Financial Speculation by jose Roncal
August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
Before you read any farther, let's start with a little background on the term securitization and how it's evolved to the present times. If you click the link toInsightful Articles and read the item entitled Wall Street's Shadow Market, you'll get a basic understanding of exactly what securitization means. It also points out how the misuse of securitization created the whole ugly economic mess we find ourselves in today.
There was a time when virtually all of the money lent to households originated with banks and other lending institutions. Lenders knew their borrowers and had ongoing dialogues with them, whether they were big companies or individual account holders. Just picture the scene from It's a Wonderful Life to get a sense of this relationship.
But over the last five or six years more than half of the money loaned has come from the securitization market. Since financial institutions have the ability to originate loans, they also have the ability to package and sell those loans to others. So they began to take their assets, many of which were "toxic" home mortgages, and, through the securitization process, create what appeared to be attractive investment packages for pension funds and other types of institutional investors.
Securitization became a tool that very efficiently enabled the flow of capital from end investors back to the borrowers who genuinely needed the money. Ironically, it was the very success of the securitization products that caused investors to assume that these complex structures—which involved a plethora of players in different roles creating something no one really understood—were put together by credible, honest and diligent professionals.
The securitization process did work very well for the most part, until chaos ensued. The more murky things got, the more the system was abused and the more financial hardship was brought to investors and to the underlying financial institutions. In fact, in this week's news it was reported that more than 150 publicly traded U.S. lenders now own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.
The public had taken it for granted that all the players, the brokers, the investment houses, the lending institutions, regulators, and everyone involved in the process knew what they were doing, and more importantly, that each player knew what all the others were doing. But clearly, that was not the case.
Even the rating agencies played a role in the ruse, making profits by over-rating investments they knew had a high probability for failure. In the case of subprime debt, when it was discovered that billions of dollars were funneled into these rating agencies, it created a huge crack in the foundation of trust and Wall Street started to crumble.
Securitization in and of itself is not the problem; it was the abuse that created a great mistrust and stymied the markets. That's why it's so important for regulators to do whatever is necessary to restore credibility to the process so that investors will feel confident to begin investing again.
We have to recreate an environment where investors can evaluate the risk and have relative confidence that their analysis of the risk is consistent with the potential performance of the underlying investment. A responsible investment needs enough transparency to allow investors to evaluate the risk. Recently, however, investors have been misled.
Naturally, no investment is risk-free. If you read our bookThe Big Gamble, there can be no doubt left about that fact.
Meanwhile, how do we get the markets restored and money flowing again? We believe the markets can be recreated with a higher degree of discipline on the part of each of the players. And that includes the regulators themselves who didn't blow the whistle or notice the things that were going wrong. Big change is called for, but let's not throw securitization out of the process.
The Solution – More Securitization
Even with the so-called TARP funds, there's no possibility of the government, i.e. the tax payers, putting enough capital into banks to allow them to support the high demand for borrowing. What is needed is to restore the practice of securitizations in an honest forthright manner.
The role of government might best be served, not by providing more funds, but by taking the lead in designating a securitization structure that covers the full range of stakeholders in the process, one that provides more transparency and puts the investors' interest out in front. We are not saying that Wall Street bonuses and incentives are bad; they are necessary. But no more rewards for blatant manipulation and dishonesty.
There are three important elements that should be considered while recreating the markets: simplicity, transparency, and fairness. The final goal should be to allow borrowers to get credit on fair terms and to make it possible for investors to truly evaluate the inherent risks before investing.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
You've probably read all the flack over this week's cover on Newsweek magazine—"The Recession is Over," with an added footnote reading, "good luck surviving the recovery." The message implies that leading indicators say the recession is nearing an end, but that the recovery is likely to be a long slow process.
End of Recession or not, there are still plenty of distressed businesses that are teetering on the brink of collapse. With my years of experience as a transformational and corporate turnaround specialist, I've noticed that those possessing similar skills are suddenly in high demand and positioned to ride out this perfect storm. In fact, I can't recall a time when these services and expertise were in greater demand.
Even as the economy tries to recover, we are still facing tight credit markets and bankruptcies continue to rise. Private equity is turning its back on traditional leveraged deals and looking toward investing in distressed companies.
I believe that many of the private equity deals that occurred in 2006 and 2007—those with weak covenants and too much debt—will go belly up in the next few years. How will it all play out? Cash usually isn't available to leverage these kinds of distressed situations and with the lack of bankruptcy credit, I predict that many of these restructurings will take place outside of bankruptcy court and end in rapid liquidation.
It is easier to do an out-of-court deal for a company that only has one or two major lenders versus one with widely syndicated credit. The sheer volume and complexity of these deals makes it virtually impossible to navigate through all of the court system's cases in a reasonable amount of time. That translates to ample opportunities for turnaround specialists.
But turnarounds are not like traditional buyouts where the companies still have positive cash flow, so these opportunities are fraught with huge challenges. Most of the distressed companies have CEOs and top management execs that aren't up to the task and need to be replaced with new capable leadership. Sometimes it requires a total housecleaning right down to the floor managers.
Then there is the problem of determining value given the fact that prices have fallen, and since there are no crystal balls, nobody knows where the bottom lies. Turnaround specialists must be both big picture visionaries and sticklers for accounting details.
Falling product and services demand is another problem. Vendors are no longer willing to give customers extensions on credit. For instance giant Circuit City went down surprisingly fast because vendors pulled the plug.
The whole equity industry has undergone some dramatic shifts. In the recent past, high-risk takers like hedge funds would simply step in and buy up the debt from troubled companies. Those were quick short-term solutions that didn't end well. For the time being, those risky-fix days are over.
I believe that the future of private equity finance will be more focused on the long term—with an investment horizon of five to eight years rather than the previous three to five years. Banks are having to exercise more patience now because even if we see an economic recovery in two or three years, the after effects of the downturn may take five to seven years to work it's way back to complete equilibrium given the weak financial markets.
There isn't a lot of good news in this recession, but it does tend to eliminate the weakest of the private equity firms and leave greater opportunity for those that survive. There will be fewer players in the long run, and more opportunity for highly qualified people that specialize in turnarounds.
When I'm not engaged in corporate restructuring and helping companies get back on their feet, I'm busy writing about the economy and a wide variety of financially related matters.
You can read more by choosing from our Main Menu links on the left or check out our recent book, The Big Gamble: Are You Investing or Speculating.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
Last fall we wroteConsumer Debt in the U.S., an extensive report on the state of credit debt in the U.S. We've also written about the credit crunch in our bookThe Big Gamble. There is valuable background information in these reports, but with so many recent changes in the news, we thought it was time to give you an update.
What has changed?
The severe economic downturn has changed the rules about those little plastic cards we carry in our wallets: credit-happy consumers have curtailed their binge spending, government regulators are tightening the standards, and credit card companies are having to re-evaluate their business models and soon will have to be more transparent about their practices.
The reasons for the decline in credit card use are all interlinked. First, credit card issuers got hit with a rising default rate—up to 8% or double the figure in 2006. That caused companies to set stricter standards making it harder for borrowers to get additional credit. At the same time consumers have become more cautious about taking on more debt because of concerns over job loss, declining home values and evaporating retirement funds.
We are all too familiar with these facts, but there's one aspect in this picture that isn't reported much: securitized credit card debt. That means packaging and selling credit card debt just like Wall Street did with mortgage-backed securities. For a little refresher on what that means, see our report entitledGet Ready for Another Crisis: The Coming Credit Card Debt Meltdown, especially on the third page under the subhead: Under the radar: Packaged credit card debt.
The securitized debt backed by credit card receivables was a whopping $915 billion industry. Who bought this debt? Pension funds and institutional investors, among others. When banks package and sell card debt, they pass some of the default risk along to investors. Yet, banks were pocketing much of the profit from rate and fee increases on those accounts. Imposing higher fees on more accounts—without an equal rise in risk—means banks were raising revenue at investors' expense.
Securitization was a major impetus for banks to expand penalty fees and rates in recent years. This increased the default rate and led to big losses for investors. It eventually unraveled the whole game—just as delinquencies in the housing market brought down the $900 billion market in mortgaged-backed securities.
These practices had been a major platform in the financial infrastructure and helped set the pace for widespread use of credit cards. But the current financial collapse has made it impossible to securitize credit card debt.
Looking back
Since 1958, back when the first credit card was issued, the industry has grown to nearly $1 trillion in revolving outstanding credit on more than 700 million U.S. credit card accounts. At the same time, the savings rate was on a steady decline.
But in May of this year, the savings rate hit a 15-year high of 6.9%, due in part to the one-time federal stimulus checks mailed in 2008, and partly due to consumer fears we've already mentioned.
Looking ahead
As we look forward, we think the future for the credit card industry will depend on what happens in the broader economic picture. Access to credit will increase a bit as the recession eases, but the mind-set of the borrower may be harder to change. The renewed compulsion for the lost art of frugality and the urge to beef up savings accounts are natural responses after having suffered through the shock of loss. But since up to 70% of the U.S. economy hinges on consumer spending, this renewed penchant for saving could actually create a drag on the recovery.
On the upside, the increased savings could eventually be used to fund new innovative startups, create new jobs and stimulate a surge of economic growth—though that's more of a long-range outlook.
In the short-term, credit cards and debt are probably not going away. The simple and habitual swipe of a plastic card makes transaction processing faster and more convenient. The growth surge may be over, but credit cards are still ubiquitous.
Meanwhile, the reforms set by the Obama administration could bring a little relief when they go into law in February 2010. The Credit Card Accountability, Responsibility and Disclosure Act is designed to end some of the deceptive tactics that credit card companies have been using for years. Since the average balance on close to half of all Americans is more than $7,000, the changes could benefit many consumers.
What are the changes?
•Billing statements will have to reveal exactly how long it would take to pay off the balance if the cardholder only makes minimum monthly payments.•Statements will be mailed 21 days before due date rather than 14 days.•There must be a 45-day advance notice of any changes to terms and conditions.•No rate increases will be permitted on existing balances unless consumers are at least 60 days late, or the initial rate was a promotional rate that has expired, and this scenario would still be required the 45 day notice as shown above.•Promotional rates will have to be valid for 6 months.•No more payment processing fees, such as surcharges for paying by telephone.•Can no longer impose penalties for late payments to another card company.•Payments will be applied to the portion of the balance with the highest rat
These changes will undoubtedly ease the burden for those with high debt. But creditworthy cardholders who are prudent and live within their means—"deadbeats” in industry parlance, because they generate negligible fee revenue—these customers will become the new targets of the industry and could see perks disappear and the imposition of, or a hike in, annual fees.
If these are the new rules, we have to ask, " In a society where paying with plastic has become a necessity rather than a luxury, can fees on all of our debit card transactions be far behind?"
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
That's the question we wish we could have posed to scores of individuals before they unwittingly put their trust in Ponzi schemer, Bernie Madoff. On June 29, when the judge handed down a sentence of 150 years, Madoff's victims no doubt experienced a healthy dose of Schadenfreude—that sense of pleasure one gets from the misfortunes of somebody else, especially if that somebody else was guilty of meting out misfortune on so many others.
Madoff received a penalty six times greater than those imposed on the chief executives of WorldCom Inc. and Enron Corp. But even the extreme sentence of 150 years, coupled with a sense of justice having been served, will not compensate for the millions lost in personal savings. In what will likely be remembered as a swindle of epic proportions, the losses could potentially reach $65 billion in both real and phantom investments.
Who's to blame? The perpetrator and his cohorts alone, or should some of the responsibility for this fiasco be placed on the shoulders of those who blindly went along with greed as the underlying motivator? What ever happened to that old axiom about something being too good to be true? How did so-called investors think they could continue to reap double-digit growth year after year without ever having received a single printed monthly statement or confirmation of how their money was being spent? Who is to blame for accepting such outright questionable financial dealings sight unseen?
That brings us back to our original question, "Are You Investing or Speculating?" the tagline in the title of our book, The Big Gamble. In the current economic crisis, the word speculation is not a popular one. Speculators, hedge funds, and most of Wall Street's elite are seen as the evil-doers responsible for the demise of the financial system.
When people expect safety and a reasonable level of assurance that their money will reap returns, the word speculation never enters their vocabulary. In our book we contend that when you examine the difference between investing, speculating and gambling, the bottom line is that it's all speculation. But most importantly, we stress that speculation, in and of itself, is not a bad thing.
First of all, let's not confuse speculation with manipulation. When the Madoffs of the world cheat and scheme, that's manipulation. When a scammer tries to pump and dump a stock, it's manipulation. When governments regulate prices so that they interfere with the free market law of supply and demand, that's also manipulation.
Manipulation for personal or political gain is illegal and should be punished. But speculation is something different. We believe that speculation, when it's well thought out, is good for both individuals and economies. Stock speculation and trading play vital roles in our economy and our lives. Trading is really just another word for speculating and investing is little more than speculating, albeit we assume it will have a longer holding period and somehow miraculously involve less risk. Speculators speculate, trader’s trade and investors invest and they all hope to make money.
Part Two of our book celebrates the kind of innovation and speculation that can grow a fledgling start-up company into an empire, and like a tide, raise all boats in the process. We describe how high-stake risk taking entrepreneurs play a pivotal role in the progress of civilization and how they bring excessive prices back into equilibrium, whether from highs or lows.
Are you a speculator? Regardless of your level of experience, we ask you to ponder these questions:
• Were you really "playing it safe" when you thought you were being conservative by investing in U.S. Treasury bills or mutual funds, General Motors, or the big financial institutions?
• Do you know the three most important characteristics you need in order to invest (actually, speculate) wisely in the financial markets?
• Are you avoiding the nine primary financial risks when building a portfolio or allocating investments in your 401(k) plan?
• Can you spot the three surefire economic signals that will show you the "next big thing" and identify potential bubbles when they are beginning to form?
We cover all of these topic and more in our book.
As we scan the current economic landscape, we believe we need more opportunities for speculation, not less. We need to allow plenty of room for risk takers to shoot for the moon. Just imagine a world in which people like Frederick Smith of Federal Express, Steve Jobs of Apple, or Larry Page and Sergey Brin of Google were just on the brink of some new breakthrough. Will venture capital or credit be available to them? How many new jobs could be created?
It's time to foster innovation and move beyond an environment in which fear robs us of the ability to take some calculated risks. So, putting aside our outrage over the Madoff scandal and looking ahead, we think the lessons you'll learn from reading The Big Gamble could give you the jump-start to help you move forward. As grim as things appear, we think there has never been a better time to start speculating on the future.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
It's a generally accepted fact that to be successful, you have to be willing to take risks. When you consider the practices of contemporary entrepreneurs like Sir Richard Branson, Frederick A. Smith, or Donald Trump, to name a few, it's hard to argue with the fact that these high-rolling risk-takers have not only realized success, they've also contributed to the economy by creating countless jobs for others.
But in today's dire financial situation, the very concept of risk-taking is taking a major beating. Who is responsible for this disaster? Was anybody minding the store? What happened to the practice of enterprise risk management (ERM)? Everybody is anxious to point fingers at somebody else, but no need to crowd folks; there's plenty of blame to go around.
With so many companies going belly up, it might appear that ERM has failed us. But we think the current financial crisis did not result from a failure of ERM, but a rather failure to properly implement the ERM process.
I've had years of experience in directing corporate turnarounds and can remember a time when Specialist Forecasting was straightforward. By the end of the first quarter, managers usually had a reasonably reliable sense of how the business was doing and whether targets were going to be met, missed or exceeded.
These were the numbers that ruled the markets. Investors placed such a high level of confidence in quarterly and annual predictions, if the numbers were off just a few points above or below projections, it was enough to create huge moves in the stock value. This year, however, things have changed. Suddenly the act of announcing projections has become a risky business, and some companies are not making any predictions about their future performance.
It's not that these firms are hesitant to provide a dismal outlook, if that's their financial situation. It's that there is so much uncertainty in the markets they can't feel confident in even making projections.
What is needed is actually very fundamental: the ability to manage risk. We now have sophisticated tools to help in managing financial risk—complex mathematical models analyze potential outcomes and probabilities, based on past performance. There has been a growing reliance on these models, yet many of them failed to predict or alert companies to the current global economic crisis. Today those that were responsible for building the models have taken the brunt of the blame for the financial meltdown.
Does this mean that the models failed? No, because models are only as good as the decisions made after reading the numbers. Even if models accurately report the extent of a potential risk, a mistake in estimating the odds of it happening can lead to a disastrous conclusion.
The current crisis should serve as a wake-up call for companies to take a long hard look at their past approaches to risk management and to start making adjustments for the future. Managers can no longer separate risks into isolated categories like operational risk, market risk, credit risk and so on. They need to have a broader view and take a more integrated approach to risk.
If you need a glaring example of what can go wrong when you isolate risk factors, consider the Wall Street trading desks. These traders were experts in managing market risk, but because they were trading instruments that were fraught with credit risk, they were blind-sighted to the impending global meltdown. It's become clear that each risk category requires it's own knowledge bank, and without an integrated team of specialists, companies are vulnerable to major problems.
How do you identify and avoid risk or use it to your advantage? We cover this topic in great detail in our book, The Big Gamble: Are You Investing or Speculating. Chapter two, entitled Risk: The Oxygen of Finance, covers the history of risk and the psychology of risk, as well as the various categories of financial risk such as inflation, interest rates, credit or default risk, market or systemic risk.
You will also find references to Peter Bernstein’s 1998 book, Against the Gods: The Remarkable Story of Risk, in which he describes man’s struggle to understand risk and probability. When addressing the dangers of relying too heavily on computer models, Bernstein wrote, "Nothing is more soothing or more persuasive than the computer screen, with its imposing arrays of numbers, glowing colors and elegantly structured graphs. As we stare at the passing show, we become so absorbed we tend to forget that the computer only answers questions; it does not ask them.... Those who live only by the numbers may find that the computer has simply replaced the oracles to whom people resorted in ancient times for guidance in risk management and decision-making."
If you'd like to know more about the successful speculators mentioned above, we devote an entire section of our book, The Big Gamble, to these and many others, starting with the turn-of-the-20th-century robber barons right up to the modern day cyber-gurus that created Amazon and Google.You can order our book here.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
Our current economic crisis is so deep and complex it's not likely to right itself anytime soon. How do we work ourselves out of this hole? Do we need more regulation or less? This is a question that has banks and Wall Street up in arms and one that is plaguing economists and the Washington elite.
We are dealing with a three-pronged problem: a housing market that bottomed out as the housing bubble burst; a credit crisis, the worst we've seen in decades; and now a decline in demand for goods and services and capital investment. Yes, there has been a slight deceleration in the rate of economic decline, but we'd much prefer to be reporting something a bit more optimistic—such as a better-than-slight acceleration.
Few would argue with the fact that things began to unravel at the bursting of the housing bubble, but when you consider the question of whether or not regulation might have prevented this, we have to pause and recognize that markets are inherently bubble-prone.
It's simple; markets create bubbles. If you need more evidence of this fact, just read our book, "The Big Gamble: Are You Investing or Speculating?" We've written several chapters on the subject of bubbles, citing some of the most notorious bubble fiascos throughout time. We also outline the warning signs for spotting a bubble in the making and suggest how you can either avoid it or go along for the ride, reap the rewards, and get out before things go awry.
So, if markets create bubbles, would closer scrutiny and stricter regulation prevent such chaos in the future? Who is in charge? Is some higher governmental agency supposed to accept responsibility for preventing asset bubbles from growing too big . . say, like the Office of Market Bubble Prevention? Government agencies have been quick to defend themselves against blame by saying that if the markets can't recognize what's coming, how can the regulators be expected to? And, of course, they have a point.
Naturally there are a few basic regulations already built in. When you are gambling in the market there are certain restrictions to protect you against self-destruction—there are margin requirements and minimum capital requirements; but even so, the market sometimes has to play a little fast and loose with those rules just to keep up with the shifting moods and emotions of the market.
It's true that the job of the regulators is to regulate. But while markets are imperfect, regulators are even more imperfect. In the best-case scenario, they are bureaucratic; in the worst case their decisions can be politically motivated. No matter how you look at it, regulation is a necessary evil, but we think it should be kept to a minimum, even though markets are inherently unstable.
During the Great Depression, we imposed many critical and necessary regulations, both on financial systems and on the real economy. But since then regulation, as well as de-regulation has created headaches. We allowed investment banks, banks, insurance companies to mingle their operations. Then we eliminated the Glass-Steagall Act, which had been wisely enacted to prohibit commercial banks from operating as investment banks. The demise of Lehman Bros, among others, stands as a stark reminder of how that all worked out.
The second big mistake was in 1999, when Congress decided against regulating derivatives, in particular credit default swaps. In 2002 those assets totaled around $1 trillion and today they're worth $33 trillion. What was the fallout of that bad decision? Thousands of mortgages got packaged and sold as mortgage-backed securities and later bundled and sold as a collateral debt obligations. Then thousands of collateral debt obligations were packaged and sold as—nobody knows for sure what to call those; and the whole mess was "insured" by the infamous credit default swaps, which are a part of that $33 trillion we mentioned. It's a little late now, but does anybody think that a little regulation might have been in order?
Policy makers have tried to convince us that self-regulation is best; by that they mean no regulation. We thought we could count on internal risk management models to keep things in balance; but who was minding the store when the risk takers were raking in all the profits in the banks? We trusted the rating agencies, but nobody told us that the very same guys that the agencies were supposed to be rating, were also paying the agency to rate them. Where does that leave the whole concept of self-regulation and market discipline? In the hole.
Yes, there is a need for oversight and regulation. But let's not forget that which has always been the basis for economic growth. Growth comes from technological innovation and gains in productivity—things that are conceived and birthed in the private sector, not in the halls of government agencies.
What we need now is wiser and more prudent regulation with intelligent oversight of the financial system. Will we find the right balance and get ourselves back on track? As this point, that's still an open question.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
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Jose D. Roncal
www.financialspeculation.com
While the G-20 world leaders meet and discuss ways to reverse the deep global recession, others like Nouriel Roubini, the New York University professor, focuses on what's happening back home. He predicts that U.S. stocks will continue to fall and that some major banks will go belly up with loan and securities losses reaching $3.6 trillion.
Others push for nationalizing the banks, but whether that's a good thing or not, depends on who you are talking to. The government is already so deeply embedded in the banks through guaranteeing debt and TARP money, it's hard to predict how banks will be able to once again function as private entities.
As the economy continues to decline, banks are being forced to weigh their options and examine how much capital they will need, what assets to sell. We suspect that the majority of banks will work out plans on their own, but that a few will have to rely on government support.
But questions remain about how banks will be able to attract new, private capital. Over the last six months, there isn't much evidence that they've raised any significant capital. In fact, most of the debt they've raised has come with government guarantees. With new, stricter regulation coming in the future, which will require banks to have higher capital ratios, that means it will be more expensive to sell debt. And what will happen once the government guarantees are gone? Even more expensive debt.
Is nationalizing the banks the solutions? We're not convinced that it's the best answer. The biggest problem today is that five major banks have controlled two-thirds of all mortgage originations and two-thirds of credit-card loans outstanding.
The changes in the banking industry have been so dramatic over the years, it's hard to imagine how they will get back to the old fashioned personal relationships our parents knew. Banks no longer know their borrowers, we don't know our lenders, and nobody bothers to find out what regional stresses the borrowers are going through.
To regain the public trust, we think it's going to require more emphasis on a regional-type lending environment. Actually, many of the more regional and localized financial institutions are healthy and have not taken any TARP funds.
The government needs to take steps to support and build up these regional lenders. The U.S. consumer is key to the health of the economy, so growing regional banks and fostering a closer relationship with borrowers could be a boost to the growth of small businesses and subsequently to the economy as a whole.
The Feds have already started to lay the groundwork for this with the "stress tests" by giving capital to the healthy banks so they can go out and acquire smaller banks, grow and consolidate.
When the strong banks begin to pay back TARP capital, some of those funds should be reallocated regional banks and lending institutions.
More regulations could create greater visibility and greater transparency, which is important to help the investors make the best decisions. But nationalizing the banks could
undermine confidence in the nation’s financial system. It would wipe out current shareholders and still there would be no guarantee that it would stabilize the country’s banking system.
In a complex fast moving world of high-speed modern technology, where global economies collide and security instruments are no longer understandable by the average investor, and where financial institutions have become so bloated and top heavy, they are considered too big to fail, maybe smaller is better and a return to good old fashioned banking concepts is not such a bad idea.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
02:57 pm | 0 recommendations | Be the first to comment
Jose D. Roncal
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After years of side-stepping oversight and regulation, the hedge fund industry is about to change. Even though it's not clear what role hedge funds played in the current economic crisis, the lackluster returns and lack of transparency have stacked the cards against the industry. Then there are the scandals surrounding AIG's questionable business decisions, which included making hedge fund bets against the housing market—news that may amount to one more nail in the coffin.
For years, there's been a hew and cry for more regulation and transparency for hedge funds. But hedge fund managers have held their ground, even when the SEC put forth a proposal that would have required the funds to register with the agency and be subjected to close scrutiny. But a federal court decided that the SEC didn't have the authority to impose such rules.
Today, the move toward regulation is getting some traction in the U.S. Congress, with ideas that could include giving the Federal Reserve broader oversight, limiting hedge funds' ability to borrow money and even curbing some of the higher-risk bets.
Hedge funds have been on a growth rampage since the early 90s as more and more deep-pocketed investors looked for ways to beat the market. There are now about 10,000 funds controlling over $1.5 trillion in assets. Things were going fairly smoothly, until the tide turned leaving hundreds of money-losing funds and stunned investors in the wake. The average hedge fund lost nearly 20% in 2008, maybe not as bad compared to the over all market returns, but when even hedge funds fail to hedge, it adds to the panic on Wall Street.
Traditionally, hedge funds only offered their high-rolling investors vague descriptions about their strategies. Their argument was that in order to give them an edge, they had to keep their trading schemes under wraps. But the Madoff fiasco will undoubtedly add fuel to the fire for more transparency, and if it doesn't it should.
Even though Madoff's operation was not a hedge fund per se, it did operate with strict secrecy and Madoff also operated a money for "funds of funds," a hedge fund off-shoot. Now, more hedge fund investors are demanding information about how their money is used and who actually holds the securities in the fund
We do know that part of the big hedge fund losses in 2008 were a result of the ban on short sales—these are bets on market declines and are an essential factor in many hedge funds' investment strategies. With short selling disallowed, the liquidity in several markets quickly dried up.
No one has ever argued that hedge funds are not risky business, but even though they have gotten a reputation for being major contributors to the current economic crisis, there really is not much evidence they are the primary villains.
We think most of the blame belongs to the investment banks that began dealing in more complex financial packages, over-leveraging their bets, and even acting as their own hedge funds. You could also blame it on the big push for home ownership, which encouraged banks to loan to buyers with bad or worse credit.
Hedge funds were originally only offered to qualified investors, the rich and famous who had money to speculate on high-risk ventures—in other words, money to burn. If these are the individuals who want to continue playing the game, more power to them. After all, the country was built by speculators. But stiffer government regulation might at least shelter innocent bystanders that have recently become entangled in hedge funds, like university endowments, charities, and pension plans—the large institutions that ventured into precarious hedge fund territory taking their unwary investors' money with them.
In spite of all the water cooler chatter and speculation, we haven't heard of many bona fide economists who are predicting that the industry will evaporate entirely. Even with expected future regulations, there will always be those who will be pulled in by the promise of extraordinary gains—at least for as long as hedge funds can continue to use strategies that mutual funds and other investment pools can not use.
There are no real specifics about what may be coming, but we're guessing that if new regulations are imposed, they will be staged in, first with tougher disclosure requirements followed by other new rules that will be draws up as red flags surface.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
02:56 pm | 0 recommendations | Be the first to comment
Jose D. Roncal
www.financialspeculation.com
The current financial crisis has changed our perceptions of the term capitalism and everything we have always assumed it stood for. The deeper the recession gets, the longer it drags on, the more anger will get directed towards Wall Street.
The intellectual impact of the economic meltdown has been so enormous the financial systems will be changed beyond recognition. The investment banks, those that were formerly the foundation of Wall Street, have already either folded or merged into the ranks of retail banks. For the middle-income families who face losing their homes and their jobs, and for the Wall Street firms that have been falling like dominoes, the economic crisis has been disastrous. Even high-profile investors like Warren Buffett describe it as having “fallen off a cliff”.
Until the dust settles, no one can guesstimate what the total fiscal cost will be. For a major portion of the financial system, it's now governments that have been thrust into the role of the primary borrowers, lenders, investors and insurers of last resort. The future landscape of the entire financial system will depend on how quickly and smoothly the government can dislodge itself from the deep hole of commitments they've dug for themselves. And the magnitude of the crisis will be measured by how well they manage it.
It's not as if we haven't been down this road before. Our economic system today is the result of the successful efforts to fix the mess of the 1930s. It's also the results of the failures. While our current situation is still not as harsh as the Great Depression, it's bound to leave a deep scars for years to come.
Over the past decade or more many government agencies have gotten sloppy or simply looked the other way as savvy, disreputable profit-seekers—the banks, hedge funds, insurance companies, and the Madoffs of the world—were allowed to take too many liberties while running roughshod through Wall Street. We are referring to the new complex investment structures, the toxic assets and tainted schemes, the so-called "wealth-creation investments" that got rammed past the gates and into the system.
These deals had so much leverage and so few underlying resources backing them up, you have to wonder how anybody managed to pull them off in the first place. The fact is that, with exception to a relatively small group of math wizards who were hired to run the numbers and structure the deals, nobody completely understood what was going on—not the buyers and not the sellers—which made it easy to keep pumping more deals into the pipeline. We now know that the government employees who get paid to understand such things, and who are charged with the responsibility to stand guard and protect the public from high level fraud, these are the guys that were asleep at the wheel.
But Wall Street and the banking industry was operating under the umbrella of capitalism, which meant that if so much money was being made, and if these deal were driving the market, then everything was fair game. It turned out to be a game alright, but not a fair game.
Now that the house of cards and the umbrella has collapsed, what is the future of capitalism? Will our current, broken system be replaced with a totally egalitarian, socialist society? That's not likely. Instead, we predict something that Adam Smith might deem suitable.
With all the financial bailouts over the past few months, as well as those still on the table, we're already witnessing a certain degree of government interference in “the market,” maybe a little more than we'd prefer, but we are taking a wait and see attitude considering the extreme situation we're in. We expect to see a gradual increase in taxes as well as an increase in public scrutiny and a demand for higher accountability on the part of those who are still taking large profits—the "capitalists!"
But capitalism, albeit in a more muted version in the short term, will survive. Yes, capitalism has it flaws, but then so does democracy or any form of government. There may be moves toward the exits as citizens explore other modes of financial systems, but when none are discovered, the masses will once again hunker around the warm glow of capitalism.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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August 23, 2009
02:53 pm | 0 recommendations | 1 comment
Jose D. Roncal
www.financialspeculation.com
Back in September, 2008 we covered a topic that we believed was getting too little attention by mainstream media: the looming credit card crisis. In both our white paper,Consumer Debt in the U.S, and in our article,Get Ready for Another Crisis: The Coming Credit Card Debt Meltdown, we gave our readers a full report on what we saw as another economic catastrophe in the making.
The Gathering Storm
The growing level of consumer debt in the U.S. is creating a drag on the economy.
All over the world, people are keeping fingers crossed that the $700 billion financial system bailout works the way it is supposed to and eases the worsening global credit crunch and restores confidence in the markets. But while the government has been focusing its attention on worldwide fallout from the mortgage debacle and the Wall Street greed, another storm is gathering on the horizon.
Over the past couple of weeks, we've seen how this news is starting to pick up steam with statements like:
The Credit Card Debt Crisis: The Next Economic Domino
Hot on the heels of the banking crisis, the employment crisis, and the mortgage/foreclosure crisis, the country is on the verge of experiencing a credit card crisis.
As we mentioned in our report, outstanding credit card debt hit an all time record high of $951 billion in 2008, and judging by the credit scores of many of the cardholders, about a third of that debt might never be collected. In fact, defaults are expected to hit 10% in 2009. With the economy is such bad shape, the under-employed and over-extended will have no choice but to make ends meet using credit cards and piling up still more debt.
But what do financial institutions—already weighed down with toxic assets—do when credit card payments start to default? They get creative. As we reported, banks have been doing the same thing with credit card debt as they did with mortgage-backed securities—packaging it up and selling it as securities to investors, including your pension fund. Selling credit card debt is a $365 billion market!
As cardholders continue to default, those who bought this packaged debt will take a serious hit. And so will cardholders who are actually paying on time, or at least are trying to keep up. Credit card companies simply raise rates and fees -- late fees, cash-advance fees, over-the-limit fees, you name it, there are fees for every occasion. Never mind that you've never missed a payment in your life, your rates are going up and your line of credit is going down.
Some, like American Express, have gotten even more creative. After having received over $3 billion in TARP money from us, the taxpayers and credit card holders, AMEX is trying to boot selected customers out of the nest all together by offering $300 vouchers if they will cancel their accounts and go away. What a sign of the times! Card companies used to lure us in with cash rewards, now, in an effort to write you and your debt off, they are willing to pay just to get rid of customers.
Does the government really want to stimulate our economy, unfreeze credit flow and restore the financial institutions? Does it really want Main Street to get back on its feet? If so, here's a thought. Let's help the average consumer right now by capping interest rates on credit cards. Let's reform the entire mess we know as the credit card industry.
Is it so hard to understand that when you're already in a hole, it's time to stop digging? Who decided it was wise economics to raise interest rates on consumers who are already have a hard time paying down their debt, or to penalize those who pay on time?
Congress is already focusing on bailing out the financial system, carmakers and state governments. Maybe it's time to bail out the families who are struggling to keep their heads above the rising waters of consumer debt.
It's also a good time to read about risk, credit, speculation and a whole chapter entitled, Mother of All Crises: Haven't We Learned Yet? It's all there in our book,The Big Gamble: Are You Investing or Speculating.
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"
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