept at least 2 sets of books and records, and sent out regular monthly statements (which supposedly included actual, albeit fictitious, trades) to his clients. It is difficult for me to believe that all this was the work of one senior citizen. In my opinion, several people had to be involved in this scam. I hope the truth will come out soon.

The Fed basically cut their target rate to zero this week. The market jumped several hundred points on this news, and now seems to be slowly giving it back. For the month of December, we are basically flat, which is clearly a lot better than the last three months. In the face of this economic decline, the good news is that the Fed is basically firing every bullet they can at the problem. The bad news is that it doesn’t seem to be working. Even worse, it would seem that the Fed is virtually out of bullets. Last time I checked, zero is the bottom. However, as this has not stimulated lending, overall rates on mortgages and bonds have not declined appreciably. For example, 2 year treasuries yield roughly .68 pct. 2 year A-rated corporate bonds yield around 6.20, or roughly 9 times as much. In other words, if rates remained here, you could earn the same amount of interest on a single A-rated corporate bond in two years that would take you over 18 years to earn on a US treasury. Of course, the rub is that you hope the corporation won’t default. Simply put, investors are unwilling to accept risk. This has major implications for our entire economic system. If companies cannot raise capital, they will have a very difficult time growing. Even worse, may of these companies are going to have a hard time repaying their existing debt. Generally, companies (and municipalities) tend to roll their debt. In other words, they tend to pay off their existing bonds by issuing new ones. In this market environment, this is extremely difficult, if not impossible. I honestly don’t know what else the Fed can do in order to alleviate this crisis. Let’s hope there are some smart people in Washington who can come up with a solution.

The Fed Makes Another Dramatic Cut

admin — Tue, 16 Dec 2008 20:07:20 +0000

In another sign that the economy is continuing to deteriorate, the Fed cut rates to a target of zero to .25 per cent. Although I will speak more about this, I have included the actual statement from the Federal Open Market Committee, which I believe speaks for itself.

“The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent”

See How the Mighty Have Fallen

admin — Mon, 15 Dec 2008 01:16:43 +0000

Investors all over the world are stunned by the ongoing fraud revelations of Bernard Madoff. Madoff, who was a former chairman of NASDAQ, also serves on several prominent boards in both the academic and charitable fields. Apparently, according to his own admissions, Madoff managed to somehow wipe out virtually his entire investor base of $50 billion. Of course, there are still many unanswered questions regarding his operation and how he managed to hide this from everyone (especially the regulators) for all this time. Although there have already been several high profile names mentioned as having invested with him, I have been told by 2 prominent attorneys that the client base Madoff had was incredible in scope. How did he manage to fool everyone? Were other employees involved? What about the auditors?

Although I don’t know more than anyone else here, I can surmise that what possibly happened is that Madoffs’ investments started going south. Madoff pioneered something called a “split-strike” strategy that supposedly profited in any type of market, both good and bad. The fact that no other trading firm could duplicate what Madoff did should clearly have raised some red flags. When Madoff starting losing money, he probably started to get more aggressive and lost more. All this time, he continued to report sterling returns to his investors. When redemptions struck, he simply didn’t have enough cash left to meet them, and so he admitted to his sons that the whole game was a giant Ponzi scheme. Again, I am quite amazed that no one at the firm knew what was going on. I find that hard to believe, but I’m sure the truth will come out eventually.

List of affected investors

The Economy and the Auto Bailout

admin — Thu, 11 Dec 2008 19:59:54 +0000

Unfortunately, the US economy continues to get demonstratively worse. The number of Americans filing for unemployment hit the highest level in 26 years. Yields on some US treasuries are at their lowest since 1929. As prices continue to decline, US household net worth declined by 4.7% in the third quarter according a Federal Reserve report. Wall Street is pretty much doom and gloom as bonuses get cut and layoffs continue. As the credit markets continue to remain tight, it seems very likely that bankruptcies on Main Street will increase. What this means in terms of an eventual recovery is debatable. However, it would seem that there will a lot less players in the game once the music starts again. If you like to read bearish predictions, please clink the following link from CNN Money: 8 really, really scary predictions

The Auto Bailout is still on the front burner. Although a bill has passed the house, the senate is balking over approval. One telling fact is that in 2007, both GM and Toyota sold almost the same number of cars (roughly 9 million). However, Toyota earned roughly $17 billion, while GM lost money. Therefore, many legislators (as well as a majority of the public) feel that a bailout will only prolong the inevitable unless there are major changes in the business plan. Normally, one could wait until the new congress is seated where the Democrats would have more voting power. However, it seems, at least in GM’s case, that they will not have the luxury of waiting this long.

Looking to Loan the Government Some Money for Free?

admin — Tue, 09 Dec 2008 20:55:32 +0000

The US government just completed its’ one month treasury auction today. They sold $20 billion worth at a rate of zero. That’s right. If you were fortunate enough to get any, you effectively loaned money to the good old USA for a zero return. Since there is some time value to money (i.e. a dollar today is worth more than a dollar a month from now), the effective rate is actually negative. By the way, the government received bids totaling four times that amount sold according to Bloomberg. Of course, one can get higher rates if you are willing to lend for longer periods. For example, three month treasuries are yielding the princely rate of .005%. That means if you put $100,000 into a three month treasury bill, you would receive approximately $125 in interest for the three months. It hardly seems worth it, but I guess it’s better than losing money.

The automakers continue to lobby Washington for some sort of bailout/bridge loan/handout. I believe that the reason this is going so slowly (as opposed to the bank bailout) is a combination of factors. The economy has gotten worse, foreclosures are increasing, public opinion is not very favorable and the first bailout doesn’t seem to have had much of an effect on the overall market. I do think that in the end, the government will agree to an assistance package but whether or not this will actually help rescue the industry temporarily or permanently is anyone’s guess.

Has the Market Bottomed?

admin — Sun, 07 Dec 2008 22:42:32 +0000

There is lots of speculation on the financial networks as to whether a bottom has been made in the stock market. Of course, a lot of these commentators have a vested interest in seeing this; their ratings are higher in bull markets! Although the market is still down for the month of December; it is only fractionally so. Could we have reached at least a temporary bottom? Lets examine the pros and cons:

Pros:

1. At least we seemed to have stopped our free fall.

2. The financial stocks which led the market down have made some nice upside moves off their lows. Here are some examples:

Stock Low Current

Citicorp 3.05 7.71

Morgan Stanley 6.71 15.72

Goldman Sachs 47.41 70.72

General Electric 12.58 17.85

3. The market has fallen so hard so quickly, we are simply oversold.

4. The market has seemed to have shrugged off extremely negative economic news.

Cons:

1. Yes, we may have stopped our free fall, but it’s been a relatively short period. In addition, the volatility is still extremely high. Does anyone think we still can’t see another 500-700 point daily move? Historically, bottoms are not made until we have based for at least a few months. Clearly, this hasn’t happened yet.

2. Yes, the financial stocks have come off their lows but they are still very far from where they were a year ago. In addition, thanks to a combination of TARP money, balance sheet deterioration and the conversion of several firms to bank holding companies, these companies no longer exist in their previous forms. There is no reason to believe that these companies will ever come close to seeing their previous valuations anytime in the near future, probably years. This move may be nothing more than short covering.

3. We have fallen quickly. However, the economic situation has deteriorated faster then at any time in our nations’ history. We have gone, in about a year and a half, from incredibly free credit to incredibly tight credit. Several large firms have gone under or been taken over to avoid bankruptcy. Many others are closing in rapidly. The auto industry, once the pride of the US, needs a major bailout. Floating new bonds have become nearly impossible without government backing. Therefore, the selloff, while dramatic, is justified considering deteriorating economy.