financial crisis

In the beginning of the year, I wrote a post on the topic of large executive bonuses at bankrupt companies (Link).  In general, if a company is making money, it's nobody's business whether an employee gets paid a gazillion dollars; however, one of my major points was that a failed company such as Merrill Lynch should have been a little more nimble (and not necessarily zero bonus) in handing out bonuses.  I also thought there was a need for some "bonus reform" in order to align together the interests of executives, shareholders, and the greater public. Specifically, there is a need to create more long-term incentives for companies instead of focusing on short-term profits through excessive risk.  I believe most shareholders may have an issue with excessive bonuses when their company is on the brink of bankruptcy. And the taxpayer is no too happy to pay for bonuses at bailed out firms.

In this post, I just wanted to bring out a different perspective on guaranteed bonuses put out by John Carney of The Business Insider (Full Article). Here is an excerpt:

"More importantly, it's just not true that traders should only be paid for returns. Banks are actually paying for something else: exposure to upside potential rather than actualized gains. And exposure to upside is not imaginary. It is, in fact, at the heart of almost all investment activity.

Who's Next?

Residential mortgage problems started the current financial market meltdown. Many experts are now worried that the commercial real estate market may collapse and extend the current crisis. This post is aimed at reviewing commercial real estate loans and indentifying the major risks associated with a market collapse.

Given that CMBS (Commercial Mortgage-backed securities) is one of the new buzz words, it seems like a good thing to know a little bit more about this market.

What is the commercial real estate loan market?

It's the market for debt used to finance hotels, offices and shopping malls. Therefore, most of these loans are issued to intitutions and private companies.

What's a proxy for the CMBS market? Size of market?

A widely followed index that started in 2004 and tracks a basket of commercial real estate-backed securties is the Markit CMBX.

As of 2007, the commercial real estate market was $3.1 trillion, with 25% of this market being in CMBS. (Source). Thus, the commercial real estate marked as a whole is much smaller than the $12 trillion residential market in 2007.

For a more detailed description of how CMBS works, this wikipedia article is a descriptive and easy article to start from. 

Indicator of future collapse?

As this Reuters article shows, Goldman Sachs

In my last post, Who Will Fund the Economic Stimuli?, I talked about how governments around the world need to finance a large sum of debt. This will likely create some crowding out of private investment and consumption and create possible long-term problems.

Besides the additional trillions we're looking to stack up (especially the U.S.), we also have to look at the current debt levels and see if there is any concern at hand. We've all heard that the consumer is "deleveraging" (or reducing their debt); however, how much deleveraging is needed and how long will it take for that to happen? Additionally, the rallies in the financial markets are expecting the U.S. consumer to rebound into strong mode very soon. It feels like that is unlikely to happen given the already high levels of debt in the U.S. economy; unless, we start giving loans to anyone again and increase debt levels even more...

Predicting the future is pretty hard. A lot of people try to do it, but only a few are able to do so somewhat accurately. Right now, the consensus prediction is "rally, rally, rally". Markets in the United States have rallied some 50% from their March lows (after a drawdown of 50%) and it seems like there is more room to go. It usually takes years upon years for markets to gain 50%; however, given that markets lost half its value in a matter of months, it's not too surprising.

Then in March 2009, markets were tumbling as if the world was going to end. There was a huge mood swing in March and markets rallied like crazy with some emerging markets gaining just about 100%. As a result, people have become scared  of missing more of the rally, and everyone seems to be jumping in. Right now, the sky is the limit and people just want to buy.

Can we trust this rally?

I'll tell you this, my Forex trades have mainly been on the long side (Euro and Australian dollar against the U.S. dollar) and it has worked out pretty well as markets have reached all time highs since the Lehman Brothers collapse.

Lately, governments around the world have been going deep into their pockets and spending a lot of money. Stimulating the world economy into economic growth is the name of the game. Some of the spending is widely considered to be necessary while some seems to be a waste. Nevertheless, it all adds up to a lot of money. Like, a lot.

Printing money is always an option but doing too much of that (possibly?) creates the unwanted consequence of high-inflation. The second option to fund the spending comes from tax revenues, but as we all know it, that's been on a downward trend with the lack of economic activity and higher unemployment in many countries. The third option is to finance the party.

Basic economy theory suggests that government spending crowds out private consumption and investment.

This is how Investopedia (Link) describes it:

'Governments often borrow money (by issuing bonds) to fund additional spending. The problem occurs when government debt 'crowds out' private companies and individuals from the lending market.

Increased government borrowing tends to increase market interest rates. The problem is that the government can always pay the market interest rate, but there comes a point when corporations and individuals can no longer afford to borrow."

As the economy tanks and people lose their jobs, the flow of people going online to find some kind of "Get Rich Quick" scheme increases substantially. Sometimes, one of these schemes you find online involve websites that help you invest in penny stocks that will give you a 400% or 1000%+ return (or they claim). Some of them are probably legit, but some of them are complete scams. Additionally, even the "legit" ones are dangerous and will probably make you lose money.

As an example, I'll use the website HotOtc.com, which claims to have more than 51,000 "smart" investors on their newsletter about penny stocks. To me, they seem pretty "legit". I've been on their newsletter for some two years now (but I've never invested in any of their stock picks or penny stocks in general).

If you go to their website, you'll see a bunch of stock picks they claim went up 400% in a day, or some 600% in a week.

First, as expected, they don't talk about the ones that went down by 50% or 80% in one day. Or the ones that went up 400% in one day and down 90% the next day. I'm sure there are a lot of them.

Second, people may not know that very small volumes can dramatically move these stocks. If you have a 5 cent stock that trades 1,000 shares a day on average, and you send a letter to 51,000 people to buy it, you're likely to have a big upswing even if only 10 or 100 people buy the stock.

How does the website/insiders profit from all of this?

The green shoots keep splashing, and they keep splashing hard. After better-than-expected earnings last week from companies such as Intel, IBM, and Goldman Sachs, the markets rallied around 9%. Additional positive housing and manufacturing data also helped fuel the rally. And today, Monday (July 20, 2009), the U.S. markets went up another 1%+ on the news that CIT Group was bailed out by its creditors.

I don't want to just criticize the happiness of economic recovery all over CBNC and what-not (which I do partially believe in), but I do prefer to talk about some important things that people like to throw to the side in these times. In the happiness-mania that has taken over the news in the last week, people close their eyes (as usual) and start to believe that only one outcome is possible (economic recovery, up markets, etc).

I do believe this recent rally could have legs, but nevertheless, let us put on our critical goggles: