Oil for January 2009 delivery is priced at $43.80. For January 2010 delivery, it is $56.21, or 28% higher. That 28% has to cover my cost of financing and storing oil for one year. Could that be? Short term interest rates are very very low -- if a bank would lend me money on a sure bet! How much could the cost of storage be? Hmmm....
And NOMINAL interest rates on US Treasury bills went negative. In the US Treasury's auction of bills, the yield was ZERO. People are willing to lend US Treasury money at no cost. Gosh, I hope the Treasury locks in as much money as they can at these "deal of the century rates." I am going to wait just a bit longer, then lock in as much long term mortgage money as I can at 4.5 to 5% (I hope).
Wednesday, December 10, 2008
Tuesday, December 09, 2008
The Cold Blast is Coming
We hit close to zero degrees Fahrenheit in Hanover the last two nights.
Southern California is due for some cold as well: "Rare 50 year Arctic Blast Sets Sights On Southern California."
And 2008 will go down as the coldest year of the decade at least.
And the US Congress has seen it wise to take money from a fund dedicated to helping Detroit produce environmentally friendly cars and use the money for keeping the Big Three out of Chapter 11 (or 7). I vote for "none of the above."
Southern California is due for some cold as well: "Rare 50 year Arctic Blast Sets Sights On Southern California."
And 2008 will go down as the coldest year of the decade at least.
And the US Congress has seen it wise to take money from a fund dedicated to helping Detroit produce environmentally friendly cars and use the money for keeping the Big Three out of Chapter 11 (or 7). I vote for "none of the above."
Selling to the Highest Bidder!
On a day that I covered auction theory in my class, it was heartening to see that Governor Blagojevich of Illinois was (allegedly) running an auction of his own. According to the New York Times Blagojevich took to heart at least the most basic auction lesson, that of selling to the highest bidder:
"CHICAGO — Gov. Rod R. Blagojevich of Illinois was arrested by federal authorities on Tuesday morning on corruption charges, including an allegation that he conspired to effectively sell President-elect Barack Obama’s seat in the United States Senate to the highest bidder."
It sounds like his wife added some nice quips on the wiretaps.
"CHICAGO — Gov. Rod R. Blagojevich of Illinois was arrested by federal authorities on Tuesday morning on corruption charges, including an allegation that he conspired to effectively sell President-elect Barack Obama’s seat in the United States Senate to the highest bidder."
It sounds like his wife added some nice quips on the wiretaps.
Thursday, November 13, 2008
Sears Brings Back the Layaway
You know that credit has really dried up when stores like Sears are again offering layaway plans!
Ask your children if they know what layaway means.
Ask your children if they know what layaway means.
Hilarious Motley Fool Column
This is a great spoof on the Paulson about-face, from the Motley Fool.
Just one quote pulled here, but read the whole thing because it is worth it:
"Paulson acknowledged that there had been criticism of the TARP's actual strategy, which quickly became one of injecting capital directly into banks, though without demanding control in the form of board representation, or cuts in dividends, or any of the other limitations used in successful bank bailout schemes in countries such as Finland and Sweden. But he said there was good reason for handing out money with no strings attached.
"America is not Finland, and it is not Sweden," Paulson explained. "I don't see any of you eating lutefisk or swatting your sweaty bodies with a birch switch."
The assembled journalists laughed, looked at one another, and admitted that America certainly isn't Finland or Sweden. "That is silly," said Barney Field of the New York Examiner/Picayune."
Just one quote pulled here, but read the whole thing because it is worth it:
"Paulson acknowledged that there had been criticism of the TARP's actual strategy, which quickly became one of injecting capital directly into banks, though without demanding control in the form of board representation, or cuts in dividends, or any of the other limitations used in successful bank bailout schemes in countries such as Finland and Sweden. But he said there was good reason for handing out money with no strings attached.
"America is not Finland, and it is not Sweden," Paulson explained. "I don't see any of you eating lutefisk or swatting your sweaty bodies with a birch switch."
The assembled journalists laughed, looked at one another, and admitted that America certainly isn't Finland or Sweden. "That is silly," said Barney Field of the New York Examiner/Picayune."
Wednesday, November 12, 2008
YouTube Institutes Google-Like Ad Auctions
YouTube is finding new ways to generate revenue off its site. The last time I visited, I was surprised at how "pure" the experience was, surprising for a company that was bought for billions.
The new revenue model uses auctions like Google's search-word mechanism. When a YouTube user types in a search phrase, sponsored links appear. As in Google, the highest placed link is from the advertiser who bid the most for that phrase. The second highest link bid the second highest amount, and so on. And I am assuming it is a "second-price" auction, with the amount that the high bidder wins being the second highest bid, and so on.
Now I wonder what they will do to make sure that there is no copyrighted material being illegally displayed by any of the advertisers. That will create a revenue link that I think would weaken Google's defense in its copyright infringement case with Viacom.
The new revenue model uses auctions like Google's search-word mechanism. When a YouTube user types in a search phrase, sponsored links appear. As in Google, the highest placed link is from the advertiser who bid the most for that phrase. The second highest link bid the second highest amount, and so on. And I am assuming it is a "second-price" auction, with the amount that the high bidder wins being the second highest bid, and so on.
Now I wonder what they will do to make sure that there is no copyrighted material being illegally displayed by any of the advertisers. That will create a revenue link that I think would weaken Google's defense in its copyright infringement case with Viacom.
Bye, Bye TARP
Has Hank Paulson lost all or merely most of his credibility?
Quotes from his statement today:
"Over these past weeks we have continued to examine the relative benefits of purchasing illiquid mortgage-related assets. Our assessment at this time is that this is not the most effective way to use TARP funds, but we will continue to examine whether targeted forms of asset purchase can play a useful role, relative to other potential uses of TARP resources, in helping to strengthen our financial system and support lending. But other strategies I will outline will help to alleviate the pressure of illiquid assets."
OK, so TARP is not going to work out as planned, in the form of buying the mortgage-backed securities that were at the heart of the initial problem. I am on record as saying that success of this program would be measured by how much MBS they had bought 3-4 weeks into the program. As the answer, up until the AIG purchase announced this week, was ZERO, we can assess the program as pretty much of a failure. But fine. Lots of people thought it was going to be hard to figure out ways to effectively buy those MBS.
But, Paulson and Treasury have been standing by TARP for the last few weeks. Saying they were still moving forward, just taking time to work out the plans. All of a sudden...Change of plans.
Come on, at least a little more explanation than saying it "is not the most effective way to use TARP funds..." would be nice. Congress signed a bill for $700 billion of expenditure on the basis of a plan that is now not going to be implemented, and that is all the explanation we get????
But Paulson and Treasury still have $700 billion -- no, wait, $700 b. less what they have spent becoming owners of some banks and AIG -- and that spare change is obviously burning a hole in their pocket. Plus Nancy Pelosi has her sights on Michigan and the auto industry, so she is putting some pressure on them as well (TARP obviously applies to all troubled assets, and if the auto industry does not have troubled assets, who does?).
So another quote by Paulson:
"Second, we are examining strategies to support consumer access to credit outside the banking system. To date, Fed, FDIC and Treasury programs have been targeted at our banking system, and the non-bank consumer finance sector continues to face difficult funding issues. Specifically, the asset-backed securitization market has played a critical role for many years in lowering the cost and increasing the availability of consumer finance. This market is currently in distress, costs of funding have skyrocketed and new issue activity has come to a halt. Today, the illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards. This is creating a heavy burden on the American people and reducing the number of jobs in our economy. With the Federal Reserve we are exploring the development of a potential liquidity facility for highly-rated AAA asset-backed securities."
Ah. Illiquidity in the credit card receivables market is beckoning for government intervention. Because, if consumers can't borrow, obviously they can't buy anything and the economy will tank.
TARP is slipping rapidly from a program aimed at preventing systemic financial system failure as evidenced by the failure or near failure of major financial institutions to an almost Keynesian-like stimulation of the economy. Surely Paulson sees a difference between the failure of Lehman Bros., and the threat of runs on banks and near-banks like money market funds; versus "raising the cost and reducing the availability of car loans, student loans and credit cards." When the US financial system appeared to be on the brink of ceasing to function in most important ways, that was a time for major and innovative intervention, such as TARP and, maybe most important, the support by Treasury and the Fed of the commercial paper market (which money market funds rely on). But are we now just shifting to supporting credit cards and car loans so that we don't reduce the number of jobs in the economy?
Is anyone surprised that the market fell over 400 points today?
Quotes from his statement today:
"Over these past weeks we have continued to examine the relative benefits of purchasing illiquid mortgage-related assets. Our assessment at this time is that this is not the most effective way to use TARP funds, but we will continue to examine whether targeted forms of asset purchase can play a useful role, relative to other potential uses of TARP resources, in helping to strengthen our financial system and support lending. But other strategies I will outline will help to alleviate the pressure of illiquid assets."
OK, so TARP is not going to work out as planned, in the form of buying the mortgage-backed securities that were at the heart of the initial problem. I am on record as saying that success of this program would be measured by how much MBS they had bought 3-4 weeks into the program. As the answer, up until the AIG purchase announced this week, was ZERO, we can assess the program as pretty much of a failure. But fine. Lots of people thought it was going to be hard to figure out ways to effectively buy those MBS.
But, Paulson and Treasury have been standing by TARP for the last few weeks. Saying they were still moving forward, just taking time to work out the plans. All of a sudden...Change of plans.
Come on, at least a little more explanation than saying it "is not the most effective way to use TARP funds..." would be nice. Congress signed a bill for $700 billion of expenditure on the basis of a plan that is now not going to be implemented, and that is all the explanation we get????
But Paulson and Treasury still have $700 billion -- no, wait, $700 b. less what they have spent becoming owners of some banks and AIG -- and that spare change is obviously burning a hole in their pocket. Plus Nancy Pelosi has her sights on Michigan and the auto industry, so she is putting some pressure on them as well (TARP obviously applies to all troubled assets, and if the auto industry does not have troubled assets, who does?).
So another quote by Paulson:
"Second, we are examining strategies to support consumer access to credit outside the banking system. To date, Fed, FDIC and Treasury programs have been targeted at our banking system, and the non-bank consumer finance sector continues to face difficult funding issues. Specifically, the asset-backed securitization market has played a critical role for many years in lowering the cost and increasing the availability of consumer finance. This market is currently in distress, costs of funding have skyrocketed and new issue activity has come to a halt. Today, the illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards. This is creating a heavy burden on the American people and reducing the number of jobs in our economy. With the Federal Reserve we are exploring the development of a potential liquidity facility for highly-rated AAA asset-backed securities."
Ah. Illiquidity in the credit card receivables market is beckoning for government intervention. Because, if consumers can't borrow, obviously they can't buy anything and the economy will tank.
TARP is slipping rapidly from a program aimed at preventing systemic financial system failure as evidenced by the failure or near failure of major financial institutions to an almost Keynesian-like stimulation of the economy. Surely Paulson sees a difference between the failure of Lehman Bros., and the threat of runs on banks and near-banks like money market funds; versus "raising the cost and reducing the availability of car loans, student loans and credit cards." When the US financial system appeared to be on the brink of ceasing to function in most important ways, that was a time for major and innovative intervention, such as TARP and, maybe most important, the support by Treasury and the Fed of the commercial paper market (which money market funds rely on). But are we now just shifting to supporting credit cards and car loans so that we don't reduce the number of jobs in the economy?
Is anyone surprised that the market fell over 400 points today?
Monday, November 10, 2008
American Express Becomes a Bank
AMEX, issuer of my favorite credit card, has been approved by the Fed to become a bank holding company. AMEX follows Morgan Stanley and Goldman Sachs on this road -- supposedly the road to a lower cost and more stabele source of funding.
I have heard several people say that one of the causes of the current crisis was the repeal of the Glass Steagall Act that prohibited commercial and investment banking being done in the same firm.
So let's see: Bear Stearns, Merrill, and Lehman, the three firms that fell, were pure investment banks (no commercial bank status). Citigroup and JP Morgan (Chase) are firms that combined investment and commercial banking and did not fail.
And now we have two of the remaining investment banks taking advantage of an open window to becoming banks, and even AMEX doing the same. They seem to think that stability comes from combining both activities.
Hmmm.....
I have heard several people say that one of the causes of the current crisis was the repeal of the Glass Steagall Act that prohibited commercial and investment banking being done in the same firm.
So let's see: Bear Stearns, Merrill, and Lehman, the three firms that fell, were pure investment banks (no commercial bank status). Citigroup and JP Morgan (Chase) are firms that combined investment and commercial banking and did not fail.
And now we have two of the remaining investment banks taking advantage of an open window to becoming banks, and even AMEX doing the same. They seem to think that stability comes from combining both activities.
Hmmm.....
Where Does Obama Stand on Vouchers?
The Obama family is checking out private schools in Washington, DC for their children. Most of us who could afford to send our children to private schools would do the same. The Clintons did so. Probably the vast bulk of Congress' kids who live in the DC area go to private schools.
The problem is that many of those same politicians will not support voucher programs that would allow middle- and lower-income families to take advantage of the better private schools. If you want to empower people, what could be stronger than letting them decide where to send their kids to school (without having to pay twice that is, once in state and local taxes and once in tuition).
Where does Obama stand on this? At one point, he seemed to be more open than the typical Democrat. Later reports suggest that the Democratic NEA establishment has gotten to him. Too bad. This would be a great chance to show some real change.
The problem is that many of those same politicians will not support voucher programs that would allow middle- and lower-income families to take advantage of the better private schools. If you want to empower people, what could be stronger than letting them decide where to send their kids to school (without having to pay twice that is, once in state and local taxes and once in tuition).
Where does Obama stand on this? At one point, he seemed to be more open than the typical Democrat. Later reports suggest that the Democratic NEA establishment has gotten to him. Too bad. This would be a great chance to show some real change.
Wednesday, November 05, 2008
Another Cause for Celebration
Massachusetts decriminalized marijuana possession! Finally some comon sense prevails. How about legalization, with a nice alcohol/tobacco type tax? Think of the revenues, and the stimulus to agriculture in states like California and Washington!
Congratulations Obama! (And the Dartmouth Reaction)
Well, it is indeed an historic moment. The passing of an administration that has been in charge for 8 years, a whole new agenda coming in, and of course the first African American President. One cannot help but be somewhat amazed and certainly excited.
I think for young people the election of Obama is really meaningful. Here is a story I heard this morning that really makes me reflect on the great side of this election.
At around 1230 am this morning, a Hanover resident heard a loud roar coming from town. He got on his bike (!) and rode in, to find several hundred Dartmouth students outside President Wright's house, celebrating. President Wright came out and gave an impromptu few words. The students went on to the Green, where they continued their joyous celebration by singing the national anthem.
That story should inspire anyone!
Obama has a great opportunity. He has great leadership capability, and he has a pretty strong mandate for change, winning more than 50% of the vote. With any luck at all, we are at the bottom of the financial crisis and while unemployment will be creeping up for some time to come, the economy should turn around well before the midpoint of Obama's first term. The US should be able to exit Iraq, with honor and leaving a country that has good economic and political prospects.
I only hope that he and his advisors take advantage of these events to make the country stronger, economically, socially and politically. I would love to see a major revision of the tax code, especially a fix to the AMT. I suspect someone should take a hard look at military expenditures and especially our intelligence services. How about some sense to the nation's drug laws? Energy policy could certainly be improved, but let's not do it by economic engineering, e.g., having folks in Washington decide which alternative energy sources should get subsidies.
I think for young people the election of Obama is really meaningful. Here is a story I heard this morning that really makes me reflect on the great side of this election.
At around 1230 am this morning, a Hanover resident heard a loud roar coming from town. He got on his bike (!) and rode in, to find several hundred Dartmouth students outside President Wright's house, celebrating. President Wright came out and gave an impromptu few words. The students went on to the Green, where they continued their joyous celebration by singing the national anthem.
That story should inspire anyone!
Obama has a great opportunity. He has great leadership capability, and he has a pretty strong mandate for change, winning more than 50% of the vote. With any luck at all, we are at the bottom of the financial crisis and while unemployment will be creeping up for some time to come, the economy should turn around well before the midpoint of Obama's first term. The US should be able to exit Iraq, with honor and leaving a country that has good economic and political prospects.
I only hope that he and his advisors take advantage of these events to make the country stronger, economically, socially and politically. I would love to see a major revision of the tax code, especially a fix to the AMT. I suspect someone should take a hard look at military expenditures and especially our intelligence services. How about some sense to the nation's drug laws? Energy policy could certainly be improved, but let's not do it by economic engineering, e.g., having folks in Washington decide which alternative energy sources should get subsidies.
Friday, October 31, 2008
Mortgage Servicer Proposal
There is no shortage of proposals by thoughtful people on how to get out of this financial/economic mess the world finds itself in. I do hope that we see the Treasury moving forward on its original plan to buy up a good chunk of the mortgage backed securities. I want to see the Treasury make some money in this market!
John Geanakoplos and Susan Koniak have an interesting oped in the New York Times today, addressing the role of the master servicer in mortgage pools.
I have been saying for some time that the incentives of the servicing organizations are key to how homeowners in default are treated. And that the terms of the mortgage trust that bought the mortgages, appointed the servicer, and sold the mortgage backed securities are the determining factors. The NYT piece argues, albeit with a lack of specificity, that the servicers are loath to renegotiate with homeowners in arrears as it will benefit some MBS owners and hurt others. I wish they had given some examples of how that would happen. If there had been only one class/tranche of MBS created, then the incentives of all would be aligned: renegotiation might make sense, say by lowering the interest rate in return for a higher likelihood of principal repayment. But with differing classes of security holders, conflicts will exist. The higher tranches won’t want to lower interest rates for a higher likelihood of repayment of principal, as they are first in line for both interest and principal. Also, there were triggering events in a lot of these pools that will benefit the higher tranches if they occur – so avoiding those events might not be in the higher tranches’ interests.
I am not sure I agree with the authors’ proposal for government-appointed trustees. No, wait, I am SURE I don’t like that proposal. What I could see working would be some legislation to change the terms of the mortgage pool contracts, or at least to give the servicers some indemnification from lawsuits.
John Geanakoplos and Susan Koniak have an interesting oped in the New York Times today, addressing the role of the master servicer in mortgage pools.
I have been saying for some time that the incentives of the servicing organizations are key to how homeowners in default are treated. And that the terms of the mortgage trust that bought the mortgages, appointed the servicer, and sold the mortgage backed securities are the determining factors. The NYT piece argues, albeit with a lack of specificity, that the servicers are loath to renegotiate with homeowners in arrears as it will benefit some MBS owners and hurt others. I wish they had given some examples of how that would happen. If there had been only one class/tranche of MBS created, then the incentives of all would be aligned: renegotiation might make sense, say by lowering the interest rate in return for a higher likelihood of principal repayment. But with differing classes of security holders, conflicts will exist. The higher tranches won’t want to lower interest rates for a higher likelihood of repayment of principal, as they are first in line for both interest and principal. Also, there were triggering events in a lot of these pools that will benefit the higher tranches if they occur – so avoiding those events might not be in the higher tranches’ interests.
I am not sure I agree with the authors’ proposal for government-appointed trustees. No, wait, I am SURE I don’t like that proposal. What I could see working would be some legislation to change the terms of the mortgage pool contracts, or at least to give the servicers some indemnification from lawsuits.
A Republican Halloween?
I was afraid that the signs in my front yard would deter trick or treaters, but that doesn't seem to be the case -- all kinds of little munchkins showing up right now! I also wonder if the signs will make it through the night. Last election, I did have my Bush signs thrown in the bushes.
One little girl was dressed up as Palin, an amazing costume. Very cute.
Saturday, October 25, 2008
Oil Demand Elasticity
Some data on oil price elasticity are starting to arrive.
Gasoline demand in the US has fallen relative to year-earlier numbers for 26 consecutive weeks, with demand last week being 6.4% below the same week last year.
According to the EIA, and as reported by Forbes, US petroleum product demand fell in the last four-week period by 8.5% relative to the same four-week period last year.
Not sure what percent change in price to use to calculate a rough elasticity. If we use a 100% change in price, which is excessive, we get an elasticity of -.085 which is not too bad. I have always thought that an elasticity of -.20 was reasonable for a period of 2-3 years. I expect we are to see more "demand destruction" even though prices have come way down -- and many of these changes will be irreversible.
Some people might say that we are not observing price elasticity but income elasticity -- as the economy slows, oil demand drops. To some extent this is true -- to the extent that the slowing economy is due to non-oil factors. But we should expect some of the demand reductions to show up as GDP decreases. That is, some economic activity is no longer undertaken at high oil prices, and that shows up as a reduction in GDP. The decline in demand for oil should be attributed in that case to price increases, not to income falling.
Gasoline demand in the US has fallen relative to year-earlier numbers for 26 consecutive weeks, with demand last week being 6.4% below the same week last year.
According to the EIA, and as reported by Forbes, US petroleum product demand fell in the last four-week period by 8.5% relative to the same four-week period last year.
Not sure what percent change in price to use to calculate a rough elasticity. If we use a 100% change in price, which is excessive, we get an elasticity of -.085 which is not too bad. I have always thought that an elasticity of -.20 was reasonable for a period of 2-3 years. I expect we are to see more "demand destruction" even though prices have come way down -- and many of these changes will be irreversible.
Some people might say that we are not observing price elasticity but income elasticity -- as the economy slows, oil demand drops. To some extent this is true -- to the extent that the slowing economy is due to non-oil factors. But we should expect some of the demand reductions to show up as GDP decreases. That is, some economic activity is no longer undertaken at high oil prices, and that shows up as a reduction in GDP. The decline in demand for oil should be attributed in that case to price increases, not to income falling.
Simply Incredible Price Volatility
Oil was at $147 per barrel in July of this summer. On Friday, about three months later, it was at $64.
The Canadian dollar, one year ago, bought more than one US dollar. On Friday, the US dollar bought 1.28 loonies.
This is incredible volatility, and to be honest, is quite hard to explain on the basis of fundamentals.
I was predicting for a long time that oil prices were too high, and that the economic forces of demand cutbacks and supply increases would bring us back from the skyhigh levels we were seeing. But the price went much higher than I would have anticipated, and it took a long time for the price to peak and start falling. Then once it started falling, it just has not stopped.
Either the price significantly overshot in the last year or it is now seriously undershooting -- or, very possibly, both.
Could it be that investment flows from hedge funds and general investors caused this incredible volatility? Or is it just that given the uncertainties in the world at this time, value is so hard to pin down? It is still true that oil demand and supply are both very inelastic, so in a sense you can have prices move a lot and not be too far away from equilibrium in regard to quantity.
Whatever the reasons, it is hard to make investments in alternative energy, or in oil production, given the volatility. As with the credit crisis, financial market turmoil has real effects.
The Canadian dollar, one year ago, bought more than one US dollar. On Friday, the US dollar bought 1.28 loonies.
This is incredible volatility, and to be honest, is quite hard to explain on the basis of fundamentals.
I was predicting for a long time that oil prices were too high, and that the economic forces of demand cutbacks and supply increases would bring us back from the skyhigh levels we were seeing. But the price went much higher than I would have anticipated, and it took a long time for the price to peak and start falling. Then once it started falling, it just has not stopped.
Either the price significantly overshot in the last year or it is now seriously undershooting -- or, very possibly, both.
Could it be that investment flows from hedge funds and general investors caused this incredible volatility? Or is it just that given the uncertainties in the world at this time, value is so hard to pin down? It is still true that oil demand and supply are both very inelastic, so in a sense you can have prices move a lot and not be too far away from equilibrium in regard to quantity.
Whatever the reasons, it is hard to make investments in alternative energy, or in oil production, given the volatility. As with the credit crisis, financial market turmoil has real effects.
Wednesday, October 15, 2008
That Great Cooling Sound
Listen carefully, and you will hear the sound of the mainstream media reporting on record cold temperatures and Alaskan glaciers growing for the first time in 200 years.
Hmmm......
On second thought, maybe you won't hear anything at all.
No, the recent data do not fall into line with accepted wisdom, so don't expect to hear about it.
Hmmm......
On second thought, maybe you won't hear anything at all.
No, the recent data do not fall into line with accepted wisdom, so don't expect to hear about it.
Monday, October 13, 2008
Moral Hazard
With McCain and Obama fighting to come up with the best plan for giving homeowners relief, especially in the form of forbearance on defaults, I wonder why anyone rational would keep up their mortgage payements?
Equity Stakes vs. Buying Bad Assets
There are a lot of policy options being considered, but the two big alternatives are buying equity stakes in banks vs. the original idea of buying bad assets from the banks, predominantly mortgage-backed securities.
Judging from the huge increase in stock prices today, it seems that the market prefers the equity injection (if there was any news today, it was about that -- and the Morgan Stanley deal).
I understand the basic rationale there, that with the normal 10 to 1 leverage of banks, an injection of $100 of equity can support $1000 of new loans.
But will that additional equity be used for new lending, or will it go to just shore up cash on the balance sheet and/or pay off some existing debt? Given the risk aversion of banks right now, who is to say that they won't just buy more Treasury bills with the new cash?
I still like the buying of mortgage assets for four main reasons:
1. It goes to the heart of the original problem, which is uncertain value of banks' assets, and that has caused interbank lending to fall off.
2. It directly removes risk from the banks' balance sheets and thereby stands a good chance of increasing lending.
3. If done by auctions, it will establish prices for all assets in the same class, creating a spillover benefit that helps us sort out good banks from bad banks, even for banks that do not sell any assets.
4. And it still gets cash onto banks' balance sheets, that can be used for new loans.
Of course, these two options are only mutually exclusive in that the Treasury only has $700 billion to play with. Perhaps they will do some of both.
Judging from the huge increase in stock prices today, it seems that the market prefers the equity injection (if there was any news today, it was about that -- and the Morgan Stanley deal).
I understand the basic rationale there, that with the normal 10 to 1 leverage of banks, an injection of $100 of equity can support $1000 of new loans.
But will that additional equity be used for new lending, or will it go to just shore up cash on the balance sheet and/or pay off some existing debt? Given the risk aversion of banks right now, who is to say that they won't just buy more Treasury bills with the new cash?
I still like the buying of mortgage assets for four main reasons:
1. It goes to the heart of the original problem, which is uncertain value of banks' assets, and that has caused interbank lending to fall off.
2. It directly removes risk from the banks' balance sheets and thereby stands a good chance of increasing lending.
3. If done by auctions, it will establish prices for all assets in the same class, creating a spillover benefit that helps us sort out good banks from bad banks, even for banks that do not sell any assets.
4. And it still gets cash onto banks' balance sheets, that can be used for new loans.
Of course, these two options are only mutually exclusive in that the Treasury only has $700 billion to play with. Perhaps they will do some of both.
Saturday, October 11, 2008
The Fundamentals of Value
The Dow is off about 33% in one year, with 20% of that coming in the last couple weeks.
I've been looking around for evidence that we have lost a third of our labor force, but that doesn't seem to have happened (in fact, labor supply has now increased tremendously, as some of our most productive workers decide they can't retire quite yet). And I looked to see if a hurricane or some kind of natural disaster destroyed a third of our capital base. Nope, nothing like that either. Not even a bad Supreme Court decision that would impact our still-strong legal regime of markets and private property.
Folks tell me that stock valuations are down because of fear that corporate earnings will be low.
Anyone who has done a discounted cash flow valuation of a company should be deeply disturbed by what is going on. In a typical valuation, with say 5 years of explicitly forecasted cash flows and then a perpetuity at the end, upwards of 75% of the total value will derive from the perpetuity value. Said differently, the first five years of cash flow make up only 1/4 of the total value of the company.
As an example: Suppose we have a very simple company that produces $10 of cash per year forever, and that the appropriate discount rate is 10%. The value of the company is then $100. Note this is a weird company, with no growth at all -- more like a bond than a company. Suppose a nasty recession next year is forecast to take the first year of cash flow away entirely. Wow -- the value of the company falls to $91. An even nastier recession is forecast, with no cash flows for two whole years -- and value falls to $83.
And bear in mind that in our real world, we are not looking at losing even one year of earnings, just lower earnings.
Folks also say that capital constraints will prevent companies from taking advantage of growth opportunities. That might be true for the short run. But are these growth opportunities going to disappear entirely? Doubtful. They will wait for capital constraints to release.
There have to be some real good deals out there right now. For instance, you could buy GM for about $3 billion. That's right, you can own all of General Motors for the low price of 3 billion dollars. One of the two largest auto manufacturers in the world, with a franchise in Europe that is to die for, and a great stake in Asia as well. And not exactly chopped liver in the US, especially if you get off the two coasts and get into the good old heartland, where folks still like to drive Chevys.
What a sale that is! KKR could write a check for $3 billion without even checking to make sure they have that much in their checkbook.
Sure, GM has some liabilities, and they have a lot of debt outstanding. But just think of the option value on that equity.
I've been looking around for evidence that we have lost a third of our labor force, but that doesn't seem to have happened (in fact, labor supply has now increased tremendously, as some of our most productive workers decide they can't retire quite yet). And I looked to see if a hurricane or some kind of natural disaster destroyed a third of our capital base. Nope, nothing like that either. Not even a bad Supreme Court decision that would impact our still-strong legal regime of markets and private property.
Folks tell me that stock valuations are down because of fear that corporate earnings will be low.
Anyone who has done a discounted cash flow valuation of a company should be deeply disturbed by what is going on. In a typical valuation, with say 5 years of explicitly forecasted cash flows and then a perpetuity at the end, upwards of 75% of the total value will derive from the perpetuity value. Said differently, the first five years of cash flow make up only 1/4 of the total value of the company.
As an example: Suppose we have a very simple company that produces $10 of cash per year forever, and that the appropriate discount rate is 10%. The value of the company is then $100. Note this is a weird company, with no growth at all -- more like a bond than a company. Suppose a nasty recession next year is forecast to take the first year of cash flow away entirely. Wow -- the value of the company falls to $91. An even nastier recession is forecast, with no cash flows for two whole years -- and value falls to $83.
And bear in mind that in our real world, we are not looking at losing even one year of earnings, just lower earnings.
Folks also say that capital constraints will prevent companies from taking advantage of growth opportunities. That might be true for the short run. But are these growth opportunities going to disappear entirely? Doubtful. They will wait for capital constraints to release.
There have to be some real good deals out there right now. For instance, you could buy GM for about $3 billion. That's right, you can own all of General Motors for the low price of 3 billion dollars. One of the two largest auto manufacturers in the world, with a franchise in Europe that is to die for, and a great stake in Asia as well. And not exactly chopped liver in the US, especially if you get off the two coasts and get into the good old heartland, where folks still like to drive Chevys.
What a sale that is! KKR could write a check for $3 billion without even checking to make sure they have that much in their checkbook.
Sure, GM has some liabilities, and they have a lot of debt outstanding. But just think of the option value on that equity.
Wednesday, October 08, 2008
Two Paradoxes: Interbank Lending, Commercial Paper
The talk is that the interbank lending market has frozen. Rates for overnight borrowing are around 5.4%, much higher than the Federal Reserve's discount rate, which is at 1.75%. Paradox: why would anyone borrow in the private market rather than from the Fed?
Second paradox is commercial paper, another market that is supposedly freezing up. Volume is down signficantly, true, you can see that in Federal Reserve data. But rates are not very high, say 3% for 3 month paper. Those data seem more consistent with a drop in supply of commercial paper rather than a drop in demand to hold. If demand to hold paper were low, then volume would go down but rates would go up.
There is a theory to reconcile these paradoxes, I think. And it reinforces the general idea that incomplete and asymmetric information is driving a lot of the patterns in all the markets.
Let me use loosely, as we sometimes do in our models, the idea of "good" banks and "bad" banks.
In the interbank market, the good banks -- those who know they are solvent -- will borrow from the Fed. The bad banks don't want to undergo the examination that I believe they will get from the Fed if they show up at the discount window. So they go to the interbank market and get charged an appropriate risk adjusted rate. And there is not much lending going on in that market, with credit being rationed on the basis of knowing that a counterparty is of decent risk.
A similar idea explains the commercial paper market -- essentially a credit rationing story. Only the best credit risks can sell their commercial paper. And they get a reasonable rate charged -- around 3%. The worse risks just cannot sell any paper at all. So the rate we see in this market is low, but that is because we are seeing only the best risks using the market.
So the Fed is stepping in to both markets, trying to get reserves to even the bad banks, and letting the marginal borrowers still access the commercial paper market.
Second paradox is commercial paper, another market that is supposedly freezing up. Volume is down signficantly, true, you can see that in Federal Reserve data. But rates are not very high, say 3% for 3 month paper. Those data seem more consistent with a drop in supply of commercial paper rather than a drop in demand to hold. If demand to hold paper were low, then volume would go down but rates would go up.
There is a theory to reconcile these paradoxes, I think. And it reinforces the general idea that incomplete and asymmetric information is driving a lot of the patterns in all the markets.
Let me use loosely, as we sometimes do in our models, the idea of "good" banks and "bad" banks.
In the interbank market, the good banks -- those who know they are solvent -- will borrow from the Fed. The bad banks don't want to undergo the examination that I believe they will get from the Fed if they show up at the discount window. So they go to the interbank market and get charged an appropriate risk adjusted rate. And there is not much lending going on in that market, with credit being rationed on the basis of knowing that a counterparty is of decent risk.
A similar idea explains the commercial paper market -- essentially a credit rationing story. Only the best credit risks can sell their commercial paper. And they get a reasonable rate charged -- around 3%. The worse risks just cannot sell any paper at all. So the rate we see in this market is low, but that is because we are seeing only the best risks using the market.
So the Fed is stepping in to both markets, trying to get reserves to even the bad banks, and letting the marginal borrowers still access the commercial paper market.
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