Mankiw Doesn't Rule Out Depression

One of the best economists out there has an interesting take on recession predictions by economists.

Jobless Claims

The number of people who filed first time claims for unemployment benefits was 478,000 which was 15,000 more than the last recording. Economists were expecting 470,000 so it was troubling because people thought labor markets couldn't get any worse than the last recording. This is a major concern right now because economic and corporate forecasts look terrible. Consumer spending is shrinking which will mean lower GDP and companies left and right are readjusting their outlooks for the next fiscal year. The economy needs a functioning labor market in order to provide goods and services but it looks like people will be making less money doing it. Right now unemployment is around 6% nationally (varying across regions), but it will almost certainly go higher. During tough times unemployment always goes down but once wages are corrected you see a turnaround in the labor market. A rebound in the economy will come once we have a rebound in the labor market, but don't expect that to come anytime soon. People are slashing jobs in all areas of business from health care to Wall Street and they obviously aren't hiring right now either. There are going to be a lot of unemployed people in the next year, but the question remains whether the government will create jobs for them or just pay them unemployment benefits. Right now with the current budget deficit I don't see any major spending programs coming through Congress so people have to be patient.

The more I think about the mess we are in the more I think we are a long way from recovery.

Recession-proof? Think twice before you jump in

It's always an interesting discussion of what is recession-proof and what is not. There is certainly no fine line or dictionary description of one or the other. As we saw in AAPL's stellar earnings yesterday, iphones and expensive computers CAN be recession proof. Or the argument that people gamble when they're feeling depressed about the finances. Really? LVS doesn't think so nor do their shareholders. Below is their chart.

As Paul Kedrosky points out in his blog, there are some segments in the economy that are more recession proof than others. He gives this chart by Nielsen.

From what he suggests, go long pasta and short KO and PEP. I'll go ahead and say that nothing is recession proof. MCD reported today a great quarter but there are still worries about the upcoming quarters and how unemployment will affect their numbers. Are people really questioning the dollar menu? Is that not recession-proof enough? WOW. Times are tough. Be picky. Be nimble.

What is wrong with our financial system: SIV redux.

I'm sure most of you saw this (but in case you missed it!) there is a nice post on Alphaville today about the resurgent use of SIVs. Some banks are beginning to use them in an attempt to provide liquidity to money market funds. The post describes how banks will use Fed-funded SIVs to bail out these funds. The SIVs will raise money by issuing commercial paper. Of this issued paper, the sponsoring banks will be required to hold 10%, with the rest of the funding being provided by the Fed.

Although Alphaville hints at this, they don't quite outright ask it. What happens when the commercial paper turns bad? Well the CP that is of bank origin will presumably end up in some shape or form being rescued by the Fed. What about that of non-banking corporations? Or worse: bank-like corporations (read GMAC)? Essentially the Fed holds the right to stop purchasing activities of these SIVs and hold their assets to maturity if any default or credit downgrades occur.

Effectively, in a deleveraging environment, banks will hold commercial paper for their money market funds off their balance sheets using Fed-provided leverage. Lets hope the banks never have to pay back the loans when (if) corporate defaults rise.

What Buffet is REALLY saying...

Everyone saw the headline: "Warren Buffet says 'Buy now'!"

While most took this as validation by the Oracle that U.S. stocks are now sufficiently cheap, NakedShorts brings up a point not mentioned by many:

"The usual suspects spun the ‘Buy America’ message for all it was worth. Nobody seemed to notice the other side of the memo: sell Treasuries. Which, thanks to the flight-to-safety trade, are perhaps the last bubble intact amidst the financial smeltage. With new supply aplenty assured."

Don't buy U.S. stocks. Sell U.S. Treasuries.

Libor rates are finally starting to come down

"Three month libor has plummeted 36 basis points to 4.02 percent this morning. My money market correspondent thinks that by the time the week is over three month Libor will have posted declines of about 100 basis points."

via acrossthecurve & Economompicdata

Andrew Lahde's Letter

Andrew Lahde, a graduate from Michigan State, wrote this letter to the investors of his fund, Lahde Capital. He returned 866% betting on subprime. Although his letter has been posted in every financial blog out there, this is a must read!

Dear Investor:

Today I write not to gloat. Given the pain that nearly everyone is experiencing, that would be entirely inappropriate. Nor am I writing to make further predictions, as most of my forecasts in previous letters have unfolded or are in the process of unfolding. Instead, I am writing to say goodbye.

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.” I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

There are far too many people for me to sincerely thank for my success. However, I do not want to sound like a Hollywood actor accepting an award. The money was reward enough. Furthermore, the endless list those deserving thanks know who they are.

I will no longer manage money for other people or institutions. I have enough of my own wealth to manage. Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices. What is the point? They will all be forgotten in fifty years anyway. Steve Balmer, Steven Cohen, and Larry Ellison will all be forgotten. I do not understand the legacy thing. Nearly everyone will be forgotten. Give up on leaving your mark. Throw the Blackberry away and enjoy life.

So this is it. With all due respect, I am dropping out. Please do not expect any type of reply to emails or voicemails within normal time frames or at all. Andy Springer and his company will be handling the dissolution of the fund. And don’t worry about my employees, they were always employed by Mr. Springer’s company and only one (who has been well-rewarded) will lose his job.

I have no interest in any deals in which anyone would like me to participate. I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years. I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle. I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life — where I had to compete for spaces in universities and graduate schools, jobs and assets under management — with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.

On the issue of the U.S. Government, I would like to make a modest proposal. First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunct institutions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it. Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government. Capitalism worked for two hundred years, but times change, and systems become corrupt. George Soros, a man of staggering wealth, has stated that he would like to be remembered as a philosopher. My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles. This forum could be similar to the one used to create the operating system, Linux, which competes with Microsoft’s near monopoly. I believe there is an answer, but for now the system is clearly broken.

Lastly, while I still have an audience, I would like to bring attention to an alternative food and energy source. You won’t see it included in BP’s, “Feel good. We are working on sustainable solutions,” television commercials, nor is it mentioned in ADM’s similar commercials. But hemp has been used for at least 5,000 years for cloth and food, as well as just about everything that is produced from petroleum products. Hemp is not marijuana and vice versa. Hemp is the male plant and it grows like a weed, hence the slang term. The original American flag was made of hemp fiber and our Constitution was printed on paper made of hemp. It was used as recently as World War II by the U.S. Government, and then promptly made illegal after the war was won. At a time when rhetoric is flying about becoming more self-sufficient in terms of energy, why is it illegal to grow this plant in this country? Ah, the female. The evil female plant — marijuana. It gets you high, it makes you laugh, it does not produce a hangover. Unlike alcohol, it does not result in bar fights or wife beating. So, why is this innocuous plant illegal? Is it a gateway drug? No, that would be alcohol, which is so heavily advertised in this country. My only conclusion as to why it is illegal, is that Corporate America, which owns Congress, would rather sell you Paxil, Zoloft, Xanax and other additive drugs, than allow you to grow a plant in your home without some of the profits going into their coffers. This policy is ludicrous. It has surely contributed to our dependency on foreign energy sources. Our policies have other countries literally laughing at our stupidity, most notably Canada, as well as several European nations (both Eastern and Western). You would not know this by paying attention to U.S. media sources though, as they tend not to elaborate on who is laughing at the United States this week. Please people, let’s stop the rhetoric and start thinking about how we can truly become self-sufficient.

With that I say good-bye and good luck.

All the best,

Andrew Lahde”

W.E.B.

"Be fearful when others are greedy, and be greedy when others are fearful"

New York Times Op-Ed -- October 16, 2008

Good Blog

Check out this blog! The author, David Gaffen, posts frequently throughout the day. Today he has live blogging on the Citi conference call, option activity in Google ahead of earnings, and much more.

Paul Krugman Wins Nobel Prize in Economics

An excerpt explaining his contributions to economics:

In the late 1970s, Mr. Krugman noticed that the accepted model economists used to explain patterns of international trade did not fit the data. The Hecksher-Ohlin model predicted that trade would be based on such factors as the ratio of capital to labor, with "capital-rich" countries exporting capital-intensive goods and importing labor-intensive goods from "labor-rich" countries. Mr. Krugman noticed that most international trade takes place between countries with roughly the same ratio of capital to labor. The auto industry in capital-intensive Sweden, for example, exports cars to capital-intensive America, while Swedish consumers also import cars from America.
Mr. Krugman's explanation is based on economies of scale. Both Volvo and General Motors reduce average costs by producing a large output in particular niches of the market. In presenting his trade model, Mr. Krugman planted the seeds for his later work in economic geography, in which he tried to explain the location of economic activity.
He summarized his basic finding (in "Geography and Trade," 1992) as follows: "Because of economies of scale, producers have an incentive to concentrate production of each good or service in a limited number of locations. Because of the cost of transacting across distance, the preferred locations for each individual producer are those where demand is large or supply of inputs is particularly convenient -- which in general are the locations chosen by other producers. Thus [geographical] concentrations of industry, once established, tend to be self-sustaining."

The Credit Crunch in one picture.

The Next Subprime

Reinsurance.

What is it?

When an insurance companies reinsures its liabilities, the initial insurer transfers the risk of the insurance to another company referred to as the reinsurer. The reinsurer rather than the insurance company that originally provided the policy then provides the financial guarantee on the insurance policy. (Via Capital Markets: Institutions and Instruments by Fabozzi and Modigliani)

Think about it:
If I am an insurance broker getting paid to originate policies and then sell them to someone else, what incentive do I have to perform extensive due diligence? How much does that end-party (the reinsurer) really know about the policy they hold?

Subprime Connection:
Just as in mortgage origination, the end-holder of the liability has little knowledge of the person underlying the asset they hold. Also, the originator of the liability looks to churn out as many policies as possible, regardless of the underlying risk.

Differences:
For one, there are a wide variety of reinsurance types, many of them including strategies that do not purchase the entire liability from the policy writer, but only the risk above and beyond a pre-determined value. Also, reinsurers take on a wide
variety of liabilities, rather than JUST home loans.

Kobe Bryant and the Financial Markets

The financial markets have been a mess lately and really hard to explain. One of the traders on Fast Money yesterday used the Kobe Bryant scandal as a great metaphor to help explain the problems we have currently with the bailout plan.

So Wall Street has been messing around with the securitization of mortgages leading to the recent credit turmoil. It's no secret that they have played a large role in bringing about the crisis we are currently in. We, the American public, know that Wall Street cheated on us because economic conditions are eating away at our standard of living. There has to be some way to make things better. Just like Kobe bought his wife a big diamond ring, the government has provided us with the bailout package to correct this mess. But the problem is we still know they cheated on us and maybe this bailout package isn't enough. We need more oversight and regulation to make sure this doesn't happen again. Obviously we can't divorce the government but people at the top need to take some blame and responsibility for their poor decisions.

I tried to find the clip on the Fast Money website but couldn't find it. If anyone has any better luck just update the post!

Armageddon? Not quite.

If you were just looking the financial media headlines you would think that were in Armageddon (the sequel of course). The markets have been brutal but wow can the media sensationalize everything (yellow journalism anyone?). Dealbreaker just introduced the world to an amazing website about sad guys on trading floors. Hilarious. Here's a few of them.

On a side note. All the publications (Time, BusinessWeek) are starting to come out with their "gloom and doom" covers. Sign of a bottom? Barry Ritholtz at The Big Picture has an opinion on the situation.

Business and economics must read sites

Here is a list of business and economics websites, by average daily visits, at Gongol.com If you want a list of blogs to add to your "daily must" this is a great start.

Via: mjperry.blogpsot.com

Global Rate Cut

The Fed has cut interest rates by a half percentage point to 1.5% in hopes to spur economic activity by injecting money into the economy. Central banks around the world have followed suit lowering their rates by 50 basis points as well. The financial crisis has spread worldwide infecting countries from Australia, Canada, Germany, and the list goes on. Over the summer there was talk of decoupling, which states that the U.S. doesn't have as big of impact on other financial markets as it used. This goes back to the idea that when the U.S. economy "sneezes" the whole world gets a cold. The U.S. doesn't have a cold; it is in cardiac arrest. Action needs to be taken immediately to put trust and faith into the credit markets. This is a step in the right direction and so is the bailout plan but we need to start creating markets for stressed assets immediately.

The good news is that we are not in the mess alone. Other countries have been hit hard and are experiencing similar economic activity as the United States. In order to get out of the mess it will take a collaborative effort, however the U.S. must take the lead role. We are running out of "bullets" but we also must remember that the measures taken by the Fed don't immediately serve their purpose because policy works with a lag.

Warren Buffett: The Next J.P. Morgan?

Great article from the NY Times comparing Warren Buffett's recent impact on the markets to J.P. Morgan during the panic of 1907. It's hard to believe that one person could have such a positive impact on the markets, but Warren Buffett's opinions carry a lot of weight.

Why Short Selling Makes the Market Go Higher

In an effort to support the markets, the SEC banned short-selling. Clearly, however, their efforts failed. MISERABLY.

Now, I WILL admit that without this rule, most financial stocks (regional banks, insurers, hedge funds, mortgage REITs) would be lower. The market as a whole, however, needs short selling. Furthermore, a rebound in stocks IS NOT POSSIBLE while this rule is in place.

Why?

Beyond the "let efficient markets determine the proper price" theory, a number of more technical explanations exist:

First, investors such as myself who maintain large short positions in the market refuse to take long positions without the ability to accurately hedge our risk. With the implementation of the short-sale ban, the Government is preventing those who purchase assets from protecting them. Would you ever buy a house without insurance? What if the Government said you're not ALLOWED to buy insurance? YOU WOULDN'T BUY THE HOUSE. The bottom line is that without the ability to mitigate the risk of their holdings, investors are discouraged from taking long positions (thus preventing the flow of capital into equity markets).

The second theory relates to the pricing of assets and investors perception of valuation. Without short selling, investors realize that asset prices are being kept artificially high, so why would anyone go long when they know the ban will expire and force stocks down?

My solution?

The SEC should apply the filing rules to both long and short positions. Investors holding more than 5% of a company's shares short should have to disclose their position. Also, stop with the temporary banning stuff...you're just delaying the inevitable.