In the past year, as the fog of unstoppable economic success lifted and some semblance of market clarity entered investors’ minds, a sobering phenomenon began to occur. It appears as though nobody had bothered to notice, during our extended surge of prosperity, that more than a few freeloaders had been discreetly riding the tidal wave at investors’ expense. After the discovery of Bernard Madoff’s $50 billion Ponzi scheme, many more suddenly surfaced, and suddenly the Securities and Exchange Commission was paying attention. In fact, 74 such schemes have been uncovered in the last two years, targeting an expansive range of people, from charitable institutions to deaf investors to retirement home residents. Throughout economic history, there have always been people who had the audacity to swindle money, but it is the ever-growing magnitude of recent endeavors that proves the most frightening. Such schemes are carefully formulated and conducted, in order to run below the surface of the roiling economic waters by which investors are captivated.
Charles Ponzi, caught in 1910, was certainly not the inventor of the ploy, but was the first person to accomplish the feat on a relatively large scale in the United States. Boiled down into its basic constituents, a Ponzi scheme requires a good salesman and a lot of suckers to take the bait. The operator takes money from people with promises of high returns, and pays them bits of their own money back as “returns” to satisfy them. As more people give money, the pool grows larger, and can keep paying these “returns” without ever physically investing a dime. In reality though, if everyone wanted their money returned at this point, nobody could retrieve the full amount of their investment, because part of it has already been paid to others, not to mention the often hefty salary Ponzi operators bestow upon themselves as a reward. The money pool can grow large enough that it can pay back in full those who back out, so as not to arouse suspicion from authorities, but the scheme as a whole resembles to a fire—it can only maintain its expansion as long as there is a supply of oxygen to feed it. Ponzi schemes can be massive, but they are fundamentally self-contained by the number of willing investors, and are therefore destined to die out after reaching critical mass.
But wait, why does this scenario sound hauntingly familiar? Perhaps it is because one such condition has been in operation since 1935, when it was signed into law by President Franklin Roosevelt. America has long been nervous about the fate of Social Security, and rightfully so. It is, essentially, one enormous nation-wide pyramid scheme, in which the first round of investors are paid by the second round of investors, for generations and generations. Having just discussed the inevitable outcome of such a process, the moment of truth has already arrived; there aren’t enough new donators to pay off baby-boomer receivers, and the timer on the bomb is ticking. Privatization of the system has been proposed, but running a business requires profitability, a trait Social Security structure clearly lacks. Are there other options? Short of pure government expenditure, no, not without sacrificing the whole program and starting over. Nobody would think to associate Madoff with Roosevelt, but unfortunately both designs have been fated to failure from the moment of inception.
Friday, February 27, 2009
Wednesday, February 25, 2009
Is Nationalization on the National Agenda?
Now that the health of Apple’s CEO, Steve Jobs, has faded once more into the background of economic news, a new source of gossip must arise to fill the role of the source of stock market volatility. Such conversation turned to plans of nationalization of floundering banks. The word itself resonates with a nerve-racking uncertainty, enough to instill fear in both types of investors: those that understand the process, consequences, and benefits, and those who yet do not. A surprising number of people hear the word ‘nationalization,’ imagine an economy dominated and controlled by government, and acknowledge such an outlook as a complete failure of America. For a nation built upon economic freedom, this scenario is a blatant nightmare. Sensing this was a touchy subject, both President Obama and Fed chairman Bernanke have been reassuring the general public that such drastic measures would not be necessary, and conveying that simply holding a minority stake in a bank is a superior solution, as opposed to bankruptcy or seizure. It seems that investors’ suspicions are unfounded, even though it does indeed seem as though banks are running out of options. Many have actually forgotten that the topic of nationalization has already come up at the onset of the financial crash.
Needless to say, Wall Street is not a fan of this chatter. In fact, a conflict of interest becomes evident, in that any investor with any stake in a bank stock dreams of a scenario where government would just toss billions to banks with no repercussions or stipulations. However, this situation would be counterintuitive to our assumed long-term goal of restoring financial stability, which would, overall, have a more beneficial effect than merely allowing bank stocks to minimally survive and scrape along the bottom. During nationalization, shareholders are given an offer they can’t refuse: the FDIC will pay each one a whopping $0.00 per share. Furthermore, the bank loses its executives and operates under complete governmental control, which contradicts our current motions of mere investment in a bank’s future. Why would such a course be considered as a viable solution?
As one example, consider the case of Sweden during the 1980’s. The nation’s collapse commenced in a shockingly familiar fashion; financial deregulation increased real estate lending without regard for the value of collateral, which could not maintain its ascension indefinitely. At one point, interest rates hit a mind-numbing 500%. In 1992, Sweden’s entire banking sector was nationalized, and absorbed into the governmental realm. All deposits were guaranteed, confidence in safety boomed, and the government had a direct stake in the success of each bank. When the economy had demonstrated a sufficient recovery, the majority of the banks were re-privatized, through which the government was able to salvage the bulk of its initial nationalization effort, and minimize net change in the deficit. Admittedly, a large cushion of capital is necessary to privatize each institution, and it is the government’s responsibility to generate those profits—a task federal administration is not accustomed to performing.
Clearly, nationalization can work as a viable solution to our financial crisis, but only if such strategies are imposed quickly. At this point, our banks are worth very little, and the government has already invested billions of dollars to keep them afloat—an effort which, though unorthodox and possibly inadequate, should not be wasted. Though I am a strong believer in the ability of markets to restructure themselves, nationalization may have been a feasible opportunity if applied early, but having come thus far, we’ve most certainly missed the boat. Given that our government is so averse to the concept, and substantial efforts have forced a massive bailout plan into action, the entire notion is effectively inapplicable.
Needless to say, Wall Street is not a fan of this chatter. In fact, a conflict of interest becomes evident, in that any investor with any stake in a bank stock dreams of a scenario where government would just toss billions to banks with no repercussions or stipulations. However, this situation would be counterintuitive to our assumed long-term goal of restoring financial stability, which would, overall, have a more beneficial effect than merely allowing bank stocks to minimally survive and scrape along the bottom. During nationalization, shareholders are given an offer they can’t refuse: the FDIC will pay each one a whopping $0.00 per share. Furthermore, the bank loses its executives and operates under complete governmental control, which contradicts our current motions of mere investment in a bank’s future. Why would such a course be considered as a viable solution?
As one example, consider the case of Sweden during the 1980’s. The nation’s collapse commenced in a shockingly familiar fashion; financial deregulation increased real estate lending without regard for the value of collateral, which could not maintain its ascension indefinitely. At one point, interest rates hit a mind-numbing 500%. In 1992, Sweden’s entire banking sector was nationalized, and absorbed into the governmental realm. All deposits were guaranteed, confidence in safety boomed, and the government had a direct stake in the success of each bank. When the economy had demonstrated a sufficient recovery, the majority of the banks were re-privatized, through which the government was able to salvage the bulk of its initial nationalization effort, and minimize net change in the deficit. Admittedly, a large cushion of capital is necessary to privatize each institution, and it is the government’s responsibility to generate those profits—a task federal administration is not accustomed to performing.
Clearly, nationalization can work as a viable solution to our financial crisis, but only if such strategies are imposed quickly. At this point, our banks are worth very little, and the government has already invested billions of dollars to keep them afloat—an effort which, though unorthodox and possibly inadequate, should not be wasted. Though I am a strong believer in the ability of markets to restructure themselves, nationalization may have been a feasible opportunity if applied early, but having come thus far, we’ve most certainly missed the boat. Given that our government is so averse to the concept, and substantial efforts have forced a massive bailout plan into action, the entire notion is effectively inapplicable.
Monday, February 23, 2009
Car companies: driving off a cliff?
Nothing epitomizes American manufacturing and industry more than massive car companies, most notably Ford, General Motors, and Chrysler. These businesses have been around for ages—GM just celebrated its 100-year anniversary—and have stood as an unstoppable wall of production power…until now. Ford has declared it has the cash to remain solvent through the end of 2009, but GM and Chrysler are teetering on the brink of bankruptcy, and after receiving $30 billion in bailout aid already, are requesting billions more. The government and general public have pointed fingers and argued that the car companies have been out of tune with demand, especially for small, fuel-efficient cars, and businesses that do not sell what consumers demand have already failed, in essence. In fact, two such brands, Saturn and Saab, have not been profitable in the last 20 years of their existence. Connecticut senator Christopher Dodd mentioned that the auto industry is “seeking treatments for wounds that, to a large extent, were self-inflicted.” The car companies counter that they had been on the brink of a comeback, but the credit crisis is at fault for breaking their momentum. How did this dramatic turnaround occur, placing Japanese automaker Toyota firmly in the top spot? Much of the answer lies in the organization of the automobile industry.
The strength of autoworker unions has bestowed benefits upon workers so all-encompassing, no other industry could bear the financial burden. After working at one of these companies for 30 years, a respectable length of time by any measure, an employee receives healthcare and pension for life, fully paid by the car company. Certainly, in the past, this was an important method of retaining employee loyalty and longevity for the automaker, but given that, after recent layoffs, GM currently employs 252,000 workers, such a comprehensive lifetime guarantee appears quite unsustainable. Is this single sector of our economy so essential that we must give complete benefits to those who are able to retire at age 48? I instinctively draw a parallel between such benefits and Wall Street bonuses; both seem unnecessary, yet both are so deeply incorporated into the core of the business that they cannot easily be extricated.
A look at the probable solutions reveal nothing that will easily shore up car companies’ failures. Though $25 billion in bailout loans was assumed to be the worst-case scenario one year ago, current requested aid for failing automakers has already reached $50 billion. Clearly, these companies need some manner of financial restructuring, and the best way to implement such a change is often bankruptcy. This would relieve automakers of the financial obligations they cannot pay. However, some estimates state that the failure of General Motors alone may cost up to $100 billion in taxpayer money, given that many consumers will shy away from buying cars from insolvent manufacturers. This will also create significant widespread effects, and even Toyota and Honda will struggle, because companies creating car parts may fail as well, many of which cater to multiple car brands. Unfortunately, neither course is a winning situation. Some argue that the loss of American auto companies will turn the United States into a country that doesn’t actually produce anything. However, our world is now an intricately linked global economy, as proven by the global collapse, and if the United States is destined to be a service industry, well, specialization is the key to economic efficiency after all.
The strength of autoworker unions has bestowed benefits upon workers so all-encompassing, no other industry could bear the financial burden. After working at one of these companies for 30 years, a respectable length of time by any measure, an employee receives healthcare and pension for life, fully paid by the car company. Certainly, in the past, this was an important method of retaining employee loyalty and longevity for the automaker, but given that, after recent layoffs, GM currently employs 252,000 workers, such a comprehensive lifetime guarantee appears quite unsustainable. Is this single sector of our economy so essential that we must give complete benefits to those who are able to retire at age 48? I instinctively draw a parallel between such benefits and Wall Street bonuses; both seem unnecessary, yet both are so deeply incorporated into the core of the business that they cannot easily be extricated.
A look at the probable solutions reveal nothing that will easily shore up car companies’ failures. Though $25 billion in bailout loans was assumed to be the worst-case scenario one year ago, current requested aid for failing automakers has already reached $50 billion. Clearly, these companies need some manner of financial restructuring, and the best way to implement such a change is often bankruptcy. This would relieve automakers of the financial obligations they cannot pay. However, some estimates state that the failure of General Motors alone may cost up to $100 billion in taxpayer money, given that many consumers will shy away from buying cars from insolvent manufacturers. This will also create significant widespread effects, and even Toyota and Honda will struggle, because companies creating car parts may fail as well, many of which cater to multiple car brands. Unfortunately, neither course is a winning situation. Some argue that the loss of American auto companies will turn the United States into a country that doesn’t actually produce anything. However, our world is now an intricately linked global economy, as proven by the global collapse, and if the United States is destined to be a service industry, well, specialization is the key to economic efficiency after all.
Friday, February 20, 2009
Low prices are a good thing, right?
Consumers in recent years have become accustomed to spending less. The vast majority have no choice in the matter. However, as the general public reins in expenditures and businesses become starved for cash, a downward spiral begins to form, and I’m not altogether convinced that a sudden increase in consumer spending would be the most practical or viable solution. Given that families are strapped for cash and saving is now a necessity rather than a preference, it seems entirely logical not to spend on anything more than the absolute bare minimum. Thus, stores have only one option available to appeal to discounted consumer tastes, and the effect is seen every time we walk through a mall and see 70%-off sale signs in front of every door.
Clearly, if the economy was in a healthy position, these price cuts would be a huge bargain, but even such drastic sacrifices on the part of businesses have failed to prove to the consumer that the value of their product is even worth 30% of what it used to be. Many families who would have come running to buy these products at 10%, 20%, and 30%-off find they can scarcely afford them even now. By dropping prices, companies figure that a loss on a small amount of sales the only alternative to a large loss on no sales at all. The overall effect of this fiasco is dangerous—consumers have adapted, and acclimatized to a new, lower price level. While most people would not regard lower costs as a particularly unpleasant effect, a sustained dip in prices leads to deflation, which can be detrimental to businesses that have expanded on the assumption that their products are worth an established and secure amount of revenue.
Many analysts and reporters have been discussing America’s unsustainable standard of living; the idea that lavish spending far beyond one’s means has become habitual, leading to the demise of economic progress as we know it. Certainly, luxury markets have boomed, selling ordinary products by associating an impressive brand name to add value, and many feel that the existence of any demand for such products epitomizes the exorbitant splurging we have seen in recent years. On the other hand, some companies, such as Apple, have continued to see strong sales despite maintaining premium prices, in which case market demand is powered by the actual value of the product, or the idea that a purchased $300 iPod carries with it $300 of value and function. Saks Inc. recently made news when it became the first luxury brand retailer to cut prices; a violation of unspoken luxury designer code, and a downgrade from an opulent product to yet another brand indicating a lack of immunity from working-class financial issues. Where should a consumer look for value when prices and worth are exhibiting such variation after such a long period of stability?
I, personally, have become completely accustomed to this reduced scope of prices. When I see price tags cut in half, the value I associate with these same products is contemporaneously reduced. Though they clearly had very little choice, businesses and retailers have fallen into a pit, and the path to recovery will be extremely challenging to maneuver. Consumers have accepted these low prices as the new base level, and if asked to pay what many of these non-selling goods used to be worth a mere two years ago, it would seem nothing short of highway robbery. Now that customers have latched on, companies are stuck keeping price tags artificially low for quite some time, as any rise in price will trigger a massive loss of any remaining customers. With no other options after having participated in the price plunge initially, businesses must weather the spending downturn and hope their products will generate revenues rivaling times before the crisis, albeit certainly not in the near future.
Clearly, if the economy was in a healthy position, these price cuts would be a huge bargain, but even such drastic sacrifices on the part of businesses have failed to prove to the consumer that the value of their product is even worth 30% of what it used to be. Many families who would have come running to buy these products at 10%, 20%, and 30%-off find they can scarcely afford them even now. By dropping prices, companies figure that a loss on a small amount of sales the only alternative to a large loss on no sales at all. The overall effect of this fiasco is dangerous—consumers have adapted, and acclimatized to a new, lower price level. While most people would not regard lower costs as a particularly unpleasant effect, a sustained dip in prices leads to deflation, which can be detrimental to businesses that have expanded on the assumption that their products are worth an established and secure amount of revenue.
Many analysts and reporters have been discussing America’s unsustainable standard of living; the idea that lavish spending far beyond one’s means has become habitual, leading to the demise of economic progress as we know it. Certainly, luxury markets have boomed, selling ordinary products by associating an impressive brand name to add value, and many feel that the existence of any demand for such products epitomizes the exorbitant splurging we have seen in recent years. On the other hand, some companies, such as Apple, have continued to see strong sales despite maintaining premium prices, in which case market demand is powered by the actual value of the product, or the idea that a purchased $300 iPod carries with it $300 of value and function. Saks Inc. recently made news when it became the first luxury brand retailer to cut prices; a violation of unspoken luxury designer code, and a downgrade from an opulent product to yet another brand indicating a lack of immunity from working-class financial issues. Where should a consumer look for value when prices and worth are exhibiting such variation after such a long period of stability?
I, personally, have become completely accustomed to this reduced scope of prices. When I see price tags cut in half, the value I associate with these same products is contemporaneously reduced. Though they clearly had very little choice, businesses and retailers have fallen into a pit, and the path to recovery will be extremely challenging to maneuver. Consumers have accepted these low prices as the new base level, and if asked to pay what many of these non-selling goods used to be worth a mere two years ago, it would seem nothing short of highway robbery. Now that customers have latched on, companies are stuck keeping price tags artificially low for quite some time, as any rise in price will trigger a massive loss of any remaining customers. With no other options after having participated in the price plunge initially, businesses must weather the spending downturn and hope their products will generate revenues rivaling times before the crisis, albeit certainly not in the near future.
Monday, February 16, 2009
A Reward for Failure?
Who is at fault for the financial crisis and who is being punished for it? Our hope is that these would be one and the same, given our country’s love for justice. Similarly, those who have worked hard to maintain financial stability with wisdom should be rewarded by seeing their investment in their future flourish. Of course, we read every day about the incompatibility of this economic ideal with our current situation, and most unfortunately, many have seen the consequences of this fault occur to their families or friends.
Initially, the finger of blame points to large corporate banks, who have made loans and allotted credit to high-risk candidates, in the hope of receiving higher returns and expanding assets on their balance sheets. Banks also packaged and repackaged bundles of mortgages so often that their true value now lies in mystery, which, in an economy that thrives upon the value placed on currency, securities, and property, carries the potential and power to devastate the fundamental aspects of the entire system. In addition, not many people associate that common, yet small footnote saying “investments cannot be guaranteed” with the idea of a large bank, known for its stability and safety for depositing savings. Who could have imagined that so many mistakes could be made in corporate investment banking? Clearly, banks are to blame for lending to risky individuals and businesses.
But what were these individuals and businesses thinking, to prompt them to take on more debt than they could possibly pay back in the present? For starters, much of the country was living under the assumption that real estate would continue to appreciate in value indefinitely. Thus, by the time the loan had been paid off, the owned property would be worth more than the value of the loan. After years of surging profits and opportunities, the future was bright, and businesses assumed that expanding in the present would yield further growth in the future. Many people bought houses that became an excessive liability, and businesses grew too quickly, loading up on debt that could not be paid back in the event of a fall in profit. Shouldn’t these people have known better? It appears that they share a large part of the blame as well.
The ensuing fear and panic has led to harsh consequences. The banks, which abused lending power, are failing, and those individuals who took on too much debt are seeing their homes foreclosed or businesses pushed over the brink of bankruptcy. This alarming news created a psychological effect, in which people stopped spending, magnifying the effects of the downturn substantially. For a length of time, Fed rate cuts and small fixes were largely ignored, and it became clear that the only way to counter a change in sentiment was to make a statement so large it would reassure the ordinary consumer. Three or four of these ‘large statements’ later, we have not seen any change in sentiment, though the effects of the stimulus packages and bailouts have been touted. Certainly, halting foreclosures and allowing failed banks to maintain operations for those frightened for their life savings is a respectable goal. However, the $800 billion, and possibly much more, in government bailout money has been tossed into the infamous balance sheet black hole, and the newly proposed $50 billion plan to hand money over to homeowners who can’t pay mortgages will also go to many of those who overextended their capabilities in order to live in an excessive manner. Needless to say, idly allowing businesses to fail and families to lose homes is not an option from a societal standpoint, and clearly a sizable action was taken. But will help eventually reach the responsible people who merit it, or will it be lost somewhere along the dicey path of uncertainty through which the aid is being fed? For the moment, this remains to be seen.
Initially, the finger of blame points to large corporate banks, who have made loans and allotted credit to high-risk candidates, in the hope of receiving higher returns and expanding assets on their balance sheets. Banks also packaged and repackaged bundles of mortgages so often that their true value now lies in mystery, which, in an economy that thrives upon the value placed on currency, securities, and property, carries the potential and power to devastate the fundamental aspects of the entire system. In addition, not many people associate that common, yet small footnote saying “investments cannot be guaranteed” with the idea of a large bank, known for its stability and safety for depositing savings. Who could have imagined that so many mistakes could be made in corporate investment banking? Clearly, banks are to blame for lending to risky individuals and businesses.
But what were these individuals and businesses thinking, to prompt them to take on more debt than they could possibly pay back in the present? For starters, much of the country was living under the assumption that real estate would continue to appreciate in value indefinitely. Thus, by the time the loan had been paid off, the owned property would be worth more than the value of the loan. After years of surging profits and opportunities, the future was bright, and businesses assumed that expanding in the present would yield further growth in the future. Many people bought houses that became an excessive liability, and businesses grew too quickly, loading up on debt that could not be paid back in the event of a fall in profit. Shouldn’t these people have known better? It appears that they share a large part of the blame as well.
The ensuing fear and panic has led to harsh consequences. The banks, which abused lending power, are failing, and those individuals who took on too much debt are seeing their homes foreclosed or businesses pushed over the brink of bankruptcy. This alarming news created a psychological effect, in which people stopped spending, magnifying the effects of the downturn substantially. For a length of time, Fed rate cuts and small fixes were largely ignored, and it became clear that the only way to counter a change in sentiment was to make a statement so large it would reassure the ordinary consumer. Three or four of these ‘large statements’ later, we have not seen any change in sentiment, though the effects of the stimulus packages and bailouts have been touted. Certainly, halting foreclosures and allowing failed banks to maintain operations for those frightened for their life savings is a respectable goal. However, the $800 billion, and possibly much more, in government bailout money has been tossed into the infamous balance sheet black hole, and the newly proposed $50 billion plan to hand money over to homeowners who can’t pay mortgages will also go to many of those who overextended their capabilities in order to live in an excessive manner. Needless to say, idly allowing businesses to fail and families to lose homes is not an option from a societal standpoint, and clearly a sizable action was taken. But will help eventually reach the responsible people who merit it, or will it be lost somewhere along the dicey path of uncertainty through which the aid is being fed? For the moment, this remains to be seen.
Friday, February 13, 2009
Tempering Expectations
Investors are currently being pitched one of the most unique curveballs in history by the stock market, and many people, despite sticking to tried-and-true investing methods, have fallen for the ruse. Intuition dictates that buying low and selling high yields the best results—more specifically, buying when the general public is just beginning to show optimism, and sell when there is a hint of pessimism in the air. Admittedly, this procedure functions admirably when the market reacts to news and consumer sentiment in a manner that aligns with investor expectations. However, individuals who are sticking to their guns and holding fast to this standard principal of the inner workings of stocks are finding their attempts to time the market correctly destroyed at every turn, as fresh waves of good and bad news dash investors’ best attempts to triumph in these turbulent times. The fact of the matter is that the present stock market is extremely bipolar, showing no indication of direction and surprising investors at every turn.
The primary shock derives from national news, which, historically, has instigated the greatest stock motion. Traditionally, good news, such as a rise in profits, would increase optimism, while bad news, such as a rise in the unemployment rate, would consequently trigger a sell-off. Recently, however, news that can be clearly interpreted as good or bad has an ambiguous and indefinite impact upon the market. For example, news
of layoffs has customarily been a source of optimism, in that cutting employment costs allows a company to be more buoyant, and better positioned to prevail in the future. When gossip regarding a more extensive bailout plan was circulating last week, stocks floated upwards. This is significant, because the market generally reacts to action more often than suspicion. However, after Geithner’s speech outlining the next phase of plan, the Dow fell a whopping 5%. Furthermore, many stocks are at exceedingly low prices, the depths of which haven’t been plumbed for decades, and despite the bargain cost, nobody is willing to put their money at risk. Historically, dwindling prices have provided enormous buying opportunities, but now we find ourselves doubting such companies have any tangible value at all. This thought process has forced the shares of many large, once stable companies down below $1. The market reacts unpredictably to predictable news, and therefore the traditional mentality of market timing is meaningless.
Obviously there is no best solution to handle the current volatility, but one can and should make educated guesses, rather than predictions, at what overall investor sentiment reveals. One noticeable trend is that it does not matter significantly if a company’s profit falls by 50% in a quarter, as long as it exceeded the expectations of those who actually tried to make a prediction in these precarious times. If the business comes out ahead, in any amount, its stock tends to rally sharply. Thus, investors are avoiding any news more painful than they were expecting to hear. In this sense, investing for mid-term profit is merely a matter of tempering expectations.
The primary shock derives from national news, which, historically, has instigated the greatest stock motion. Traditionally, good news, such as a rise in profits, would increase optimism, while bad news, such as a rise in the unemployment rate, would consequently trigger a sell-off. Recently, however, news that can be clearly interpreted as good or bad has an ambiguous and indefinite impact upon the market. For example, news
of layoffs has customarily been a source of optimism, in that cutting employment costs allows a company to be more buoyant, and better positioned to prevail in the future. When gossip regarding a more extensive bailout plan was circulating last week, stocks floated upwards. This is significant, because the market generally reacts to action more often than suspicion. However, after Geithner’s speech outlining the next phase of plan, the Dow fell a whopping 5%. Furthermore, many stocks are at exceedingly low prices, the depths of which haven’t been plumbed for decades, and despite the bargain cost, nobody is willing to put their money at risk. Historically, dwindling prices have provided enormous buying opportunities, but now we find ourselves doubting such companies have any tangible value at all. This thought process has forced the shares of many large, once stable companies down below $1. The market reacts unpredictably to predictable news, and therefore the traditional mentality of market timing is meaningless.
Obviously there is no best solution to handle the current volatility, but one can and should make educated guesses, rather than predictions, at what overall investor sentiment reveals. One noticeable trend is that it does not matter significantly if a company’s profit falls by 50% in a quarter, as long as it exceeded the expectations of those who actually tried to make a prediction in these precarious times. If the business comes out ahead, in any amount, its stock tends to rally sharply. Thus, investors are avoiding any news more painful than they were expecting to hear. In this sense, investing for mid-term profit is merely a matter of tempering expectations.
Wednesday, February 11, 2009
Bailout Basics
The federal bailout movement has always had one clear goal in mind: confidence must be restored in the banking system in order to nurture lending practices once more, eventually loosening the clenched fist of credit, which has been choking businesses and homeowners alike. This plan sounds quite logical, and the goal is certainly noble, but will we get the results we intended? The answer requires a few steps backward along the timeline of the financial crisis and TARP action.
The origins of the financial meltdown are rooted in failed loans. Mortgages and other large debts were offered to ‘risky’ individuals and business with few questions, on the basis that real estate values would rise indefinitely, and consequently, collateral would multiply. Loans flowed freely for the entirety of this boom. Once real estate began falling, many people realized that it was in their best interest to default on their loan, because they were paying more than the property was worth, and banks were left with low-valued real estate worth far less than the original loan. Thus, both banks and loan-accepters lose, and the downward spiral begins.
Now, let’s fast-forward a couple years. The federal government is handing banks money to spur lending practices, intending to give people money to rebuild their lives and businesses. Most people fail to take note, however, of the new recipients of such loans. The people most in need of bank credit are: those who cannot afford their homes, the unemployed, new business ventures, and those who were not able to ride out the crisis on their own savings. In other words, these are people who are at risk of failing to make proper payment, and who should have been denied a loan in the first place. Before this fiasco, banks were motivated by profits to lend to as many people as possible, regardless of risk, in order to pad their balance sheets. Now, banks are motivated by the GOVERNMENT to lend as much as possible to risky individuals, in order to prove to the public that the $45 billion in taxpayer money is being put to use. Are we likely to see a similar situation in the not-so-distant future? This seems like an awfully large oversight, especially when we should have learned from such a mistake the first time.
Buy American
A major component of the original bailout plan proposed by the administration was a “Buy American” clause, requiring all money spent on domestic construction projects and employment to be paid only to American companies, though luckily much of this component has been edited out. It is true that seeing 11.6 million people unemployed in our country is certainly nothing to gloss over. Having paying jobs in the United States is imperative to the health of our nation. However, we no longer live in a world where an American company is only operated in America with only American suppliers and only American consumers. Is a Ford factory in Japan considered more American than the Honda factory in Ohio that employs thousands of U.S. workers? Boeing, which is the largest American airplane maker, receives input parts from Turkey, South Africa, Romania, Japan, Korea, China, and many other countries, merely to build one plane. Thus, it is evident that we are part of a global economy, and can no more easily define “buying American” as we can perform such a feat. In addition to its unfeasibility, such a plan hearkens back to protectionism and isolationism, which has historically hindered closed-off countries, such as China, and could very well spark a trade war. Decreasing international trade has never aided a country’s growth, and is unlikely to be a solution for boosting U.S. employment. Trying to enforce such an ideal at this pivotal point in our economic restructuring has the potential to tear the United States down from its high level of prominence in the realm of global trade.
The origins of the financial meltdown are rooted in failed loans. Mortgages and other large debts were offered to ‘risky’ individuals and business with few questions, on the basis that real estate values would rise indefinitely, and consequently, collateral would multiply. Loans flowed freely for the entirety of this boom. Once real estate began falling, many people realized that it was in their best interest to default on their loan, because they were paying more than the property was worth, and banks were left with low-valued real estate worth far less than the original loan. Thus, both banks and loan-accepters lose, and the downward spiral begins.
Now, let’s fast-forward a couple years. The federal government is handing banks money to spur lending practices, intending to give people money to rebuild their lives and businesses. Most people fail to take note, however, of the new recipients of such loans. The people most in need of bank credit are: those who cannot afford their homes, the unemployed, new business ventures, and those who were not able to ride out the crisis on their own savings. In other words, these are people who are at risk of failing to make proper payment, and who should have been denied a loan in the first place. Before this fiasco, banks were motivated by profits to lend to as many people as possible, regardless of risk, in order to pad their balance sheets. Now, banks are motivated by the GOVERNMENT to lend as much as possible to risky individuals, in order to prove to the public that the $45 billion in taxpayer money is being put to use. Are we likely to see a similar situation in the not-so-distant future? This seems like an awfully large oversight, especially when we should have learned from such a mistake the first time.
Buy American
A major component of the original bailout plan proposed by the administration was a “Buy American” clause, requiring all money spent on domestic construction projects and employment to be paid only to American companies, though luckily much of this component has been edited out. It is true that seeing 11.6 million people unemployed in our country is certainly nothing to gloss over. Having paying jobs in the United States is imperative to the health of our nation. However, we no longer live in a world where an American company is only operated in America with only American suppliers and only American consumers. Is a Ford factory in Japan considered more American than the Honda factory in Ohio that employs thousands of U.S. workers? Boeing, which is the largest American airplane maker, receives input parts from Turkey, South Africa, Romania, Japan, Korea, China, and many other countries, merely to build one plane. Thus, it is evident that we are part of a global economy, and can no more easily define “buying American” as we can perform such a feat. In addition to its unfeasibility, such a plan hearkens back to protectionism and isolationism, which has historically hindered closed-off countries, such as China, and could very well spark a trade war. Decreasing international trade has never aided a country’s growth, and is unlikely to be a solution for boosting U.S. employment. Trying to enforce such an ideal at this pivotal point in our economic restructuring has the potential to tear the United States down from its high level of prominence in the realm of global trade.
Monday, February 9, 2009
New Horizons Await
Given the year and a half of economic and market turmoil we find ourselves still forced to endure, the horizon is a good place to look for stability, wealth, and recovery. But this is not new news--even the most basic investor knows that 'investing,' as a rule, is putting your money somewhere profitable over a fairly long duration. This philosophy is incontestable, and I certainly agree. However, in recent months, a mixture of constant bombardment of terrible economic news, the plummeting stock market, layoffs, and pay cuts, has created a situation in which nearly everyone is highly attuned to every bit of worrisome news that pops up on the television news ticker. It is obvious we are foraging through unprecedented times: the Dow completes an entire week of 200-point swings or larger (thought to be impossible years ago), oil rocketed up to a new peak of $147 per barrel and now sits below $40 (thought to be impossible mere months ago), and investors wildly overreact both positively and negatively to any inkling of earnings data, often in ways that escape all the logic we, as thoughtful, rational, common-sense-driven people, have ever learned pertaining to the stock market. Evidently, day trading is out of the question as well, since nobody can predict the next 4% free-fall. How, then, is one expected to profit in this day and age, when the stock market--the epitome of public sentiment--is less rational than a tantrum-prone toddler?
One strategy is, at this point, completely out of our hands. The headlines that dominate the daily news these days are all debating the governmental bailout plan. The word ‘bailout’ in itself represents more than a simple catch-phrase to describe a loan given to a company in distress. Companies in general shouldn’t need to be bailed out unless they have already made mistakes grievous enough to threaten the health of separate industries, forcing a rescue operation. Thus, companies with healthy, proper practices would not require a bailout, since they should be the model of a respectable business operation. Needless to say, both the struggling financial company and the latter company are both suffering greatly in this financial mess, though only one deserves it. I don’t associate fully with either Republican or Democratic ideals, but I firmly believe that the basis of market stability is economics’ amazing ability to equalize and compensate. Clearing out businesses that failed, operated improperly, or disappoint consumers is a process that makes way for new companies that have learned from these mistakes and seize creative opportunities to become more successful and efficient than their predecessors. This is the definition of progress.
However, the government has strongly decided that this natural system has not functioned at all well enough, and threw its weight behind a bailout plan. Though this may not have been the wisest action, especially in retrospect, we must realize its implications and intentions. The original plan allotted $250 billion to be spent purchasing bank stock, thereby contributing to the capital available to banks in order to balance out their lending practices. Purchasing equity would give the government some handhold on bank operations, and improve both lending and efficiency. Pitched this way, it sounds like a reasonable plan, and if there must be a bailout, I see few better options. Unfortunately, these guidelines promptly faded away, and over $500 billion in taxpayer money has been spent, literally handed over to banks, in cash. As anybody could have predicted, that money is long gone, buried in a bank vault or converted to compensation and bonuses, corporate jets, or executive trips to Las Vegas. In this moment, we must be very careful; totaling up all proposals for saving the financial industry yields almost $1.5 trillion. Our country already has a national deficit of $10.7 trillion, and a higher deficit today equals higher taxes in the future. If it's going to be nearly 1/6 of our country's current deficit, let’s hope this round of the bailout works.
In the meantime, oil and energy prices are pushed down to artificial lows, sure to spike again at the faintest whiff of economic recovery or increased demand. The technology sector, which historically documents a fairly low cost of operation, will likely be a front-runner in the race out of the recession pit. Given that stocks perk up around six months before the general economy, I expect to see slow improvement through mid 2009, though I doubt we’ll keep seeing the leaps and bounds that have been tolerated in the past year. This page will be updated Mondays, Wednesdays, and Fridays, and I look forward to discussing financial strategies and current economic news with you.
One strategy is, at this point, completely out of our hands. The headlines that dominate the daily news these days are all debating the governmental bailout plan. The word ‘bailout’ in itself represents more than a simple catch-phrase to describe a loan given to a company in distress. Companies in general shouldn’t need to be bailed out unless they have already made mistakes grievous enough to threaten the health of separate industries, forcing a rescue operation. Thus, companies with healthy, proper practices would not require a bailout, since they should be the model of a respectable business operation. Needless to say, both the struggling financial company and the latter company are both suffering greatly in this financial mess, though only one deserves it. I don’t associate fully with either Republican or Democratic ideals, but I firmly believe that the basis of market stability is economics’ amazing ability to equalize and compensate. Clearing out businesses that failed, operated improperly, or disappoint consumers is a process that makes way for new companies that have learned from these mistakes and seize creative opportunities to become more successful and efficient than their predecessors. This is the definition of progress.
However, the government has strongly decided that this natural system has not functioned at all well enough, and threw its weight behind a bailout plan. Though this may not have been the wisest action, especially in retrospect, we must realize its implications and intentions. The original plan allotted $250 billion to be spent purchasing bank stock, thereby contributing to the capital available to banks in order to balance out their lending practices. Purchasing equity would give the government some handhold on bank operations, and improve both lending and efficiency. Pitched this way, it sounds like a reasonable plan, and if there must be a bailout, I see few better options. Unfortunately, these guidelines promptly faded away, and over $500 billion in taxpayer money has been spent, literally handed over to banks, in cash. As anybody could have predicted, that money is long gone, buried in a bank vault or converted to compensation and bonuses, corporate jets, or executive trips to Las Vegas. In this moment, we must be very careful; totaling up all proposals for saving the financial industry yields almost $1.5 trillion. Our country already has a national deficit of $10.7 trillion, and a higher deficit today equals higher taxes in the future. If it's going to be nearly 1/6 of our country's current deficit, let’s hope this round of the bailout works.
In the meantime, oil and energy prices are pushed down to artificial lows, sure to spike again at the faintest whiff of economic recovery or increased demand. The technology sector, which historically documents a fairly low cost of operation, will likely be a front-runner in the race out of the recession pit. Given that stocks perk up around six months before the general economy, I expect to see slow improvement through mid 2009, though I doubt we’ll keep seeing the leaps and bounds that have been tolerated in the past year. This page will be updated Mondays, Wednesdays, and Fridays, and I look forward to discussing financial strategies and current economic news with you.
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