I was fortunate enough to receive a decent education at some decent educational institutions. I also took corporate, business, accounting, banking, finance, and various other management courses.
However, I must be honest. I do not understand even a quarter of what occurred over the past 20 – 30 years to lead to our current financial situation.
Although I am sure that most of us can point to some emotional, conceptual issues, be it outsourcing, illegal immigration, two foreign wars, decreased industrial output, and greed, I just really feel like I am in the minority in terms of understanding investment banks, hedge funds, selling short, bundling, derivatives, and such.
Just last week, I contacted two of my graduate school buddies, one with a specialty in banking, and the other in corporate securities, and I told them that I hoped that they were in the Senate Banking Committee sessions to keep them honest.
One of them, “The Bear” (no relation to the term to describe financial markets), forwarded the following article to us by John P. Hussman, Ph.D. of Hussman Funds, entitled You Can’t Rescue the Financial System If You Can’t Read a Balance Sheet, which was posted by Dr. Hussman earlier today. It provides food for thought.
September 29, 2008
You Can't Rescue the Financial System If You Can't Read a Balance Sheet
John P. Hussman, Ph.D.
All rights reserved and actively enforced.
This is a bad idea.
However the final legislation is written, the Troubled Assets Relief Program (TARP) being rushed through Congress will evidently be built around its single worst provision, which is that the Treasury will have authority to purchase distressed mortgage securities from U.S. financials.
As I noted last week in An Open Letter To Congress Regarding the Current Financial Crisis, the sequence of bankruptcies that we've observed among U.S. financials has been almost exactly in order of their gross leverage (the ratio of total assets to shareholder equity). The reason for that is:
1) as the assets of a financial company lose value, the losses reduce the asset side of the balance sheet, but also reduce shareholder equity on the liability side;
2) as the cushion of shareholder equity becomes thinner, customers begin to make withdrawals;
3) in order to satisfy customer withdrawals, the financial company is forced to liquidate assets at distressed prices, prompting a further reduction in shareholder equity;
4) go back to 1) and continue the vicious cycle until shareholder equity goes negative and the company becomes insolvent.
Let's return to the basic balance sheet of a typical financial company before the writedowns:
To read the remainder, click on: http://www.hussmanfunds.com/wmc/wmc080929.htm.
Showing posts with label banks. Show all posts
Showing posts with label banks. Show all posts
Monday, September 29, 2008
Wednesday, September 10, 2008
Post 41c: Article of Interest from Forbes.com
Adviser Soapbox
Professional Bailout No. Six
Ron Rowland, All Star Fund Trader 09.08.08, 2:49 PM ET
Austin, Texas -
Monday brought a sense of deja vu in the markets. How many financial sector bailouts can we have in one year? Quite a few, apparently. Six times in the last 13 months, the game has changed or appeared to change due to political intervention in the markets. Let's review:
August 2007: The Federal Reserve makes emergency cut in the discount rate
December 2007: Fed announces creation of special lending privileges for banks
January 2008: Another emergency 75 basis point rate cut
March 2008: Bear Stearns bailout
July 2008: First Fannie/Freddie rescue attempt
September 2008: Another Fannie/Freddie rescue attempt
The latest action effectively brings Fannie Mae and Freddie Mac under governmental control. Existing shareholders in these institutions are not, to our surprise, being totally wiped out--yet. There is still plenty of time for that to happen.
There is an even bigger loser in this transaction: anyone who owns U.S. Treasury bonds. Interest rates spiked higher, leaving the principal value of government debt sharply lower than it was last week. This is perfectly logical. Having just taken on the massive obligations of Fannie and Freddie, the Treasury's own credit rating had to take a hit. There are no free lunches.
In the big picture, the government's goal is clear: drive down mortgage rates and, more important, convince bankers to actually lend money to people who want to buy houses. Wholesale mortgage rates dropped dramatically Monday morning, so by that standard we have to say the bailout is doing what it is supposed to do. Whether the new liquidity will trickle down to individual borrowers is not yet clear.
Will the sixth bailout be the charm? The record of the last year is not very encouraging. Each action brought a market rally, but the rallies have been getting progressively weaker and shorter each time. As noted above, there are no free lunches. Risk cannot be eliminated, but it can be moved around. What is happening now is that the losses in the mortgage market are being transferred to what may be the only larger fixed-income sector: U.S. Treasury securities.
Since other kinds of bonds take their cue from the Treasury market, the bottom line is that interest rates on all kinds of debt will rise so that those who lost money in mortgage debt can be saved from loss. Is this a good thing? Maybe. But whatever it is, it is not capitalism. It is not what happens when markets are allowed to operate freely and without interference.
In a free market economy, people bear the cost of their own decisions, for better or worse. With that principle out the window, who will be next? This precedent is now in place: If an industry proves that its continued functioning is crucial to the economy and its failure will bring widespread pain, it is entitled to be saved from its otherwise inevitable demise by the collective action of society. The automobile industry is already making noise along these lines. Other applicants will no doubt follow.
For now, stocks are rallying around the globe. Monday morning's opening surge faded with remarkable alacrity, though, suggesting that at least a few investors remain skeptical. We count ourselves among them.
Professional Bailout No. Six
Ron Rowland, All Star Fund Trader 09.08.08, 2:49 PM ET
Austin, Texas -
Monday brought a sense of deja vu in the markets. How many financial sector bailouts can we have in one year? Quite a few, apparently. Six times in the last 13 months, the game has changed or appeared to change due to political intervention in the markets. Let's review:
August 2007: The Federal Reserve makes emergency cut in the discount rate
December 2007: Fed announces creation of special lending privileges for banks
January 2008: Another emergency 75 basis point rate cut
March 2008: Bear Stearns bailout
July 2008: First Fannie/Freddie rescue attempt
September 2008: Another Fannie/Freddie rescue attempt
The latest action effectively brings Fannie Mae and Freddie Mac under governmental control. Existing shareholders in these institutions are not, to our surprise, being totally wiped out--yet. There is still plenty of time for that to happen.
There is an even bigger loser in this transaction: anyone who owns U.S. Treasury bonds. Interest rates spiked higher, leaving the principal value of government debt sharply lower than it was last week. This is perfectly logical. Having just taken on the massive obligations of Fannie and Freddie, the Treasury's own credit rating had to take a hit. There are no free lunches.
In the big picture, the government's goal is clear: drive down mortgage rates and, more important, convince bankers to actually lend money to people who want to buy houses. Wholesale mortgage rates dropped dramatically Monday morning, so by that standard we have to say the bailout is doing what it is supposed to do. Whether the new liquidity will trickle down to individual borrowers is not yet clear.
Will the sixth bailout be the charm? The record of the last year is not very encouraging. Each action brought a market rally, but the rallies have been getting progressively weaker and shorter each time. As noted above, there are no free lunches. Risk cannot be eliminated, but it can be moved around. What is happening now is that the losses in the mortgage market are being transferred to what may be the only larger fixed-income sector: U.S. Treasury securities.
Since other kinds of bonds take their cue from the Treasury market, the bottom line is that interest rates on all kinds of debt will rise so that those who lost money in mortgage debt can be saved from loss. Is this a good thing? Maybe. But whatever it is, it is not capitalism. It is not what happens when markets are allowed to operate freely and without interference.
In a free market economy, people bear the cost of their own decisions, for better or worse. With that principle out the window, who will be next? This precedent is now in place: If an industry proves that its continued functioning is crucial to the economy and its failure will bring widespread pain, it is entitled to be saved from its otherwise inevitable demise by the collective action of society. The automobile industry is already making noise along these lines. Other applicants will no doubt follow.
For now, stocks are rallying around the globe. Monday morning's opening surge faded with remarkable alacrity, though, suggesting that at least a few investors remain skeptical. We count ourselves among them.
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