After a well needed break, the KoolAidMan is back! During the time off, he’s been disconnected from the markets and the media, however upon returning it seems that not much has changed. Housing values haven’t rebounded yet, and the markets are still jittery.

Instead of linking to a top story about home values dropping again, we found a nice piece at Marketwatch reminding us of some old expressions that are very applicable to the realtors, home buyers, sellers, and lenders who sparked this mess that we’re in.

What goes up must come down. One reason people did this is that home prices were rising faster than personal incomes for a number of years, but that could not go on forever, as we know now.

We know now, and we could have known this back when the mania was at its prime. Most people involved chose to ignore reality and decided to speculate instead. We’re going to guess that there’s a handful of people who knew this and were able to cash out while they could, but there are millions of handfuls of people who are left holding the bag right now.

You can’t make a silk purse from a sow’s ear (or kiss a frog and turn it into a prince). These securities were based on loans of questionable quality that, when bundled together, somehow were blessed with AAA ratings by the debt-rating agencies.

There is no such thing as a free lunch. It boggles the mind how many money managers, investors and just about everyone else thought these securities could be rated almost as high as supersafe U.S. Treasurys — without any added risk. No wonder people from all corners of the planet, from sophisticated hedge funds and banks to the proverbial man or woman on the street, put chunks of money into these mortgage-backed issues.

We’ll be listening for any news on investigations into the ratings agencies as this mess unfolds. It’s difficult to predict what will happen because there are so many things going on behind the scenes that average Joe Investor doesn’t know, but we’re not in the game of making predictions here. We’d rather drink our Kool-Aid and believe that everything is OK!

Stay tuned, for later this week we’ll be covering holiday retail sales and consumer spending. We’re sure to see some interesting statistics in the coming days!

Financial Market, Investing, Economy, Stock Market, Real Estate | No Comments »

The United States may or may not be on the brink of a recession, but one thing that’s certain is that our economy is starting to slow down. There are several causes, however most of the blame lies with problems with easy credit that were fueled by historically low interest rates.

CNN (and every other media source) is reporting that the Federal Reserve lowered its forecast for economic growth in 2008, with the markets responding by betting on a rate cut in December.

… in a new economic outlook, the central bank also lowered its growth target for the economy in 2008, raising hopes that the Fed will cut rates again when it meets in December.

In its forecast, the Fed cited “tightened terms and reduced availability of sub-prime and jumbo mortgages, weaker-than-expected housing data, and rising oil prices” as the main reason for revising its projections downward.

Let’s try to solve the problem by doing the exact thing that caused it and lower interest rates again! Maybe with lower rates, subprime borrowers who can’t get loans right now will be able to get back into the housing market.

Let’s hope the Federal Reserve has a good understanding of the scale of the problems we’re dealing with. Is it worth saving the economy from recession at the expense of an increasingly devalued dollar and higher inflation? Deflation is also a risk

Eventually the American consumer (and the American economy) has to pay, either now or later. Which will be less painful?

Lower interest rates will devalue the US dollar even more than it already is and will almost certainly lead to more inflation.

Financial Market, Kool-Aid, Stock Market | No Comments »

Shareholders in the securities industry are having the worst year since 2002, however Wall Street is paying a record $38 Billion in bonuses this year.

Goldman’s record earnings and gains at Morgan Stanley and Lehman mean all the New York-based firms will be forced to pay more in a year when all but Goldman lost more than 20 percent of their market value, said Charles Geisst, finance professor at Manhattan College in Riverdale, New York.

The industry’s bonuses are larger than the gross domestic products of Sri Lanka, Lebanon or Bulgaria. The average $201,500 bonus is more than four times the $48,201 median household income in the U.S. last year, according to U.S. Census Bureau statistics.

Is this fair? As long as the boards or the companies’ shareholders don’t complain. Those big bonuses may just be fair compensation for the hard work and long hours that anyone involved in the financial industry puts in.

The size of the payouts is a concern given how badly the shares of most securities firms have performed this year, said Fitzpatrick of Johnson Asset Management.

“They’re paid very handsomely in good times because they’re supposed to take a hit in bad times,” Fitzpatrick said. “Performance has dwindled this year, and I think they should feel that.”

Financial Market, Kool-Aid, Stock Market | 1 Comment »

Earlier this week, CNN reported how Wall Street took a beating from the subprime crisis and credit crunch, and gave some good insight as to what caused the problems. It’s a few days old and it’s a lengthy article, but it’s very informative and explains how some major banks shifted their own investment strategy during the golden era of CDOs and mortgage backed securities during the past decade.

“The fee engine becomes so huge that these products take on a life of their own,” says Tiger Williams, CEO of Williams Trading, a leading financial services firm for hedge funds. “Everyone rationalizes that it’s safe because they’re making so much money. But it’s far from safe.”

The ‘fee engine’ helped drive the real estate market to it’s peak. Mortgage brokers, realtors, banks, and nearly everyone involved was paid a commission for their service. Their only incentive was to close a sale to collect their commission. Thanks to the increase in innovative financial products such as CDOs over the past decade, mortgages could be sold off and the agents/brokers involved in originating them were no longer liable.

Here’s how a typical CDO backed by subprime mortgages might work. The game starts when a client - known as the collateral manager - approaches Merrill Lynch and asks it to provide financing for a CDO that will hold, for example, $1 billion worth of bonds backed by subprime mortgages. The clients are mostly big money-management firms like Pimco, Trust Co. of the West, and Cohen & Co.

To get things rolling, Merrill makes $1 billion available to the collateral manager, taking a fee of 1.5% to 2%, or $15 million to $20 million. The collateral manager uses the balance to purchase bonds backed by pools of subprime mortgages (known as “subprime mortgage ABS,” for asset-backed securities) issued by Wall Street firms, including Merrill.

…

That seems fairly straightforward, though yet again we have a service fee involved. The big financial firms stood to benefit greatly from creating CDOs.

How are CDOs able to offer premium yields on their bonds? Most of them did it by purchasing the riskiest, lowest-rated mortgage-backed bonds - you know, the ones built on loans to borrowers with spotty credit and dubious résumés. Such bonds paid what were then super-high rates of 9% to 11% in 2006.

Didn’t those loans carry a high risk of default? Well, yes, they did. But here’s the key point, and where Wall Street went astray. During the early years of the housing boom, default rates on all mortgages were unusually low. That led bankers - and more important, rating agencies - to build unrealistic assumptions about future default rates into their valuation models.

The markets are working, and now that Wall Street is understanding the reality of these products there are many writedowns and few new investors. How long until history is forgotten?

The subprime saga is far from over. The markets remain on high alert. Each day seems to bring new rumors or announcements of losses. A golden age for banks and brokers has come to a sudden end.

The moral is clear. When Wall Street appears in genius mode, raking in huge profits on mysterious products and complex trades, the secret isn’t genius at all. It’s that hubris is running wild, and so is risk. And whether it’s tomorrow or five years hence, risk will jump from the shadows, knife in hand, to cut genius down to size.

Financial Market | 1 Comment »